Kris Newton - VP of Investor Relations Tom Georgens - CEO Nick Noviello - CFO.

Alex Kurtz - Sterne Agee Joe Wittine - Longbow Research Brent Bracelin - Pacific Crest Katy Huberty - Morgan Stanley Brian White - Cantor Fitzgerald Kaushik Roy - Wunderlich Srini Nandury - Summit Research Keith Bachman - Bank of Montreal Lou Miscioscia - CLSA Rajesh Ghai - Macquarie Sherri Scribner - Deutsche Bank Scott Craig - Bank of America Maynard Um - Wells Fargo.

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

Hello and thank you for joining us on our Q4 fiscal year 2014 earnings call. With me today are CEO, Tom Georgens; and our CFO, Nick Noviello.

This call is being webcast live and will be available for replay on our Web site at netapp.com along with the earnings release, our financial tables, a historical supplemental data table and the non-GAAP to GAAP reconciliation.

As a reminder, during today's call, we will make forward-looking statements and projections with respect to our financial outlook and future prospects, such as our guidance for the first quarter and full fiscal year 2015, all of which involve risk and uncertainty.

Such statements reflect our best judgment based on factors currently known to us and are being made as of today. We disclaim any obligation to update our forward-looking statements and projections. Actual results may differ materially from our statements and projections for a variety of reasons.

We described some of these reasons in our accompanying press release, which we have furnished to the SEC on the Form 8-K.

Please refer to the documents we file from time-to-time with the SEC, specifically our Form 10-K for fiscal year 2013, subsequent Form 10-Q quarterly reports and our current reports on Form 8-K also on file with the SEC and available on our Web site. During the call, we will also discuss non-GAAP financial measures.

These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of our GAAP and non-GAAP results is provided in today's press release, prepared remarks and on our Web site.

In a moment, Nick will walk you through some additional color on our financial results, and then Tom will give you his perspective on the business this quarter. I'll now turn the call over to Nick..

Thank you, Kris. Good afternoon, everyone, and thank you for joining us. NetApp delivered another quarter of solid financial performance, driven by our innovative portfolio solutions, competitive positioning and strong operational execution.

We achieved Q4 revenue inside our prior guidance range and non-GAAP gross margin, operating margin and EPS all above Q4 guidance ranges. Before discussing our fiscal 2014 results and future expectations, I'd like to first provide more detail on our performance in the fourth quarter.

Net revenues of $1.65 billion were up 2% sequentially, but down 4% year-over-year. Branded revenue grew 6% sequentially, and as expected was relatively flat on a year-over-year basis. OEM revenue declined further than expected and was down 30% from Q3 and 34% from Q4 last year.

Indirect revenues through the channels and OEMs accounted for 83% of Q4 revenue consistent with the last two quarters. Arrow and Avnet contributed 24% and 17% of net revenue respectively. Non-GAAP gross margin of 64.4% was almost a point better than Q3 and above our previous guidance.

Non-GAAP product gross margin of 58% was up almost one point sequentially and two points year-over-year due to a combination of continued operational productivity, favorable product mix and lower hardware warranty costs.

Non-GAAP service gross margin of 62.7% was up almost two points sequentially and more than six points year-over-year due to higher support revenue and lower spending partially related to delayed projects as well as lower headcounts related to realignment actions.

Non-GAAP operating margin of 20.9% was above our previous guidance range driven by a combination of higher gross margins and lower operating expenses resulting from the realignment action we took mid quarter.

We made the realignment decision to accelerate key strategic initiatives, while at the same time streamlining certain elements of the business such as OEM. Overall, this action resulted in a headcount reduction of approximately 4% and a GAAP restructuring charge of approximately $39 million in the quarter.

Non-GAAP EPS of $0.84 was up 22% year-over-year and was $0.02 over the high-end of our prior guidance range. This reflects solid operational performance as well as an approximate $0.01 net benefit from the combination of realignment activities and lower share counts, partially offset by a higher Q4 effective tax rate versus prior guidance.

Q4 weighted average diluted share counts of 336 million shares decreased by almost 10 million shares from Q3 due to repurchase activity throughout the quarter. Cash and balance sheet metrics for Q4 remains strong. Free cash flow of $313 million was 19% of net revenue.

Inventory turns were at 19 and days sales outstanding increased to 47, reflecting typical seasonality. Deferred revenue was up $141 million versus Q3 and up $91 million from Q4 last year. Finally, we repurchased approximately $374 million of stock and paid $49 million in cash dividend during the quarter.

Now turning to fiscal year 2014, I would characterize the year in much the same way as I characterize Q4. Solid financial performance based on innovation leadership, robust operational execution and strong competitive positioning.

Throughout the year we introduced new solutions that enable customers to solve their challenges today while providing them with an innovative architecture for tomorrow. For the fiscal year, net revenues of $6.33 billion were flat from fiscal year 2013. Branded revenue was up 4% that was offset by lower OEM revenue, which was down 26%.

Including the impact of lower OEM revenue, geographic revenues in EMEA and Asia-Pacific were up slightly, offset by lower revenue in the Americas, which was due to challenges in U.S. Federal spending. Full year non-GAAP gross margin was 63.2%, up 2.5 points from fiscal 2013, and non-GAAP operating margin was 18.3%, up three points from fiscal 2013.

Our non-GAAP effective tax rate for the year was 17.2%, slightly above our prior guidance and fiscal 2013, reflecting the impact of our geographical sales mix and year end true-ups. Non-GAAP EPS for fiscal 2014 was $2.78, up 22% from fiscal year 2013.

We ended the year with a strong balance sheet and a continued high degree of financial flexibility to invest in the business and enhanced value of the shareholders. We closed fiscal 2014 with approximately $5 billion in cash in short-term investments, approximately 14% of which is onshore.

Over the course of the year we generated $1.1 billion of free cash flow and fully executed our capital allocation strategy, which included retiring just under $1.3 billion in convertible notes and returning $2.1 billion to shareholders through a combination of share repurchases and dividends.

As expected, we ended this fiscal year with approximately $1.1 billion remaining in our share repurchase program. Today we are pleased to announce an increase in our next dividend to $0.165 per share to be paid on July 22.

This represents a 10% increase compared to Q4 and reflects our confidence in the business, our consistent ability to generate healthy domestic cash flow and our ongoing commitment to generating shareholder value.

Now to guidance; we expect our Q1 target revenues to range between $1.42 billion and $1.52 billion which at the midpoint implies a sequential decline of approximately 11% and a 3% decrease year-over-year.

This sequential decline reflects our typical Q4 to Q1 seasonal revenue dynamics as well as conservatism around OEM business in light of our Q4 results and our future expectations given the business conditions impacting certain OEM customers. With that said we expect to continue to drive strong operational performance and prudently manage expenses.

In Q1 we expect to generate consolidated non-GAAP gross margins of approximately 63.5 to 64%, and non-GAAP operating margins of approximately 15%.

Based on our stock repurchases in Q4 and in the first 10 days of Q1, we expect our diluted share counts for the quarter to decline to approximately 332 million shares and non-GAAP earnings per share for Q1 to range from approximately $0.53 to $0.58 per share.

Overall as we look at fiscal year 2015, NetApp remains well positioned to help customers navigate through their hybrid cloud strategies with market-leading scale out and converged solutions. We remain confident in our strategy and committed to enhancing shareholder value over the long-term.

For the year, we anticipate mid single-digit branded revenue growth ramping over the course of the year and partially offset by declines in OEM revenue of up to 40%. They're ultimately dependent on revenue mix and growth. We expect fiscal 2015 gross margin of approximately 63 to 64% and operating margin of approximately 18%.

As I mentioned last quarter, we are implementing a change in how we report our non-GAAP effective tax rate to be more reflective of our operational results and tax structure and to provide a better comparison with our peers. For the year, we currently expect our non-GAAP effective tax rate under this new methodology to be approximately 16.5%.

Finally, we intend to accelerate our current share repurchases program and to complete it over the course of the next 12 months, a year earlier than originally announced. Bottom line, our plans for fiscal 2015 translate to just under 10% growth in earnings per share and continued strong cash flow generation.

With that, I will turn the call over to Tom for more detail on the business momentum.

Tom?.

Thanks, Nick, and good afternoon, everyone. I'm pleased with our operational execution again this quarter. We delivered revenue within our guidance range, while expanding gross in operating profit margins to levels among the highest in the history of the company, all despite unanticipated headwinds in our OEM business.

In calendar 2013 we outgrew the market, gained share and increased gross margins, demonstrating our competitive advantage and the value we deliver.

With the steep ramp of Clustered ONTAP, the acceleration of our broad flash portfolio and our differentiated approach to the cloud, we are participating in a greater range of customer engagements than in any time in our history.

As we've discussed before, customers have choice in new technology and IT delivery options that enable them to modernize and create compelling business outcomes that were not previously possible.

A particular impact is the cloud, which offers a degree of flexibility; and for certain workloads, economic benefits that cannot be achieved with traditional on-premises computing..

One of the biggest challenges to this vision is data management. While other parts of the infrastructure are largely fungible and carry no history, once data is created, it needs to be protected and managed for its lifetime. As data grows data and application mobility become increasingly bandwidth and time consuming.

The net result is that data management, NetApp's core competency is absolutely essential in the realization of the promise of the hybrid cloud.

Data ONTAP, the number one storage operating system in the world already delivers the industry's richest data management portfolio and Clustered ONTAP is unmatched in meeting IT transformation requirements of both the enterprise and service providers. It is the only enterprise scale at the SAN platform.

It is more reliable and easier to manage than other scale on NAS solutions and is able to consistently support multiple workloads with multi tenant management and performance scaling across disk, flash and hybrid storage. On our Q4 call last year, we talked about the complex development transition to Clustered Data ONTAP being behind us.

Over the course of fiscal year '14 we saw a increasing momentum as customers and partners learned about the value of Clustered ONTAP and began deploying it broadly. For the full year fiscal year '14 clustered notes grew 242% from fiscal year '13.

The attach rate of Clustered ONTAP increased across all of our product lines with high end platforms approaching 50% in Q4. Most notably the attach rate of our new FAS8000 product line was over 60%. To-date we have shipped over one Xobite of storage managed by Clustered ONTAP systems.

With hybrid cloud as the dominant paradigm, on-premise's IT is not going away. However, due to budget constraints the customer's ability to evaluate, integrate and ultimately deploy solutions is being impacted. This trend is driving a demand that convert solutions that reduce the time of deployment and lower integration risk.

By working with other best of breed hardware and software providers, we can offer a compelling business value with reduced risk in ways that cannot be matched by the proprietary staffs at the server vendors.

Our strategic partnership at Cisco around FlexPod Solutions delivers on this promise, and we said FlexPod unit shipments grow 71% from Q4 of last year. With over 18 petabytes of flash sold last quarter, NetApp is the leader in the flash market with the best position portfolio both in terms of what is available today and what is coming.

We are seeing multiple use cases emerging with different requirements balancing price, performance and features. One of the clearest examples is database acceleration. We are seeing rapid adoption in database environments using the EF all-flash array where data management is done by the application.

Given the high end nature of these workloads, exceptional performance and availability are necessary. The latter requirement frequently disqualifies the less mature new entrance to the market. We frequently see EF systems in front of frame arrays sometimes actually replacing them.

We are very confident in the competitive position of the EF both now and in the future. A second less clear set of use cases are those that have to be served by more fully featured flash arrays as customers balance the performance and power saving advantages with the higher cost of flash media.

We are seeing some traction highly compressible, less mission critical workloads like BDI. As mentioned in our last call, we are seeing increased deployment of all-flash FAS arrays with Clustered ONTAP.

A customer can create an all-flash node within a cluster and use transparent volume migrations and move less active data to lower cost media as the data ages. Or a customer can distribute the flash throughout the cluster to effectively produce a scale out multi protocol hybrid or all-flash solution.

These are capabilities that no other vendor offers and we expect adoption to accelerate with the introduction of our newly refreshed high performance controller platforms. Units shipped of the EF family grew more than 3000% and all-flash FAS units increased 80% from Q4 a year ago.

Beyond the strong growth of the EF family the branded E-Series products also grew nicely. E-Series units shipped exclusive of the EF products grew more than 170% from Q4 of last year. Our high end FAS shipments grew 8% year-on-year. Mid range FAS systems shipped were roughly flat, and interest expense we're down 18%.

In Q4 we introduced the FAS8000 product line, our first generation of clustered optimized systems. We are very pleased with the performance of the new products and have the fastest initial quarter ramp of any systems in our history. Soon you can expect us to refresh the remainder of the FAS product line.

In past calls I've discussed a difficult environment which we are operating in. Budgets are compressed; customers are expending the life of their assets and delaying purchases while evaluating new technologies. In a constrained environment we must hone our competitive edge and capture more than our fair share of the opportunities.

With the re-architected Clustered ONTAP the introduction of the EF, the ramp of the E-Series and the promise of flash array, we are participating in opportunities that would not have previously been available to us.

We also need to be sure we are investing in the technologies that will be industry leading as the market transitions and new architectures emerge. Our recent realignment was specifically intended to direct our resources towards our biggest opportunities.

Our investments in the integration of cloud services and open source solutions into our software-defined data management framework uniquely position us to enable our customers to operationalize the cloud and other new emerging technologies.

We expect our branded revenue growth to once again outpace that of the total industry in fiscal year '15 with solid gross margins and strong cash flow. Before opening the call for Q&A I'd like to thank the entire NetApp team for their hard work and dedication.

We are focused on innovation and execution, which enables us to meet the evolving needs of our customers and we've strong operational returns. In a challenging environment we are generating operating leverage in our business model supporting continued investment and innovation and yielding strong cash flow.

At this point, we will open up the call for Q&A. As always I ask that you be respectful of your peers on the call and limit yourself to one question, so we can address as many people as possible. Thank you.

Operator?.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Alex Kurtz from Sterne Agee..

Yeah. Sorry about that guys; I was on mute.

Tom, can you just talk about how you see the next fiscal year playing off us around channels in our pipeline whether it's refreshes of new products, new verticals that you are attacking? I think people are looking at the branded product guide for the year and trying to understand how do you get to that number and sort of where you are sort of seeing that play off from a seasonality perspective and new products we expect to have come to the market next phase six to 12 months?.

Yeah, I think as you look at the market overall, clearly that's a challenging environment as you talked about. We see people extending the life of their assets, and if you take assets from a three or four year life to a four or five year life, that's a pretty big hold on growth rate of market, and I think we are clearly seeing that.

There is a couple of things that I think that are specific to us as well. We have a very, very strong federal business. We are number one in market share there. And clearly with the shutdown at the end of the fiscal year, we didn't have that at the beginning of last year.

So I think we got top of Q1 and Q2 compared on the federal side of the business that ultimately will age off. So I think overall we will take a tailwind if we get it, but I don't think anybody is predicting that at this point in time. We are going to try and competing within the market that we are at.

But if I look at the business overall, certainly the OEM were disappointing in this quarter and looking forward with the uncertainty and lack of visibility we have deep into those businesses, I think we are just trying to take that down, so we don't have any more surprises and focus on the branded business.

The branded business was up 4% year-over-year last year. And if I look at our portfolio whether it would be the ramp of Clustered ONTAP it would still relatively early days a year ago.

If I look at how far we come with EF from effectively a standing start to a compelling position in the market, I think the field is embracing E-Series in a meaningful way that they weren't doing a year ago.

And flash only on the way and the other thing is you will hear more about our software-defined and cloud story at Analyst Day, but sharing that with customers I think people view that very, very positively and see that as a reduction of risk by NetApp (indiscernible).

So I think that we've got a set of things even independent in the macro around us that we did not have in our toolkit a year ago. And while we have some tough comparison on the federal side and I don't think anybody is expecting a miraculous turnaround in overall spending, I just think our competitiveness is that much better.

And I think that we can leverage those into growth. And like I said in the aggregate we did 4% branded growth this year. So I believe while we are on the side that's really going to be challenging. We want to take that down, so we can stop talking about it for the time being.

And the real focus is those OEM businesses that are still growing and likewise primarily around the branded. And that's why we broke out the OEM comparison all along because we knew we would be on this downward trend and we will focus on the go-forward businesses..

And Alex, this is Nick, just a follow up on you asked a little bit on seasonality on that branded side of business. We expect that seasonality even for the Q1 to be pretty consistent with what we've talked about in the past, and as I indicated this ramps over the course of the year.

We will go through -- Tom talked about federal in Q2, go through year end in Q3 and a ramp up in Q4, but pretty normal in terms of certainly with the Q4 to (indiscernible) branded side and then ramping through the year..

All right. Thanks, guys..

Your next question comes from Joe Wittine from Longbow Research..

Hi, thanks. The question is on the service provider business, EMC recently came out and framed up the size of the infrastructure, they are selling to cloud SPEs. I think it would be effective kind of lifting the curtain and easing investor concerns on the overall cloud risks.

I know you referenced the third-party data in the past, saying you are number one, but are you willing to kind of frame up the relative size of that business for you and really the world of opportunity going forward as well?.

Well, I think that there is plenty of cloud business definitions out there. We had a vertical market around the service provider community which includes the TELCOs and the traditional service providers. And in fact that's been the fastest growing segment for us.

On prior calls we talked about 200 service provider customers and a number of applications that we run there. And so the service provider, you are seeing the data NetApp number one in storage for the public cloud.

But are we used to go actually beyond that into the hyperscalers and it doesn't certainly mean that we are going to sell the hyperscaler systems, but the hyperscalers are offering capability that's attracting to our customer set.

And what you usually expect to see from NetApp as we rollout, we talked about our strategy is how do we enable customers to realize the benefits of that? How do we enable them to create a seamless extension of their on-premise computing? So, for us the data management component and the software component that is key and I think in some ways that's effectively the ultimate in unified stores just the ability to create an opportunity to seamlessly extend our data management whether it's on our systems or other people's systems whether it's not a private storage in conjunction with Amazon or whether it's actually in the cloud.

So from our point of view is that all of those are components as the traditional sell-through of the service providers that are providing enterprise services and therefore big consumers of commercial equipment. And I think our position there speaks for itself and like I said even last year in a tough market that was our fastest growing segment.

And then beyond that we are also looking to embrace the hyperscalers into our data management framework. So all of those components of the cloud both the traditional service providers and the hyperscalers are integral to our overall strategy..

The next question comes from Brent Bracelin from Pacific Crest Securities..

Tom, I wanted to follow up on the strategy side specifically. What's your appetite -- risk appetite to diversify the portfolio, accelerate growth through M&A? And the reason why I ask you generated over a billion dollars in cash flow over the last four years.

And each of the last four years you have over $4 billion in cash net of debt, but if I look at that OEM partnering strategy that business has been cut in half, now to $440 million kind of run rate. Your branded business has grown 3% or 4% over the last couple of years, but again has benefited from a tailwind around a new product cycle.

So a question here, what's the strategy, the plan that kind of stays the course with what you are doing or are you thinking about different ways to accelerate growth diversify the portfolio through M&A given the strong cash flows, given the cash that you have on your balance sheet..

Yeah. I think first on the OEM side, I think one thing to bear in mind on the OEM is probably two facts. One is while we talk about the OEM business and the OEM business declined there is multiple components to that.

Part of that is E-Series, but there is also N-Series which is the old ONTAP based products for the IBM relationship which is on a similar trajectory, so the OEM business discussions and specifically in E-Series discussion.

On the other hand the branded side of E-Series brought with us the capability to be in the position that we are in with all-flash arrays. In the aggregate you see our flash number, so we are very, very happy with that and likewise the momentum of the E-Series.

And the thing I point out on the EF and the E-Series is the nature of the business that we are competing for and winning there. We in the majority -- the overall majority case we would not have been competing for how we not have those products in our portfolio.

So we are very excited about the E-Series component of the portfolio from a technology perspective as we ever have, and clearly the OEM business, we are on a trajectory that it's on. And clearly we are breaking up that separately anticipating the trajectory that it would be moving albeit to stay a step down was a bit of a surprise.

To be more complete on the M&A side, clearly I think we are open to opportunities that are going to drive the growth of the company.

I think that we are looking for deals that are executable that are obviously affordable that's shipped within our core competency that we can bring value to that by virtue of having it in our portfolio we can add value to the business and ultimately they are going to drive growth.

So I think in a transitioning market whether there is a lot of new technologies and a lot of new alternatives for customers, there is a lot of properties out there to look at. So to answer your question I am not going to signal any intention of any timeframe or any targets.

I am surprised to say we understand the dynamics, we understand what customers are thinking and for the right transactions we'd be very much inclined to do M&A..

That's helpful. Thank you..

The next question comes from Katy Huberty from Morgan Stanley..

Yes, thanks. DSOs would suggest that it was a backend loaded quarter and others have talked about a stronger April relative to the calendar first quarter. Just curious whether you saw that April strength and if that could possibly deliver some surprise in the July quarter relative to your seasonal guidance..

Katy, sure, DSOs at 47 days were a little higher than they were in Q4 of last year. It does talk to certain elements of the business happening towards the end of April, it's all current. So we have no concerns on those and no concerns on collectability.

In terms of the guidance again that guidance is based on bottom up, so we do across the business, across the geographies, across the OEMs and bottom up for Q1. So I would point out that what we talked about before that sequential view of Q4 to Q1 is pretty consistent with what we have done in the past.

We've remained conservative on the OEM side on top of it, which we think is appropriate given how Q4 went and given the position of some of the OEM partners. And I think the guidance stands and I don't think there is anything to suggest that it should be higher than what we've put out there to you at this point.

And the DSOs again are just an element of the business and there is strong execution happening already in Q1 with respect to bringing in all of that cash..

Another point I'd add is that this tends to be a highest DSO quarter of the year, so we are up substantially from the prior quarter. It's up from the prior year, but not as much as the few days, so four or five days. Yeah, there tend to be the cyclicality of the business. But I wouldn't try and read anything into the DSO and second guess our guidance..

Okay, thank you..

Your next question comes from Brian White from Cantor Fitzgerald..

Yeah, just a couple of things, number one could you talk a little bit about the relationship with Cisco and ACI was obviously and also inner cloud that was a big deal at Cisco Live this week. I know you are part of it, their announcements around it.

So maybe how do you think that will play out? And just Nick, around operating margins, it seems like there is a much steeper drop in this Q1 on operating margins and we saw last year we had a similar revenue follow up, so maybe you can address that. Thank you..

Yeah. I think general on many fronts. We continue to collaborate with Cisco. So certainly the ACI, the inner cloud obviously continued with FlexPods and other things around some other initiatives, OpenStack. So we continue to actually need to be, and continues to be a very multi-faceted relationship.

So, in our relation with them I think it's all systems at go. I think we are finding more and more ways to engage. As far as inner cloud and ACI, clearly those are top initiatives for them. So I think being connected to them, being part of messaging, being part of private offering and part of their customer discussion is really important to us.

So I think -- although I think Cisco is pushing pretty hard and I think that collaboration with NetApp is working really well. I think we continue to have momentum where we talked about FlexPod shipments being up 71% year-over-year. So I think -- so very, very much alive and well.

And in fact now with ACI and inner cloud I think we just had an appearance with them this week at the Cisco Live Event..

Yeah, I think the other point I would make on the in terms of the sequential here, I talked about the sequential revenue declines and when I go back a couple of years and there were sequential revenue declines from Q4 to Q1 of intimate teams. Last year it was 12% which is Q4 '13 to Q1 '14.

Those will carry with them, a decline in operating margin of the company, all of them were. We also have gotten some benefits in the fourth quarter from our repositioning activity that we did and quarterly talked about that in terms of the earnings. We will start reinvesting those that's a reallocation activity.

So that's all baked into the change the difference in operating margins from Q4 of '14 to Q1 of '15. So I don't think there is anything outside of that. We are balancing investment, we are balancing returns from the business and we are balancing sequential revenue decline that we typically expect from Q4 to Q1..

Yeah, in fact we are -- if we go through the guidance we are actually guiding above where we were a year ago and that promising the same trajectory to see we are at almost 21 points at this point by now. So clearly there is seasonality.

We think gross margin of the business obviously the revenue fall through the bottom line is actually quite large, so as the revenue is volatile so is the bottom line. So yeah, it's a transition from Q4 to Q1, I get that, but if you do the year-over-year compare I think it leads us in a position to deliver on next full year commitment..

Great, thank you..

The next question comes from Kaushik Roy from Wunderlich..

Hi, Tom.

So can you help us understand why the traditional storage system vendors IBM, EMC and others start to see negative revenue growth whereas the new hybrid vendors such as (indiscernible) growing so rapidly? Is it because they have a new architecture that's superior? Alternatively does NetApp need to build something from the ground up?.

Well, I think that obviously you have got much, much different scale. You've got install base. There is a whole bunch of dynamics that separate the smaller players from the bigger players. And when I look at this I mean those cover a fair amount of ground in terms of use cases.

I think there are some of those technologies there that are outside of our current space if we were to participate organically we would have to start from scratch, but in the storage systems market, if anything I'd use flash as an example.

We certainly heard a lot of this start from scratch new technology, everything we knew about the past is no longer relevant and here we are with EF in a very, very strong position, in a very, very well defined segment of flash.

And then likewise I think the ability to deploy flash not necessarily as a standalone point product, but as a nod in a cluster with all of the data management and the volume migration and all of that that goes with it, it's a pretty compelling offering.

So we've heard this, do I need to start from scratch and certainly if it's not in a business that we are currently in the answer to that is yes. And the businesses that we are in if I actually look at where the momentum lies in this business and who is actually driving the leadership position here, it's actually NetApp.

And flash is probably the classic example here. I'll just state it flat out. I would not trade the flash portfolio of NetApp with the flash portfolio of any other company we have to start it from scratch or otherwise..

Okay. Thank you..

The next question comes from Srini Nandury from Summit Research..

As you look at last quarter you gave us information about the number of customers you are adding, can you provide this statistic if you can this quarter? And as you look at average deal size over the years, how has that changed most recently?.

I don't remember a new customer component. We may have talked about in specifically in terms of maybe in EF or E-Series, but suffice to say those numbers were up huge, in fact the E-Series bookings roughly doubled in two quarters with the EF included. So that continues at a big number.

So I don't remember that number off the top of my head, but its fine to say it's robust. In terms of aggregate deal size, in terms of overall transactions, if you look at our mix we are seeing 3000 and 6000 so I should say the mid range and high end platforms doing a bit better than the lower end platforms.

So in the aggregate the ASP just on that basis will be going up, but that's individual box ASP. I think more broadly if there is probably one trend that we saw over the course of certainly of Q4 is we actually saw more bigger deals available to us.

And if I said there was one thing that we saw in that quarter that was different than perhaps some other quarters is just very, very significant deals. And they come in various varieties. Some of them are Tech refresh and some of them in new projects. And the other thing is enterprise service and enterprise license agreements.

Very, very large transactions are not to mention while I don't have this in a new term in terms of revenue realization you will see it on the differed balances up $100 million from last year. So if I just go to deals overall, I would say more bigger deals available to us, maybe that's a positive development, but too early to tell.

But the other thing that we saw a lot of last quarter more so than any other quarters enterprise license agreements, enterprise service agreements. And the value to that of course is while it does have the near term revenue because of the ratability of it.

It's a commitment to NetApp over the long term, obviously it's key and in some ways because the software is pretty sold. That's also a commitment to on-premises' computing..

Thank you, Tom..

The next question comes from Keith Bachman from Bank of Montreal..

Hi, Tom, I would like to ask on a strategy question as well, particularly related to the OEM business. The OEM business was down 34% this quarter. You are guiding it to decline by another 40%. The margins are lower than the branded business. Why be in the business? It sounds like you are letting customers continue to take their business back.

Why not be more proactive in taking the business to its natural state rather than watching it decline?.

Well, I think that being in the business means a few things. I want to be clear on a couple of points. We could cease to serve products to our OEMs. I guess that's a way to exit the business.

If the idea is why don't we just get rid of that business on the technology is that the technology underneath that business is the E-Series technology and the EF that goes with it, which is very strategic for us and there is a lot of momentum? And likewise the N-Series which is also on the same downward trajectory with IBM have ONTAP underneath it.

So at the end of the day the technology investments behind these technologies that are driving our branded business are alive as well and we are excited about those as ever. However, they are taking through those through the OEM channels clearly is what we are talking about here..

Yes..

There are two things. One of which is the investment in terms of the restructuring that we just did. Clearly the OEM go to market activity around those vendors that are more committed to us long term that's clearly an area that we have taken down. And we get that next size in proportion to where we think this business needs to be.

The other question of why we just stop selling to them, I think what that does is just takes the number down fast and that doesn't change the ultimate outcome. In the meantime there is no doubt that some of those products that are being sold to customers and we were going to get to on our own.

Now the broader question for partners that have made choices other than NetApp we are not sitting idle by. We are competing to preserve that business and bring it into the NetApp domain. So the idea that this is a passive where you will sit and watch, I wouldn't say that. We've clearly scaled the business appropriately.

We are clearly investing in the technology although targeted primarily for our branded customers. At the same time where the relationship is not good or where they are making choices about other products in that portfolio, we are aggressively pursuing that and competing with our branded product in our existing channels..

So the inference time just that this business ends up being a 50 million to 60 million run rate business or does it ultimately go to a position where it's at zero. And I understand the technology is important, that not what I am suggesting, but just the OEM slice in particular..

Yeah. I don't think it will ever go to zero, because their elements, their relationships in the OEM business that are actually quite positive that are entirely incremental to us and with the right investment very profitable for us as well. So we are not going to get rid of those.

But it should be quirky, the reason why we broke this business out in the first place two years ago or three years ago from the very beginning was the understanding that was going to be on a trajectory different than the branded. The rationale of the transaction was not about the branded business. That was nice.

That was really about the technology and the opportunity -- I'm sorry, it's not about the OEM business, it's not the technology and the opportunity we can connect on -- we could go after on the branded side.

So if we thought that this business have the same economics and the same run rate we've never broken it out if they are two different categories.

It was an understanding that we will be moving in this direction is why we want to be able to carve this off and just view whatever we get out of that as incremental and focus on the momentum on the branded side which on the E-Series has actually been quite strong. So at the end of the day, I think this latest step down was a surprise.

We will upfront about that, that's not what we forecasted. On the other hand, the overall trajectory of down from the first day when we acquired it, that is not a surprise, and that's why we broke the businesses out and report the way we do..

Okay. Thanks, guys..

The next question comes from Lou Miscioscia from CLSA..

Lou Miscioscia - CLSA:.

And then secondarily, we've talked to a lot of service providers in hyperscale, web hosters and not all of them actually designed their own software, so making it difficult for you to sell any product to them.

Where does that break exist? Could you shed some light on that? Is it just three or four that do it all themselves, five, 10, 15, where do you think it might exist? Thank you..

Okay. So clearly a few questions in there; I think -- so let's actually start from the hyperscalers and work back.

And so the likelihood of our selling or companies like us selling full systems to the hyperscalers to deploy in their environment is pretty low, because they've engineered their environment and written their own tools and in a lot of case they've written their own apps.

So in that particular case, would we consider unbundling our software and selling elements of our intellectual property to them? Absolutely, we would, because the data management problems that they face don't go away. There are still challenging problems.

I don't want to signal that that's what we're doing whether there is an incremental revenue stream associated with that, I'd just say that that's something that we will be opened to under the right circumstances.

But the difference between the hyperscalers and some of the other service providers, even the large ones is in order to do these roll your own, develop your own solutions and infrastructure takes an enormous amount of R&D..

However, they ultimately will need to compete with Amazon. And it isn't clear or certainly not clear that they've got the R&D to basically engineer all of these things themselves, which is driving a level of collaboration with them, and that drives the desire for such things. Its OpenStack technologies or open source technologies like OpenStack.

So, from our point of view in helping our service providers create services that can compete with those guys we are also collaborating with a lot of the open source community to help them create solutions that they can customize for their environment that leverage the open source community. So it's a whole hierarchy of things.

So I think if we are going to sell for the hyperscalers, primarily being intellectual property type of transaction and if we sell to service providers, in some cases depending on the scope and scale and complexity of the services they are offering by standard products, and in addition we will also try and do some element of customized do-it-yourself open source and that's what's really driving our investment in OpenStack.

But the other thing about the hyperscalers is we are viewing this as the hyperscale only as the customer, and I think what you will hear more from us on Analyst Day, too much to go into here is the hyperscalers offer a set of capabilities that are very attractive to the customer and being able to operationilize that and deliver those values to the enterprise customer is still a very difficult problem.

And the question is how do you create a seamless extension of on-premise computing into the cloud that can leverage the hyperscalers? And the key component of doing that is data management. And we will talk about our software-defined strategy and how ONTAP enables us to solve all of that.

So the kind of longwinded answer here is that all of the service providers are both also partners.

Sometimes we will sell them full systems, sometimes we will collaborate with them around their open source, sometimes we will sell intellectual property, but at the end of the day the end goal is how do we create a set of services that could be consumed by the enterprise and then afterward the seamless expansion of on-premise computing and the data management that goes with it is very, very, very important to realizing the hybrid cloud vision..

Thanks, Tom..

Your next question comes from Rajesh Ghai from Macquarie..

Yes, thanks. A lot of commentary on the goal regarding the momentum of the E-Series and EF-Series; I was hoping you could quantify the size of the branded E-Series business.

And related to that, I wanted to understand the factors behind the decline of OEM business, how much of that has been caused by OEMs moving to other solutions or their own solutions and how much is related to the macro, secular challenges you are facing in the server businesses? Thank you..

Well, I think the nature of the OEM business is first and foremost their ability to compete, and then the other factor is what is the product mix within that account? And I think that they all vary. IBM is probably the most visible and the most common one.

They report the storage business separately down significantly in the last few quarters over 20%. Likewise, IBM also has a portfolio of products that they can sell that are alternatives to NetApp.

So I think at IBM we have both of those dynamics in play, and that is their ability to sell-through has been challenged and likewise our positioning within their portfolio has been challenged. Now, the other OEMs vary OEM-by-OEM. And one of the things about the OEM business is you need to be careful about what we disclose about them.

But I'd say that amongst our other OEMs I think we are firmly positioned in terms of the products that we offer, so the dynamic of mix shift within the OEM I don't think is in play. And I think most of the OEM dynamic is related to their own sell-through..

So, maybe why don't I make a point there, Rajesh. We actually don't go into the specific details on the sizing of each piece of business. What I would say to you and Tom mentioned before around why we did this transaction three years ago and the value of the E-Series to that transaction.

So when we go look at how are we doing on the transaction side of the fence and we look at the ramp up and the run rate we are now driving for on the E-Series branded side, we are actually well within, if not, trending above our original expectations of that business.

So we are very satisfied with how the E-Series branded business is going and how that technology is working in this portfolio..

Probably the other thing I would add on E-Series is that if you look at where EF is moving aggressively which is effectively SAN database acceleration. That's probably not a market that's been a dominant notion for us in the past.

And it's probably safe to say that overwhelming majority of the opportunities we're pursuing there are opportunities that would not have been available to NetApp, had we not have that product in our portfolio.

And I think likewise, if we look more broadly at the E-Series and where that's been deployed, the type of use cases around pricing performance and capacity optimization, those two are workloads that probably would not have been pursued by our sales force, but we not had those elements in the portfolio.

So if I look at E-Series I think that there is no doubt that E-Series is not substantially overlapping what we currently have that E-Series is truly bringing incremental opportunities to NetApp both within our existing accounts and as a tool to open new accounts..

Excellent, and thank you..

Your next question comes from Sherri Scribner from Deutsche Bank..

Hi, thank you. I wanted to get your thoughts on overall enterprise spending as we move into the back half of the year, obviously enterprises have been confused about what they want to invest in terms of their infrastructure, and we are seeing a positive spending.

Your guidance suggests there are some acceleration in growth in the back half of the year. I think IDC has updated their expectations expecting an acceleration on the back half, I just wanted to get your thoughts about linearity for the year. Thanks..

Well, I think one of the things that's a factor that will be unique in NetApp is really federal. We saw a federal slowdown with the shutdown and the budget activities. And that hit us hard in Q3 and Q4. So we will have tougher compares on the federal side for sure in Q1 and Q2. So that's clearly a factor that's specific to us.

I also think that we have got our own dynamics as our own product refresh, but the product's family of the hardware platforms are probably never been newer than they are today. So as we get the laps of those announcements into the market I think we could see some uptick there.

I think a broader sense of overall IT spending, certainly we see equipment aging. We clearly see that. We see some bigger deals that I talked about earlier last quarter, but I think at this point it will be probably a little bit too early to both predict and return and also factor that into our guidance.

Our guidance is pretty much based on the NetApp's specific factors and no fundamental material change in the market overall. If we get a tailwind we will take it, but right now we are assuming no change in the market as we think about our go-forward plans..

Okay, that's helpful. Thank you..

The next question comes from Scott Craig from Bank of America..

Hi, thanks, good afternoon. And Nick, I was wondering if you could just discuss the gross margin outlook for fiscal 2015, there is obviously going to be a number of moving parts and that could be mix or whatever.

So I was just wondering if you could give us your sort of assumptions as you look at the product and services and then some of the underlying assumptions even within those banks..

Sure. I think when you look at the year and you look to the overall guidance of 63% to 64% there is always going to be puts and takes quarter-to-quarter. Over the past year on the product gross margin side we had a pretty substantial ramp up here over the course of the year. We've talked about the productivity we've driven in the system.

Right? We have also talked about continued price competitiveness in spite of driving that additional productivity in the system. And in addition there is going to OEM mix. And that certainly was part of Q4. And I talked about warranty and those types of things as well. So those are all factors that we will work through in FY'15.

So on the product side of the fence I'm not specifically pointing out your guidance range for product or service or SEM should be X. I'll potentially talk more about that at the end of June at our Analyst Day, but these types of rates certainly I would expect that product gross margin will be down a bit in Q1.

So I wouldn't want anybody to take away that 58%, which is the exit from Q4 is the floor for next year and this will be what it is. It's going to be little bit more dynamic than that. But continuing to work the productivity side, looking at the mix, all of those pieces will play a part.

On the services side of the fence we ended the year pretty substantially up. The services side is little fundamentally different from the product side.

And why is that, because on the services side of the business we invest in front of the revenue that is to come, because in many respects big chunk of this business is us servicing contracts that we have entered into for periods of time.

So we will from time-to-time make significant investments in that infrastructure and then take advantage of those investments as we go. So certainly when we look from a Q4 to a Q1, I'm expecting that services gross margin to come down.

I expect the services gross margin to move around a bit over the course of the year, but again be within those types of guide posts of the overall margin guidance I gave at 63% to 64%. Last point on that service is 62.6%, which is a Q4 exit is a high watermark, and I'm looking at four years of history here.

So I don't think you should take away -- that's the type of rate we would expect on services gross margin certainly in Q1 and likely for good part of the year and 2015..

Yeah, I'd like to actually add a little bit different -- an additional commentary on the gross margin side. The gross margin side in terms of where we've been, it's actually up three points year-over-year in each of the last two quarters. And I think that's a function of several things.

Nick went through a number of the elements, but on the product side, clearly we spend a lot of time this year working through the COGS side of the equation driving efficiencies in the business, and I'm really pleased with the work of the team on that front.

But at the end of the day, the competitiveness in gross margin goes through the competitiveness of the product. And I think there is a lot to be said in that number in terms of the competitiveness of products than we were a year ago.

So one of the questions that we get a lot in forums like this or in callbacks later is are you basically letting growth go in favor of gross margins? It's just simply not the case.

I mean one of the things that I want to be really clear about is that in this environment there are not a lot of big deals running around and we have a lot of capacity chasing too few deals and nobody can afford to walk from deals. So we are competitive, we are aggressive, particularly in trying to break into new accounts.

And NetApp is not walking away from business based on price. On the other hand, within a reasonable set of bounds at the other day price is not the primary driver, ultimately functionality, not with that limit, but within bounds functionality ultimately determines who wins and who loses here.

I think what NetApp has proven over the course of this year is that with the training of our partners, the training of our people and the understanding of our customers of the value proposition that we can win on function that we don't have to the price leader to be successful here.

I think that's what you are seeing, three points of gross margin increase for NetApp and you are also seeing declines in gross margin of our competitors. I don't think that's a coincidence that's directly tied to the competitiveness of products in the face of the customer..

Thank you..

Our final question comes from Maynard Um from Wells Fargo..

Hi, thank you. Free cash flow as a percentage of net income over the past four years in the fourth quarter has been really in the mid-high 20% to 30%. In this quarter it's at 19%.

I think some are obvious, but can you just talk about the puts and takes and then how we should think about free cash flow in Q1 and fiscal '15? Can this drive back up to sort of the 19% to 21% type levels? Thanks..

Yeah. Maynard, I'll go into cash flow certainly at our Analyst Day. When we look at cash flow we certainly think about the high-teens types of numbers, and that's what we model out. And we are thinking through what we need in the business and what runs through on the net income side, but we are going to have to think about DSOs.

Obviously we've talked about that earlier on this call; CapEx and a number of other factors. So when you think about free cash flow as a percentage of revenue, those types of high-teens is where we aim for that. Certainly it doesn't happen quarter-to-quarter. And Q1s are usually lower in terms of cash flow performance as a percentage of revenue.

And then we look at capital allocation and I'll just reiterate we're going to expect again a year where we generate over a billion. We had very strong performance each year of the last several, and this is a cash flow generating company and at a high-teens as a percentage of revenue I think is very, very healthy.

And then we go and talk about capital allocation. I think what we've done there over the past year and what we plan to do for this coming year is also very strong..

Great, thank you..

I would now like to turn the call back over to Tom Georgens for final comments..

Thank you, and thank you all of you for your interest in NetApp. I think as we finished Q4 and we finish the fiscal year, if I had a high level theme it's that NetApp was very, very strong on the execution front on the operational perspective driving very, very high gross margin, very, very high operating margins.

So, on a tough environment I think the ability of the company to execute, drive value to our customers and ultimately deliver compelling returns to our shareholders with EPS up 22%, I think that came through.

In calendar year 2013, where we had market share gains above the average of our last 10 years, and we continue to look forward to the upcoming year where we have things we did not have a year ago, we've got Clustered ONTAP, and that was true momentum. We've got the E-Series. We've got the momentum of our flash. We've got new platforms.

We've got flash array on the way. And we also look forward at Analyst Day recognizing that this is also an industry in transition, but now we can compete for on-premise computing and the elements today.

We are also talking about where we are going as a company, our vision for software defined, our vision for the cloud, and NetApp continues to be relevant and continues to be successful. So thanks all of you for your time today, and I look forward to seeing all of you at Analyst Day. Thank you..

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect..