NetApp Inc (NTAP) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the NetApp fourth-quarter and FY16 results conference call.

(Operator Instructions)

I would now like to hand the conference over to Kris Newton, Vice President, Investor Relations.

Please go ahead.

Hello and thank you for joining us on our Q4 FY16 earnings call.

With me today are our CEO, George Kurian, and CFO, Ron Pasek.

This call is being webcast live and will be available for replay on our website at netapp.com along with the earnings release, our financial tables and guidance, a historical supplemental data table, and 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 first quarter and FY17; our expectations regarding future revenue growth; improved profitability, including run rate savings, cash flow, effective tax rate and shareholder returns; our expectations about our ability to drive operational and financial performance; and about the impact of the SolidFire acquisition and business, 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, including the macroeconomic environment; overall growth rates for IT; our ability to successfully pivot to the growth areas of the market and enable customer migrations to our strategic solutions; our ability to expand our operating margin; our ability to reduce our cost structure, streamline the business, and improve efficiency within the planned time frame; and our ability to continue our capital allocation strategy and invest in strategic opportunities.

Please refer to the documents we file from time to time with the SEC, specifically our most recent Forms 10-Q, our Form 10-K for FY15, 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 indicated.

I'll now turn the call over to George.

Thanks, Kris, and good afternoon, everyone.

In Q4, we continued our disciplined execution.

Revenue and EPS were within our guidance ranges, despite significant and ongoing changes to both the industry and NetApp.

Like others, we continued to experience constrained enterprise IT spending, as customers act with caution due to an uncertain macroeconomic environment and shift some of their workloads to the cloud.

As we discussed last quarter, we're making fundamental changes to return the Company to revenue growth with improved profitability, cash flow, and shareholder returns.

To deliver on this commitment, we are executing a comprehensive and sustained transformation.

Let me remind you of the key priorities associated with this plan.

First, we are focused on our data fabric strategy and the strategic solutions that form the foundation of how we enable customer success in the data powered digital era.

To provide context for our confidence in the future, we are providing greater transparency into the progress of these solutions.

Second, we are substantially reducing cost and systematically streamlining our operations, while maintaining our ability to deliver innovation and lead the market.

And third, we have a robust capital allocation program which includes a combination of share repurchases, dividends, and investment for the long-term growth of the business.

I'll start with an update on the first priority, our emphasis on strategic solutions.

We are facilitating our customers' success as they navigate through their own IT transformations, which leverage modern architectures and hybrid cloud environments.

Our strategic solutions cluster data ONTAP, branded E-Series, all flash arrays including SolidFire, hybrid cloud solutions and OnCommand Insight enable these transformations and are the basis of our pivot to the growth segments of the market.

In Q4, strategic solutions increased to 61% of net product revenue.

For the full year, strategic solutions were 53% of net product revenue and grew 21% from FY15.

The alignment of our strategic solutions with our customers' IT imperatives underpins our confidence that these solutions will expand our leadership in the fastest growing segments of the market.

As expected, net product revenue from our mature solutions, OEM, ONTAP 7-Mode and add-on, for both Q4 and the full year, declined at roughly 40% year-over-year, driven by declines in ONTAP 7-Mode.

As mature solutions become a smaller contributor to product revenue, the headwinds they generate will lessen.

This will allow the growth of our strategic solutions to drive a reacceleration of the business and return the Company to moderated revenue growth in FY18.

As a part of their IT transformation efforts, customers want scale-out and software defined storage functionality for the efficient management of data growth and to achieve the agility and flexibility needed for success in the data powered digital era.

Uniquely in the storage industry, clustered ONTAP enables seamless enterprise data management across flash, disk, public and private cloud footprints for enterprise applications.

With clustered ONTAP, IT organizations can consolidate multiple workloads into a single repository, dramatically improving the efficiency of their storage environments when compared to the siloed legacy SAN architectures that we are displacing.

Clustered ONTAP was deployed on 85% of FAS systems shipped in Q4, up from 50% a year ago.

Customer demand for clustered ONTAP accelerated from Q3, with system shipments growing roughly 80% year-over-year.

Our install base of clustered ONTAP and 7-Mode systems continues to grow in total and clustered ONTAP is now running on 26% of that growing install base.

In addition, we increased the number of clustered ONTAP customers by almost 90% in FY16 from the prior year.

We're pleased with the success of the clustered ONTAP transition program we put in place at the start of the year.

In FY16, it accelerated migrations at approximately 1,300 install base customers who were ready to upgrade both their systems and their software.

The install base mix will continue to shift to clustered ONTAP.

However, as we've said before, we anticipate that this transition will happen over the course of years as these migrations are projects that must fit within our customers' overall IT priorities and budgets.

In the coming weeks, you'll hear about breakthrough innovations, as we introduce the next generation of ONTAP, which combines new levels of simplicity with unparalleled storage efficiencies and enterprise data management capabilities.

It will simplify customers' IT transformations to modern data centers and hybrid cloud environments.

And customers can choose the architecture of their choice, engineered systems, software defined storage, or cloud, all with industry-leading efficiency, performance, and density for flash environments, rapid and simplified deployment and greater data protection and security.

In FY16, we accelerated the adoption of clustered ONTAP and moved into a leadership position in the flash market and we expect to break away from the pack with the next generation of ONTAP.

As customers build private clouds, or move to hybrid cloud environments, they need to monitor and manage their storage as an end-to-end service across heterogeneous public and private clouds.

OnCommand Insight addresses this requirement and enables customers to simplify their operations and substantially lower costs.

Together, clustered ONTAP and OnCommand Insight give customers the ability to bring tremendous efficiency to their IT environments.

One of the largest children's hospitals in the US chose all flash FAS running clustered ONTAP to replace legacy high-end frame arrays from our leading competitor and will also utilize OnCommand Insight to manage their entire heterogeneous storage infrastructure across multiple data centers.

Flash plays a key role in customers' IT transformation efforts, as they seek to gain advantage through greater speed, responsiveness and value from key business applications, while substantially lowering total cost of ownership.

The continually improving performance and economics of flash is enabling modern modular storage systems with scale-out software to replace legacy frame array SAN architectures.

Flash is becoming the de facto technology for primary workloads as customers look to realize performance and economic benefits by replacing hard disk installations with flash.

As they make this transition, customers cannot forego enterprise data management and data protection capabilities.

With a highly differentiated and complete portfolio of all flash array offerings, NetApp is without question far better positioned to enable customers to accomplish this transition than any other vendor.

We won a multi-million dollar deal over emerging all-flash competitors at a US-based customer in the transportation industry, with all-flash FAS and EF for its production database, VDI, and disaster recovery environments.

They chose NetApp due to the reliability and rich feature set of our product portfolio.

Reflecting this strength, our all-flash array business inclusive of all-flash FAS, EF and SolidFire product and services, grew 35% from Q3 to an annualized net revenue run rate of over $700 million.

The majority of this growth was driven by high demand for the all-flash FAS.

In addition to providing a complete set of enterprise data management and protection capabilities, we enable customers to preserve and leverage existing investments while taking advantage of new technologies and rapidly improving cost curves, by supporting mixed capacity SSDs within a single system.

Something that most of our competitors cannot do.

Soon, we will become the first vendor to give customers the ability to take advantage of 16 terabyte solid state drives.

Our support for mixed capacities will create even greater customer value, with the introduction of these high capacity SSDs.

By allowing further workload and system consolidation, dramatically reducing data center space requirements.

I'm pleased to report that the integration of SolidFire is going well and progressing as planned.

The NetApp sales team is selling SolidFire as part of the portfolio and introducing it into new accounts.

We're winning against and replacing footprints of both established and emerging vendors in customers building next generation data centers.

Execution of the product road map is on track and we'll have exciting SolidFire innovations to announce in early June.

NetApp has an extraordinary opportunity to help customers as they move to modern architectures and hybrid cloud solutions.

Our data fabric strategy enables data management that seamlessly connects disparate clouds and data centers.

We enable our customers to manage, secure, and protect their data across flash, disk, and public and private cloud resources, all at the scale needed to accommodate the exponential data growth of the digital world.

A leading telecommunications and service provider in the Asia-Pacific region has embraced our hybrid cloud strategy, leveraging clustered ONTAP, our flash technologies, and data fabric capabilities to evolve its cloud offerings.

They are deploying a solution that leverages the public cloud while retaining data sovereignty.

It will give their customers choice, control, and confidence and improve business agility, by enabling the movement of data in and out of multiple clouds from an on-premises private cloud into a public cloud and perhaps back again, all seamlessly.

This service provider is so confident in the solutions themselves that they are moving their primary workloads to it, in order to solve their own data management challenges.

Ron will go into depth about cost savings and capital allocation.

But I want to underscore our commitments to both of these priorities.

We've launched a comprehensive program to reduce the cost base of our business, even while investing in strategic opportunities such as SolidFire.

In Q4, we took the first significant step in achieving these savings and I want to thank the NetApp team for remaining focused on execution while making difficult restructuring decisions.

We are also fully committed to executing our capital allocation programs and creating value for shareholders.

In conclusion, I want to spend a little time reflecting on the strides we've made this year.

When I took over as CEO, NetApp was dealing with several internal challenges.

We were late to the all-flash array market, we were not prepared to assist our installed base of customers in migrating to clustered ONTAP and we had limited traction in the hybrid cloud.

Over the course of the year, we've made substantial progress.

We have moved into a leadership position in the flash market with a broad portfolio that addresses multiple workload requirements and deployment styles.

We regained ground with our channel partners by successfully enabling them to migrate the install base to clustered ONTAP.

Our data fabric strategy has proven effective in positioning us to win leading edge cloud deployments.

Additionally, we've added key new leaders with fresh insight and deep experience to the Management Team and the Board of Directors and took the first step to permanently lowering our cost base.

Heading into FY17, our momentum with customers is accelerating.

Data is at the heart of our customers' IT transformation efforts and this is where NetApp has a profoundly important role to play.

Our strategic relevance to customers' digital transformation road maps is evidenced by the growth of our strategic solutions.

We are making meaningful progress but still have work ahead of us and remain focused on execution.

I remain highly confident in NetApp's potential.

The leadership team is sharply focused on our business model and committed to returning the Company to long-term growth and our target operating margin.

The fundamental transformation we're undertaking to streamline the business and reduce the cost base will position us for future success by allowing investment in strategic opportunities while accelerating our ability to deliver shareholder value in the form of improved profitability and cash flow.

I'll now turn the call over to Ron to take you through the numbers.

I'm sure many of you already know him.

In our search for a CFO, I looked for someone who was forward-looking, operationally astute, collaborative and an effective leader with high standards of ethics and integrity.

We found that in Ron and I'm very excited that he's on board as part of this leadership team.

Welcome, Ron.

Thank you, George, and good afternoon to everyone on the call.

I'm looking forward to meeting with many of you in the coming months.

Before I get started, I'd like to thank the Board and George for the confidence they have placed in me and the NetApp team for the warm welcome I've received.

I'm excited to be joining the team at this time for a number of reasons.

As a long-time NetApp customer, I know firsthand the innovative products and passionate employees that are core to NetApp's strong foundation.

In the short time I've been with NetApp, I continue to be very impressed with the commitment of employees, the dedication and quality of the Management Team, and the relentless focus on customer success.

I look forward to building on NetApp's strong foundation and leveraging my experience to help execute our transformation efforts to drive long-term growth and streamline the business.

Now, before providing detail on our FY16 performance and forward-looking guidance, I'd like to first discuss our results for Q4.

As a reminder, unless otherwise noted, I will be referring to non-GAAP metrics today.

Q4 net revenues of $1.38 billion were relatively flat on a sequential basis and down 10% year-over-year.

Product revenue was up about 1% sequentially and declined 17% year-over-year.

While branded product revenue was in line with our expectations, discounting and promotions remained high and we had 6 points of impact sequentially and 4 points of impact year-over-year from weaker than expected OEM business.

As George discussed, revenue from strategic solutions continued to grow, but are not yet sufficient to offset the headwinds from mature areas of our business.

As expected, revenue declines in our mature solutions continue to put pressure on overall product revenue.

The combination of software maintenance and hardware maintenance in other services revenue was down 2% sequentially and relatively flat year-over-year.

Our gross margin was 61.1%.

Product gross margin of 46.8% was down about 7 points year-over-year.

The decline in ASPs outpaced the decline in average unit cost, largely due to discounting and product promotions.

Software maintenance gross margin was essentially flat year-over-year, while hardware maintenance in other services gross margin was up approximately 5 points, largely reflecting the continued services infrastructure cost efficiencies and ongoing improvements in product quality.

Operating margin of 13.4% decreased 4 points sequentially and 2 points year-over-year, driven by lower revenue, lower product margin, and the acquisition of SolidFire, partially offset by the lower cost of hardware maintenance revenue and OpEx.

As outlined last quarter, we're driving to achieve a gross run rate savings of $400 million across both cost of revenue and OpEx by the end of FY17.

We will reinvest some of these savings into strategic opportunities such as SolidFire and other initiatives, yielding a net run rate savings of roughly $130 million by the end of FY17.

In Q4 we took significant steps forward by reducing our headcount by approximately 11% sequentially.

This action resulted in a GAAP restructuring charge of approximately $80 million and a gross savings of approximately $32 million in Q4.

To be clear, aligning our cost structure with the opportunity ahead of us is my top priority, given it's completely within our control.

We're driving additional changes that include implementing tighter cost controls over indirect spending, improving supply chain efficiency, portfolio streamlining, operational process redesign, and organizational restructuring and realignment.

We will report back quarterly with more specifics as we realize these savings.

Our effective tax rate was 13.1% for the quarter, lower than our previous guidance, reflecting the impact of our geographic sales mix.

EPS was within our guidance range of $0.55 per share.

Weighted average diluted shares outstanding were approximately 287 million.

Moving onto cash and balance sheet metrics for Q4.

We generated $345 million in cash flow from operations during the quarter, down 13% year-over-year.

Free cash flow of $310 million was about 22% of net revenues, down 1% sequentially and 14% year-over-year.

Deferred revenue and financed unearned services revenue of $259 million was up 8% versus Q3 and 6% versus last year.

Inventory turns increased to 22 turns and DSO was 54 days, reflecting a back-end loaded quarter.

Finally, we repurchased approximately $262 million of stock and paid $51 million in cash dividends in the fourth quarter.

Now turning to FY16 results.

Net revenues for the full year of $5.55 billion were down about 9% from FY15.

Gross margin of 62.5% was down about 1.5 points from FY15, reflecting discounting and product promotions we ran throughout most of FY16.

Operating margin of 13.5% was down 3.5 points versus FY15.

Our effective tax rate for the year was 15.4%.

EPS for the year was $2.13, down about 21% from FY15.

We ended the year with approximately $5.3 billion in cash and short-term investments, with approximately 10% held by our domestic entities.

Over the course of the year, we generated $814 million in free cash flow.

We continue to deliver on our capital allocation strategy.

Over the course of FY16, we returned over 140% of free cash flow to shareholders through a combination of dividends and share repurchases.

Finally, we completed the first $1 billion of the $2.5 billion repurchase program we announced in February 2015, ahead of our original schedule.

Through dividends and share repurchases, we have returned approximately $4.6 billion to shareholders since May 2013.

This represents over 150% of free cash flow generated during that time frame.

We remain on track to complete the remaining $1.5 billion of the share repurchase program by the end of May 2018.

Today, we also announced an increase in our next cash dividend of $0.19 per share, which will be paid on July 27, 2016.

Now to guidance.

We are confident in our competitive positioning and long-term growth potential.

However, we expect FY17 to be a year of transition, while we transform the Company in order to streamline the business, improve efficiency and rapidly address the changing market.

Consistent with what was said last quarter, we expect that the growth of our strategic solutions will offset the declines in our mature solutions and ultimately drive moderated revenue growth as we emerge from FY17.

For FY17, we are forecasting gross margin of 61% to 63%.

We expect operating margin of 15% to 17%, including about 2 points of dilution from SolidFire.

We expect our effective tax rate for the year to be approximately 16.5% and we expect to generate significant free cash flow, enabling us to invest in the business as well as to continue to again return significant capital to our shareholders.

Finally, we remain committed to delivering meaningful EPS growth including dilution from SolidFire through leverage in our business model.

Turning to our outlook for the first quarter of FY17.

We are targeting a net revenue range of $1.2 billion to $1.35 billion.

At the midpoint, this implies a year-over-year decline of 4.5%, which reflects a reduction in declines as strategic overtakes mature.

As a reminder, year-over-year compares are against the 14-week quarter we had in Q1 of FY16, which benefited software maintenance and hardware maintenance and other services revenues.

We expect gross margin of 62% to 63%, reflecting the impact of continued product promotions, partially offset by cost savings initiatives.

We are targeting operating margin of approximately 10% and an EPS range of $0.34 to $0.39.

In closing, I'm excited to be here and want to emphasize that everyone at NetApp is focused and committed to permanently transforming the business by pivoting toward the growth areas of the market and reducing costs, while also delivering near-term results.

While our transformation is far from complete, we have made significant progress and are confident about our future.

With that, I'd like to hand it back to Kris to open the call for Q&A.

Kris?

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 Jim Suva from Citi.

Yes, hello, this is Justin on for Jim Suva.

I just had a quick question in terms of your overall linearity in the quarter.

If you could just talk about, a little bit about the demand, was it deteriorating, stabilizing or improving and how is the demand looking now in May?

Is it shaping up in the same sort of format, is it deteriorating or stabilizing?

Thank you.

First of all, the demand for enterprise IT is shaped by the global macroeconomic environment and we did see the effects of an uncertain macro in certain parts of the world.

At the same time, when you compare Q4 with Q3, where the last month of our Q3 was in January, we saw a generally improving environment in Q4.

We in our business, saw accelerating momentum through the end of the quarter and so we feel pleased with the progress we've made through the quarter and as we finished.

Thanks.

Just a reminder, we were back-end loaded in Q4, reflecting that demand.

Thanks.

Next question.

Our next question comes from the line of Amit Daryanani from RBC Capital Markets.

Hello, guys.

This is [Irving Luth] calling on behalf of Amit.

I just had a question about your product gross margins.

They fell below 10% for the first time in quite a while.

Can you just talk about the discounting and promotional activity?

Is it geared more towards some mature revenues or strategic revenues?

We ran a up couple promos for strategic products, mainly flash and C-dot.

Those ran most of the year.

We also had some significant discounting across the board, which is just what you see in the market today.

The promotions are essentially to help our customers offset the cost of the need to migrate to clustered ONTAP.

We've seen good results from the promotions.

We've also seen progress with our all-flash array momentum, as we've outlined on the call.

We tend to continue those promotions but we're offsetting the impact of those promotions with cost take-out activities on both the cost of revenue as well as the cost of service infrastructure.

Thanks.

We'll take the next question.

Thank you.

Our next question comes from the line of Lou Miscioscia of CLSA.

Sure.

Can you talk about the industry headwinds that you're running into?

You mentioned in your opening comments that you're actually seeing more business shift to the clouds.

I assume that when it goes there, you end up not having the majority of the storage sales from that, especially if it's obviously going to AWS.

And maybe combine that with service-side flash and software defined storage.

Our checks suggest that there is improvement in that area and now you can use software defined storage to pull together all the storage in servers, where before there were islands.

So is that also going to be a big competitive threat going forward?

Thank you.

First of all, we said in the prepared remarks that the majority of the uncertainty in the spending environment is due to the macro, not from a secular shift to the cloud.

We did not see any sort of substantial trend between Q3 and Q4 in terms of the cloud.

In terms of our positioning for the cloud, we have substantially improved our own positioning over the course of the year, force being serving customers with workloads on the cloud.

And let me articulate that in three ways.

First, as a supplier of technology to cloud providers, both people in enterprises building their own clouds as well as service providers building clouds, we have seen strong progress with both our clustered ONTAP offering as well as SolidFire that allows us to build both traditional cloud environments as well as next generation clouds.

We are also the leader from an enterprise storage and data management technology Company without question in the open stack cloud deployments where we have seen strong year-on-year growth.

In terms of the hyper scalers, our solutions that combine hyper scaler cloud computing environments with our technology like NetApp private storage and our data fabric solutions have seen good growth through the course of the year.

It's early, but as we noted, we are winning our share of leading-edge hybrid cloud deployments and are the only enterprise vendor who has the capability to combine a hyper scaler cloud with enterprise data management.

Finally, as you note through the course of the year, there are several examples of customers that started out on public clouds and decided to either migrate data and storage footprints to on-premises environments and we are uniquely positioned to capture those workloads as they transition either on-prem to the cloud or from the public cloud back on prem.

Thanks, Lou.

Next question.

Thank you.

Our next question comes from the line of Steven Fox from Cross Research.

Thanks.

Good afternoon.

On the cost reductions, it sounds like you guys got off to a good start with the plan to exit this fiscal year at $400 million.

Can you just help us on the slope of the cost or the shape of the cost reductions for this fiscal year?

Whether we should see a more front-end loaded and if there's much difference in that shape between gross and net.

And within that gross and net, if there's any discounting that's being factored into the difference.

Thank you.

You'll see the cost reductions both in COGS and OpEx throughout the year.

They will tend to be a little more back-end loaded.

But they'll be throughout the year.

You should see us realigning our go-to-market to the opportunity we see in the marketplace.

We're going to be simplifying product offerings, which will benefit the entire Company.

You'll see us aggregating back office functions to a shared services model and we will be doing business process redesign, organization realignment and further streamlining of our portfolio.

So some of those things will take a little bit of time.

We talked about them last quarter.

They've been ongoing.

You'll see the benefit some extent throughout the first quarter and into the second quarter and throughout the year.

We're taking it systematically so that we can permanently and systematically reduce the cost base of the Company.

What we're really trying to do is not do a short-term action that precludes us from fundamentally reengineering that business process so that it can be permanently reduced to a lower cost basis.

So as Ron said, we're being thoughtful and deliberate, but you'll see us make progress on the $400 million that we committed to.

We've also already demonstrated progress this past quarter and we're taking it on systematically and rigorously.

Thanks, Steve.

Next question.

Thank you.

Our next question comes from the line of Simona Jankowski from Goldman Sachs.

Yes, hello.

I wanted to ask you first if you can up quantify how much SolidFire might have contributed to the quarter and what you're expecting for the current quarter.

And then in terms of the competitive environment, we saw significant announcements from a bunch of your competitors including EMC, Pure and Nimble during the quarter.

So just wanted to see what your thoughts are on the competitive environment in response.

SolidFire was immaterial during the course of this quarter.

We felt good about the progress we've made and you'll see us continue to execute our integration plan, focused on the team, the product road map, as well as the go-to-market.

From our internal benchmarks, we are ahead of our plan, so we feel good on the start with SolidFire.

In terms of the all-flash array segment, you'll see us not only demonstrate leadership with the progress we've made this quarter, where we are clearly outpacing both traditional vendors as well as the pure play all-flash array start-ups, without question, representing the maturity of our portfolio and the ability to address the largest part of the flash market opportunity, as customers transition mainstream storage environments from legacy SAN architectures to modern flash based storage systems.

As a simple data point, the attach rate of fiber channel environments in our all-flash configuration is three times higher than in our disc-based configurations, representing without question the fact that we are gaining share at the expense of the legacy fiber channel vendors and stay tuned.

In a few weeks, we'll have exciting announcements, as I mentioned on the call, with both SolidFire and ONTAP 9, announcing major progress and expanded leadership in the fastest growing category in storage.

Thanks, Simona.

Next question.

Thank you.

Our next question comes from the line of Mark Kelleher from D.A. Davidson.

Great.

Thanks for taking the question.

I just wanted to follow up on the operating margin guidance.

I think you said 10% for Q1.

That seems to with be a pretty significant step down sequentially.

You talked about some cuts and some savings that you made and your reduction in force, gross margins are going to kind of hold in there.

Can you just give some detail on where there's some negative leverage going into Q1 in the operating lines?

Thanks.

The only real negative is having SolidFire in there now, that's in the run rate for OpEx.

We do have a little lower revenue in Q1 but we did get significant savings from the reduction we had in Q4.

It benefited the quarter significantly.

About $50 million for a run rate in Q1.

Okay.

Thanks.

Thanks, Mark.

Next question.

Thank you.

Our next question comes from the line of Sherri Scribner from Deutsche Bank.

Hello.

Thanks.

I just wanted to ask, it looks like the strategic solutions growth decelerated from 26% last quarter to somewhere around 15% this quarter.

Just wanted to know what was driving that and thinking about FY17, I think you said that strategic solutions growth should offset the declines in the mature solutions, so does that suggest flat revenue?

Trying to understand how to think about that.

Thanks.

First of all, the growth of strategic solutions accelerated through the quarter.

If you saw the shipments of clustered ONTAP, the unit shipments were up substantially, 80% year-on-year, and if you do the math, 16% growth in aggregate on a sequential basis in strategic revenue.

The all-flash segment as well shows us accelerating our all-flash array shipments and the growth rates continue to be strong off larger footprints.

So in aggregate, we are actually very confident about the strategic solutions.

We saw accelerating momentum with them in Q4 and through the course of the quarter.

And we look forward to, over the course of FY17, having strategic solutions more offset the decline in the mature category.

Thanks, Sheri.

Next question.

Thank you.

And our next question comes from the line of James Kisner from Jefferies.

This is Jason North for James.

Following up on that last question, as you look into Q1, are you expecting mature solutions that declined to lessen year-over-year?

Or conversely, do you think strategic solutions could increase year-over-year to get to the midpoint of your revenue guidance?

Thanks.

The mature solutions are -- we do not expect mature solutions to be substantially different than the path we've had.

It will not increase as a percentage of our business and will continue to be a smaller part of our business on a go-forward basis.

So we expect, through the course of next year, that strategic solutions will maintain their growth trajectory and will be an ever-increasing part of both product revenue and total Company revenue.

Thanks, Jason.

Next question.

Our next question comes from the line of Andrew Nowinski from Piper Jaffray.

Great.

Thank you.

I just wanted to ask a question on the FlexPod.

So Cisco obviously launched their own hyper conversion platform called HyperFlex and Nimble's partnering with Cisco now, so it seems like the revenue opportunity for FlexPod might be getting a little bit smaller.

I guess how do you view the opportunity with Cisco, and then more broadly speaking, how do you view NetApp's position in the broader hyper conversion market relative to leaders like Nutanix and EMC's VNX rail?

Thanks.

Let me address those with -- those are two questions.

I'd asked that we just ask a single question.

But on FlexPod, we just announced several new exciting innovations that we've been working on with Cisco for a while, an all-flash configuration of the FlexPod that allows us to improve the performance and latency of traditional converged systems as well as FlexPod systems by over 20X.

We've announced the FlexPod life cycle automation solution, which is a capability that allows us to provide a highly automated deployment model for FlexPod customers that allows you to shrink the time from receiving equipment to serving data to less than an hour.

This is competitive with the hyper converged solutions that are shipping in the market.

And third, with SolidFire, we get the extreme ease of deployment, the simple scalability and the ability to offer, through the use of solutions like OpenStack, the benefits of hyper converged technology, meaning rapid time to value and ease of deployment and administration, without the compromises that hyper converged solutions offer.

Thanks, Andrew.

Next question.

Thank you.

Our next question comes from the line of Rod Hall from JPMorgan.

Hello, guys.

This is Arki on behalf of Rod.

Thanks for taking my questions and congratulations to Ron.

My question is around services revenue growth.

That has been deteriorating through the course of FY16.

Could you help us think about that going forward?

Would it just continue to deteriorate at a drag to product revenue growth?

So no, we still are increasing our installed base, therefore, are increasing our services revenue.

We saw a large increase as well in deferred revenue this quarter of a little over $200 million.

So I think even though you have mature business declining, it's still adding to the installed base as are our strategic solutions.

As well, what you see is the services business is becoming more profitable.

So I don't know if that answers your question, but I think we don't see that being a drag on the business.

Thanks, Arki.

Next question.

Thank you.

Our next question comes from the line of Brian White from Hamilton.

Hello, George.

I'm wondering if you could give us some color on the growth rate NetApp had with the hyper scale cloud providers in FY16 and some type of range around a percentage of revenue.

Obviously, this is a big theme and it's having an impact on the industry.

So how did you grow in FY16?

Thanks.

We're not going to break out numbers.

They're small numbers, but we had good growth of the solutions that connect to the hyper scale providers.

Essentially, we have NetApp private storage that provides customers with secure data management capabilities and allow you to use the compute clouds of hyper scale providers.

We have AltaVault that provides backup as a service to the cloud providers, where essentially, a customer can use a cloud provider as their repository and use it as an alternate to on-prem backup solutions and we have cloud ONTAP.

All of those had substantial growth, but off small numbers.

We actually measure the impact of those solutions in the way they allow us to beat competitors that are building closed proprietary stacks and we've seen, as I said on the call, we had substantial wins in several parts of the world, where our open data fabric strategy, allowing people to combine public hybrid clouds with on-premises data centers, gives us a strategic advantage over people who are building proprietary clouds.

Thanks, Brian.

Next question.

Thank you.

Our next question comes from the line of Steve Milunovich from UBS.

Thank you.

Hello, it's John Roy for Steve.

So real quick.

On the outlook for flash pricing and the upcoming 16 terabyte SSDs, is that going to help you guys with margins or is that something you think you're going to have to pass through to customers?

How does the pricing environment kind of look going forward?

First of all, we feel good about the progress that these promotions have enabled us to achieve.

We've gained channel, mind share.

We have essentially come from a long way back in the flash market to rapidly outpacing everybody, big and small, in that market into a leadership position.

And we have enabled our installed base of clustered of ONTAP customers to move to our clustered operating system.

We have those promotions in place.

We intend to continue them.

But we do have control for how long we run them, first of all.

The second is, as we introduce the next versions of ONTAP, we will continue to expand our leadership in enterprise data management as well as introduce particular patent pending storage efficiency techniques that allow us to be more cost effective than we have been so far.

And you'll see us take advantage of that by improving the margins over time.

Right now, I think you should assume the margins are neutral.

They're really not any different.

All right.

Thanks, John.

Next question.

Thank you.

Our next question comes from the line of Maynard Um from Wells Fargo.

Yes, it's Manjal on behalf of Maynard.

My question was, if we look at strategic revenue that's 61% in Q4, for the full year, it was 53%.

So it's already more than half of your business.

Then why do we view FY17 still as a transition year?

And should we be looking at the mix of all-flash array as a better gauge to see when your top line turns around?

And then just a clarification.

Do you still expect 2% growth from SolidFire in FY17?

So first of all, with regard to the comment about being a transition year, it's a transition year with regard to product revenue, where the absolute dollar decline of the mature category is still a drag in FY17.

61% is not 100% yet, right?

And so it will be a drag until we transition the mature business to where it's a far less important part of our business.

In terms of SolidFire, the outlook for SolidFire is the same as we communicated last quarter, which is about 2%.

Thanks.

Next question.

Thank you.

Our next question comes from the line of Katy Huberty from Morgan Stanley.

Hello, this is Jerry Lou for Katy.

Can you guys talk about, for the first quarter of 2017, what's driving that gross margin improvement sequentially?

Is it less discounting?

Is it sustainable or is it product mix and other things?

Thanks.

It's mainly product mix, within products, and then to some extent, the products and services piece too.

Thanks.

Next question.

Thank you.

Our next question comes from the line of Aaron Rakers from Stifel.

This is Andy Shin on for Aaron.

Thanks for taking the question.

So I think that I heard you guys say that product gross margins were lower, just due to promotions to incentiveize customers to switch over to C-dot.

But I'm curious why didn't you see relatively more of the installed base upgrade to C-dot versus the 26% you reported?

And basically, what percentage of that installed base is at risk of leaving NetApp?

So let me answer that question in a couple of ways.

First of all, the total installed base of 7-Mode systems and clustered ONTAP systems is growing.

So our installed base is not declining.

It's actually growing.

And clustered ONTAP is growing as a percentage of that.

The installed base is a very large number, so even 26% of that installed base is actually a substantial number.

We have run promotions through the course of the year to enable customers to transition from 7-Mode to clustered ONTAP.

As we noted, about 1,300 customers accelerating through the course of the year, decided to move forward from 7-Mode to clustered ONTAP.

The percentage of the installed base number that you see sometimes lags the point at which they actually decide to convert, because we have to see that show up in our reporting systems.

We also see as they migrate, that some of those smaller systems get replaced potentially by fewer larger clustered ONTAP systems.

So the percentage of systems under clustered ONTAP actually represents, under represents sometimes, the total value of the systems that we have transitioned.

In terms of the overall outlook for clustered ONTAP, we continue to stay focused on the total percentage of our installed base, look like total percentage of shipments and, as you see, the percentage of shipments is now very much clustered ONTAP: 85% of shipments of the factory and capacity under management which is now close to 40%.

Thanks.

Next question.

Thank you.

(Operator Instructions)

Our next question is a follow-up from the line of Lou Miscioscia from CLSA.

How did I know this was going to happen?

When you look at the flash marketplace, do you think that actually, due to the dynamics of flash, there will actually be an upward cycle from it or are you seeing most customers just actually replacing their obviously spinning disc drives or their hybrid drives with flash as the environment comes around?

I think we see, first of all, the flash market transitioning from a place where it was essentially a performance use case to one where it replaces performance drives, meaning SaaS drives in the market.

As customers make that transition, what they really want in sort of the majority move is they want the enterprise data management features and how they choose to use it can be one of three ways.

The first is greenfields, where for new deployments of enterprise applications, they choose to deploy an all-flash configuration as opposed to a hybrid or disc-based configurations.

The second could be a retrofit of an existing architecture where, in the case of clustered ONTAP, we are able to give people a completely transparent way to upgrade a disc drive system to an all-flash system.

So if you've got temporal needs or need for additional performance at a particular point in the season, you can do that very, very easily with us.

And the third, as we have noted, is all-flash systems are the new SAN configuration.

And we have replaced, in customer after customer, traditional fiber channel frame arrays from our incumbent competitors with all-flash storage systems.

Thanks, Lou.

Next question.

Thank you.

And that concludes our question-and-answer session for today.

I would like to turn the conference back over to NetApp for any closing comments.

Thank you for your attendance on the call this afternoon.

In closing, let me reiterate my confidence in NetApp's potential.

We're committed to fundamental change and remain sharply focused on the execution of our three key priorities.

Pivot to growth with our differentiated portfolio of strategic solutions, reduce cost, improve speed and focus by streamlining our business, and a robust capital allocation plan that includes shareholder returns and investment for the long-term growth of the business.

We're building on a lot of positives.

Our data fabric strategy is aligned with our customers' strategic IT imperatives.

The strategic solutions are greater than 60% of product revenue and growing well.

We have a large and growing installed base.

And we saw accelerating customer momentum in Q4.

And in the coming weeks, we will further advance our leadership position in flash and the next generation data center with exciting ONTAP and SolidFire innovation.

I'm confident in our potential and I'm excited to have new leaders on-board.

FY17 will be a year of transition.

We expect that the growth of strategic solutions will outpace the declines in mature, returning the Company to growth in FY18.

I look forward to speaking with you all again next quarter.

Thank you.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This does conclude the program and you may now disconnect.

Everyone have a good evening.