Kris Newton - Vice President, Investor Relations George Kurian - Chief Executive Officer and Director Jeffrey Bergmann - Interim Chief Financial Officer

Steven Fox - Cross Research James Kisner - Jefferies LLC Maynard Um - Wells Fargo Rod Hall - JPMorgan Sherri Scribner - Deutsche Bank Brian White - Drexel Hamilton Amit Daryanani - RBC Capital Markets Mark Moskowitz - Barclays Steve Milunovich - UBS Kulbinder Garcha - Credit Suisse Aaron Rakers - Stifel Jim Suva - Citigroup Andrew Nowinski - Piper Jaffray Bob Hahn - Raymond James Srini Nandury - Summit Research Brent Bracelin - Pacific Crest Securities Simona Jankowski - Goldman Sachs David Ryzhik - Susquehanna Financial

Good day, ladies and gentlemen, and welcome to the NetApp third quarter fiscal year 2016 results conference call. [Operator Instructions] I would now like to turn the conference over to Kris Newton, Vice President, Investor Relations. Please go ahead.

Hello, and thank you for joining us on our Q3 fiscal year 2016 earnings call. With me today are CEO, George Kurian; and Interim CFO, Jeff Bergmann. This call is being webcast live and will be available for replay on our website at netapp.com along with the earnings release, our financial tables and guidance, a historical supplemental data table and a non-GAAP to GAAP reconciliation. As a reminder, during today's call, we will make forward-looking statements and projections with respect to our financial outlook and future prospects, such as our guidance for the fourth quarter and fiscal year 2016 and for fiscal year 2017, our expectations regarding future revenue growth, improved profitability, 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, the overall growth rates for IT, our ability to successfully pivot to the growth areas of the market, our ability to expand our operating margin, our ability to reduce our cost structure within the planned timeframe and our ability to continue our capital allocation strategy and investment in strategic opportunities. Please also refer to the documents we file from time-to-time with the SEC, specifically our most recent Forms 10-Q, our Form 10-K for fiscal year 2015 and our current reports on Form 8-K, all of which can also be found on our website. During the call, all financial measures presented will be non-GAAP unless otherwise indicated. I'll now turn the call over to George.

Thanks, Kris. Good afternoon, everyone. Thank you for joining us. Our Q3 performance reflects our strong focus on operational execution as well as continued challenges from a number of headwinds. For the quarter we achieved our margin and EPS targets. However, we recorded lower than expected revenue. These mixed results reflect the impact of an uncertain and volatile macroeconomic environment, which is causing a slowdown in spending that became more evident in January. Additionally, overall growth rates for enterprise IT remain under pressure, as customers shift some of their spending to the cloud. Despite these headwinds, we had a number of positives in the quarter. Our data fabric strategy and pivot towards the growth segments of the market, scale-out, software-defined, flash, converged and hybrid cloud continue to yield positive results. Earlier this month we closed the SolidFire acquisition, positioning us to lead the rapidly growing All Flash array market. Before I go into greater depth on the progress we've made in these areas, I want to spend time on the fundamental changes we are undertaking to return NetApp to revenue growth with improved profitability, cash flow and shareholder returns. On prior calls I told you that I was driving a detailed inspection of the business. I have now concluded that formal review. Parts of our business are working well and growing, but we are managing through declines in other parts. We have many exciting innovative industry-leading products, strong relationships with customers and partners and a large growing installed base. NetApp does not need to completely reinvent itself, but we do need to execute comprehensive and sustained transformation to deliver on our commitment to return to revenue growth and enhanced profitability and shareholder returns. We will take significant steps to streamline the business and further advance our pivot to the growth areas of the market in order to capture the full potential of NetApp. To accomplish this we've adopted a plan with several key priorities. First, we have focused on the strategic solutions that represent our pivot to the growth segments of the market and are the foundation of how we enable customer success in the data-powered digital era. Second, we are substantially reducing cost and systematically streamlining the business, even while investing for the future. Third, we will provide greater visibility into the business and our revenue mix to demonstrate why we are so confident in our ability to capitalize on our strategic solutions. And fourth, we remain committed to our capital allocation strategy, which includes a combination of share repurchases, dividends and investing for the long-term growth of the business. Let's start with our strategic solutions. As a baseline, our focus remains in enabling our customer success, as they navigate through their own IT transmissions, which leverage modern architectures and hybrid cloud solutions. Clustered ONTAP, branded E-Series, All Flash arrays, hybrid cloud solutions and OnCommand Insight are the set of strategic solutions that are the basis of our pivot to the growth segments of the market. The growth rate of our strategic solutions is strong, but as I have discussed, not yet sufficient to offset the headwinds from the mature areas of our business, OEM, ONTAP 7-Mode and add-on. We expect that these headwinds will lessen, as we progress through fiscal year 2017. As we emerge from FY '17, the transition to clustered ONTAP should be mostly behind us, as will the downward pressure that the transition has put on our add-on storage business. As OEM and ONTAP 7-Mode become a smaller part of our mix, we anticipate that our pivot towards the growth areas of the market will return the company to revenue growth albeit moderated. During this transition period, we will maintain a sharp focus and execution, reduce our cost base and take additional steps to manage the trends in the storage industry. We will make transformational moves to become more focused, efficient and effective, while fundamentally lowering the cost structure of the company even as we invest in strategic opportunities, which brings us to our second priority, cost control. We will utilize disciplined portfolio management to improve productivity and better align resources with opportunities, while simultaneously maximizing returns from the mature portions of our business. We must also streamline the business to increase our effectiveness and flexibility in responding to the rapidly changing market. All of this will expand operating margin. We have launched a comprehensive program to reduce the cost base of our business by $400 million gross annually with run rate savings achieved by the end of fiscal year '17. We have already embarked on this initiative. We have made decisions that streamline our business, such as consolidating our hardware engineering and manufacturing operations teams, implementing tighter controls on indirect spending and improving supply chain efficiency. These actions and lower variable compensation enabled us to lower our Q3 operating expenses by 8% sequentially. Today we announced our restructuring and reduction in workforce of approximately 12% of total headcount. This action will generate annualized run rate savings of approximately $200 million against our gross target. We expect the majority of this workforce reduction to occur in fiscal Q4. As these cost efficiencies materialize, we are reinvesting some of these savings into strategic solutions like SolidFire and productivity improvements, which will allow us to be more effective at a lower cost structure, yielding a net run rate savings of roughly $130 million by the end of fiscal year '17. We are taking a thoughtful approach to the reductions, employing disciplined portfolio management and fundamentally changing the way we operate. Savings will be achieved through business transformation, including operational process redesign, organizational restructuring and realignment and further portfolio streamlining. We are also putting into place controls to ensure that these savings are sustained. These transformational moves will better align our resources against the strategic opportunity and our cost structure to the near-term growth trajectory of the business. While we've been working to make our model more efficient for some time now, this comprehensive and sustained transformation will enable us to realize the benefit of our pivot to the growth areas of the market at a faster pace. Looking past the streamlining and transformation phase into fiscal year '18 and beyond, we will continue our focus on productivity and the improvements in efficiency will more substantially materialize. Our non-GAAP operating margins will improve towards the high-end of our target range, inclusive of SolidFire. By coupling the strength of our data fabric strategy and the benefits we deliver to customers with a more efficient and agile business, we can increase the value we generate for customers, partners, employees and shareholders. Overtime, we believe that the investments we've made in innovation and streamlining will enable us to grow at an accelerating pace with improved operating margin and cash flow. Our third priority is transparency. The progress we've already made in our pivot towards the growth areas of the market has not been easy to measure from outside the company. To help provide visibility into this transition, we are providing greater clarity into the dynamics of our product revenue. In Q3, our strategic solutions trusted ONTAP, branded E-Series, All Flash arrays, hybrid cloud solutions and OnCommand Insight made up almost 55% of product revenue and grew 26% year-over-year. By contrast, product revenue from our mature solutions OEM, ONTAP 7-Mode an add-on declined 40% year-over-year, predominantly from the declines in OEM and ONTAP 7-Mode. In Q2 FY '16 we reached a significant milestone, when the revenue from strategic solutions exceeded that of the mature ones. In other words, the products with the higher aggregate growth profile had a bigger proportion of our product revenue. We are getting closer to a mix, where our strategic solutions can drive a reacceleration of the business. This shift in the composition of our product revenue is a good indicator of the progress we've made in our pivot to the growth areas of the market. This plus our strong software and hardware maintenance revenues create a solid foundation for NetApp. The tight alignment between our strategic solutions and our customers IT imperatives underscores our confidence that we will generate continued growth from this area of the business. As part of their IT modernization efforts, customer's wants scale-out and software-defined storage functionality for the efficient management of data growth. Clustered ONTAP enables seamless data management across flash, disk and cloud footprints and across public and private clouds for enterprise applications, regardless of the underlying hardware. Clustered ONTAP was deployed in almost 80% of FAS systems shipped in Q3, up from roughly 40% a year-ago. Unit shipments of Clustered ONTAP systems saw strong continued customer demand, growing roughly 70% year-over-year. The clustered ONTAP transition acceleration program, we put in place at the start of the year, is speeding the migration of install base customers, who are ready to upgrade both their systems and their software from ONTAP 7-Mode to clustered ONTAP. Our FAS install base is growing and clustered ONTAP now represents 24% of installed systems. The installed base mix will continue to ship to clustered ONTAP, but you should not expect a linear progression. These migrations are projects that must fit within the overall IT priorities and budgets of our customers, and we anticipate that the transition of the install base will happen over the course of years. Both the total number of customers and new to NetApp customers, who made clustered ONTAP purchases in Q3, grew by approximately 60% from Q3 last year. Flash is becoming the de facto technology for primary workloads. Our EF All Flash arrays deliver the extreme performance for standalone applications that infrastructure buyers and application owners need. The All Flash FAS arrays have industry-leading data management services with a unified multi-protocol capability that appeals to infrastructure architects driving data center consolidation. Customer demand for our All Flash arrays continues to grow. Our existing All Flash array business, inclusive of EF and All Flash FAS products and services, has accelerated to an almost $600 million annual run rate. To this strong foundation, we are excited to add SolidFire's, unique scale-out block storage architecture that is compelling for the cloud architect, master minding the next generation data center. With this acquisition, NetApp is the clear technology leader in the All Flash array market with the broadest portfolio of All Flash arrays in the industry, addressing the diverse needs of enterprises and service providers, which cannot be adequately met by the one-size-fits-all compromise approach of our competitors. Our Data Fabric solutions are successfully positioning us to help customers with leading-edge cloud deployments. A leading Software-as-a-Service provider in the Asia-Pacific region, created a next generation service for its customers, utilizing NetApp private storage for cloud, AltaVault and OnCommand Insight, connected to multiple hyperscale clouds for compute services. They provide an outstanding customer experience and an enterprise solution built on a single modern platform with a consistent look and feel without the risk of single cloud dependency. By storing data on NetApp private storage, they can meet customer preference for a specific cloud provider as well as improve their ability to meet SLA guarantees by failing over to other clouds, when the primary cloud is unavailable. The myriad efficiency of NetApp private storage also allows them to improve their profitability by effectively storing less data on tiers of flash, and creating rapid virtual copies for test and development during new customer acquisitions. Additionally, they can satisfy regulators by proving where data resides at all times for government, financial services and healthcare customers. This is a great example of what I've discussed in the past, data is at the heart of the transmission our customers are going through to improve the efficiency of their businesses and better serve their customers. At the same time, they are reducing IT budgets, looking for simpler solutions and rethinking how they consume IT. This evaluation is diverting spend towards transformational projects and architectures like scale-out, software-defined, flash, converge and hybrid cloud, where our data fabric strategy gives us a compelling advantage. NetApp is the only company able to span flash to disk to cloud, and the only company delivering the ability to manage data across multiple clouds and on-premises today. Finally, I want to briefly touch on capital allocation, our fourth priority. I'll let Jeff get into the details, but in short, we are fully committed to executing our capital allocation programs and creating value for shareholders. We expect to complete our current share buyback authorization by the end of May 2018, as planned, and remain committed to our dividend program. I am more confident than ever in NetApp's potential. While we must manage through a dynamic IT market and declines in our mature solutions, we have a clear plan and a lot of positives. We have a large and growing install base. Our data fabric strategy uniquely enables us to assist customers in achieving their strategic IT imperatives. Our strategic solutions are greater than 50% of product revenue and growing. We are making substantial progress in the transition to clustered ONTAP. And we've just expanded our comprehensive All Flash array portfolio. We are keenly focused on our business model and managing our investments between our strategic and mature solutions. The changes we are making to streamline the business and reduce the cost structure will enable investment and strategic opportunities, while accelerating our ability to deliver shareholder value in the form of profitability and cash flow. We look forward to updating you on our progress next quarter. I'll now turn it over to Jeff to take you through the numbers. Jeff?

Thank you, and good afternoon to everyone. I'd like to start by thanking George and the NetApp Board for the opportunity to step-in as Interim CFO. It's an exciting time of transformation for NetApp, as we streamline the business to become more focused and efficient, and at the same time pivot the company toward growth areas of the market and take advantage of the opportunities in front of us. The team is energized to leverage the strength of our strategic solutions to bolster the company and ultimately drive growth. We have made good progress to date, and as you heard from George, are committed to providing you with greater visibility into the dynamics of our business. With that said, let's move to the financial results for the third quarter of fiscal 2016. I want to remind you that unless otherwise specified, I will be using non-GAAP metrics to discuss our financial results and guidance. Q3 net revenues of $1.39 billion were down about 4% sequentially and 11% year-over-year. While there were indicators that strengthen our results, such as clustered ONTAP traction and rapid All Flash array adoption, which drove growth in our strategic solutions, our revenue performance felt short of our expectations. The shortfall was a result of a combination of the macroeconomic uncertainty George talked about, that created the lengthening of deal cycles, greater than anticipated rate of decline in our mature business and mix shift to deferred revenue and FX headwinds of about 3 points year-over-year. When we reiterated guidance in early January, our sales volume was in line with our forecast, which assumed a bank-end loaded quarter, consistent with historical performance and as is typical in the industry. However, after a moderate calendar year budget flush, that macroeconomic environment worsened and we saw an increase in the deferred mix of our business over the course of last two weeks of the quarter. Product revenue declined 8% sequentially and 19% year-over-year. We saw higher than expected volume of software and hardware maintenance contract renewals, as some customers opted to delay equipment purchases. The combination of software maintenance and hardware maintenance and other services revenues was up 2% year-over-year. Now, to provide some context and better visibility into our business model, I'd like to walk through how we think about the strategic solutions revenue in software and hardware maintenance revenues coming together to create a foundation from which we can build. Revenue from strategic solutions continues to show strong growth, and as George highlighted, is now more than 50% of our product revenue. The year-over-year decline in our mature solutions revenue is driving overall product revenue declines in the near-term. But the size and growth of the strategic solutions revenue gives us confidence in our strategy to drive overall product revenue growth in the future. Looking at software and hardware maintenance revenues. I talked about the strength of our renewal business during the quarter, and as George said, 24% of our install base is running on clustered ONTAP. While the product revenue declines will ultimately pressure software and hardware maintenance revenues, the lengthening of product lifecycles, growth of our install base, rapidly increasing mix of clustered ONTAP install base, and high renewal volume create support for future software and hardware maintenance revenues. Indirect revenue accounted for 78% of net revenues. Gross margin was 63.1% in the third quarter, above our previous guidance, reflecting favorable mix, partially offset by aggressive pricing. Product gross margin of 51.1% was down about 6 points year-over-year, reflecting about 2 point of FX and higher discounting. Software maintenance gross margin was roughly flat, while hardware maintenance and other services gross margin was up about 2 points, largely reflecting higher contract renewal revenue, as well as services infrastructure cost efficiencies. Operating expenses of $630 million decreased 12% year-over-year, reflecting 3 points of the FX benefit, lower headcount related compensation costs and their early work toward driving greater efficiency across the business, as George mentioned in his opening remarks. Operating margin of 17.6% was almost 1 point above our guidance. Our effective tax rate was 14.9% and lower than our previous guidance, which reflects a change in the geographic mix of profits and its cumulative year-to-date impact. We expect our effective tax rate for Q4 to be approximately 16%. Our weighted average diluted share count for the third quarter was 296 million shares. Earnings per share was $0.70 within our guidance range. Moving on to cash and balance sheet metrics. We ended the quarter with approximately $5 billion in cash in short-term investments with approximately 12% held by our domestic entities. Deferred and financed unearned services revenue increased $80 million sequentially and $16 million year-over-year. Inventory turns increased to 20 and DSO was at 38 days. We generated $355 million in cash flow from operations during the quarter, up 29% year-over-year. Free cash flow of $314 million was about 23% in net revenues, up 217% sequentially and 28% year-over-year. We expect free cash flow as a percentage of revenue for Q4 to be slightly above 20%. Now, I'd like to discuss share repurchases for a moment. In Q3, we repurchased approximately $85 million of our stock. This was less than we would have liked due to the events such as the SolidFire transaction, which reduced the number of days we could be in the market. However, as George noted, we remain fully committed to completing our $2.5 billion share repurchase program by the end of May 2018, with [ph] $262 million is remaining by the end of May 2016. Additionally, we paid $52 million in cash dividends in the third quarter. Today, we also announced next cash dividend of $0.18 per share of the company's common stock, which will be paid on April 27, 2016. Overall, we are confident in our allocation of capital between growth initiatives and shareholder returns, as we continue to execute on our transformation strategy. Looking forward to guidance. Given the increasingly uncertain macroeconomic environment, continued shifts in enterprise IT spending and our own work in transforming the company, we are tempering our forecast. For the fourth quarter, we are forecasting a revenue range of $1.35 billion to $1.5 billion. Given the aggressive pricing environment, we expect gross margins to decline to approximately 61.5%, driven by higher discounting, which will be partially offset by cost savings initiatives. Looking at operating margin, we are transforming the company in order to streamline the business, improve efficiency, become more focused and enhance our ability to rapidly address the changing market. Our initiatives will fundamentally change the way we do business by centralizing similar activities across functions, optimizing geographic location resources and consolidating suppliers. We are better positioning NetApp for near and long-term success, while reducing our cost structure across both cost of revenues and OpEx and ensuring that the changes we make are sustainable. To minimize disruption, the pace of these changes will be dictated by the company's preparedness for each transformative initiative. As George mentioned, we're driving to achieve a gross run rate savings of $400 million by the end of fiscal 2017, which will include the previously announced discontinuance of our flash array product line. We plan to use these cost savings to minimize erosion of margins in a price competitive environment. We will reinvest some of the gross savings into strategic opportunities, such as SolidFire and productivity improvements, yielding a net run rate savings of roughly $130 million by the end of fiscal 2017. While George touched upon several initiatives that are already underway, we will provide more specifics around additional initiatives, as they are executed. As a step towards lowering our cost and rewiring the company, we will initiate a headcount reduction of approximately 12% during the fourth quarter. We expect to realize Q4 savings of just over $30 million, resulting in a Q4 operating margin of approximately 15% and earnings per share target range of $0.55 to $0.60 for the fourth quarter, including the impact of the SolidFire acquisition. We expect a GAAP restructuring charge of approximately $60 million to $70 million in Q4 relating to this action. Finally, to help with your models, I'd like to provide some color around the impact of SolidFire on our outlook. As you know, the acquisition closed on February 2. We funded the transaction through a short-term loan of $870 million. We intend to integrate SolidFire into our global operating structure and expect to retire the acquisition debt with our global earnings by the beginning of Q3 FY '17. In Q4, we expect SolidFire to reduce operating margin by about 3 points, resulting in an operating margin of approximately 15%. Looking forward to FY '17, we expect our strategic plans for SolidFire to contribute about 2 points of revenue growth and be dilutive to operating profit by about 2 points and to earnings per share by $0.28 to $0.30. This is at the high-end of the guidance range that we gave you on the acquisition call as that range includes benefit of flash array discontinuance, which we are now reporting as part of the overall cost reduction plan. We anticipate that SolidFire will be accretive in FY '18. The IT environment is changing rapidly and we've provided a lot of additional content to give you more insight into how it's impacting us and the actions we're taking to adapt. Let me summarize the four themes around this transformation that I want to ensure that you take away from this call. First, underlying our topline results there is a strong strategic business that is material and growing. Second, we are significantly reducing the cost structure of our core NetApp business, aligning our resources to the market opportunity, which will expand operating margin. Third, we are committed to providing greater transparency and visibility into our business. And fourth, we're committed to our capital allocation strategy of providing a meaningful dividend that grows over time and executing a robust share repurchase program, while investing in the long-term growth of the business. With that, I would 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. Thank you for your cooperation. Operator?

[Operator Instructions] And our first question comes from the line of Steven Fox of Cross Research.

George, just on the cost saving initiatives and the $400 million total, can you sort of foot that versus what you just announced? In other words, how much of the $400 million was realized to date? And if you, I assume that's a gross number, so if you net that out what were the savings? And then specifically, where were you getting them from? And along those lines, I guess, there's some product mix issues that are helping you as well, can you address that in terms of just how your margins are benefiting?

The total program is a comprehensive program that encompasses across the board, business process redesign, organizational restructuring and realignment and further streamlining of the portfolio. The total dollar savings that we are going after, the gross savings, between the end of Q3 of fiscal '16 and the end of fiscal '17 is a gross number of $400 million in cost savings. The first step in that program is the restructuring action that we are announcing today, and which will be complete in Q4. Within Q4, we will be recording about $30 million of savings from the action itself, which over a full year annualized run rate is about $200 million.

Just to be clear there, that's without any mix benefits, that's just all costs going forward, then the mix would be separate?

That's correct.

Thanks, Steve. Next question?

Our next question comes from the line of James Kisner of Jefferies LLC.

So you said that 55% of your product revenue I think in Q3 was strategic solutions. I'm just wondering if could you share some rough thoughts on what you think that composition might be as you exit fiscal '17 that gives you confidence that you'll be set up to return revenue growth in FY '18.

I think as we indicated, we are providing greater visibility into the product mix between our mature products and our strategic products. I think we've also given you the size and relative growth rates of each of those categories. We're not going to provide guidance beyond that in terms of the specific buckets. Add-on storage, just to be clear, is not going to go to zero from the mature bucket. From the mature bucket the declines are primarily from 7-Mode and OEM. The add-on piece of the mature bucket is essentially going through a transition from 7-Mode to clustered ONTAP, and so will be the majority of the mature bucket going forward.

Thanks, James. Next question?

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

I just wanted to make sure I understood the use of cash. I understand that you're still committed to the capital allocation program, but should we anticipate that you'll pause the share repurchase as you focus on paying down the debt. And it also feels like you have a broad portfolio to address the growth areas of the market. So should we read into those comments that a use of cash wouldn't be to do further M&A?

So we do plan to resume our stock repurchase activity in the quarter. Our stock price, obviously, is attractive at these levels and we will look forward to be opportunistic. I would say that in terms of M&A, we are really focused on integrating SolidFire and so our focus will be to invest in that area rather than focus on M&A at this point.

Thanks, Maynard. Next question?

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

I just wanted to circle back to these percentages of strategic and mature revenue that you guys talked about and the growth rates. I guess if I assume that the balance of the revenue, the 55% is mature, and I just multiply it by growth rates, I get the wrong number. So I'm wondering if you could help us kind of reconcile that percentages in growth rates back to the reported product revenue growth rate, so that we understand is there another segment in there you're not talking about? And what is the growth rate in that segment? And then I have one follow-up as well.

The product revenue numbers essentially are broken out in 100% between the mature pieces and the strategic pieces. I would tell you that in the mature pieces, you should be cognizant of the facts that the declines are primarily in the 7-Mode and OEM pieces of the mature bucket. The add-on storage numbers are essentially a large percentage of the mature bucket and they are not deteriorating at the rate of 7-Mode or OEM. They're essentially going through the transition from 7 to clustered ONTAP. And so will be a relatively stable business, will also be affected by the trends of disc to flash. But I would just tell you that a 100% of our product revenues are either categorized as mature or strategic.

George, just on my follow-up. If you multiply the things out, so 55% product revenue by 26% growth and then the remaining 45% via 40% decline you get like 4% decline, which isn't the same thing that you guys reported. So maybe offline you guys could elaborate or later in the call. And then it would also be helpful if you could those growth rates that you call out for this quarter last quarter, so we can see the trajectory like are we seeing stabilization of the decline in the mature stuff?

Real quickly, I think the reason why the math may not work is the percentages that we are calculating are based upon our gross revenue for those product lines, but that sit within mature and strategic.

Thanks, Rod. Next question?

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

I just want to clarify; I think you said that the All Flash array business was now for you $600 million run rate, which I assume does not include SolidFire? And how much SolidFire revenue are you expecting or including in the guidance for fiscal 4Q?

So the $600 million run rate on the flash business is just EF and our AFF product lines. That doesn't include SolidFire. We just have minimal revenue planned in Q4 for SolidFire in our plan.

Thanks, Sherri. Next question?

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

You talked about business slowing a bit at the end of January. Maybe you can just walk us around the world and give us a view of what you're seeing by geography and also by vertical?

So our business reflected the general commentary in the market about the macro. Asia Pacific, particularly the economy is dependant on China, as well as Japan saw a pretty choppy business in January. Certainly sectors like oil and gas and countries that are dependent on oil and gas were also affected. The service provider business in the U.S. is down as many telcos are divesting of their cloud business and reevaluating their approach to the data center business. And as we noted before, 2015 has been a year where the U.S. Fed has lower IT spending as well as shifted priorities within this spending envelope to initiatives such as cyber security and some on the cloud.

Thanks Brian. Next question.

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

I guess just from the strategic piece of the revenue that's growing 20% plus, basically the gross numbers. Could you just talk about -- give us sense on how much of that is potentially just cannibalizing your own legacy or mature piece of business versus what's net-new? And then the strategic bucket itself, do you think its margin and free cash flow accretive versus the overall business or it's dilutive to your model?

First of all, in terms of clustered ONTAP the net new-to-NetApp customers and total customers on clustered ONTAP grew strongly 60% year-on-year. So we are winning more than our fair share of both new customers, as well as transformational activity within our existing customers using our strategic solutions. I would say that the EF-Series, the All Flash arrays are also primarily growing in parts of the market that we historically did not serve the high performance fiber channel segment of the market. So we feel good about the new solutions being allowing us to get wallet share in both existing customers as well as net new-to-NetApp customers.

Just to add on the margin, we think that the shift between the mature and strategic is pretty much neutral in terms of gross margin.

Thanks, Amit. Next question?

Our next question comes from the line of Mark Moskowitz of Barclays.

I want to talk maybe bigger picture, just given this kind of perennial cost cutting and kind of almost the morale busting job force reduction you're announcing today, are you signaling despite your optimism around some of these strategic imperatives that longer-term the storage market is going to decrease and compress for other reasons outside of your control, whether it's from the cloud displacement or just because of data-reduction technologies, because I'm just trying to reconcile some of your optimism around why you're going to cut more muscle from the bone?

We are going through, as I indicated on the call, we are going through a transition in our business from the traditional to the strategic segments of our business. We feel very good about the strategic portions of our business growing double-digits. At the same time, we want to manage the business responsibly, as we go through the transition and set up the company to be able to generate margins and shareholder returns in a moderated growth environment. We are not sacrificing investments in growth areas. For example, we are continuing to invest in our All Flash arrays, we continue to invest in clustered ONTAP acceleration, we continue to invest in strategic solutions like SolidFire and our hybrid cloud solutions. We're just getting much more focused on the company as a company on the parts of the market that are really growing.

Yes, Mark, I would just add a little briefly on that that we've done a pretty extensive analysis on our operating model and compared ourselves to the top performing companies. And this is really about aligning ourselves with the profile that we need to address the market going forward and feel confident in where we're ending up.

Next question?

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

George, you kind of positioned the recovery beginning in '18, so I know it's premature perhaps. But when you think about '17, it sounds like you might be kind of in a mid-teens operating margin, you're going to have some SolidFire revenues, so I don't know revenue maybe flattish to slightly down. Just curious, if you are prepared to make any broad comments about what '17 looks like before things accelerated to '18?

We're not going to provide any comments and guidance on '17. We'll give you that when we're ready to do so. Right now, we're focused on streamlining the business and doing so in a responsible fashion, so that we can manage the risk, but also make sure that we can take the strategic actions that set us up for a better productivity model going forward.

Do you view it as a transition year?

'17 as I said, if you do the evaluation of our strategic solutions and our mature parts of the portfolio, we still have some transition ahead of us.

Thanks, Steve. Next question, please?

Our next question comes from the line of Kulbinder Garcha of Credit Suisse.

I just had a clarification, on the $400 million of cost savings, is it right to think $200 million OpEx and $200 million of cost of goods sold [indiscernible] clarification. And then my deeper question is --.

Kulbinder, we can barely hear you.

My question is on the $400 million of cost savings, how does that split between OpEx and COGS?

We would tell you once we get through the cost savings approach. As I said, we've got programs in flight, some of which are already in flight, some of which have been part of the Q4 restructuring action. We'll give you more detailed updates as we execute the transformation program.

Just to add a little color to that, the $400 million is really -- we expect to accomplish that during FY '17 and part of Q4, so that is really a run rate exit level for FY '17.

Thanks, Kulbinder.

And our next question comes from the line of Aaron Rakers of Stifel.

I want to go into the revenue a little bit. As you guys go through this transformation, it looks like you still have about high-30% kind of 40% contribution of your revenue coming off the balance sheet software entitlement maintenance, as well as the maintenance service revenue. So as you see the declines in your traditional or mature businesses, how are we to think about the progression of that revenue as we look into fiscal '17?

First of all, I'll let Jeff provide some more details. But our install base is growing. The install base of systems that are under maintenance contracts with NetApp is growing, both reflecting a longer lifespan of utilization of existing systems and their strategic value-serving, high-performance, data-rich applications in our customers, but also the fact that our strategic solutions are growing. So our overall install base of systems is growing, which is supportive of the fact that our maintenance revenues are strong.

I would just add to that. We just think that that provides us a strong foundation for that revenue stream. We clearly have an install base that's growing, and with cDOT at 24% and growing, we think that gives us confidence in that as we move forward.

Thanks, Aaron. Next question?

Our next question comes from the line of Jim Suva of Citigroup.

Can you help us understand how we should quantify or measure the milestones of the SourceFire acquisition, whether that be profitability or breakeven of earnings or revenues, how can we measure the integration? And do you actually have a timeline for breakeven?

SolidFire will be accretive in fiscal year '18. We'll provide more insight into the program, as we integrate that and as we lay out our plans for fiscal year '17. But at the moment, we'd see that SolidFire will be accretive in fiscal year '18.

Thank you. Next questions please.

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

So sorry if I missed it, but can you give us any color on your new customer growth relative to prior quarters, because that may give us a better sense of how compelling clustered ONTAP is relative to some of the other next-gen vendors like Nutanix and Tintri and others?

We've got good growth quarter-on-quarter as well as year-on-year. As I said, year-on-year net new-to-NetApp, as well as cDOT customers in aggregate grew 60% year-on-year. And so we feel good about both expanding footprints in existing customers, as well as access to net-new customers. SolidFire, for example, allows us to be able to be competitive in customer environments that have historically valued the extreme simplicity, as well as the efficiency of hyper conversion environments. We've seen good success with SolidFire's base of customers that are able to meet that design point. So we think that both clustered ONTAP and SolidFire give us good footprints in both traditional as well as emerging categories.

Thanks, Andrew. Next question.

And our next question comes from the line of Brian Alexander of Raymond James.

This is actually Bob Hahn calling in for Brian. I just wanted to ask a quick question regarding your 7-Mode install base. I know last quarter you mentioned that Q2 marked the first time that you did not experience growth in the 7-Mode install base. Now, I was wondering if that install base is now declining, and do you think that you'll be able to convert over a lot of these customers or how confident are you that you can convert over these customers over time?

The aggregate install base of 7-Mode and clustered ONTAP FAS Systems is actually growing. So we feel good, not only about the overall install base, but if you think about the percentage of the install base that its clustered ONTAP, it's at 24%, up from 17% a quarter ago, so strong growth in terms of the install base and execution. I would tell you that the pace of those transitions are IT projects in our customer environments, right. And so to the extent that enterprise IT spending overall is pressured there will be some tactical moves that customers might make to just stay on 7 for a period of time before they cut over. The programs that we initiated at the start of the year, clustered ONTAP accelerations program have seen strong growth. We've already exceeded our expectations for the year with that program in terms of customers, the total volume of transactions, as well as the number of resellers engaged in moving customers, so we feel good.

Thanks Bob. Next question?

Our next question comes from the line of Srini Nandury of Summit Research.

Can you talk about the competitive environment, who is being aggressive and what's your outlook for the startups who are competing in the space?

I would say that the competitive environment, we have seen some more price discounting from select players in the market. We think that the dynamic of them discounting is relatively unchanged. HP, HDS, they are the key players that lack the innovation value, so they are being aggressive on price to compete. We don't see much change from the startups. I think Nimble has continued to retrench mostly into the SMB market. Pure is unchanged in terms of its competitive stance and EMC is challenged with the transaction that they are about to undertake. So we do see some opportunities where we have been able to take footprints from EMC, given the lack of clarity in terms of their roadmap going forward.

Thanks, Srini. Next question?

Our next question comes from the line of Brent Bracelin of Pacific Crest Securities.

George, I had a follow-up on the mature products segment. As you think about that 44% decline that you saw this quarter, how much would you attribute to a pause, macro-related concern versus a more accelerated shift towards this industry transitioning into flash and cloud? If you could help us parse out that decline and how much of it is kind of a change in the environment and the demand environment versus more of an acceleration to these transitions?

I would say, there was certainly a percentage of it that was rather than doing technology refresh, it was basically moved towards a maintenance contract or a service agreement, that said here I'm going to wait until I see what happens in the macro before undertaking a big project. I don't think that represents a shift to the cloud, it's just I'm not ready to take on a major capital project at this point in time. It's much more of the discussion threat there. I think in terms of the migrations from our existing platforms to solid state, I would say that the strength of our solid-state portfolio is not just a transition from our existing footprint, right. We are actually getting a lot of new customers, because the majority of our footprint is essentially with solid-state arrays is in high-performance fiber-channel environments that we historically did not have a big landscape in. So I would say that some of the declines are from pauses, some of them are from our natural migrations to clustered ONTAP and some of it is essentially going through a period of, I've got enough things going on in my business, where I've acquired new platforms and I'm waiting to consume them.

Next question?

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

I think you said that you had a $600 million run rate in the flash products. And on the call in December, I think you cited $370 million, which would imply about 60% quarter-on-quarter growth. I just wanted to clarify that I've got that correctly? And then in terms of my question, I wanted to ask about your strategy for addressing the hyper converge segment of the market?

First of all, your analysis is correct, Simona, on the sequential growth rate. The second is, in terms of the hyper converge market, we see what customers really want is essentially simplified provisioning and operational management, a relatively simple pay-as-you-go building block architecture. And you will see us address those customer needs with both the SolidFire architecture, which is built with a scale-out, simplified design right out of the get-go as well as some exciting new innovations in the flex spot lineup.

Next question?

And our final question comes from the line of Mehdi Hosseini of Susquehanna Financial.

This is David Ryzhik for Mehdi Hosseini. Just going to April guidance, April quarter guidance for gross margins, it looks like its down 200 basis points quarter-over-quarter and it seems like higher discounting is the reason. But earlier on the call you mentioned that the dynamics of discounting is unchanged. So just wanted to clarify, does this mean that pricing pressure has basically accelerated in the April quarter? And should we anticipate that in both the strategic and mature or mostly in the mature segment of the business?

These are year-on-year numbers. I think we are being cautious about the mix, we're being cautious about the macroeconomic environment and typically the discounting behavior in our yearend quarter.

And there's also just an unfavorable product mix involved in that as well.

I'm going to pass it over to George for some final comment. End of Q&A

In closing, let me reiterate my confidence in NetApp's potential. We have a lot of positives with our strategic solutions that are the foundation of how we enable customer success in the data-powered digital era. We have a large and growing install base, our data fabric strategy uniquely enables us to assist customers in achieving their strategic IT imperatives. Our strategic solutions are greater than 50% of product revenue and growing. We are making substantial progress in the transition to clustered ONTAP. And we've just expanded our comprehensive All Flash array portfolio. While we must manage through a dynamic IT market and declines in our mature solutions, we have a clear plan to drive long-term growth and profitability. We are focused on driving continued growth of the strategic solutions. We are substantially reducing cost and systematically streamlining the business. We are providing greater transparency to give you better visibility into the basis of our confidence. And finally, we remain committed to our capital allocation strategy. Thank you. I look forward to giving you further updates next quarter.

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