Operator:

Good day, and welcome to the NetApp Fourth Quarter Fiscal Year 2024 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President, Investor Relations. Please go ahead.

George Kurian:

Thank you, Kris. Welcome, everyone. We concluded FY '24 on a high note, demonstrating robust performance in the fourth quarter and building positive momentum as we step into FY '25. Our revenue for both Q4 and FY '24 exceeded the midpoint of our guidance, reflecting the strong growth of our expanded all-flash portfolio. Throughout FY '24, we maintained a high level of operational discipline, leading to company records for annual gross margin, operating margin, earnings per share, operating cash flow, and free cash flow. At the start of FY '24, we implemented a plan to enhance the performance of our storage business and build a more focused approach to the Public Cloud business, while managing the elements within our control in an uncertain macro environment. This plan has yielded tangible results, and our value proposition is resonating strongly in the marketplace. Customers are increasingly turning to NetApp to help them build intelligent data infrastructures and leverage the power of public and hybrid clouds for rapidly growing, data-intensive workloads like AI, cloud-native, open-source, and enterprise applications, while ensuring their data remains secure and protected from ransomware attacks. NetApp uniquely delivers a comprehensive and integrated portfolio of unified data storage solutions based on one operating system, ONTAP, supporting any application, any data type, and spanning on-premises and multiple cloud environments. We deliver unparalleled simplicity of data management, and infrastructure and application deployment with consistent automation, all unified by common APIs and a single control plane. In a world of limited IT resources, rapid data growth, and escalating cybersecurity threats, we empower customers with the flexibility to rapidly deploy new applications, unify their data for AI, simplify cloud integration, and strengthen data protection. Now to the results of the quarter. We delivered robust year-over-year performance in our Hybrid Cloud segment, with revenue growth of 6% and product revenue growth of 8%. Strong customer demand for our broad portfolio of modern all-flash arrays, particularly the C-series capacity flash and ASA block optimized flash, was again ahead of our expectations. This demand propelled our all-flash array annualized revenue run rate to an all-time high at $3.6 billion, up 17% year-over-year. Early in Q1 of FY '25, we unveiled our new all-flash A series unified data storage products, offering customers enhanced performance and effective density at a lower cost than the previous A series generation. These products set a new standard for enterprise storage, enabling customers to turbocharge workloads ranging from traditional enterprise applications to GenAI. The new AFF A-series, coupled with our highly successful C-series and TAM expanding ASA product, position us to further increase our share in the all-flash market. Keystone, our Storage-as-a-Service offering was also a highlight of the quarter. Keystone provides cloud like management for hybrid cloud resources in a single subscription with flexible multiyear contracts that align storage costs with business needs, enabling rapid response to changing capacity and performance requirements. We consistently hear from customers that our integrated service level assurance, with performance, availability, ransomware recovery, and sustainability guarantees, is our differentiator. This has enabled us to accelerate growth by displacing competitors' storage-as-a-service subscriptions, winning new Keystone subscriptions, and expanding existing ones. FY '24 total contract value sales of Keystone more than doubled from the prior year to almost $150 million. We expect this momentum to continue and that FY '25 will be another significant growth year for Keystone. A leading semiconductor manufacturer selected Keystone as the vehicle to consolidate its storage needs. Initially aiming to select one vendor for block and another for file, we established ourselves as their single global standard for both environments, displacing the incumbent for block storage. This multi-year eight-figure deal allowed the customer to reduce the complexity and improve the availability of their storage environment. AI is a top priority for organizations as they seek to accelerate innovation, revolutionize operations, drive competitive advantage, and deliver superior solutions to their customers. Data management is essential for enterprise AI. Customers choose NetApp to support them at every phase of the AI lifecycle due to our high performance all-flash storage complemented by comprehensive data management capabilities that support requirements from data preparation, model training and tuning, retrieval-augmented generation or RAG, and inferencing, as well as requirements for responsible AI including model and data versioning, data governance and privacy. We continue to strengthen our position in enterprise AI, focusing on making it easier for customers to derive value from their AI investments. In Q4, we introduced NetApp AIPod with C-series capacity flash systems, delivering a new level of cost and performance, rack space utilization, and sustainability. In conjunction with Cisco, we updated FlexPod AI reference architectures to support the NVIDIA AI Enterprise software platform, giving customers an end-to-end blueprint to efficiently design, deploy, and operate AI infrastructure. We were one of the first partners to complete the storage validation for NVIDIA OVX systems and at the start of Q1, we were the first to announce a full-stack OVX system. The NetApp AIPod with Lenovo ThinkSystem servers for NVIDIA OVX is optimized for GenAI and designed to support RAG. We announced much of this innovation at NVIDIA GTC, where we were honored to be recognized during the Keynote for our role in storing a significant portion of enterprises' unstructured data, which is the fuel for GenAI. Through our partnership with NVIDIA, we give customers the ability to talk directly to the large amount of existing data stored on NetApp on-premises and in the cloud, demonstrating the value of our installed base and this critical role we play in AI. We are the AI infrastructure of choice for one of the world's leading oil and gas companies. The company is developing its own large language model, using a high performance AI cluster with NetApp all-flash storage. They are now also building an AI Center of Excellence to support various departmental AI initiatives and have again selected NetApp storage for this part of their AI infrastructure, leveraging C-series to optimize price and performance. They are rapidly ramping up their AI infrastructure, building new models, and onboarding AI resources. They awarded us the deal over their AI server vendor because of our ability to remove to remove roadblocks in their AI workflows and accelerate the time to value from their AI investments. Public Cloud segment revenue was $152 million, up 1% year-over-year. First-party and hyperscaler marketplace storage services remain our priority and are growing rapidly, increasing more than 30% year-over-year and driving cloud storage services to two-thirds of total Public Cloud ARR. These offerings are highly differentiated and closely aligned with customers' purchase preferences. In Q4, we had a good number of takeouts of competitors' on-premises infrastructure with cloud storage services based on NetApp ONTAP technology, which helped drive our best quarter for cloud storage services with each of our hyperscaler partners. We are well ahead of the competition in cloud storage services and we are innovating to further extend our leadership position. In Q4, we further increased the performance of Amazon FSx for NetApp ONTAP, addressing an even broader set of performance intensive workloads. We also introduced a new service level for Google Cloud NetApp Volumes giving customers more granular control to match the capacity and performance needs of their cloud workloads. We were proud to receive Google Cloud's Technology Partner of the Year for Infrastructure, Storage for the second consecutive year. Reflecting on FY '24, I want to thank the NetApp team for their work to strengthen our position. We have a stronger, more complete all-flash portfolio are addressing a wider set of cloud storage workloads, and have a robust go-to-market plan, better positioning us to win across the board and in new markets like AI. Without question, our modern approach to unified data storage, spanning data types, price points, and hybrid multi-cloud environments is resonating in the market, giving us solid momentum as we enter the new fiscal year. Looking ahead to FY '25, we are cautiously optimistic on the macro environment. The backdrop is better now than it was at the start of FY '24. We will remain laser focused on our top priorities while continuing to raise the bar on execution and maintaining our operational discipline. NetApp is leading the evolution of the storage industry, helping our customers make their data infrastructure intelligent for the age of AI. I am confident that this leadership, coupled with the strong momentum we've built through FY '24 positions us for continued growth and share gains. I encourage you to attend or tune into our June 11th Investor Day to learn more about our long term strategy. Visit our investor relations website for more information. I'll now turn the call over to Mike.

Kris Newton:

Thanks, Mike. Operator, let's begin the Q&A.

David Vogt:

Great. Thank you, guys for taking my question. Maybe, George, to start, you spent some time talking about the competitive successes that you had in the quarter and the strength of both the A-series and the C-series. Can you maybe expand upon that relative to sort of what you're seeing in the macro? I mean, there's a lot of discussion in the market, not just for storage, but in IT for general macro headwinds and it doesn't appear to be a big factor for you this quarter. And then with regards to Keystone, you talked about some displacements because of a whole host of factors with the offering. Can you maybe expand upon what were some of the more important factors? You mentioned performance. Was price a consideration, or is it really the suite of solutions, the suite of offerings that really drives sort of that Keystone success? And can you maybe talk about the average length of these agreements? Are these two to three year agreements? Any color there would be helpful. Thank you.

David Vogt:

Perfect. Thank you very much.

Matt Sheerin:

Yes. Thank you. George, regarding your outlook for growth for fiscal '25, 4.5% growth, which, as you say, reflects macro concerns, we are hearing another reason is that vendors focusing on AI investments, which are leading to push-outs of other projects, including both hardware and software. We heard from another -- a number of big companies just this week. Are you seeing signs of that as well in your business, or is that just -- are you just seeing continued cautiousness concerning all budgets?

Matt Sheerin:

Okay. Thank you very much.

Meta Marshall:

Great. Thanks. Maybe the first question, just on the first-party and marketplace cloud storage strength, is there any trends that you're seeing with the type of customer? Is that somebody who is an existing NetApp customer or those largely new customers? Just any trends of who are those customers where you're seeing that strength? And then, maybe just the second question for Mike. It would seem that Q1 is starting seasonally strong, at least in comparison with last year, which maybe was seasonally weak. Is some of that A-series launch -- just how to think about how A-series launch impacts the seasonality of the year? Thanks.

Mike Berry:

Thank you, George. Thanks for the question, Meta. So yes, we do expect Q1 to be seasonally strong. As you mentioned, Q1 of last year was seasonally weak, so it is one of the easier compares, I'll say, for the year. In reference to the A-series launch, we're super excited about it. That is something that's just gotten started, though, so it won't have a big impact on Q1. We do expect that though, to start driving some nice trajectory as we move through fiscal '25.

George Kurian:

Thank you.

Samik Chatterjee:

Hey. Thanks for taking my question. I guess, George, you talked about the support and sort of the infrastructure that you're providing your customers as they go through their AI deployments and the wins you have. I was just curious if you can give us a bit more sense about how to then translate that into revenue, particularly when I think about sort of fiscal '25 guide here, how much of that is incorporated in terms of those deployments in your revenue and how to think about that ramping in the out year. And a quick follow-up for Mike. Mike, if you can just help me with the puts and takes in terms of gross margin variance between Q3 and Q4, that will be helpful in terms of what the headwinds and tailwinds were. Thank you.

Mike Berry:

And on your follow-up, Samik, on gross margins from Q3 to Q4, so as we talked about in the prepared remarks, we did come in about 130 basis points higher on product margins. We had guided around 60%. That was largely due to better mix. As we had talked about, we did expect that to come down from Q3 just because it was our Q4 and that's largely what happened. We support gross margin very consistent. And importantly, we started to see a nice increase in our cloud gross margins and we expect that to continue in the next year. So pretty consistent performance Q3 to Q4 in our gross margin line.

Operator:

The next question comes from Mehdi Hosseini with SIG. Please go ahead.

Mike Berry:

Yeah. So we got it in full year, 27% to 28% operating margin. And yes, operating margin was always a little bit lower on a percentage in Q1 just given the seasonality. So I think what you're referring to, Mehdi, is we did do the restructuring last year in Q4. As we enter fiscal '25, we do have some leverage continuing in OpEx. We do expect OpEx to grow, I'm going to say, about 2% for the full year basis on a revenue guide of about 4.5%. We are doing targeted hiring in sales and in engineering to drive key product initiatives. Outside of that, as we've always said, our goal is to always drive operating leverage in the business and have OpEx grow at a rate less than OpEx -- than revenue growth, excuse me.

George Kurian:

Yeah. So, the 30%, keep in mind, that was the highest that we saw in our gross margin numbers. And we have talked about many of those starting higher in fiscal '25 and then coming down as we go through the year as we go through the pre-buys that we have for SSD. So, it is significantly influenced by that gross margin number. We'd love to get back to the 30%. At this point, a lot of that depends on where the gross margin line goes.

George Kurian:

Thank you.

Steven Fox:

Hi, Mike. Just to follow up on his points on pre-buys, can you just maybe further outline your strategy in terms of pre-buys? Would you continue to do that six months out, 12 months out, etc., or is it more depending on how you view the market? And along those lines, can you give us a better sense for sort of the gross margin headwinds as you get into the second half from the higher NAND costs? Thanks.

Steven Fox:

Great. That's helpful. Thank you.

Operator:

The next question is from Simon Leopold with Raymond James. Please go ahead.

George Kurian:

Yeah. Listen, a couple of quarters ago, we said that we were taking action to sharpen the focus of our public cloud business. Those are along two dimensions. The first was to continue to drive the execution of a growth strategy around our first-party and hyperscaler storage services. As we said, storage is now about two-thirds of the total cloud business, and first-party and marketplace cloud storage services are the preponderant majority of our cloud storage. And that has performed really, really well and is the foundation for long-term success and growth in cloud. Second, we said that the subscription business had headwinds related to cloud optimization, and we took several actions to improve the health of our subscription business. As a reminder, we said that subscription was about a fifth of the total cloud business, so a small part, and we took actions to both stop selling certain products and services that were no longer a part of our go-forward plan, to migrate some customers from our subscription offerings to our first-party cloud consumption offerings, to integrate some of the subscription products as being features of our cloud storage offerings, and to be able to sharpen the value proposition of our subscription offerings and work with our customer success team to improve the value to the client. What this has resulted in is a decrease in subscription revenue in the second half of this year, as we forecast, but the headwinds from that decrease are getting smaller and smaller, and over the course of the first half of next year, we feel that a large part of those headwinds will be mitigated. We expect that cloud first-party and marketplace cloud storage should continue to ramp strongly, which will deliver overall growth in cloud, consistent revenue growth in cloud in fiscal year '25, stronger in the second half than in the first half.

Operator:

The next question comes from Wamsi Mohan with Bank of America. Please go ahead.

Mike Berry:

Yeah. So, Wamsi, so sorry if -- hopefully, I said it correctly. What we talked about is we're still comfortable with the 58% to 60% range in product growth margins for the full year, starting out higher in the first half and then sliding down as we go through the second half and use the inventory of pre-buys.

George Kurian:

Listen, I'll take that question in two parts, one on the revenue side and the second on the gross margin side. On the revenue side, we continue to believe that customers budget in dollars, not in systems. And so, while we expect that the industry will follow the normal course of behavior, which is to raise prices to customers as commodity prices go up, we don't expect that to translate into directly increasing revenue. Customers will buy smaller amounts of storage if they have to pay more for it, but they will spend the dollars budgeted for it, and that's what's reflected in our top-line. With regard to cost of goods sold, I think, first of all, as Mike said, we have completed a large percentage of our forecasted demand for NAND through the course of next year, and as we have said before, NAND is less than 50% of our total cost of goods, the rest of which is flat. The outlook we are providing is based on our current -- is based on current market pricing. If the overall market raises prices as we have done in the past, we expect to follow the market, and that should be accreted to the outlook that we have provided.

Wamsi Mohan:

Okay. Thank you so much.

Tim Long:

Thank you. Two also, if I could. First, [Technical Difficulty] Can you hear me?

Operator:

Tim, if you can hear us, we'll move on, but you can dial back into the queue at any time. The next question is from Nehal Chokshi with Northland Capital Markets. Please go ahead.

George Kurian:

We expect public cloud storage, particularly first-party and marketplace, which are the focus of our cloud efforts to continue to grow nicely through the course of the year. I'm not going to comment about sequential growth rate each quarter. We had a really nice quarter this quarter, and we had a good year all year. I think that we see that first-party and cloud storage and marketplace is a much bigger part of our overall cloud business entering fiscal year '25 than it was entering fiscal year '24. And the rest of the offerings, as I said, we continue to sharpen the focus and be more targeted in terms of our subscription offerings. They will have a little bit more headwinds in the first half of the year, but we expect cloud to grow consistently in FY '25, stronger in the second half than in the first.

Operator:

Thank you. The next question comes from Tim Long with Barclays. Please go ahead.

George Kurian:

Yeah. Thanks for the question. With regard to upgrading an existing hybrid flash customer to our C-series, there are enormous advantages for a customer of NetApp to stay in place because we have the same operating system, the same management console, the same telemetry system, and we can do that virtually seamlessly for customers. And so, we've seen a good chunk of upgrades from 10K drive environments to our all-flash, and we expect that to continue over time. Those will come up as customers upgrade their fleet in a periodic and steady fashion. We also saw a lot of new to NetApp environments in our customers where we were able to either displace competitive footprints and/or bring new footprints to NetApp as customers deployed new applications. We talked about the example with Keystone in a large customer that was considering two different approaches, one for file and one for block, and decided to unify on NetApp. We have seen several environments where hyper-converged VMware landscapes are now moving to optimize the cost of their VMware licenses and are using C-series. And over time, we just introduced the C-series AI part that gives clients a cost-effective capacity flash-based AI model training and inferencing environment. So, we're excited about the prospects with C-series. Listen, everybody will have their alternatives in the market. We feel really good about the fact that we have the industry's most comprehensive data management, the only real hybrid cloud solution, and a track record of having really large-scale data management capabilities on our flash products. And we feel very, very confident getting into next year.

Operator:

The next question is from Ananda Baruah with Loop Capital. Please go ahead.

George Kurian:

We have four growth opportunities that we are focused on, all-flash storage, block storage, cloud storage, and AI. And let me get each of those in turn. In all-flash storage, we have seen strong success with high-performance flash replacing legacy frame array and sort of traditional mainframe class storage with much more modern high-performance landscapes. We have seen the C-series both replace hyperconverged as well as traditional hybrid flash architectures, upgrading both our install base and competitor install bases. With the ASA platform, which is block, the second part of the growth opportunity, that is TAM-expanding for NetApp. And we are excited at the wins that we've seen and the momentum that we have. It will be a smaller business this coming year relative to the C-series and the AFF A-series, but it will be all TAM-expanding for NetApp. And I'm excited at where we are today. With cloud storage, listen, the cloud market is an enormous market. It's a multi-billion-dollar opportunity, and our cloud storage is a part of that opportunity. As the cloud providers have seen a reacceleration in their business, we are well positioned to grow our business and our focus is to grow it at a rate higher than the infrastructure-as-a-service growth rates of the big hyper-scalers. And then finally, AI, this is the opportunity that will become much more meaningful over time. We are well positioned with the huge installed base of unstructured data, which is the fuel for GenAI, and we are focused on helping customers do in-place RAG and inferencing of that data. Second, our unified data storage systems with integrated data services provide an ideal foundation for customers looking to build a data lake or model training landscapes. And then our hybrid cloud architecture gives us a unique place in the environment, allowing customers to use public cloud AI platforms such as Vertex from Google or Bedrock from AWS with their on-premises data and be able to scale inferencing to where every piece of customers' data and IT landscape exists. So, those are the four. We're excited about the year ahead. We will tell you more about the specific puts and takes of each opportunity at our Financial Analyst Day on June 11th.

Operator:

The next question is from Krish Sankar with TD Cowen. Please go ahead.

George Kurian:

Listen, I think with the -- I didn't hear the question entirely clearly, but what we see with RAG is customers wanting to use a large amount of unstructured data alongside a model that has already been trained to get it even more aware of the context in which its operating. Our CCVs and ACVs are both well suited for that. For customers that want really large landscapes, we are really excited about the opportunity with the C-series where we already have 30 terabyte drives that are adding higher density drives as customers need. And then for large-scale data lakes, we are able to build highly dense object storage or mixed object and file storage landscapes that we have done for many, many clients over the last quarter.

Mike Berry:

We have 30 terabyte SSDs and they are growing quickly as a percentage of the total capacity. The way our systems are built, we can pass a lot more density into a single system than many of our competitors.

George Kurian:

Welcome.

Asiya Merchant:

Great. Thanks. Apologize if this question has been asked, but maybe if I can just focus on the free cash flow for next year. I don't know if this is a guide that was provided for that and how you can think about how we should think about that and the shareholder returns for the fiscal year.

Asiya Merchant:

Great. Thank you.

Kris Newton:

Thank you. I'll now pass it over to George for some final comments.

Operator:

The conference has now concluded. Thank you for your participation. You may now disconnect your lines.

Operator:

Good day, and welcome to the NetApp Third Quarter of Fiscal Year 2024 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President, Investor Relations. Please go ahead.

George Kurian:

Thanks, Kris. Good afternoon, everyone. Thank you for joining us on our Q3 FY 2024 call. I'm pleased to report, that we delivered exceptional performance across the board, despite an uncertain macro environment. Revenue was above the midpoint of our guidance, driven by the momentum of our expanded all-flash product portfolio. This strength coupled with continued operational discipline yielded company all-time highs for consolidated gross margin, operating margin, and EPS for the second consecutive quarter. Entering FY 2024, we laid out a plan to drive better performance in our Storage business and build a more focused approach to our Public Cloud business, while managing the elements within our control in an uncertain macroeconomy to further improve our profitability. These actions have delivered strong results to-date, support our raised outlook for the year. And enhance our position for the long-term. Only NetApp delivers a comprehensive architecture based on a single operating system, that supports any application or data type, spans on-premises and multiple cloud environments, and is available in traditional CapEx or as-a-service procurement models. Our unified data solutions, address some of the biggest priorities IT organizations face today, modernizing legacy infrastructure, improving resiliency against ransomware attacks, and building scalable, high performance data pipelines for AI workloads. The consistent operations, common management tools, integrated data services, and unique and proven capabilities for Hybrid Cloud of our unified storage architecture, provides customers the ability to simplify at scale and lower storage costs. Our silo-free approach to unified data storage is clearly resonating with customers, driving healthy demand for our products and services, and positioning us well to deliver long-term growth. Turning to the results of the quarter, we delivered robust year-over-year performance in our Hybrid Cloud segment with revenue growth of 6% and product revenue growth of 10%, driven by momentum from our newly introduced all-flash products and the go-to-market changes we made at the start of the year. Strong customer demand for our industry leading all-flash solutions drove all-flash growth of 21% year-over-year, to an all-time high annualized revenue run rate of $3.4 billion. In Q3, our all-flash business expanded to approximately 60% of Hybrid Cloud segment revenue. As Mike will detail, we expect a sustainable step-up in our baseline product gross margin going forward with the continued revenue shift to all-flash. The AFF C-Series all-flash arrays again exceeded our expectations, delivering new-to-NetApp customers and numerous wins over the competition. As customers modernize Legacy 10k Hard Disk Drives and Hybrid Flash environments, we are displacing competitors' installed bases with our All-Flash Solutions, driving share gains. Our newly introduced ASA families, of SAN-optimized, high-performance and capacity-oriented all-flash arrays also outperformed our expectations. We're excited about the enormous potential in the nearly $20 billion SAN market. Our modern all-flash SAN arrays, backed by industry-leading data availability and efficiency guarantees, are well-positioned to redefine the competitive landscape. In Q3, we had numerous competitive take-outs across a broad set of workloads and vertical markets as customers leveraged our C-Series and ASA products to modernize their legacy infrastructures and deploy new applications like Artificial Intelligence. We continue to see strong interest in our advanced portfolio of Ransomware Protection Solutions. We help customers, take proactive steps to protect, detect, and recover their data. Competitive Solutions focus only on data recovery, but NetApp keeps data protected and secured from the start with products designed to block cybersecurity risks and mitigate the high cost of downtime. ONTAP is the first Enterprise-Class Storage Solution validated by the NSA for the Commercial Solutions for Classified Program, demonstrating the strength of our state-of-the-art, data protection and cybersecurity solutions. We saw good momentum in AI, with dozens of customer wins in the quarter, including several large NVIDIA SuperPOD and BasePOD deployments. We help organizations in use cases that range from unifying their data in modern data lakes to deploying large model training environments, and to operationalize those models into production environments. To best take advantage of Generative AI capabilities, customers are looking to augment foundational models with their own data. Our high-performance, scalable unified data storage systems create intelligent data pipelines that allow customers to capture, aggregate and prepare their data for AI. NetApp delivers the data management capabilities for security, performance, and simplicity that enterprises require for their GenAI workflows. We continue to advance our position with the development of GenAI driven cloud and on-premises solutions in partnership with industry leaders. Demand for consumption options is also growing as some customers look to increase budget flexibility in an ongoing uncertain macro and higher interest rate environment. However, this is not a universal mandate. Our unified data storage solutions are available as CapEx, as-a-service, and cloud native offerings, providing customers with the widest range of buying options, enabling them to meet their budget requirements. Keystone, our Storage-as-a-Service offering, delivered another strong quarter, with revenue growing triple-digits from Q3 a year ago. Keystone is a great solution for customers who want a cloud-like operating model on premises. For customers who are ready to move to the cloud, we uniquely partner with the leading hyperscalers to deliver cloud-native storage services. Public Cloud segment revenue was $151 million, up 1% year-over-year. First party and hyperscaler marketplace storage services remain our priority and are growing rapidly, with the ARR of these services up more than 35% year-over-year. These offerings are highly differentiated and tightly aligned to customer buying preference. We continue to deepen our hyperscaler partnerships, and deliver growth in customer count, capacity, revenue and ARR with this part of the portfolio. As I outlined last quarter, we are taking action to sharpen our approach to our Public Cloud business. As a part of this plan, we exited two small services in the quarter. We also began the work of refocusing Cloud Insights and InstaClustr to complement and extend our hybrid cloud storage offerings and integrating some standalone services into the core functionality of Cloud Volumes to widen our competitive moat. In Q4, we anticipate approximately $20 million in ARR headwinds from unrenewed subscriptions. This will create minimal revenue impact and should be largely offset by growth in first-party and marketplace services. We will continue refining our focus in fiscal year 2025, building a stronger base from which to grow. Our hyperscaler partnerships and natively integrated storage services, position us to address the new and emerging GenAI opportunity in the cloud. A leading open-source developer of GenAI tools, datasets and models is leveraging AWS’ FSx for NetApp ONTAP as a part of its offerings. The customer was looking for a high-performance and resilient file storage solution to train extensive AI/ML workloads. FSxN gave them a scalable solution with performant storage for intensive AI model training. As a fully managed service, FSxN removes operational burdens, allowing their DevOps teams to focus on business value activities. In summary, we entered the final quarter of fiscal year '24 in a much stronger position than we were at the start of the year despite the ongoing macro uncertainty, our modern approach to unified data storage, which spans data types, price points and hybrid multi-cloud environments is resonating in the market. We are successfully executing against our top priorities, growing in all flash and cloud storage services. We are well positioned with an expanded TAM, including block storage, and new market opportunities like AI to drive continued growth and share gains. We are moving to a higher product margin profile, supported by growth in all-flash products. And we will continue to maintain the operating discipline that has yielded record profitability. I'm very pleased with our momentum and very confident in our ability to deliver positive outcomes for customers and stockholders. Finally, I want to make you aware of our June 11, Investor Day, where we will provide an update on our long-term strategy and business model. Now, I'll turn the call over to Mike.

Kris Newton:

Thanks, Mike. Operator, let's begin the Q&A.

Meta Marshall:

Great. Thank you and congrats on the quarter. I guess, George, you went into a lot of detail just around what you're seeing on the AI side. I guess if you could just get a sense of when you're seeing the timing of maybe people making investments versus -- kind of the various stages of AI? And then maybe just as a follow-up question, just what you're seeing in terms of the competitive environment just in terms of kind of innovative thinking around AI solutions. Thanks.

Meta Marshall:

Great. Thank you.

Eddie Pellon:

Hey guys, this is Eddie for Chris. Congrats on the great execution here. George, I think many people still underappreciate how file services is an AI beneficiary. For example, if you set up an AWS SageMaker account, developers can have plenty of file services options, including NetApp's FSX, so maybe talk about what differentiates FSX versus other file services, and what kind of customers you attract, what use cases is it used for? And if you can touch on how big ANF and FSX are within public cloud, that would be great. I do have another question, please.

Eddie Pellon:

That's very helpful, George. Thank you. And one for Mike quickly. Can you give a fresh, please our memory about how customer behavior has historically changed when NAND prices increase aggressively in short periods of time? Like do they usually reduce purchases of all flash arrays and go more to hybrids? Or is NAND a small percentage of the bill of materials today, because of a very low pricing, where a 50% increase in NAND prices, for example, will not meaningfully change the system price you guys charge customers. That's it for me. Thank you.

George Kurian:

And just to add to that, SSDs are not 50%. They are less than 50% of our bill of materials or probably anybody else's bill of materials.

Joe Cardoso:

Hey. Thanks for the question. This is Joe Cardoso on for Samik. So, first one for me. It seems like you continue to see strong momentum with the C-Series and the other new flash products that you guys have introduced and they even appear to be outperforming your expectation in each quarter. So just curious, if you could talk to how momentum for those products have tracked through 3Q and into 4Q to-date. It doesn't sound like you're seeing any signs of that momentum slowing down, but can you just confirm that. And do you expect that we're still very much in the early innings of these product cycles with your customers? And then I have a follow-up. Thanks.

Joe Cardoso:

Got it. I appreciate the color there, George. And then just as my second one, it appears the appetite from customers to consume storage more on a consumption basis is increasing based on our checks with the channel as well as comments from you and your peers. I know you touched on the driver being in some part due to this uneven macro that we're seeing. But are you seeing anything else as a driver there, like the maturity around the offerings or go-to-market motion. The reason I'm asking, it just feels like it wasn't too long ago when the opportunity here felt more theoretical and there was not as much appetite coming from the customers. So I would just be interested to hear, like has anything changed on that front? Thank you.

Joe Cardoso:

Great. You appreciate the questions.

Mehdi Hosseini:

Yes. Thanks for taking my question. George, I just wanted to better understand the current competitive landscape for fiber storage market, especially given the AI application. And I have a follow-up.

Mehdi Hosseini:

Maybe perhaps I could rephrase my question. Mike just, raised is product gross margin to 60%, which is pretty much what you're guiding for the January quarter. You're also increasing use of QLC. So should we anticipate some flexibility with pricing that QLC gives you, by remaining competitive with your competitors? Because I don't see gross margins already at work the new target is. So where do we go from here?

Mehdi Hosseini:

Thank you.

Mike Cadiz:

Hi, good afternoon. This is Mike Cadiz for Asiya at Citi. So my one question is, given ongoing -- in the AI field, given ongoing security and data sovereignty concerns by many companies, is there anything notable in the customer conversations regarding AI model placements, whether on-prem or in the cloud or any other architecture preferences that they may have?

Mike Cadiz:

Okay, got it. Thank you very much. Have a good day.

Nehal Chokshi:

Hey, thanks, and congrats on the strong results here. Mike, can you give us some early thoughts on fiscal year 2025. And what are the key things we should be thinking about when modeling fiscal year 2025 here?

Nehal Chokshi:

That's fantastic. If I may, how should we think about the support revenue? You're coming off 4 quarters of year-over-year product revenue declines now that you're back into year-over-year growth on the product revenue, how long do you expect the Support revenue start to cut back up basically?

Nehal Chokshi:

Fantastic. Thank you.

Ananda Baruah:

Yes. Good afternoon guys. Thanks for taking the question. Yes. Congrats I mean congrats on a strong number of quarters here and really good ongoing execution. And I guess George, that's I guess what I'd like to ask, I guess the first question is -- and I'm sorry if you spoke to some of this, I was -- there's a few calls going on tonight. So I came on late. But to what degree the last couple of quarters or so, do you think that the strong product growth that you guys have put up. I'm going to try to actually parse to the degree that's possible. Is the result of new product features, kind of new products, things that customers are doing beginning to do sort of differently with their data? It sounds like not really a material GNA benefit yet, which makes sense. But if you could parse -- if there's any way to parse through those things, that would be helpful. And then, I guess the second part of the question is, I think I heard you make mention of you think there is like a tail to this going forward. And I mean is part of what you're saying is that you think the product demand sort of outlook begins to look a lot different as you go through calendar 2024 and then maybe even beyond? I know that's a lot, but I'd appreciate that. Thanks.

Ananda Baruah:

That's great context. I appreciate that. And just a quick follow-up for Mike here. Mike, you talked about attach in some context. And I guess I just wanted to ask you with the operating margins already in the high 20s, philosophically, is there any reason why with everything you have going on with mix and attach over time, you couldn't touch 30% operating margin?

Ananda Baruah:

Sorry, it's funny. I haven't -- yes, I apologize. I have to with all the numbers I had you didn't -- that's a miss on me. So well, let me just ask you then, let's start there. Like I mean, should we just expect mix up then going forward? I mean, how are you thinking about like showing the margins in the P&L versus doing something else with the op income dollars as mix continues to work in your favor? Thanks.

Ananda Baruah:

Thank you. That’s super helpful. Thanks a lot, Mike.

Operator:

[Operator Instructions] The next question is from Amit Daryanani with Evercore ISI. Please go ahead.

George Kurian:

Listen, we always start with one environment, and then we can cross-sell other environments into the customer. I think what we have seen quite clearly in the market is that the idea of having multiple different operating systems and storage landscapes in our customer is causing cost, complexity and security vulnerabilities and the idea of going to one consistent architecture across multiple landscapes is clearly seeing resonance and customers. And I think that as we have got obviously both unified, as well as block focused offerings across high-performance AFF A Series, as well as more value-oriented C-Series products, we see opportunity to not only win one part of our customers' footprint, but over time, win all of their footprint. The work that we've done in public cloud allows us to penetrate accounts that we don't have a relationship with using the public cloud sales motion. And as we have shared many times, the number of new to NetApp customers in the public cloud sales motion is very strong, and we are excited about that. We continue to see good progress on that front even this past quarter.

George Kurian:

It's just normal seasonality. I think public sector actually was a strong number for us across the globe and nothing other than normal seasonality for us.

Kris Newton:

All right. Thanks, Irvin.. I'm going to pass it back to George now for some closing comments.

Operator:

The conference has now concluded. Thank you for your participation. You may now disconnect your lines.

Operator:

Good day and welcome to the NetApp's Second Quarter Fiscal Year 2024 Earnings Call. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President, Investor Relations. Please go ahead.

George Kurian:

Thanks, Kris. Good afternoon, everyone. Thank you for joining us today. Q2 improved on our solid start to FY 2024 in what continues to be a challenging macroeconomic environment. We delivered revenue above the midpoint of guidance while our operational discipline yielded company all-time highs for gross margin, operating margin, and EPS. We remain relentlessly focused on managing the elements within our control while driving better performance in our storage business and building a more focused approach to our Public Cloud business. We are seeing positive results from these actions, with increased profitability and a stronger position for delivering long-term growth. In Q2, we held our INSIGHT user conference where I witnessed the tangible excitement for the silo-free innovation, our unified data storage provides. It was invigorating to be with the thousands of attendees and hear stories of the extraordinary outcomes NetApp delivers for our customers. NetApp is at the forefront of the evolution of the storage industry, helping our customers turn disruption into opportunity with intelligent data infrastructure. Today’s organizations need storage infrastructure that harnesses the power of public and hybrid clouds while keeping data secure and protected from ransomware attacks. They need infrastructure that supports dynamic workloads like AI, cloud-native, and open-source applications. And they need infrastructure that helps to create more sustainable data centers. Only NetApp delivers an entire architecture of unified data storage solutions based on one operating system, ONTAP, that supports any application, any data type, and spans on-premises and multiple cloud environments. This comprehensive architecture delivers unparalleled simplicity of management, simplicity of deployment, and consistency of automation, all unified by common APIs and a single control plane. We further elevate the customer experience with our BlueXP sustainability dashboard and NetApp Advance a common set of programs and guarantees that include Storage Life Cycle program, which removes the burden of upgrade cycles as well as storage efficiency, ransomware recovery and data availability guarantees. Intelligent data infrastructure combines unified data storage, integrated data services, and intelligent operations, so customers can operate with seamless flexibility to deploy new applications, unify their data for AI and simplify data protection in a world of limited IT resources, rapid data growth and increased cybersecurity threats. Looking at the results of the quarter, momentum from new products and the go-to-market changes we made at the start of the year drove 10% quarter-over-quarter growth in hybrid cloud segment revenue to $1.4 billion. Our all-flash array business benefited from the growth of the AFF C-Series increasing 14% from Q1 to an annualized revenue run rate of $3.2 billion. The AFF C-Series all-flash array continues to exceed our expectations, delivering new-to-NetApp customers and numerous wins over the competition. In the quarter, we successfully competed against an all-flash competitor with C-Series to win a $16 million deal at an Infrastructure-as-a-Service company. The customer was looking for new storage to host a broad variety of critical applications. Our ease of management for large storage environments, unique data resilience, common toolkit across all our storage systems and the right price performance ratio secured our win despite the competitor's attempt to use price once they realize their value proposition was insufficient. ONTAP One, our all-in-one software license that gives customers access to the industry's most comprehensive data management suite has laid the groundwork to future tech refresh and expansion opportunities. Building on the success of the C-Series, we introduced blocked optimized and AI-ready visions. The ASA C-Series family is a solution tailored to deliver high-performance and guaranteed high availability storage for critical applications, databases and VMware infrastructure, coupled with capacity flash to make enterprise-grade block storage more affordable and sustainable than ever. We added the AFF C-Series to the ONTAP AI architecture, lowering the overall cost of entry to scalable AI without sacrificing performance. Keystone, our Storage as a Service offering is also growing rapidly. In Q2, we added performance and availability guarantees to Keystone, expanding on the existing sustainability and storage efficiency guarantees, creating a comprehensive program to keep storage operations running optimally. We also announced NetApp storage on Equinix Metal, powered by Keystone, providing customers with a single subscription to a full stack of compute, networking and storage infrastructure with low-latency interconnection to all major public clouds. Turning to Public Cloud. As we said last quarter, our priority is growing first party cloud storage services. We aligned our cloud sales specialists to our hyperscaler partners’ go-to-market structures at the start of the fiscal year and are seeing new customer additions and growth in those services. However, that growth has been masked by weakness in subscription services, which have declined to 23% of Public Cloud ARR. During the quarter, we engaged in a strategic review to sharpen the focus of our cloud portfolio. As a result, we will continue to prioritize cloud storage offerings delivered through the hyperscalers, while refocusing some services, such as Cloud Insights and Instaclustr, to complement and extend our hybrid cloud storage offerings, creating greater differentiation and additional value for customers. We will integrate other services that are sold as standalone subscriptions today, such as data protection, into the core functionality of Cloud Volumes. We will also carefully manage the transition of cloud storage subscription services to align to customer preference for consumption offerings. And, we have decided to exit the SaaS backup and virtual desktop services. We anticipate ARR headwinds of approximately $55 million from exited services and unrenewed subscriptions in the second half of fiscal year '24. Growth in first party and marketplace services are expected to partially offset this decline, positioning us to enter FY '25 with a more focused and much healthier business from which to grow. Now to the results of the quarter. Public Cloud segment revenue in Q2 was $154 million, flat from Q1 and up 8% year-over-year. Our first party and marketplace offerings are highly differentiated and are tightly aligned with customers’ buying preferences. These services grew over 30% from Q2 a year ago. We continue to see customer expansion and deepening partnerships, as well as increases in customer count, capacity, revenue and ARR in this part of the portfolio. In Q2, we extended our partnership with Google with the introduction of Google Cloud NetApp Volumes. Now, we are not only the only vendor to have a natively integrated storage service in the public cloud, but we are natively integrated into all three of the leading hyperscale vendors. And we are not standing still with this advantage. Just two months after introducing the GCNV service, we announced the availability of a new lower-cost tier of Google Cloud NetApp Volumes, expanding the offering to address a greater range of workloads. These partnerships uniquely position and enable us to participate in the innovation and adoption of AI services in the public cloud. As examples, during Q2, we announced support for Google Cloud’s Vertex AI with Google Cloud NetApp Volumes, as well as cross-protocol, hybrid cloud AI pipelines on Amazon FSx for NetApp ONTAP with support for SageMaker Studio notebooks. Our position with the hyperscalers also enables us to displace legacy on-premises competitors as customers migrate workloads to the cloud. A U.S.-based medical equipment company chose FSx for NetApp ONTAP to replace a competitor’s SAN systems when they moved their database workloads to the cloud. This is the customer’s first engagement with NetApp. Following a successful initial deployment, they are evaluating FSxN for workload consolidation and disaster recovery. Looking forward, our focus is clear and is delivering results. We expect the momentum we saw in Q2 to continue through FY '24, despite continued softness in the demand environment due to the challenging macro. Customers value our modern approach to hybrid, multi-cloud infrastructure, and data management which enables IT organizations to leverage data across their entire estate simply, securely, and sustainably. With recent innovations that enable us to address a broader set of markets more efficiently, I am confident that we are well positioned to deliver positive outcomes for customers and stockholders. I’ll now turn the call over to Mike.

Kris Newton:

Thanks, Mike. Operator, we'll begin the Q&A.

Mehdi Hosseini:

Thanks for taking my question. Two quick follow-up. Given the updated fiscal year '24 revenue guide, should we assume that the July product revenue of $590 million was essentially the bottom and you would continue to see a sequential improvement in the second half? And the second question has to do with and momentum with some of these higher margin, higher capacity to product. To what extent should we assume these market share has enabled you to ride out a tough IT spend environment?

Mike Berry:

Thank you, George. Good afternoon, Mehdi. On your question on product revenue, certainly for fiscal '24 implied in the guidance is continued growth in – or growth in the second half for the product line. Total revenue growth averages about 4% for the second half. We have not guided for fiscal '25 yet, but we certainly would -- we feel good about going into '25 as it relates to our product portfolio and our operational improvements.

Kris Newton:

Thanks Mehdi. Next question.

Meta Marshall:

Great. Thanks. A couple of questions. Just one, realizing that you're saying there's no major contributor to the gross margin upside. But just how do you see NAND prices increasing, just an outlook on how you see gross margins developing throughout the year and whether these are sustainable? And then just as a second question, do you attribute the more confident in the year to the early success that you're having with C-Series? Do you attribute it to signs you're seeing coming out of INSIGHT? Just what gives you more confidence on the year just given the dampened environment? Thanks.

George Kurian:

With regard to your question on the underlying factors that support our optimism in the guide. First of all, from a macro perspective, it's still a challenged macro with the soft demand environment. We saw incremental improvement in North America, but equally a deceleration in certain parts of Europe, mirroring the economic landscape in the public domain. I think within the large enterprise, we see a case-by-case situation in terms of demand and we continue to see a more robust product business in this commercial or mid-market customer base. So, no real fundamental change in the demand environment. With regard to the two underlying factors for confidence. One is, we are a much more focused go-to-market organization, and we are seeing the second consecutive quarter of pipeline and performance from the changes we made at the start of the fiscal year. And so I want to credit our go-to-market teams for their focus and the results that they have delivered this quarter, and that is one of the key contributors. The second is the really strong performance of our all-flash portfolio. We talked in the prepared remarks about a large competitive win against a purely flash competitor. And we see that across multiple segments where we are seeing competitive wins with our portfolio. So those are the two fundamental reasons

Operator:

And our next question today comes from Krish Sankar with TD Cowen. Please go ahead.

George Kurian:

With regard to lead times, we are at normal lead times for our portfolio, and we reached those normal lead times a few quarters ago. With regard to the question on storage demand for AI, listen, I think we have been in the AI business for predictive AI or industrial AI for five years. And there are large data sets that are built out to support training of those models and the implementation of those models across the enterprise. So we have a good and robust business there. We are starting to see early signs of trials and use cases with generative AI. Generative AI is particularly well suited for NetApp's capabilities because it operates on unstructured data, files, documents, video, audio and so on. And so we have large repositories of those and customers, and we are able to use that data set and add to that data set to support AI use cases. This quarter, we won a large AI implementation at a very large U.S. bank that was really focused on generative AI document summarization analysis and so on, and we are the infrastructure foundation for that. So it will take time for generative AI to become a demand driver. We are seeing early positive signs there.

Operator:

Thank you. And our next question comes from Steven Fox with Fox Advisors. Please go ahead.

George Kurian:

Listen, on pricing, we've been in this industry for a very long period of time. And while there will be people who are vendors who are aggressive in any particular transaction or other, depending on their own strategic reasons. Overall, we don't see fundamental changes in the pricing environment. Clearly, the room with lower component costs gives you an opportunity to do more in terms of pricing flexibility. But I think that our past quarter's gross margin results our demonstration of the fact that we've been able to maintain pricing discipline at a time where demand is soft, and it talks to both the differentiation of our product portfolio and the execution in our field teams. I'll have Mike talk a bit about your second question.

Steven Fox:

Yes. That’s very helpful. Thank you.

Asiya Merchant:

Great. Thank you. Maybe just a little bit on the macro. Clearly, you're executing really well. And should we -- should we expect slightly better than seasonal growth for you guys in the second half, just given the fact that you guys are ramping on a new product? And then just broadly on the macro, are we starting to see more adoption of flash across the customer base in general as people start to appreciate maybe more pricing being more attractive or is this something that was specific to NetApp just given the success that you're seeing in your C-Series? Thank you.

Mike Berry:

Sure. On your question, Asiya, as it relates to linearity, we did see a nice quarter-on-quarter pickup in Q2 which was really driven by the factors that George discussed. And look at the midpoint of guidance for the year, we do expect it to be relatively consistent with the numbers we like to talk about, which is the 48% in the first half and 52% in the second. Again, keep in mind that the good bit of our revenue, thankfully comes from support, very predictable. Hopefully, we can do a little better, but that is -- the midpoint of guidance is pretty much right on linearity.

Mike Berry:

Thank you.

Wamsi Mohan:

Yes, thank you so much. I was wondering, George, if you could comment a little bit on a public cloud revenue trajectory in fiscal '24, given some of the changes that you noted? And given those changes in CloudOps, how does that change your long-term revenue outlook for that business on a relative basis, I think before you were thinking 40% of total Public Cloud. Wondering where you're thinking that, that might shake out now in the long-term?

Wamsi Mohan:

Okay. Thanks, George. And if I could, Mike, your margins were really, really strong, both sequentially and on an absolute basis. Wondering as we think about free cash flow margins, would all this EBIT margin improvement flow through into free cash flow margins? And secondarily, just on the EBIT margins, is there a way to dimension out of the three things that you noted, maybe rank order or order of magnitude so that we can get some sense around the confidence of sustainability, especially as it relates to commodity pricing, which you seem to indicate won't really matter too much sequentially. But just wondering what was the biggest sequential driver of that margin improvement? Thank you.

Wamsi Mohan:

Yes, thanks.

Nehal Chokshi:

Great. Thanks for taking my question. You guys mentioned 30% growth in first-party storage services. What's the NRR underlying that?

Nehal Chokshi:

Maybe phrasing it in a different way, the driver of that growth is expansion or lands?

Nehal Chokshi:

Great. And then a follow-up, quick question. George, you talked about how you had a $16 million win with the C-Series. And you mentioned four drivers behind that. Much of those four drivers was really probably the biggest element of that win?

Nehal Chokshi:

Awesome. Thank you.

Simon Leopold:

Great. Thanks for taking the question. First, just a quick clarification. On the strategic review update, I just want to confirm, it sounds like you've concluded that review apart from sort of regular business kind of reviews. I just want to confirm that, that's the case. And then really, the element I'm trying to sort of tease out here is you've taken out $55 million of ARR, so roughly $15 million of revenue, yet your outlook is higher. What is informing the higher outlook? What's been the biggest surprise and the biggest delta contributing to the higher outlook? Thank you.

Simon Leopold:

Thank you.

Aaron Rakers:

Yes. Thanks for taking the question. A lot of those have been asked and answered. But I wanted to go back to some prior discussion around this notion of AI. And we hear a lot about like AI, large language models becoming smaller and implemented more maybe pervasively over time in traditional enterprise environments. We've even heard more about inferencing and how that might evolve in enterprises. I'm just curious, are you seeing at all any signs of that pulling either discussions or early signs of demand? And if so, is it a prerequisite that, that has to pull as all-flash storage with that kind of footprint. And the reason I ask is there's a lot of discussion about a lot of this existing infrastructure that's going to have to be upgraded to support these acceleration of AI in infrastructure? Sorry for the long-winded question.

Aaron Rakers:

That's very helpful. And as a quick follow-up, real quickly, who is your predominant competitor that you see on the block optimized C-level all-flash arrays or C-Series arrays?

Aaron Rakers:

Yes. Thank you.

Samik Chatterjee:

Hi. Thanks for taking my questions. I guess if I start with the Public Cloud strategic review that you discussed, just wanted to clarify, based on the changes you're making there, are there any cost implications other changes? I'm assuming that allows you to focus your go-to-market a bit more, but is there any sort of cost implication where you're enabling some cost take out there? And secondly, Mike, you mentioned sort of the 58% to 60% gross margin on the product revenue in the second half. When we think about, sort of, prebuys that you might do going into fiscal '25, how should we think about the trajectory of the gross margin into fiscal '25. Any levers that you have to offset sort of the flow-through of that to the operating margin that you're really reporting at a very strong level right now? Thank you.

Mike Berry:

Okay. And then thanks for the question, Samik. On the question, especially going into fiscal '25 from the product margin, I'll go over a little bit my answer to Meta when he asked the same question. So as we've all seen from the analyst reports, we have -- we do expect that NAND is largely bottomed. We're at the loss component pricing we've been at in a while. We did a really nice job and kudos to the supply chain team for doing the prebuys and purchase agreements for '24. We will certainly look at those and continue to look at those in '25, but it has to make sense for both NetApp and our suppliers. So as we go into '21, there are certainly some levers. The big question there, Samik that I don't have an answer to is what does the market do and pricing do over the next six months. That's why we're going to wait, will guide the margin number when we guide for the full year because we really want to get through the next couple of quarters to see how component pricing goes, what we expect the mix to be. And then what happens from a pricing environment perspective.

George Kurian:

On the cost side, listen, I think we will, for the most part, just repurpose those resources Thank you.

Ananda Baruah:

Yes. Good afternoon. Thanks for taking the questions. I guess, George, an inference related question, maybe two quick parts. Are you hearing any of your customers talk about legislation around inferencing, having an impact on their plans? And I guess, just generally speaking, any opinion you have on sort of what that ramp over what time period kind of looks like even. If just anecdotally would be helpful. I appreciate it. Thanks.

Ananda Baruah:

Yes. Thanks for the context. That’s helpful.

Sidney Ho:

Great. Apologize if you have already addressed this. On the macro level, are you seeing any major differences between demand from large enterprises, small leading businesses in federal. Any particular verticals you would point out that shows particular strength of weakness both on the Hybrid Cloud and the Public Cloud? Thanks

Sidney Ho:

Great. Thank you.

George Kurian:

In closing, I want to thank the entire NetApp team for their strong execution and operational discipline in Q2, which drove revenue above the midpoint of our guidance and record gross margin, operating margin and EPS. Only NetApp delivers an entire architecture of unified data storage solutions, helping customers operate with seamless flexibility to deploy new applications, unifying their data for AI and simplify data protection in a world of limited IT sources, rapid data growth and increased cybersecurity threats. Innovation in our all-flash storage portfolio enables us to address a broader TAM and we continue to innovate and lead in Public Cloud storage services. Our go-to-market team is laser- focused on these positions of strength, enabling us to deliver strong results in the challenged macro landscape. Looking ahead, I'm confident that the momentum we saw in Q2 will continue through the remainder of fiscal year '24. Thank you.

Operator:

Good day, and welcome to the NetApp First Quarter of Fiscal Year 2024 Earnings Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President, Investor Relations. Please go ahead.

George Kurian:

Thanks, Kris. Good afternoon, everyone. Thank you for joining us today. Q1 marks a solid start to FY '24 in what continues to be a challenging macroeconomic environment. We delivered revenue above the midpoint of guidance, while our operational discipline yielded operating margin and EPS above our guidance ranges. As I have outlined on previous calls, we are focused on

Kris Newton:

Thanks, Mike. Operator, let’s begin the Q&A.

Sidney Ho:

Great. Thanks for doing the call. So last quarter, you guys talked about spending for large enterprises were cautious, where obviously you guys are overexposed. That doesn't seem like that has changed that much. From your conversation with customers, do you have a sense when demand could start picking up, maybe based on utilization data or whatnot? First, just give us some historical context at what utilization rate level do you start seeing demand pick up, and do you think that will be quite any different this cycle? I mean, while you’re at it talk about the trends in small and medium businesses as well? Thanks.

Sidney Ho:

Okay, thank you.

Mehdi Hosseini:

Yes. Thanks for taking my question. I have two quick follow-ups. George, I want to go back to the big picture and revisit the topic of repatriation. How do you see generative AI strengthening this argument that there will be repatriation enterprises have better ownership of the data that, that would actually help with a faster adoption? Is there any update? Is there any feedback from the -- your conversation from your enterprise customers that you can share? And a quick follow-up. Can you provide a mix of a QLC NAND that you're procuring? And how do you see that changing towards the end of the calendar year?

Mike Berry:

And then, hey, Mehdi, it's Mike. On the QLC, we're not going to break-out specific numbers, but we would say we are procuring more of that. We started to see the pickup. We'll see how the rest of the year goes, but we do expect that to continue as a percentage as we go through fiscal '24.

Operator:

The next question is from Samik Chatterjee with JP Morgan. Please go ahead.

Mike Berry:

Hey Joe, it's Mike. So, on your question, we've talked a lot about premiums and as we talked about last-time, we're super-excited and not have to talk about them anymore. So largely in Q1, all of those premiums have I would say gone away, not only from a P&L perspective, but cash. We talked about that number was anywhere typically between, call it, $30 million and $40 million a quarter, sometimes it bumped up to $50 million, so call it an average of about $40 million. That -- we got a good bit of that. We did not have to accrue in Q4 and then the rest hold to Q1. So it's 55% last quarter, 55% this quarter. And now premiums are fully out-of-the number. So as you look-forward, it's one of the reasons why we feel confident in the 55% guide. There -- hey, there has always been price competition. We see it in certain geographies or certain customers. We haven't seen any material change to that in our guide. We do expect that we will be -- we will need to be, call it, marginally more aggressive in certain situations, but certainly nothing significantly different than we are today.

Mike Berry:

Yes.

Michael Tsvetanov:

Yes, thank you, guys. This is Michael on behalf of Aaron. I wanted to ask, your ARR in the quarter -- your ARR growth in the quarter slowed quite a bit. And I know you guys have pushed out your $2 billion sort of target, but I just wanted to take a step-back and I think about like to your first billion, what -- how would you describe the trajectory to getting there and maybe timing? If you can kind of just help us think about where we go from here? Thank you.

Michael Tsvetanov:

Okay. Thank you. That's helpful. And if I can just add one more. I just want to understand your all-flash business is down about 7%. And I can appreciate the macro backdrop there, but I'm wondering if you can just help me understand the share kind of trends? And maybe your best estimate where that's been this quarter? How it's changing? And kind of what your expectations are moving through the year? Thank you.

Operator:

The next question is from Simon Leopold with Raymond James. Please go ahead.

Mike Berry:

Yes. Hey, Victor, it's Mike. So, hey, we haven't guided for fiscal '25, but let us walk you through that. As we talked about between pre-buys and price locks, we have secured a large portion of our NAND purchases for fiscal '24, not all of it, you never want to hedge the whole bucket, but we feel really good about that. In addition, some of those agreements do flow into fiscal '25, it's not a majority at this point. So where we stand today as we feel really good about where we are at ‘24, we have some of that rolling into '25 and we are certainly looking for about -- what should we do? We'll do a lot more work on that, call it, in the next 90-days and update you on the next call. As you know, it's a very changing market. We want to make sure it be prudent and think through that, but it is something that we are looking hard at.

George Kurian:

Listen, I think we have the best spinning media and the best flash technologies in the market. I think that's reflected by the richness of our feature set, the flexibility of our operating system and increasingly the data security functionality that natively integrated into our offerings. I think that the outlines of what our competitors have talked about is a long-time. And so we give our customers choice and we'll continue to invest in a broad range of technologies that meet the right price performance points. When you cannot support a type of technology, like our competitors cannot, then you have to throw grenades and say that that technology doesn't exist because you frankly can't support it.

George Kurian:

Five years is a long-time in technology as we've all learned.

Operator:

The next question is from Asiya Merchant with Citigroup. Please go ahead.

George Kurian:

Yes, thank you for the question. So, on the first question on linearity, based on the midpoint of guidance, we are still assuming about 48% revenue in the first-half and 52% in the second, pretty close to round in which is very consistent with what we did last quarter. So, no big change there. And that's very consistent with the linearity that we've shown historically. Also, our Q2 guide is up about 7% quarter-on-quarter, which is well within our historical linearity as well. On the cloud revenue number, so we're not going to update the guidance. We had originally thought and forecasted somewhere around, call it, mid-teens growth in that cloud revenue business. Even if as you look at the historical numbers, that cloud revenue, and we're not forecasting it, well, if it stays where it's at today, there would still be growth year-over-year because of the growth last year. So we have baked all of that into our full-year number, so we feel good about where we are on that guide. We'll see how the rest of the year goes. But at this point, we've reflected that in our full-year number.

George Kurian:

Thank you.

Krish Sankar:

Yes, hi, thanks for taking my question. I have two high-level questions in AI for George. Our understanding is that most of the benefit of storage, as we put all-flash unified file and object solution; A, is that assessment accurate or are you seeing hybrid HDD solutions being used in AI workloads today? And second, for unified cloud and object, can you speak about your product portfolio there and your competitive position, compared to other solutions like FlashBlade from Pure Storage and PowerScale from Dell. And also if unified filing object solutions are more expected of benefit from AI, it's a market share that's similar to market-share in other storage solutions like block and file? Thank you.

Krish Sankar:

Thank you, guys.

David Vogt:

Great, thanks. Hey, George. Hey Mike. I had some phone difficulties. So I apologize if you addressed this. On sort of the AI sort of strategy going forward versus like mass capacity storage, what are you hearing from your customers from the enterprise side in terms of what the priority looks like from an investment perspective? I know your mass capacity product is seeing some really strong traction out of the gate. But over the longer term, how do you think the mix between high-end, high-performance storage and mass capacity trends? And then maybe just on Public Cloud real quickly, I know this has been sort of a fits and starts business for you. When you think about how much of maybe an impact on your management bandwidth, how are you thinking about that business longer term now? I know you're talking about giving out updated outlook maybe next quarter. But do you still think it has the same opportunity to be a key driver for the business? Or is it maybe a little bit less of a longer-term opportunity today than you might have thought 90 days ago or even a year ago at this point? Thanks.

David Vogt:

Great, thanks guys.

Steven Fox:

Hi, thanks. Good afternoon. I just wanted to follow-up on some of those last comments, George, especially on subscription. I guess I'm wondering, obviously, you want to grow faster in public cloud. But -- and the subscription business being down, it seems like it's consistent with the type of macro we're in. So I guess I'm trying to understand more specifically, given all the other stuff that's going on in terms of public cloud, in terms of refining the business, why the subscription business is especially disappointing here as opposed to maybe riding it out until you start to see an up cycle? Thanks.

Steven Fox:

Great, that’s helpful. Thank you.

Wamsi Mohan:

Yes. Thank you. It sounds from your comments like you had at least 7 to 8 points of backlog-related headwind from last year in AFA. Can you help us think through is the magnitude sort of similar in fiscal 2Q? And for fiscal second-half on the Hybrid Cloud side, is it fair to think that there's going to be a 4 to 5 point acceleration in growth? And as you look at the estimates that the Street's modeling is kind of -- that's kind of what is implied. And I'm wondering if you could talk about what is the upside that you're seeing in hybrid that's offsetting the weakness in public, given your relative overall guidance didn't change? Thank you so much.

Wamsi Mohan:

Okay, great. Thank you so much.

Meta Marshall:

Great, thanks. Maybe as a first question, you noted that the storage and consumption piece of the business you expected that, that was growing about market rate this quarter. I guess just is kind of the assumption there that essentially optimization has stabilized, and we are starting to see growth again? I just kind of want to get a sense of where you guys are in terms of what you -- if we're at kind of the bottom of optimization and seeing growth again or if we're still kind of in this bottom out period? And then as a second question, just if there's any kind of surprises in terms of customer types or workload types that have been more interested in C-Series than kind of initially expected? Thanks.

Meta Marshall:

Great, thank you.

Amit Daryanani:

Yes. Thanks for taking my questions. I got caught off in the middle, so I apologize if this was addressed. But on the Public Cloud, can you just talk about what are the reasons that led to the miss of here? Was it macro or there any micro impact as well? And then when you talk about the initiatives you're taking, is it more around just aligning your specialists to the hyperscalers? Or are you taking any more incremental initiatives? Just love to understand macro versus micro impact? And then what are the initiatives you're specifically taking to address them?

Amit Daryanani:

Got it. That's really helpful. And Mike, if I could just have you clarify Q1 free cash flow, I think, was much better than what I had expected and what you typically be in Q1, I think, as well. Can you just touch on maybe what drove that, if there was a bit of a pull-in or something with some of the stuff? And any view on fiscal year free cash flow, given the strong performance here?

Amit Daryanani:

Thank you.

Shannon Cross:

Thank you very much. I guess my first question, George, can you talk about ONTAP AI from a competitive standpoint? Are you seeing this as an ability basically to sell into your existing customer base you are using ONTAP and comfortable with it in that? Or is this something that, from a competitive differentiation standpoint, can actually drive switchers to NetApp's product set? And then I have a follow-up. Thank you.

Shannon Cross:

Okay. And then I guess we've asked you about AI from sort of an opportunity standpoint. But how are you thinking about utilizing generative AI internally within NetApp to increase productivity, save costs and maybe, I don't know, improve customer experience? Thanks.

Shannon Cross:

Thank you.

Operator:

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Operator:

Good day and welcome to the NetApp Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President of Investor Relations. Please go ahead.

George Kurian:

Thanks Kris. Welcome, everyone, to our fourth quarter FY 23 call. Our Q4 results reflect solid execution in the face of ongoing macroeconomic challenges. We delivered revenue above the midpoint of our guidance, with disciplined operational management yielding all-time high quarterly operating margin and EPS above expectations. For FY 23, we delivered record high annual operating margin and EPS, despite the slow demand environment and relatively flat revenue from FY 22. Even as customers are tightening their budgets in response to the macro, they are not stopping investments in applications and technologies that drive business productivity and growth. Digital transformation projects involving business analytics, AI, data security, and application modernization, both on premises and in the cloud remain top priorities for IT organizations. This drives our confidence in the health of our markets and future growth opportunity, despite the temporary macro headwinds. We are participating in the areas of priority spending with a modern approach to hybrid, multi-cloud infrastructure and data management. By providing customers with the ability to leverage data across their entire estate with simplicity, security, and sustainability, we increase our relevance and value. And we continue to introduce new innovations to deliver greater customer value, further strengthening our position. On our last call, I outlined our three areas of focus to sharpen our execution to better deliver results, while at the same time, positioning ourselves for long-term success. As a reminder, the focus areas are

Kris Newton:

Thanks Mike. Operator, let’s begin the Q&A.

Unidentified Analyst:

Hi, guys. Thank you. This is Mike on behalf of Aaron. I just wanted to ask, you mentioned some customers have kicked off new projects following a period of digestion or optimization. I'm just curious, can you give us a sense of how many customers you put in this bucket versus ones that continue to be cautious or maybe are becoming incrementally more cautious, just trying to get a sense of how the demand environment has changed? Thanks.

Unidentified Analyst:

Got it. Thank you.

Samik Chatterjee:

Thanks for taking my question. I guess for the first one. If I sort of -- you reiterated a few times you're really not baking in any macro improvement to the guide, but you did highlight the opportunity to get back to revenue growth in the second half. Just wondering if you can help us think through both of those pieces, particularly when I sort of put them against each other, it does look like you're calling for more of a share gain than revenue rebound in the second half of the year, what sort of drives confidence in this sort of a sequential ramp in revenue through the year? And is there more to it than sort of share gain? And I have a quick follow-up. Thank you.

Mike Berry:

Hey, Samik, it's Mike. If I could just add on to that and want to underline the one point George made. When we talk about our guide for 2024, when we talk about linearity, that's -- and we define that as total revenue we expect in the first half versus the second half. That's much more at where we've been historically, which is about 48% and 52% in those halves. So, when you take a look at the year-over-year growth rates in 2024, just keep in mind that those were heavily influenced by the backlog last year. So when you normalize for that, it looks like a much more normal linearity in 2024.

George Kurian:

Listen, I think, first of all, we are very pleased with new customer acquisition, the broadening of our workloads, clearly the performance, and the efficiency and multiprotocol capability of our storage is an advantage whether for AI workloads, whether they are on-premises or in Public Cloud. What we've seen in Public Cloud for AI is a lot of data science teams using the prebuilt tools that are available on the Public Cloud to calibrate and get their learning models of the curve quickly. And that's uniquely available with NetApp. I think with regard to our perspective for the full year, listen, cloud storage, especially the storage that's sold alongside the hyperscalers will be the primary driver of our business next year. I think if you look at the total dollars in any given year, the opportunity to expand existing customers is substantially larger than the amount that new customers contribute because they are just small, but we feel good about the pace of new customer acquisition. And now our installed base of cloud customers is very substantial. So, there's a good opportunity to cross-sell and upsell them more capabilities.

Operator:

The next question comes from Meta Marshall of Morgan Stanley. Please go ahead.

George Kurian:

Yes. So, let me get the two questions. The first one is what we've seen in the cloud environment is that customers are still progressing new workload deployment, meaning new applications, analytics environment, AIML environment and so on, right, and that has not slowed down. I think there was a period of time where customers were monitoring their environments and optimizing the infrastructure, but the new deployments continue. I think where we have seen people being more cautious is about migration of on-premises environments, for example, to Public Cloud, where they are benchmarking the total cost of each of those landscapes. We have a large and growing opportunity in public cloud on new workloads because of the capabilities and the certifications that we continue to bring. And so we're excited about that opportunity. I think with regard to the customer we mentioned, they were not using NetApp for the landscape that we won. We won -- we replaced a competitive environment, and we did so based on the new C-Series products that had a significant advantage over all the competitive products, both in terms of our traditional advantages around multiprotocol and all of the data management features, but we're also substantially more efficient from a power consumption and density standpoint.

Operator:

The next question comes from Steven Fox of Fox Advisors. Please go ahead.

Mike Berry:

Sure. Hey, Steven, it's Mike. So, let's do the walk from Q3 to Q4, what we guided and where we ended up. So, Q3 product margins were about 46%. We guided approximately 50% largely with the full expectation that we would continue to get relief from premiums that we've talked a lot about. And my goal is to never mention the work premium is on another call going forward. That was about 500 basis point benefit to the quarter, and we expected that to be. The two things that were incremental is mix came in better than we expected. And by that, we mean the capacity per system came in a little bit better. If you remember, in Q3, we talked about that, that caused a little bit of a reduction in gross margins as well as a little bit better all-flash margin. And then FX helped a little bit quarter-on-quarter as well. So, that's the walk from 46% to 55%. As we look into next year, we're assuming that we can retain that 55%. There's a little bit of premium benefit left, but we're also going to make sure that we are flexible as the component pricing rolls through that we can be competitive in the market. And then in addition, we also talked about, hey, we've done some strategic purchase commitments to lock in a large portion of the NAND supply for fiscal 2024 at today's prices. So, we're excited about that, being able to not have to deal with that when in the likely event it starts to go up. As we all know, NAND pricing is at an all-time fall. So, that's the walk from Q3 to Q4, how we did a little bit better and our outlook into fiscal 2024.

George Kurian:

Thank you.

Irvin Liu:

Hi. Thank you. This is Irvin Liu on for Amit. I wanted to double-click on the drivers of a public cloud ARR outperformance during the quarter. I think you referenced cloud storage services strength. But can you talk about what you saw in data management and cloud optimization. Is there anything to call out for Spot just given the increased focus on optimizing cloud spend? And I also have a follow-up.

Irvin Liu:

Got it. Thank you. And then about 11% of your revenue is public sector. From a debt ceiling perspective, I wanted to ask, are there direct impacts we should be thinking about as it relates to your federal government exposure. Is there a potential for a delay in your accounts payable, or any potential changes in how you view the budget environment looking through the back half of calendar 2023?

Irvin Liu:

Got it. Thank you.

Shannon Cross:

Thank you very much. George, can you take a step back and maybe talk a bit from a higher level on how conversations with customers are going with regard to AI. And I'm thinking not just like near-term, but I'm trying to understand or figure out because I think we all are, what the various roles IT hardware will play in the AI proliferation that we're seeing? So, I'm wondering, well, you've got training, so do you need fast storage, and then you move to inferencing, so it could be more traditional storage or -- is that not correct? I'm just -- I'm wondering, I know you're having probably a lot of conversations with customers that could be beneficial to us. Thank you.

Shannon Cross:

Thank you. That was helpful. Mike, can you talk a bit about -- I know OpEx is supposed to be flatter -- you're planning on it being flat this year. But I'm wondering, you delayed some investments and you've had some cost cutting in that. I'm wondering, given the gross margin outperformance in the relative strength you're seeing or improvement you're seeing, is there room to maybe reaccelerate some of those investments? Or is it just too early to make that call?

Shannon Cross:

Great. Thank you very much.

Operator:

The next question comes from Ananda Baruah of Loop Capital. Please go ahead.

George Kurian:

I think the AI applications that drive business productivity are a topic of discussion in every CEO room around the globe because it is a key way to bring speed and operating efficiency to companies. And so many of the applications that we talked about help transform a company's business model. And so they will get prioritized in spending envelopes and we are really excited about our opportunity to capitalize on that. We have done the work not only to build high-performance storage, but in addition, build the integrations into all of the AI and data science tool chains that are common in the world and to enable a really flexible data pipeline that can start in the cloud where the tools are available, but then can be operated at a scale on the data in your data center. So, we're really excited about what the future holds and we're going to keep pushing forward. I see cloud and I see AI as two big opportunities for NetApp. We are super well positioned in both, and we look to take advantage of both of them going forward.

George Kurian:

I think the lower cost NAND technology that we've introduced in our products will become a bigger part of our business through the course of fiscal year 2024 and will be the biggest part of the flash storage growth rate in the industry over the next two or three years. These HDD replacement cycles are multiyear, right? I think if you saw the high-performance 15,000 HDD segment, it took multiple years to transition that footprint. And so 10,000, which is an even bigger part of the market will take many years to transition. But we're excited about our offerings, the start that we've had and the opportunity over the next many years.

Operator:

The next question comes from Krish Sankar of Cowen. Please go ahead.

Mike Berry:

Sure. It's Mike. So, let's take both of those. So, the guide of 55% assumes that's what we came out of Q4 with. There are some nice continued tailwinds going into next year. One is, of course, the continued shift to all-flash, which has higher margins. In addition to that, we do have a little bit of benefit from premium. So, we feel good about the 55% number. The strategic purchases really help, I'll call it hedge that number to lock the prices in that we have today. I would certainly assume given the lower price of NAND that other folks are doing similar exercises. And why we're at 55%, probably we want to make sure that we have some flexibility around pricing to your very point. So, to the extent that there are changes in the market pricing, we feel like we have that flexibility to stay within 55%, but still be able to get to our product revenue goals for the year.

George Kurian:

I think it's premature to signal that cloud optimization is behind us. As we commented in our prepared remarks, I think that this customers will continue to manage their spend where that is on data center infrastructure or on public cloud. I think what we continue to see is the projects and applications that drive business performance especially core business growth are getting prioritized and invested. Those could be analytics, those could be AI, those could be digital manufacturing projects and on and on, right? I think where we have seen optimization and some amount of caution is in migration of enterprise workloads from data centers, the old lift and shift, I think people are taking a hard look at benchmarking both environments, whether it's public cloud or on-premises. So I think that's where we continue to see some optimization. In the plan for 2024, the real focus is on accelerating our hyperscaler storage. The storage that is sold alongside our cloud providers, it had a good quarter this quarter. We are uniquely positioned in the market, and we are serving a wider and wider range of applications with the strength of our technology. So, we're excited about that.

Operator:

The next question comes from Tim Long of Barclays. Please go ahead.

George Kurian:

Yes. So, maybe I can start with the portfolio. We've introduced three major expansions of our portfolio in the all-flash segment over the last four months to five months. We have capacity flash, the broadest, most feature-rich, most competitive capacity flash products in the industry. We've announced a set of entry flash products that are shipping, which brings our industry-leading software in an all-flash configuration at a price point that is perfect for midsized enterprises. And we introduced early this quarter and All SAN Array, which is a block-only storage configuration for customers that have large block storage environment and don't want to use unified storage for those offerings. So, major expansion to our product portfolio, the most significant expansion since we introduced our flash portfolio many years ago. So, I'm excited about that. That gives us opportunity to both expand wallet share in enterprise customers going after parts of the wallet that we used to not serve, but importantly, address the expanding opportunity within commercial customers. Our commercial segment has outperformed the enterprise segment throughout this fiscal year and again did so in Q4, representing the resilience of those customers to the macro spending environment. So, we feel good about that. We moved some resources within our spending envelope. We reprioritized some more resources to cover the commercial market for fiscal year 2024.

Operator:

The next question comes from Nehal Chokshi of Northland Capital Markets. Please go ahead.

Mike Berry:

Yes. Hey, Nehal, it's Mike. So, if you take a look at Q4, so total revenue was down year-over-year by about 6%. Total billings were down by about 17%. When you take a look at the difference between billings and revenue, product revenue and product billings are basically the same because there is no change in deferred. What we saw in the second half, especially in Q4, is lower product bookings than correlated with less support bookings, specifically multiyear bookings that come with new sales. So, we do expect to see that come back as we go through next year. That's going to be the difference that you see in billings and revenue. So based on the guidance for the year, which is revenue down low to mid-single-digit percent, we do expect billings to be more flat to somewhere around plus or minus a couple of percentage points to do a little bit better than revenue, again, because of the contribution from support.

Mike Berry:

Thank you.

Simon Leopold:

Thanks for taking the question. I wanted to see if we could maybe unpack the public cloud business a little bit. In that last quarter, it seemed apparent that some of it was very much a recurring revenue stream and some of it was more sensitive and consumption-based. And I'd just like to get level set as to how to think of the composition of PCS as to what you would consider consumption-based and what you would consider truly recurring? Thank you.

Simon Leopold:

Thank you very much for that.

Operator:

The next question comes from David Vogt of UBS. Please go ahead.

George Kurian:

Okay. Let me hit the sort of the broad picture, right, which is, listen, I think that we are disciplined managers of the business. We are balancing an uncertain macro with the strength of our product portfolio and the long-term opportunity. And I think what you'll see us is we continue to invest in the areas where we see the best returns so that we don't forgo the long-term health of the business. If we see the year outperform, we will certainly look at investing to further accelerate the business. But I think at this point in time, we want to be prudent in terms of managing the business just given the macro landscape. I think the second is, with regard to AI uses at NetApp, we have a broad range of users. We already use AI in our customer support and our product portfolio to help customers be able to have much reduced management requirements, right? So, we automate how data is managed in the system and automate self-healing of a system, as well as give customers intelligent chat bots, for example, so that they don't have to wait in queue for all of their basic questions. I think with regard to the big areas that we see opportunity is, is really in software development productivity. We have some exciting work already underway using some of these large language models and this profound opportunity for innovation there that we are leaning into. And you'll see the benefit of that in the ability to deliver more software to customers in a faster period of time. And I think those are some of the key areas of focus for us.

David Vogt:

Great. Thanks George. Thanks Mike.

Sidney Ho:

Great. Thank you. I have a cash flow question. So, I know Q1 is going to be impacted by all these strategic buys. But Mike, how are you thinking about free cash flow for the fiscal year, maybe the linearity of that? It sounds like you're expecting to return 100% of free cash flow to shareholders this year. At what point, do you think M&A will come back to be a priority? Thanks.

Sidney Ho:

Okay, great. Thanks.

Operator:

Our last question will come from Louis Miscioscia of Daiwa Capital Markets. Please go ahead.

George Kurian:

Louis, first of all, if you look at the recent print from our competitors, I think we took share already in the current quarter. So, that's a good start to that dynamic. I think with regard to our overall kind of focus areas, we talked about expanding innovation to support our storage business. And so we've done a lot of product-led innovation into the market as well as broad innovation in storage life cycle management programs, the simplified licensing, the industry's most advanced and complete ransomware protection and recovery guarantees of lots of service innovations as well for our customers. We have aligned our go-to-market teams starting fiscal year 2024 to be laser focused on our flash portfolio. We think we've got a strong opportunity there. Last year, as I mentioned in our Q3 call, we had a compensation plan that was complex, having our frontline sales team sell a broad array of products, and that impacted execution. We have sharpened that starting FY 2024 per our commitment, and we have brought a much more focused approach to our cloud portfolio. So, I expect us to -- we have the strongest hybrid flash portfolio in the industry. We now have the broadest capacity flash portfolio in the industry and truly the only unified storage portfolio in the industry. Unified now includes block, file, object and cloud. And so we've redefined the landscape for unified to take it to the next level. So we're excited about the portfolio. We've got to execute, and we're focused on it.

Mike Berry:

Yes. Hey, Louis, it's Mike. Our expectation is it's not going to be a big impact at all, less than 1% based on where we sit today from a revenue perspective. So, we don't think FX is going to be a big hit. And that's a small benefit where we are. Who knows where FX rates go after all of the fund that we've had with the debt ceiling and other things. So, we don't think it's going to be a big driver next year.

Mike Berry:

Thank you.

George Kurian:

Thanks Kris. Our focused execution yielded solid Q4 results, capping off fiscal year 2023 with record high annual operating margin and EPS, despite the slow demand environment. The fundamentals of our business model are sound and our confidence in our strategy and the health of long-term opportunity is unchanged. We will continue to prudently manage the elements within our control to drive margin expansion and improve profitability. I'm excited to enter FY 2024 with substantial new innovations and a more focused operating model to better address areas of priority spending within our customers. I look forward to updating you on our progress on next quarter's call.

Operator:

Good day, and welcome to the NetApp Third Quarter Fiscal Year 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President of Investor Relations. Please go ahead.

George Kurian:

Thanks, Kris. Good afternoon, everyone. Thanks for joining us today. In Q3, we executed well on the elements under our control in the face of a weakening IT spending environment and continued cloud cost optimization. Disciplined operational management yielded operating margin and EPS that exceeded expectations, despite revenue coming in at the low end of our guidance. We are delivering on our commitments and responding to the dynamic environment. We adjusted our cost structure, introduced a portfolio of capacity-flash arrays to support cost sensitive customers, and continue to work with our customers to help them optimize their cloud spending. On today’s call, I will discuss our Q3 results in the context of the current environment and our plans to sharpen our execution to accelerate near-term results and enhance our long-term position. We continued to see increased budget scrutiny, requiring higher level approvals, which resulted in smaller deal sizes, longer selling cycles, and some deals pushing out. We are feeling this most acutely in large enterprise and the Americas tech and service provider sectors. Customers are looking to stretch their budget dollars, sweating assets, shifting spend to hybrid flash and capacity flash arrays from higher-cost performance flash arrays and, as our cloud partners have described, optimizing cloud spending. We saw signs of a softening environment early in fiscal year ‘23 and took swift action to control costs, with increased scrutiny of program spending, a hiring slowdown in Q2, and a hiring freeze in Q3. At the start of Q4, we implemented a workforce reduction of approximately 8%. Decisions that impact our employees are always difficult. I take great pride in fostering the NetApp culture and am committed to using this difficult action to refocus our team, guided by the values and mission of the Company. Our hybrid flash and QLC-based all-flash arrays continue to perform well, benefiting from customers’ price sensitivity in this challenging macro. The shift from high-performance all-flash arrays to lower cost solutions, coupled with the lower spending environment, especially among large enterprise, and U.S. tech and service provider customers who are large consumers of flash, created headwinds to our product and all-flash array revenues. In Q3, our all-flash array business decreased 12% from Q3 a year ago to an annualized revenue run rate of $2.8 billion. Public Cloud ARR of $605 million did not meet our expectations, driven by a shortfall in cloud storage as a result of the same factors we experienced last quarter. Spending optimization and the winding down of project-based workloads like chip design, EDA, and HPC were headwinds again in Q3. We have a sizable base of public cloud customers, with a number of large customers who have grown rapidly over the past year and are now optimizing. Their cost optimizations mask the growth of other customers. We continue to add new customers and churn has remained consistently low. Overall, the CloudOps portfolio performed to plan. Cloud Insights has stabilized, and Spot continues to grow nicely, benefiting from the cost optimization trend. Our dollar-based net revenue retention rate decreased to 120% but is still within healthy industry norms. We are confident that we remain well positioned to take advantage of the secular growth trends of data-driven digital and cloud transformations. We are aligned to customers’ top priorities and have demonstrated success in controlling the elements within our control. Building on that solid foundation, we are sharpening our execution to accelerate near-term results while strengthening our position for when the spending environment rebounds. We have three areas of focus

Kris Newton:

Thanks Mike. Operator, let’s begin the Q&A.

Amit Daryanani:

Thanks for taking my question. I guess the first one I had was if I think about the delta and cloud ARR from $700 million last quarter that we were expecting to maybe $605 million range right now, how much of the delta or the drop, if you may, is due to macro issues versus something that might be more company-specific? Is there a way to parse that out? And then do you see the resumption of growth happening in '24 as you go forward?

Amit Daryanani:

Got it. And could I spend maybe 60 seconds on the gross margin dynamics into April quarter? I think you’re essentially saying, I think, gross margins are flat, up 20 basis points sequentially, but that's despite the fact you have a little bit of revenue leverage. And then it sounds like NAND pricing and commodity pricing broadly is coming down. So, I would have thought gross margins could be up a bit more maybe in the April quarter. So maybe you can just talk about the puts and takes on the gross margin line, that'd be super helpful. Thank you.

Operator:

The next question will come from David Vogt with UBS. Please go ahead.

George Kurian:

I think there are three elements of that. I think the first, we have been a little bit later than we would have liked to introduce lower cost more value-oriented capacity flash arrays. We've corrected that. We feel really good about the early interest in our C-Series. The second was that we have moved resources to the more stable, steady growth parts of the market, like the commercial market and lower parts of the enterprise from the cyclical large enterprise segment. We haven't done as much as we need to, and we'll continue to do that heading forward. And the third is that from a compensation and goal alignment perspective, we're going to sharply focus certain parts of our field organization to drive our flash portfolio while aligning other parts of our field organization to focus on the cloud business.

George Kurian:

I think, first of all, we are excited about the C-Series products. They will be available this quarter. I think the material impact of those product portfolios will be in the first half of next fiscal year. The large enterprise segment will continue to be a place of caution for us. I think that we will need -- we are working with our customers to understand their buying behavior. My sense is that -- and my hope is that they are back buying more aggressively than they have been in the second part of next fiscal year. So, we hope that -- the product portfolio is in the market this quarter. Commercial and lower-end parts of the enterprise should see some benefits from that in the first half of next fiscal year. But the large enterprise segment, we're a bit more cautious about. And your expectation is more accurate around second half of next fiscal year is our hope.

Steven Fox:

Just following up on those last comments around the commercial versus large enterprise. I guess, how do we think about just sort of a pivot back so that you prepared for the cycle? Like what are you looking for in order to maybe have the right resources ready for when the large enterprises do come back and you need to be prepared to service them in a more aggressive manner? And then, I had a follow-up.

Steven Fox:

Okay. That's helpful. And then, just in terms of the benefits now with NAND and other component costs low, can you just talk about -- give us a sense for how much of your sales are benefiting from the low-cost NAND in this current quarter? And how much more there would be to go before you like at 100% of where NAND prices are? Thanks.

Operator:

The next question will come from Wamsi Mohan with Bank of America. Please go ahead.

George Kurian:

I think that our exposure to the large tech and service provider segments and our large market share in markets like Germany exposed us when those segments and countries slowed down in their purchasing behavior. I think that having a smaller number of QLC products also precluded us from participating in some purchasing activities, some RFPs in the past couple of quarters. And I think we are excited about the return to having the best lineup of flash, both performance and capacity flash. And we've got to see progress in terms of -- continued progress in our enterprise and commercial customers over the next few quarters to wait for the large enterprise purchasing to come back.

George Kurian:

Yes. I think, first of all, you have seen us be disciplined stewards of the business in good times and bad. You should expect us to continue to maintain operating expenses tightly managed until we see growth. Product margins, as Mike said, should have significant upside as we roll into fiscal year '24 as both mix shifts towards all-flash and component costs in all-flash come down as well as premiums go away. In terms of returning to growth, listen, I think that we will -- we are aligning our resources to be much more focused on our respective businesses. In the flash market, you should expect us to continue to track the progress of our flash market share. I think that, as I said, both enterprise and commercial segments should see growth while the large enterprise takes some more time to come back. And then, I think in terms of cloud, listen, I think consumption will continue to be a headwind for a period of time as our cloud provider partners have also said. That does not mean that we are going to not continue to accelerate new customer acquisition. And a more aligned go-to-market model for flash and for public cloud services, respectively, will help us do that, execute better against each of those opportunities. We'll tell you more when we guide fiscal year '24.

Mehdi Hosseini:

It seems like April being the fourth quarter fiscal year helps with a little sequential bump in revenue, but should I expect a rather seasonal trend into Q1 fiscal year '24? And I have a follow-up.

Mehdi Hosseini:

Got it. And then for Mike, should I assume that the full impact of the headcount reduction is dialed into the April quarter, or would you be able to reduce the OpEx into July quarter?

Operator:

The next question will come from Tim Long with Barclays. Please go ahead.

George Kurian:

I think the capacity flash arrays that we recently announced have a workload profile and a performance profile that's distinct from the performance flash array. Performance flash are typically sub-millisecond kind of latency. In capacity flash, it's about 2 to 3 milliseconds. So, they are distinct use cases. Capacity flash will be an upsell on the hybrid flash array and will over time impact the percentage of our business mix that's hybrid flash.

George Kurian:

We continue to have great engagement with our cloud provider partners. As I mentioned, customer acquisition continues to be a good part of our cloud business. The impact in the quarter is limited because the initial deployments are small. So that's the first. Second, with regard to cross-selling multiple cloud services after the initial use case, we have done well, and I'm pleased with progress. In terms of the customers that we are engaged with on consumption, there is no churn difference, right? So, the pattern is they are reducing the performance level of the storage use case, but they're not churning off our service. So, I feel really good. Actually, I think it's the best part of being a partner is to help your clients use the right combination of services. And then, in terms of penetration of our installed base, while it's early, we continue to see that moving forward steadily. I think the penetration in our NetApp managed enterprise accounts is much higher than in our commercial segment.

Samik Chatterjee:

I guess I had two on the Public Cloud. And if I can just start with just the broader trends that you're seeing in relation to Public Cloud and the pressures around consumption and optimization. It does indicate that not every use case that the enterprises were leveraging were critical in the cloud. I mean how do you think about some of the addressable market that you were defining around the cloud storage and CloudOps? Just in relation to that, I guess, enterprises don't see everything as being critical in the cloud, and there's a lot more room for optimization as is being demonstrated during these budget cuts. And I have a follow-up.

Samik Chatterjee:

Okay. And maybe on the same line, just digging a little bit deeper. Like, what are you seeing in relation to sort of the difference in engagement on Spot versus Cloud Insights? And when you have net revenue retention rates of around 120%, like how does that break down between Spot and the rest of the portfolio maybe seeing a bit more challenges?

Operator:

The next question will come from Krish Sankar with Cowen and Company. Please go ahead.

George Kurian:

We continue to add new customers to our -- all of our cloud services, CloudOps and cloud storage. The impact of those customers in the first few quarters of they are being acquired is actually small because they typically find small deals, and they are testing out the services or they deploy a development and test environment rather than a production environment. Those customers were actually -- the benefits to our business from those customers was overrun by the reduction from some of the large customers who contracted their spending in the quarter. So, we feel good about new customer additions. Can we do more there? Surely, but I don't think that was a material issue in the quarter.

Mehdi Hosseini:

Got it. Got it. Super helpful, George and Mike. And then as a quick follow-up, George, kind of like what is your visibility today? Like, how many months’ visibility do you have? And also to an earlier question, George, you mentioned that when a customer's business gets better, they'll start spending again. I mean, I just wanted to find, is it as simple as that, or do you have to look at other metrics like kind of how you said, deal sizes are smaller, maybe deal size gets larger, you don't need a CFO approval for purchases? Are there any other leading indicators to look into? Thank you.

Operator:

The next question will come from Matt Sheerin with Stifel. Please go ahead.

George Kurian:

I think it's always a competitive environment, and it continues to be a competitive environment in a tough demand environment. I don't see any player doing anything kind of out of the ordinary. I think that just like everyone else, we see the opportunity, especially with QLC-based flash arrays, to be competitive in the market.

Sidney Ho:

You guys have seen a few down cycles in the past 10 years where you saw multiple quarters of overall revenue decline of 10% or more on a year-over-year basis. I think that was in 2016, 2020. Curious how you think this cycle will shake out. Maybe just help us compare and contrast with the previous cycles in terms of the depth and duration of the downturn. Maybe they're completely different. And then I have follow-up question.

Sidney Ho:

Okay. That's great. Maybe a quick follow-up here. Just on the earlier answer on the operating expenses. You talked about holding OpEx flat until you see growth. But to be clear, are you expecting OpEx to be down in the July quarter from the 675 level in the April quarter, which I know it's seasonally down for OpEx anyway for the July quarter? And you hold expenses at those levels going forward until revenue growth resumes? Is that how we should think about it?

Operator:

The next question will come from Jim Suva with Citigroup. Please go ahead.

George Kurian:

I think on the share part, our exposure to the large enterprise is bigger than some of our competitors. And so, I think in a down cycle, we will probably concede share given our exposure to those customers. I think the second is now that we have a more kind of full lineup of capacity flash arrays, I feel good that we can compete in all the segments of the flash market, which are key to driving share gains, and keep the hybrid flash segment where we have a strong offering moving forward. And then, I think, as I noted in my comments, we are going to better align our execution in the field so that we can more sharply focus on the storage market and more sharply focus on the cloud market in a more tailored go-to-market model for each.

Operator:

The next question will come from Jason Ader with William Blair. Please go ahead.

George Kurian:

I think that overall customers' budget in dollars, and so we segmented the market and the use cases quite distinctly for performance versus capacity flash. I don't think there's going to be material cannibalization between the two. I think it really comes down to customer budget dollars being available.

George Kurian:

I think that we've always seen customers buy in dollars, and they budget in dollars. So, I think if you ask me right now, I don't actually see the NAND pricing coming down being the real headwind. I really do think it’s customers' budget and IT spending that's the more material area of focus for us.

Meta Marshall:

On the CloudOps portfolio, you guys have spoken to kind of a more aligned or sharpened go-to-market motion. I just wanted to get a sense of some of the integrations of that product portfolio that was going to happen and just whether that's a part of that kind of refined go-to-market and where we are on that. And then the second kind of piece of that question is just on the cloud storage piece. You guys have had a little bit less of visibility into kind of that customer set, just getting a sense of, are some of these sharpening go-to-market motions kind of overlay sales? Just anything that's happening on the cloud storage to increase visibility there. Thanks.

Operator:

Next question will come from Shannon Cross with Credit Suisse. Please go ahead.

George Kurian:

I think that those cuts were -- are factored into our guidance for this quarter. And when we guide next year, you should expect us to factor those into the guidance. Broadly speaking, we focused our resources on the biggest market opportunities, and the places that we impacted were less significant contributors to revenue for us. I think in the cloud portfolio as well as in CloudOps, we've made some decisions that will have impact to ARR going forward. But I think that those are in the spirit of let's focus on the best markets and the best opportunities. Our guidance for the quarter envisages those changes. Mike, do you want to add anything?

Shannon Cross:

I guess, were there any cuts in Hybrid Cloud? And then my second question is, what drove the year-over-year increase in stock-based comp given all of the pressures you're seeing? Thank you.

Mike Berry:

Shannon, on your question on stock-based comp, every six months, we have to do a look back on ESPP program. And there was about an $11 million, I'll call it, catch-up entry in the quarter to take into account the lower price of those purchases. And you'll see that typically every six months when we do our ESPP, depending on the price movements of the stock during that period of time.

Mike Berry:

So, it stays in the run rate. It won't drop down. And what happens in six months is dependent on where the stock price is at that purchase date.

Nehal Chokshi:

What has been the year-over-year demand trend in the month of February relative to the January quarter? Has it worsened as implied by the guidance even with the C-Series now available?

Nehal Chokshi:

Okay. And what's the postmortem on why you guys were late with the lower capacity product on all-flash arrays?

Operator:

The next question will come from Ananda Baruah with Loop Capital. Please go ahead.

George Kurian:

Listen, I don't want to comment about our competitors. I should let you ask them that question. I think what we have seen is that we are -- have got a large base of high-tech and service provider customers and large enterprise customers. They are demanding customers, and they are forward-leaning. And there's lots of benefits to having those customers. But when they are in a down cycle, it does impact our business. Over the years, we've done a few things to expand our business. I think, one, we continue to invest in the commercial segment. It's too early to call that a broad push, but we've seen good results. We've also brought in the number of enterprise customers. We sign up below the large enterprise. And perhaps most importantly, has been the push to grow our cloud business. Cloud has been the single most strongest vehicle for new customer issues for us, and I'm very pleased with that route-to-market that we've enabled over the past few years.

George Kurian:

I think broadly speaking, as we have said in past cycles, when the price of NAND comes down, you see a mix shift towards a flash-based system. Disk-based systems costs have been more steady than sort of up and down like flash. So, that's the broad trend. In our case, we expect that shift to also benefit from the fact that we now have two complete lineups, high-performance flash, which will benefit from NAND and capacity flash, which will also benefit from NAND.

Kyle McNealy:

Can you talk a little bit about the positive impact you expect to have from AI on the business? What's the positive impact? Where it will come from? Is it a higher mix of high-performance, low-latency all-flash? Is it sheer data growth or both those factors? And do you think we'll have to get past the near-term softer macro environment that you've been talking about through '23 until we see some kind of material new AI workload growth? Thanks.

Kris Newton:

Thanks, Kyle. I'm going to pass it back to George for some closing comments.

Operator:

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Operator:

Good day, and welcome to the NetApp Second Quarter Fiscal Year 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President of Investor Relations. Please go ahead.

George Kurian:

Thanks, Kris and welcome everyone to our Q2 FY 2023 earnings call. Coming off a strong Q1, our team delivered a solid quarter, with all-time highs for Q2 billings, revenue, gross profit dollars, operating income, and EPS. We remain focused on disciplined operational management and the execution of our strategy, which is tightly aligned with customer priorities. On today’s call, I will walk through four topics; one, we delivered a good quarter in a dynamic environment. However, we are disappointed with the deceleration of growth in our cloud services. Our conviction in the cloud opportunity and our ability to execute against it is unwavering. Two, we are aligned with the durable, megatrends of data-driven digital and cloud transformations. We continue to deliver innovation that furthers our already strong position. Three, we believe strongly in the opportunity ahead, but have slightly tempered our revenue outlook for the remainder of the fiscal year, due to near-term macro headwinds. Four, we understand the imperative to deliver shareholder value in a slowing environment and will focus on our strategic growth opportunities, while continually optimizing our operating costs. Let's start with the first point, our performance in the quarter. Q2 public cloud segment revenue increased 63% year-over-year to $142 million and dollar-based net revenue retention rate remained healthy at 140%. However, Public Cloud ARR of $603 million fell short of our expectations. As our cloud partners discussed on their earnings calls, growth has slowed as customers look to optimize cloud spending. This macro-related optimization caused some slowing of growth in our cloud storage services as well. Additionally, we had a few customers with very large project-based workloads like chip design, that came to their natural conclusion, resulting in capacity reductions in those environments. We expect these customers to kick off new projects early next calendar year, as the number of cloud customers and their usage of our cloud services grows, the impact of this type of workload will be smoothed over a much broader customer base. In our cloud operations portfolio, Spot is benefiting from the same desire to optimize cloud spending that was a headwind to our cloud storage services. Spot's value proposition is a strong engine for new logo acquisition and Q2 saw an acceleration of new Spot customer additions from Q1. As we've discussed on past calls, we continue to refine our approach to cloud insights and are seeing early positive signs, with the growth of new Cloud Insights customers in Q2. We continue to see healthy growth of new-to-NetApp customers and of existing NetApp enterprise customers adopting our cloud services and those customers are growing in scale as well. The number of customers with greater than $1 million in ARR has more than doubled from Q1 last year. Our public cloud services are highly differentiated and create customer preference for NetApp. We have a multiyear advantage over our traditional competitors in this critical market, positioning us well to deliver sustained growth. Compared to Q2 a year ago, Hybrid Cloud revenue grew 3% and our all-flash array business increased 2% to an annualized revenue run rate of $3.1 billion. Adjusting for the significant FX headwinds, Hybrid Cloud grew 8% and all-flash grew 7% in constant currency. All flash penetration of our installed base grew to 33% of installed systems. Our lower cost, capacity-oriented all-flash arrays and FAS hybrid flash arrays, both performed well. Onto the second point, our alignment to the industry megatrends and our continued innovation. The world is moving faster than ever, raising data-driven digital and cloud transformations to business necessities. NetApp helps meet these objectives with a modern approach to hybrid multi-cloud infrastructure and data management that we term the evolved cloud. We provide customers the ability to leverage data across their entire estate with simplicity, security, and sustainability, which increases our relevance and value to our customers. We believe strongly in the sizeable, durable, and growing opportunity created by these megatrends. As many of you know, we bring significant value to customers running VMware environments on-premises. With a series of announcements made in conjunction with VMware, we are now able to bring that same value to customers in the cloud. Our native cloud storage service integrated with VMware, helps customers quickly, easily, and cost effectively migrate enterprise workloads to the cloud and accelerate modern application development using Kubernetes. We are the only certified and supported third-party cloud storage solution for VMware Cloud, which creates significant new opportunity for us. As those VMware environments move to the cloud, we can capture the data that resides on competitors’ on-premises systems. At the start of November, we introduced BlueXP, the next big step in fulfilling our vision to give customers the simplicity, security, savings, and sustainability needed for an evolved cloud. It delivers true hybrid, multi-cloud operations by bringing storage and data services together in a single, unified control plane. BlueXP is a highly differentiated solution that enables customers to deploy, discover, manage, and optimize not only infrastructure and data, but supporting business processes across multiple clouds and on-premises environments. In addition to bringing forward technical capabilities, we are helping customers achieve their environmental goals by creating energy efficient products. We have added power and temperature reporting in Cloud Insights to give customers a real-time view into energy expenditure and our carbon footprint reports provide a reasonable estimate for the carbon impact of their NetApp systems. We enhanced our storage efficiency with a 4:1 efficiency guarantee for SAN workloads to help customers minimize their storage footprint and lower energy usage. We not only help customers practice sound environmental stewardship, we practice it ourselves. I am proud to announce that EcoVadis, the leading evidence-based ESG rating agency, awarded NetApp a gold ranking, placing us within the top 7% of evaluated companies. Now the third point, the macro environment and our business outlook. As we moved through the quarter, we saw increased budget scrutiny, requiring higher level approvals, which resulted in smaller deal sizes, longer selling cycles, and some deals moving out of the quarter. In Q2, we felt this most acutely in the Americas hi-tech and service provider sectors. We see no change to our underlying opportunity and are confident in our position. However, current economic realities and unprecedented FX headwinds are and will continue to impact IT spending, causing us to temper our revenue expectations for the second half. And finally, point four, driving shareholder value. In response to the slowing top line, we are being agile and taking action to lower operating expenses. Already, we have implemented a broad-based hiring freeze, and are reducing discretionary spending, as well as further optimizing our real estate footprint. We will remain disciplined as we continue to shift resources away from lower yield activities to our biggest opportunities. In closing, we are clearly aligned with our customers' strategic priorities and remain confident in our long-term opportunity, despite the current external headwinds. By focusing on what we can control, we will aggressively seek to maximize the near-term return on our product and services portfolio, while leveraging our leadership position in all-flash, cloud storage, and cloud infrastructure optimization. I would like to thank the entire NetApp team for delivering a strong first half. In a challenging environment, we remain focused on innovation, execution, and operational discipline. I’ll now turn the call over to Mike.

Kris Newton:

Thanks Mike. Operator, let’s begin the Q&A.

Unidentified Analyst:

Can you hear me?

Unidentified Analyst:

Okay. So this is Abdulla [ph] speaking in for Amit. So I think your guys' cloud ARR expectation is coming down by $100 million versus prior expectations. And I just wanted to ask whether you guys could perhaps touch on the softness there? Is this more on compute, storage or analytics? And maybe if there's one cloud provider where the ramps are more challenged versus not? I would appreciate any details here. Thank you.

A – Kris Newton:

Thank you. Next question please.

Q – Mehdi Hosseini:

Yes. Thanks for taking my question. Two follow-ups. George, if I just take your guidance commentary, you suggest that all-flash array revenues should show Q-over-Q and year-over-year decline in January quarter?

Q – Mehdi Hosseini:

Just that's what I walked away with. Is that a realistic assumption for all-flash array revenues were to decline?

Q – Mehdi Hosseini:

Yeah. That's fine. At least I tried. Just -- and then a follow-up to your comment about the chip design. There's obviously product migration. They are expected to introduce new products for AI application. You also suggested that, that should help you with a rebound in the cloud data services. And I want to better understand whether your underlying assumption, do you think that product transition is going to ramp in early calendar year. Is it -- is your guide on cloud data services completely derisked given this transition. Sometimes these transitions take longer. And I'm just wondering what are the key assumptions there?

Mehdi Hosseini:

Thank you.

David Vogt:

Great. Thanks guys for taking my question. Hi George, hi Mike. Maybe just a big picture question on macro and linearity and how you thought about the quarter as it progressed because obviously, you did a good job of cutting costs, managing the business to the economic backdrop. But all-flash arrays were relatively weaker in the quarter, suggesting that obviously, you probably knew early in the quarter that customers were looking for more maybe cost conscious or cost-effective solutions. And you mentioned a lot of decisions were picked up to the CTO level or the CFO level. So, can you, kind of, discuss what you saw as the quarter progressed from a demand perspective? Was there a pivot point or was it just sort of a gradual bleed as we walk through each of the months? And how did it relate to, let's say, 90 days ago when we had this conversation? Thanks.

Mike Berry:

Yes. Thanks, George. So David. Per George's comments, when we saw linearity in the quarter, month one was relatively consistent with what we've seen in, I'll call it, non-Q4 quarters. What we really saw was month two push into month three. And typically, we will see, call it, mid 40% of transactions and invoices in month three. That pushed to almost 60% this quarter. So, what you saw was in the second month of the quarter really started to push into the third month. And that's what we saw that really back-end linearity that I spoke about in my prepared remarks.

Mike Berry:

Yes. Sure, David, happy to. So, the significant foreign currencies we have like most international companies, it's euro, GBP, yen and Aussie dollar. And what we saw, again, across most of those is August and September was when the dollar was the strongest. So, that's when the most significant impact hit. That stayed largely through October. Now, what we saw after our quarter ended, is, hey, it got a little bit better in November, the dollar weakened a little bit. Yes, we'll see if that holds. Everything we've put in front of you, we have used FX rates as of the end of October. So, it says a little bit better, that will be good. But making our living betting on FX rates, we're not going to try that. So we use October rates for the rest of the year.

Mike Berry:

Thank you, David.

Angela Jin:

Hi. This is Angela Jin on for Samik Chatterjee. And my first question. So, I think in your prepared remarks, you mentioned that, customer weakness was concentrated in Americas hi-tech and service provider sectors. Can we just dive more into the dynamics of each of your customer vertical/segments. Were there certain ones that held up better, enterprise versus SMB, for example? And what types of specific behaviors or patterns that you see in each vertical?

Angela Jin:

Got it. And then for my follow-up, with the cloud ARR target lowered to $700 million, looking ahead to the out year, I'm not asking for you to predict how deep or long a potential downturn could be. But how are you thinking about risk to that $2 billion cloud ARR target by fiscal year '26. And what gives you confidence that you can accelerate ARR in those out years?

George Kurian:

I think where we are focused on at the moment with our cloud business is to make sure that we are a good partner to our customers so that we can optimize their spend where they need help doing that. We are going to be continuing to accelerate our focus on selling more of our cloud products to our installed base where today it's about 15% of our Hybrid Cloud customers have our cloud products. And we have grown the number of cloud customers and the number of them that are buying more than one cloud service. So there's lots of opportunity ahead. We're focused on blocking and tackling and executing on the opportunities in front of us.

Operator:

Our next question will come from Krish Sankar with Cowen and Company. Please go ahead.

George Kurian:

I think with regard to what we saw in the quarter was really we have unique cloud services, which are native, first party cloud services. Those are consumption offerings that we give customers. They were the ones most impacted. None of our competitors have native first-party consumption cloud services. They offer it through the marketplace. The marketplace business for us stayed relatively consistent. And so that is what you would expect. The subscription business is less susceptible to near-term changes in usage than the consumption business. And so the benefits of consumption being you can turn it on and off also shows up when customers want to optimize spend. We want to be a good partner to the customers that want to do that. And so we are working with our hyperscaler partners to give them access to more options to be more cost effective with their spend. Spot, which is the compute optimization platform actually did well in the quarter. So while the storage consumption was impacted by spend, as I noted in my remarks, Spot was a -- which is a vehicle to optimize computing spend did very well in the quarter. And so we continue to help our customers through that journey. With regard to growth opportunities, listen, as I said, we felt very good about the number of customer adds. We felt very good about the amount of cross-selling we are starting to see dollar-based net retention rate has been strong, and so several good things in our cloud business.

Mike Berry:

So on the ARR point, so there's been a couple of questions about the $800 million down to the $700 million. So when we looked at that, originally, when we had given the $800 million, we expect it to be, call it, somewhere around $650 million as of the end of Q2. Taking a look at the second half now, we expect to grow about $100 million. That's all organic because we don't have any acquisitions baked in. And we expect that to continue to grow across cloud storage, specifically ANF, FSx and GCP, we all expect to see some good growth. We have tried to be conservative or cautious, I will say, around the consumption business because we do expect that to come back in the second half. We're just not really sure if it's going to be Q3 or Q4. So we feel really good about the $700 million, still a significant growth in that business. But stepping it down a little bit based on the Q2 results and also take a step back a little bit on Cloud Insights. So that's the -- I'll call it, Krish, the product view of the rest of the year.

A – George Kurian:

Thank you.

Q – Sidney Ho:

Thanks for taking my question. Maybe a couple more on the public cloud side. So on the reported quarter, your public cloud revenue on an annualized basis was lower than your ARR exiting last quarter. Is it fair to say that there were some cancellations and maybe some restructuring of some of the deals based on the three dynamics that you guys talked about earlier. And if so, how do you feel comfortable about the future ARR would not be reduced from the churn level? And maybe I'll just throw in the next question here. If you look at your revised ARR for the $700 million, if I exclude the inorganic growth and then make some certain assumptions about dollar-based net retention, you still need quite a bit of ARR coming from new customers. So in terms of new customers, which offerings are you seeing the most traction at this point? Thank you.

Q – Sidney Ho:

Great. And in terms of the new customers -- ARR from new customers?

Q – Sidney Ho:

Great. Thank you very much.

Q – Victor Chiu:

This is Victor Chiu in for Simon Leopold. You noted several customers that concluded several large projects and then drove capacity reductions. Can you help clarify what changed versus your expectations exactly because the way that you kind of described at the conclusions were kind of natural and then so we assumed it would have been somewhat expected. So, either did they conclude earlier? I think you mentioned there was some chip design kind of timing-related issues. Can you just help us clarify why this dynamic was not expected?

Victor Chiu:

Okay. And then just quickly, regarding your commentary on macro headwinds, are you observing explicit behavioral trends or having explicit discussions with customers that makes you confident that the slowing is specific to the macro environment versus a more secular shift like accelerating workload migrations to the public cloud?

Victor Chiu:

Got it. That’s helpful. Thank you.

Meta Marshall:

Great. Thanks. I just wanted to get a sense of whether we could get what the size of Hi-tech and service provider is as a percentage of the cloud revenue or just kind of any vertical concentration that we should be mindful of? And then maybe last quarter, you had given kind of the storage services as a percentage of cloud ARR. If we could just have an update there, that would be helpful as well. Thanks,

Mike Berry:

Amy [ph], it's Mike. On your second question, so two data points for you. Cloud storage continues to be almost exactly 60% of the total and that includes, as of the end of Q2, Instaclustr and CloudCheckr which are in CloudOps. So there you see the great growth we've seen in cloud storage because overall, as a total number has stayed right around 60%. The other important number is we've talked about consumption versus subscription. As of the end of Q2, it's pretty close to 50-50, a little bit a couple of percentage points higher for consumption. We do expect by the end of the year with that $700 million for that to get much closer to 60%, because that's where we expect the growth across ANF, GCP and FSx, those products as well. So those are the two data points we gave you that break down that cloud ARR number.

Mike Berry:

Thank you.

Ananda Baruah:

Hi, thanks guys for taking the question. Actually two clarifications, if I could. Mike, just the remarks you made a couple of times in the prepared comments about and this is really the clarification. FX driving sort of some portion of the guide down or whatever that context was. Could you clarify that that? And then I have a quick follow-up clarification as well.

Ananda Baruah:

I got it. That's super helpful. And then, the second clarification is, to one of the questions, you mentioned, you gave some context around timing of pickup and something along -- well, it was sort of -- that was sort of the gist of it. But I think, Mike, the comments you made, where you expect demand to come back in the second half, though you weren't sure it was Q3 or Q4. Could you clarify that? And is it -- is it fiscal Q3, Q4, or is it calendar '23 Q3, Q4 in addition to the clarification. Thanks.

Ananda Baruah:

That's super helpful. And so, was that the same, like, that anecdotally, you guys are experiencing, and George, feel free to jump in on this too, anecdotally, you guys are -- you're experiencing a little bit of a sideways here, call it, a pause. You anticipate that it's going to last, I guess, like in period of max six months, eight months, let's say starts slowing mid-quarter, could last an additional six months But you do expect then pickup in some context after that. Anecdotally, is that the gist of what you guys are communicating?

Ananda Baruah:

Got it, got it, got it. Okay, cool. Thanks guys. Appreciate it.

Operator:

Our next question will come from Jim Suva with Citigroup. Please go ahead.

George Kurian:

We did not see any order cancellations or any of those things. As we have mentioned repeatedly, we have good line of sight into our customer’s spending priorities and behaviors and are directly engaged with the largest of them. I think as we saw in this quarter, and we continue to be cautious about looking at the second half of the year. These are clearly related to IT budget revisions, right, where they are reducing deal sizes or scrutinizing projects and things, we'll defer a portion of that project to a subsequent quarter or a subsequent part of the calendar year. So we have good visibility into the activities in our customers, and we did not see cancellations of orders because of prior orders or double ordering.

George Kurian:

Typically, during macro situations like these, we have seen customers sweat their assets. And so what we mean by that is they will drive a system to a higher level of utilization and so that they can defer either capacity augmentation or system upgrades for a period of time. Now that's not forever, right? Storage is consumed because data keeps growing. And so there's always that trade-off. We certainly see some of that behavior going on. Jim, I think, certainly in our service provider segment, we see that. And in some of the hi-tech verticals, we saw that as well.

George Kurian:

Yeah. Thank you.

George Wang:

It's actually George Wang on for Tim Long. I have two questions. Firstly, George, maybe you can elaborate on the current state of deal integration in terms of Spot, Instaclustr. And any thought process behind the following deal until FY 2024?

Q – George Wang:

Okay. Cool. Yeah, a quick follow-up is on the cost cuts. Maybe you can elaborate on the kind of disaggregate just components for the cost cuts, whether that's sales and marketing, the SG&A or kind of some of the R&D? Any color would be appreciated.

Q – George Wang:

Yes.

Q – George Wang:

Okay. Great. Thank you.

Q – Nehal Chokshi:

Yeah. Thanks. So -- the total revenue guidance is lowered by 400 basis points that characterizes 100 basis points due to incremental FX, another 100 basis points due to lower PCS ARR target. And then the remaining 200 basis points either due to weaker billings results on a constant currency basis during the quarter, or is it a weaker billings result that has started to transpire during the third quarter, again, on a constant currency basis?

Nehal Chokshi:

Excellent. Okay. And then dollar-based net revenue retention rate declined quite significantly, 192 to 140. Is this largely because of the project-related stuff?

Mike Berry:

And to George's point, Nehal, we've been calling that for several quarters, which is add that ARR number gets bigger, that dollar-based net retention percentage will come down. We like to call it the 120, 130, where we think it will land, but we have been calling that percentage to continue to decline as that number increases.

George Kurian:

The PCS gross margin came down because of the revenue scale relative to the infrastructure that we have deployed. Note that the consumption business, some elements of those are based on our deployed systems, right, in the cloud provider environments. And when they have less scale, you see less utilization, you see less gross margin.

Nehal Chokshi:

Thank you.

Wamsi Mohan:

Yes. Thank you. I appreciate the fiscal year guide. But George, you were talking earlier about IT budgets and some caution around that. I was wondering if you could share some color on what you're hearing from customers more around calendar 2023 IT budgets? And what's your view on how you expect the storage market to grow in 2023 and your growth relative to that? And I have a follow-up.

Wamsi Mohan:

Okay. That's helpful, George. And just a follow-up on your last comment about the NAND market. Every few years, you see the significant dislocation in pricing and this one is quite severe. You guys noted the benefit that you will recognize in gross margin terms. But can you just remind us on how you're thinking about the impact to revenues based on the NAND price decline? Are you expecting a deceleration in AFA revenues, or are you expecting elasticity of demand to offset that? Thank you.

Wamsi Mohan:

Okay. But in aggregate terms, would you say that the customer budgets would be up or down like in full in aggregate, whether it's cloud on-prem, all put together?

Wamsi Mohan:

Okay. Thank you so much, George.

Operator:

Our next question will come from Shannon Cross with Credit Suisse. Please go ahead.

George Kurian:

It's early, but good traction. We are focused with a few channel partners who are enabled on selling Keystone. We've had good customer wins, good momentum in terms of our offerings. We brought new innovation to market in the last quarter, both a unified control plane so that you can use either a Keystone-based consumption offering in your environment or our public cloud offerings, and you can move workloads and licenses across those. So a good amount of innovation. And you're correct, we'll continue to see opportunities to help customers around whatever their kind of buying model is in this environment.

Mike Berry:

I as well look forward to seeing on Thursday.

Kyle McNealy:

Hey good afternoon. Thanks very much for the question. You touched on this a bit earlier, but not directly. But does the budget scrutiny that you're seeing right now from some subset of customers' impact their decisions for provisioning the mix that they're provisioning of all-flash versus hybrid arrays at least for new projects. And I know you mentioned that our all-flash portfolio has leading cost efficiency, but do you expect the mindset to change on how much customers are willing to embrace more all-flash? Will the pockets of slowdown that you're seeing potentially pull everything back and the mix stays relatively on the same trajectory? Thanks.

Kyle McNealy:

Okay. Thanks very much. That’s helpful.

George Kurian:

While there are near-term economic challenges for every company, we know that our opportunity ahead is substantial, durable and growing. The fundamentals of our business are strong and the value we bring customers is undeniable. Our strategic growth opportunities all-flash arrays, cloud storage and cloud infrastructure optimization are tightly aligned to customers' top priority and represent the potential for long-term sustained and profitable growth. We will continue to be disciplined stewards of the business, focusing on our strategic growth opportunities while continually optimizing our operating costs to drive shareholder value. Thank you.

Operator:

Good afternoon, ladies and gentlemen, and welcome to the NetApp First Quarter Fiscal Year 2023 Earnings Call. At this time, all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. I would now like to turn the conference over to Kris Newton, Vice President and Investor Relations. Please, go ahead.

George Kurian:

Thanks, Kris. Welcome, everyone. Thank you for joining us this afternoon. We delivered a great start to the year, with company all-time Q1 highs for billings, revenue, gross margin dollars, operating income and EPS, fueled by broad-based demand across our portfolio and geographies. Achieving record results in the face of ongoing macroeconomic uncertainty, decades-high inflation and supply constraints underscores our disciplined operational management. As organizations accelerate their data-driven digital and cloud transformations, our relevance grows. We are helping customers navigate disruption with a modern approach to hybrid multi-cloud infrastructure and data management. Our opportunity is defined by the complexities created by rapid data and cloud growth, multi-cloud management and the adoption of next-generation technologies such as AI, Kubernetes and modern databases. The urgency to address these priorities increased with the COVID pandemic, and is further driven by the turbulent macro economy. Customers are searching for ways to reduce costs, improve flexibility, increase automation and accelerate application delivery in the public cloud, in their own data centers and in hybrid cloud environments. Our role in helping organizations achieve these transformation goals underpins our strategy and confidence in future growth. Let me share with you a couple of examples how data intensive applications like AI drive demand for both our Public Cloud and Hybrid Cloud solutions. A global e-commerce company chose ONTAP AI for several AI workloads, including natural language processing, recommendation engines, and deep learning. Our ultra-high-performance storage, close partnership with NVIDIA and tight application integration were key to the win and the customer has realized better performance and reliability while reducing its operating costs and data center footprint. A Fortune 500 hyperscaler is adopting a hybrid cloud strategy to augment existing on-premises AI/ML workloads. It chose Azure NetApp Files to accelerate AI research and development on cutting-edge machine learning, training workloads for its AI business unit. The initial footprint consists of nearly one petabyte of Azure NetApp Files storage with plenty of opportunity for continued growth. Our AI solutions remove data processing bottlenecks at the edge, core, and cloud to enable more efficient data collection, accelerated AI workloads, faster time to insight, and smoother cloud integration. Now, let’s turn to our Public Cloud segment performance for the quarter. In Q1, we continued to see strong demand for our Public Cloud services. Public Cloud ARR grew 73% year-over-year, exiting Q1 at $584 million. Public Cloud segment revenue grew 67% from Q1 a year ago to $132 million and dollar-based net revenue retention rate of 151% remains healthy. We continue to expand our Public Cloud customer base, the penetration into our Hybrid Cloud installed base, and the percentage of customers using multiple of our public cloud services. Storage services constitute approximately 60% of our Public Cloud ARR. We see significant opportunity for continued growth in this part of our business as we help customers migrate or deploy data-intensive, demanding storage workloads to the cloud. Early in Q1, AWS announced that FSx for NetApp ONTAP is SAP-certified. SAP certification for Azure NetApp Files has helped drive large, business-critical deployments on that service and we are excited about the potential to see similar workloads deployed on FSx for ONTAP. We recently announced that NetApp is the only cloud storage service provider certified and supported for use as an external data store for VMware Cloud environments, further expanding the opportunity for our public cloud storage services. We’ve long been known for the high levels of enterprise-grade data services, we bring to on-premises VMware environments and now, we can bring those same benefits to VMware workloads running in the major public clouds. As we discussed on last quarter's call, we made organizational changes to increase focus on renewal and expansion motions and refined our go-to-market execution to better address the cloud operations opportunity. These actions are starting to deliver results. In Q1, Spot bounced back, returning to its prior growth trajectory. Cloud Insights stabilized but remains a work in progress as we continue to optimize our sales and customer success motions. We delivered a substantial amount of innovation in our cloud operations portfolio with announcements of general availability of Spot Security, Spot PC, and Ocean for Apache Spark, providing fully managed serverless infrastructure for Apache Spark, on Google Cloud. We also completed the acquisition of Instaclustr, a leading provider of fully managed open-source database, pipeline, and workflow applications. We can now combine the Spot capabilities of continuous infrastructure optimization, automation, monitoring, and security with expertise in deploying and operating fully managed open-source applications to help our customers focus on their business goals, building and releasing leading-edge applications at speed. Onto our Hybrid Cloud segment. In Q1, Hybrid Cloud revenue grew 6% year-over-year, driven by solid product revenue growth of 8%. All-flash array annualized revenue run rate grew 7% year-over-year to $3 billion. All-flash penetration of our installed base grew to 32% of installed systems. FAS hybrid arrays again posted strong unit growth. The breadth of our storage systems portfolio enables us to address a broad range of customer business, technical and economic requirements. Under a single, unified management environment, we offer high-performance all-flash arrays for mission-critical, performance-sensitive deployments, QLC-based all-flash arrays for capacity-oriented applications, and hybrid flash arrays for price-sensitive workloads. Despite the uncertain macro, the enterprise spending environment has remained steady, driven by priority investments in digital and cloud transformations. Organizations around the globe want to learn how NetApp can increase the performance and reliability of these transformational projects, while helping reduce cost, risk, and complexity. Our ability to address a broad range of customer problems, while also optimizing cloud and IT investments makes NetApp more resilient to a potential further slowdown than many of our peers. Just as our customers are looking to save while transforming, we, too, must be agile in our response to the dynamic macro. We will continue to invest into areas of high return to drive growth, while at the same time moderating spending elsewhere. In closing, we delivered a great quarter, kicking off a strong start to FY 2023. Customer priorities are increasingly aligned, with the solutions that we uniquely provide. You are seeing evidence of that in the strong growth of our revenue, billings, and profitability. I am proud of the NetApp team's focus, execution and disciplined operational management in navigating this dynamic environment. I'll now turn the call over to Mike to walk through the details of our outstanding Q1.

Kris Newton:

Thanks Mike. Operator, let’s begin the Q&A.

Jim Suva:

Thank you very much. And wow, congratulations to you and your team. Great results. My question to you is, look, the past two, two-and-a-half years have been very challenging with COVID. And it appears that NetApp has stepped it up by going the extra distance to procuring the shortages of parts, paying premiums and delivering to the customers. Does this set you up with relationships and customer expectations and even deeper, longer visibility and opportunities? I'm just kind of wondering, because it seems like you walked down this aisle of going way beyond just what a normal agreement would be. And it seems like things are even deeper now in a positive way. Thank you.

Kris Newton:

Thanks, Jim. Next question, please.

Meta Marshall:

Great. Thanks. A couple of questions for me. Just on the outlook and saying that you're kind of observing signs for macro conditions, just any sense of, in your conversations, kind of any change in tone or what you would be looking for to kind of detect whether you were seeing any of that macro impact? And then maybe second question, just whether there's any benefit that you're seeing from memory prices kind of coming down that maybe offset some of the higher componentry costs that you're seeing elsewhere? Thanks.

Mike Berry:

Sure. Thanks, George. Meta, thanks for the question. So as we talked about on the earnings call last quarter, we did expect and we still do expect the memory prices to be a slight headwind in the first half and then moving to a tailwind in the second half. All the surveys and discussions we've had certainly support that. As you know, we did add a good bit of inventory after the issue that we saw with SSDs in Q4. So it will take a little bit of time to work through the P&L. And all of that is in our guidance, by the way, that we do expect to see memory prices become a little bit more of a tailwind in the second half.

Kris Newton:

Thanks, Meta. Next question.

Shannon Cross:

Thank you very much for taking my question. I was wondering, as we think about the growth in Public Cloud ARR up 73%, how should we think about the length of the contracts. Has there been any change, or I'm trying to think about how quickly that will continue to flow through in terms of cloud growth overall. Just as you talk to your customers in the environment that we're in right now, have you seen any shifts in contract length or timing of when you expect things to be recognized? And then I was just wondering, from a cost perspective, you mentioned being a little bit more cautious, I guess. I'm just wondering, are you still planning on increasing headcount. I mean, how cautious are you thinking when you look at your OpEx? Thank you.

Mike Berry:

Yes. And keep in mind, too, as well, Shannon, that ARRs are – is what we expect to recognize during the next 12 months. So, those – that you'll see ARR tie pretty closely to revenue. And then on your headcount question, as we talked about, hey, we're going to be very disciplined. We want to continue to invest in the areas that are going to drive growth, specifically around cloud as well as some of our sales headcount. We are taking a look at just like everybody else, making sure that we reallocate dollars to drive growth, and we'll be very prudent around other additions.

Kris Newton:

Thank you. And next question.

Sidney Ho:

Great. Thanks for taking my question. Maybe just to follow up on the Public Cloud side. The ARR in Q1 seems to have come in better than expected, up 6% to 8% organically. It looks like the upside was driven by some of the issues being resolved like maybe in the Spot. But why not more positive on the ARR exiting the year? Is FX impact in this business? And can you talk about maybe some of the other issues that you're working on? When do you expect them to get resolved? Thanks.

Sidney Ho:

Thank you.

Operator:

The next question will come from David Vogt with UBS. Please go ahead.

Mike Berry:

Yeah. Hey, David, it's Mike. So, great question. So let's go through that. As we talked about on the call last quarter, we did expect and without the incremental impact of FX, it would have been true that, we expected product gross margins to be at its lowest in Q4. Q1 came in pretty much as we expected. When we gave the guidance at the midpoint, we're saying, hey, relatively consistent in Q2. To your point, keep in mind that on a year-over-year basis, we are paying, call it – and we talked about this a couple of calls ago, about $60 million a quarter for premiums. We expect that to continue in Q2 and then get better as we go through the rest of the year. In addition to Meta's earlier question, we do expect memory prices to get a little bit better in the second half. Again, all of that is baked into our guidance when we gave our full year number. So all else being equal, no crazy on the supply chain things happening or things that we don't know of at this time. We would expect gross margins to continue to improve as we go throughout the year.

Mike Berry:

Yes. So thanks for the question. So, overall, we were down about $20 million quarter-on-quarter total company. To your point, sales and marketing was down about 7%. There were three major moves -- movements in OpEx quarter-over-quarter. That was -- FX gave us about a $10 million benefit, because the stronger dollar means lower OpEx. Q1, David, we always have a reset of incentives, incentive pay as well as commissions, and that -- part of that flowed through sales and marketing. And then in R&D, mostly you saw the addition of Instaclustr. Also, keep in mind that marketing, one of the big variables there is just marketing spend program timing. Q1 is typically a lower program spend for marketing. So those are the three big movements. And as Meta asked as well, hey, we're looking hard at making sure that we're investing in growth. Candidly, sales and marketing will be one of those areas, especially as it looks to drive growth in cloud.

Kris Newton:

All right. Thanks David. Next question.

Michael Tsvetanov:

Yes. Thank you. This is Michael on behalf of Aaron. How should we think about your recent price increases flowing through the model from a timing perspective? I guess, really what I'm trying to get at is, how much of your fiscal 2023 revenue growth can be attributed to those price increases? Thank you.

Michael Tsvetanov:

Okay. Thank you.

Operator:

The next question will come from Rod Hall with Goldman Sachs. Please, go ahead.

Mike Berry :

Yes. Hey, Rod, it's Mike. Thanks for the question. So the big driver there is -- and we'll go back to what we talked about last time, it's really supply chain in terms of how it impacts the GOs on a quarterly basis. You did see nice growth in USPS, which was great. EMEA and APAC grew as well. So that was more really an issue of supply chain where we were able to place our product versus any change in demand on a quarter-on-quarter basis.

Mike Berry :

Yes. So it's a nuanced answer, Rod. And no, we didn't decide to do that. It depends on what availability we have, what customers are purchasing, when those purchase orders came in, linearity matters. So hey, there's a lot that goes in there, but no, there was no outright decision or direction that way. It just was how it fell in the quarter.