NetApp Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 24, 2022

There are 14 speakers on the call.

Operator

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 Chris Newton, Vice President and Investor Relations. Please go ahead.

Speaker 1

Thank you for joining us. With me today are our CEO, George Kurian and CFO, Mike Barry. This call is being webcast live and will be available for replay on our website at netop.com. During today's call, we will make forward looking statements and projections with respect to our financial outlook and future prospects, such as our guidance for Q2 fiscal year 2023, Our expectations regarding future revenue, profitability and shareholder returns our resilience and opportunity for growth in the turbulent macroeconomic environment our ability to drive continued growth in both our hybrid cloud and public cloud segments Our ability to invest in areas of high return while managing supply chain constraints and maintaining disciplined operational management, all of which involve risk and uncertainty. We disclaim any obligation to update our forward looking statements and projections.

Speaker 1

Actual results may differ materially for a variety of reasons, including macroeconomic and market conditions such as The continuing impact and uneven recovery of the COVID-nineteen pandemic, including the resulting supply chain disruptions and the IT capital spending environment as well as our ability to keep pace with the rapid industry technological and market trends and changes in the markets in which we operate, execute our data fabric strategy and introduce and gain market acceptance for our products and services and generate greater cash flow. Please also refer to the documents we file from time to time with the SEC and available on our website, specifically our most recent Form 10 ks, including in the Management's Discussion and Analysis of Financial Condition and Results of Operation and Risk Factors sections. During the call, all financial measures presented will be non GAAP unless otherwise indicated. Reconciliations of GAAP to non GAAP estimates are posted on our website. I'll now turn the call over to George.

Speaker 2

Thanks, Chris. 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.

Speaker 2

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.

Speaker 2

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 We're 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 AIML workloads. It shows Azure NetApp Files to accelerate AI research and development on cutting edge machine learning, training workloads for its AI business unit.

Speaker 2

The initial footprint consists of nearly 1 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 $584,000,000 Public Cloud segment revenue grew 67% from Q1 a year ago to 100 $32,000,000 and dollar based net revenue retention rate of 151% remains healthy.

Speaker 2

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.

Speaker 2

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.

Speaker 2

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 Spark Security, Spark PC and Ocean for Apache Spark, providing a 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 focused on their business goals, building and releasing leading edge applications at speed. Onto our hybrid cloud segment.

Speaker 2

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 $3,000,000,000 All flash penetration of our installed base Grew to 32% of installed systems. Fast 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.

Speaker 2

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 'twenty three.

Speaker 2

Customer priorities are increasingly aligned With the solutions that we uniquely provide, you are seeing evidence of that in the strong growth of our revenues, 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.

Speaker 3

Thank you, George. Good afternoon, everyone, and thank you for joining us. Before we go through the financial details, I think it would be valuable to walk you through the key themes for today's discussion. Number 1, as George highlighted, we had an outstanding Q1 in a dynamic environment with all time Q1 company highs for billings, revenue, gross profit dollars, operating income and EPS, despite an uncertain macro and unprecedented FX headwinds. Number 2, Our public cloud business had an outstanding quarter with excellent performance by our cloud volume service offerings from AWS, Azure And Google Cloud, which collectively grew ARR over 100% year over year.

Speaker 3

We also saw improved execution in our cloud ops portfolio. Number 3, As George mentioned, we continue to see healthy customer engagement and demand trends. Like everyone on this call, We are mindful of the complexity in both the macro backdrop and supply chain. We will remain extremely disciplined in running our business, while continuing to invest in our key strategic initiatives. And number 4, We are reaffirming our full year guidance for revenue, margins, EPS, free cash flow and public cloud ARR even when factoring in a 3 to 4 point revenue headwind from FX versus the 2 point FX headwind contemplated in our guide provided last quarter.

Speaker 3

Now to the details. As a reminder, I'll be referring to non GAAP numbers unless otherwise noted. In Q1, despite elevated freight and logistical expense, Significant component cost premiums and unprecedented FX headwinds, we delivered solid revenue with both operating margin and EPS coming in above the high end of guidance. Strong execution yielded Q1 billings of $1,560,000,000 up 13% year over year. Revenue came in at $1,590,000,000 up 9% year over year.

Speaker 3

Adjusting for the 4 point headwind from FX, Billings and revenue would have been up 18% 13% year over year respectively. Our solid Q1 results were driven by broad based demand across our portfolio and geographies. Our cloud portfolio continues to positively impact the overall growth profile of NetApp, delivering 3.5 of the 9 points in revenue growth. Hybrid Cloud segment revenue of $1,460,000,000 was up 6% year over year. Within hybrid cloud, we delivered product revenue growth for the 6th Consecutive quarter and expect this momentum to continue as we go through fiscal 2023.

Speaker 3

Product revenue of $786,000,000 increased 8% year over year. Consistent with growth in fiscal 2022, Software product revenue of $476,000,000 increased 15% year over year, driven by the value of our ONTAP software and data services. Total Q1 recurring support revenue of $598,000,000 increased 3% year over year, highlighting the health of our installed base. Public cloud ARR exited Q1 at $584,000,000 up 73% year over year, driven by strength in cloud storage led by Azure NetApp Files, AWS FSX for ONTAP and Google CVS. Public cloud revenue recognized in the quarter was $132,000,000 up 67% year over year and 10% sequentially.

Speaker 3

Recurring support and public cloud revenue of $730,000,000 was up 11% year over year, constituting 46 percent of total revenue, a new record for NetApp. We ended Q1 with $4,200,000,000 in deferred revenue, an increase of 7% year over year. Q1 marks the 18th consecutive quarter of year over year deferred revenue growth, which is the best leading indicator for recurring revenue growth. Total gross margin was 67% in line with our guidance. Total hybrid cloud gross margin was 66% in Q1.

Speaker 3

Within our hybrid cloud segment, product gross margin was 50%, including a 2 point year over year headwind from FX. Our growing recurring support business continues to be very profitable with gross margin of 93%. Public cloud gross margin of 70% was again accretive to the corporate average. The sequential increase in public cloud gross margin was driven by improving software mix within our public cloud business. We remain confident in our long term public cloud gross margin goal of 75% to 80% as we continue to scale the business and an increasing percentage of our public cloud revenue is driven by cloud and software solution.

Speaker 3

Q1 highlighted the strong leverage in our operating model with operating margin of 23% despite the ongoing supply chain and currency headwinds. EPS of $1.20 came in nicely ahead of guidance. Cash flow from operations was $281,000,000 and free cash flow was $216,000,000 During Q1, we had strong cash collections, while we continue to invest in inventory that included paying substantial premiums for constrained, trailing edge analog parts. This purchasing strategy allowed us to meet as much customer demand as Possible, but was clearly a headwind to cash flow and gross margins. We are seeing early signs of relief in supply availability.

Speaker 3

The timing of a full supply recovery remains uncertain. However, as our inventory levels start to normalize, It will be a tailwind of free cash flow as we go through fiscal 2023. During Q1, We repurchased $350,000,000 in stock and paid out $110,000,000 in Cash dividends. In total, we returned $460,000,000 to shareholders, representing 2 13% of free cash flow. We closed Q1 with $3,400,000,000 in cash and short term investment.

Speaker 3

Now to guidance. We are reaffirming our fiscal 2023 guidance. Our revenue guide of 6% to 8 Growth year over year now includes 3 to 4 points of FX headwind versus the 2 point headwind assumed in our original guidance provided last quarter. We will continue to grow and invest in our public cloud business and expect to exit fiscal 2023 with public cloud ARR of 780 to $820,000,000 At the ARR midpoint, we expect Public Cloud segment to drive 4 points of Total company revenue growth. In fiscal 2023, we expect gross margin to range between 66% 67% as elevated component costs and logistical expenses from supply constraints continue to weigh on product margins.

Speaker 3

Adding to these product cost overhangs is an additional one point from incremental FX headwinds. As you know, the vast majority of our bill of materials is procured in U. S. Dollars. We are cautiously optimistic that supply constraints will ease further in the second half of our fiscal year, reducing our dependence on We should also start to see a benefit from declining prices for our hardware components.

Speaker 3

While the timing is uncertain, we remain confident that our structural product margins will normalize back to the mid-50s in the fullness of time. Despite the incremental currency headwinds, we remain committed to driving operating margin of 23 to 24% and EPS of $5.40 to 5.60 here. Like all of you, we are closely monitoring the demand signals and broader macro trends. As George noted, Customer engagement and demand remain healthy. However, given the fluidity of the environment, we will continue to be appropriately measured in our outlook and extremely disciplined with our spending envelope.

Speaker 3

We continue to expect to generate greater than $1,400,000,000 in operating cash flow and $1,100,000,000 in and free cash flow for the full year. Now to Q2 guidance. We expect Q2 net revenues to range between $1,595,000,000

Speaker 2

$1,745,000,000

Speaker 3

which at the midpoint implies a 7% increase year over year, including 4 points of currency headwinds. We expect consolidated gross margin to range between 66% 67% and operating margin to be approximately 23%. We anticipate our tax rate to be between 21% 22% and we expect earnings per share for Q2 to range between $1.28 $1.38 per share. Assumed in our Q2 guidance is net interest expense of $5,000,000 and a share count of approximately 223,000,000 In closing, I want to thank the entire NetApp team for the outstanding execution in Q1. As a result, the year is off to a strong start.

Speaker 3

I'll now hand it back to Chris to open the call for Q and A. Chris?

Speaker 1

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

Operator

Thank you. We will now begin the question and answer session. And the first question will come from Jim Suva with Citigroup. Please go

Speaker 3

ahead. Thank you very much. And wow, congratulations to you and your team, great results. My question to you is, look, the past 2, two 2 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, delivering to the customers, does this set you up with relationships and customer expectations of even deeper, longer visibility and 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.

Speaker 3

Thank you.

Speaker 2

Thank you, Jim. I think first of all, we continue to see Demand ahead of supply. We had a broad based book of business in Q1 with healthy demand trends and we're doing everything we can to meet customer expectations by procuring parts in as many ways as we can. We think that that helps us to be able to deliver on the promises that we make to customers. I think equally importantly, we broadened the range of capabilities that we bring to customers, particularly with our cloud offerings, our cloud storage and our cloud operations portfolio that now address a vast Range of both digital and cloud transformations.

Speaker 2

And so the combination of meeting expectations for the day to day business as well as being part of their Go forward transformations allowing them to kind of make their businesses a lot more digital and cloud capable It's helping us broaden our exposure to new buyers and customers and deepen relationships within existing buyers as well as net new buyers. So I'm excited about what the year ahead holds for us.

Speaker 1

Thanks, Jim. Next question please.

Operator

The next Question will come from Meta Marshall with Morgan Stanley. Please go ahead.

Speaker 4

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 Tactile whether you were seeing any of that macro impact. And then maybe second question, just whether there is 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?

Speaker 4

Thanks.

Speaker 2

Good afternoon, Meta. Thanks for the question. I think first of all, we have a broad book of business Across geographies, customer segments, vertical industries. And so we monitor the discussions going on with our field teams and about their intent to purchase the projects that they want to do with us. So I think clearly, We continue to see healthy investment in the transformational projects.

Speaker 2

I think that, we are fortunate given the work We've done in the cloud business to be able to participate in those projects in a truly unique way, whether they are in Modernizing data centers or migrating them to cloud. I think that we continue to see new application deployments And business process transformations continue to take priority in customer budgets. In public sector, we saw the Late start to public sector spending now start to create opportunity for us to participate, particularly with agencies that were generally closed to doing business during COVID. Some of the more defense and Security focused agencies that we couldn't really engage with because of the COVID trend. So overall, a good balanced book of business.

Speaker 2

Priority are the transformational projects and then really kind of engagement across our customers showing a steady rebound from 2 years of COVID delays. Mike, you want to talk about supply?

Speaker 3

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.

Speaker 3

As you know, we did add a good bit to the inventory after the issue that we saw with in Q4. So it will take a little bit of time to work through the P and 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.

Speaker 4

Great. Thanks so much.

Speaker 1

Thanks, Meta. Next question?

Operator

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

Speaker 4

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 And 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?

Speaker 4

I mean, how cautious are you thinking when you look at your OpEx? Thank

Speaker 2

you. Yes. In terms of cloud contracts, we have a broad book of business. We have Contracts that are subscription contracts, they're usually a couple of years in duration, though they can move around a bit. And then we have, of course, consumption type contracts, which are the type of agreements that we work on with customers in the kind of first party cloud services, so a broad range.

Speaker 2

I think overall, we see strong demand for our offerings because they help our customers use the cloud more efficiently. Our storage cloud services are much more efficient than So hyperscaler native services, so you can get more performance for less dollars using our capabilities. And then of course, our cloud operations portfolio directly address customer concerns about cloud spending by optimizing Their overall usage of compute and storage and network on the public cloud. Mike? Yes.

Speaker 2

And keep in

Speaker 3

mind too as well Shannon that ARR is what we expect to recognize during the next 12 months. So those that you'll see ARR tie 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 just like everybody else at Making sure that we reallocate dollars to drive growth and we'll be very prudent around other additions.

Speaker 4

Thank you.

Speaker 1

Thank you, Shannon. Next question?

Operator

The next question will come from Sidney Ho with Deutsche Bank. Please go ahead.

Speaker 5

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 about 60% organically. It looks like the upside was driven by some of the issues being resolved like maybe in the spot.

Speaker 5

But why not more positive on the AR exiting the year? Is FX an 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.

Speaker 2

Listen, we're pleased to the start of the year. I think our cloud storage portfolio is really strong. And as we said, We are in the early innings with Amazon and Google and there's plenty of opportunity to expand our business with them. We are doing the work to To be able to do so, with regard to the cloud operations portfolio, we've had a really good start to the year in the spot portfolio, which where we've had new sales leadership, strong disciplined execution in the product team and in the field organization. And I feel pretty Good about the focus so far.

Speaker 2

I think on Cloud Insights, we still have some more work to do, particularly sharpening the parts of the market that we attack and the execution on customer success motions in that part of the business. So we're pleased we are at the end of the Q1. If we see more strength at that point, we can talk about the full year guidance. But I feel really good about Reiterating our guidance, it's a strong growth target for the full year for our cloud portfolio. And at the start of the year, we're off to a great start.

Speaker 5

Thank you.

Speaker 1

All right. Thank you, Sydney. Next question?

Operator

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

Speaker 5

Hey, guys. Thanks again for taking my question. Maybe this is a question for both George and Mike. So when I think about the profitability and the challenges The industry is facing. It looks like just quickly from our math that the hybrid cloud incremental gross margin might be Yes, at the lowest level that we've seen in quite some time, kind of below 20%.

Speaker 5

And should we so therefore, if I think about the business going forward, Are we at the low watermark from product gross margin this quarter, given your commentary about supply chain getting better? And should we expect Sort of a sequential improvement in product gross margin going forward. Or is there something else under the hood, like are we expecting some sort of public cloud gross margin pressure in the back half as well. I'm just trying to triangulate kind of where we are today versus where we might be in 3 to 4 quarters from now. Thanks.

Speaker 3

Yes. 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 Yes, it's lowest in Q4.

Speaker 3

Q1 came in pretty much as we expected. When we gave the guidance at a midpoint, 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 $60,000,000 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.

Speaker 3

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

Speaker 6

things that we don't

Speaker 3

know of at this time. We would expect gross 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.

Speaker 5

And then maybe can I just follow-up, Mike, so you may be leveraging what Meta had asked before on operating expenses? Was there anything sort of unique in the first Quarter, it certainly appeared to us at least maybe there might have been some tight cost controls on your end to keep sales and marketing looks like flat year over year and down Meaningfully quarter over quarter, as supply chain gets better and revenue continues to ramp, should we expect some incremental dollars to flow back into the OpEx lines over the next couple of quarters.

Speaker 3

Yes. So thanks for the question. So overall, we were down about $20,000,000 quarter on quarter total company. To your point, Sales and marketing was down about 7. There were 3 major moves movements in OpEx quarter over quarter.

Speaker 3

That was FX gave us about a $10,000,000 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 flow through sales and marketing. And then, in R and 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.

Speaker 3

So those are the 3 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.

Speaker 5

Perfect. Thanks, Mike. Thanks again, guys.

Speaker 1

All right. Thanks, David. Next question?

Operator

The next question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Speaker 5

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?

Speaker 5

Thank you.

Speaker 2

Listen, we've implemented, as we've shared before, 2 price increases and we are seeing our sales teams being Disciplined to be able to capture the value of those price increases. The important thing to note is Customers budget in dollars, they don't get incremental IT budget just because vendors raise prices. So I do not See the fact that our revenue is strong being tied to price increases. I think customer spend and you got to go get Your fair share or more than your fair share of their spend. And so we'll continue to monitor how the supply base And we'll adjust pricing.

Speaker 2

If we need to take another action, we will do that at the appropriate point in time. Right now, I don't see the need to do that.

Speaker 6

Okay. Thank you.

Speaker 1

Thank you, Michael. Next question?

Operator

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

Speaker 7

Yes. Hi. Thanks for the question. I wanted to dig into the Americas commercial revenue a little bit, just the trajectory there. What I see there is quarter on quarter deterioration and a little bit worse than normal seasonality at about 12%.

Speaker 7

Last couple of years, you were below 8% quarter on quarter and that's off of an April quarter that was just flat seasonally, so it was weak seasonally in April as well. And then if I look at the year over year on that line, it was just under 7% year over year growth deteriorating from 10.5% last Quarter and then about 20 the quarter before. So it looks like it's moderated a little bit. And I just wondered if you guys could maybe dig into What you think is happening there? Is there a demand fluctuation in that particular line or is there something else going on?

Speaker 3

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 GEOs on a quarterly basis.

Speaker 3

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.

Speaker 7

And Mike, can I just follow that up and ask, did you guys make a decision to allocate less to that particular Group of customers or is there any could you give us any more color on why maybe they got less supply than some of these other regions?

Speaker 3

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.

Speaker 7

Okay. All right. Thanks a lot. I appreciate it.

Speaker 3

Thank you.

Speaker 1

All right. Thanks, Rod. Next question?

Operator

Your next question will come from Amit Dariani with Evercore. Please go ahead.

Speaker 6

Thanks for taking my question. I guess I have 2 as well. I'll ask them together. I guess the full So on an organic basis, on the top line, it looks like you're actually raising your revenue guide by about 150 basis points or so given the FX issues you have. I'd love to just understand what is driving that better organic performance?

Speaker 6

Is it end demand trends that

Speaker 2

are better or share gains and

Speaker 6

kind of which Okay. So you see it on, that would be really good to understand. And then secondly, and my decision to be for you, I think, but you beat Q1 by $0.10 Your Q2 guide, I think, is I think 6 is ahead of the street. But you're not weighing your full year numbers really on an EPS basis. So I guess, what are you seeing or not seeing that's not letting you flow the

Speaker 2

I'll take the demand one and then Michael cover the EPS. First of all, we're pleased with the book of business we saw in Q1. Our teams are engaged With our customers deeply across all of the segments and geographies and as you see from our results, We had a really good balanced book of business with strength across all of the geographies. I think with regard to the year ahead, listen, we are 1 quarter in. We feel really good about the progress.

Speaker 2

We are reiterating our guidance. Yes, you correctly note that we saw incremental FX headwinds from the time we guided. So by reiterating guidance today, it actually shows that we have confidence in our business through the course of the year. I would say if you ask me what's sort of top of mind for me at the moment, it really is about having supply and I wish I could just Get to confidence on having all of the supply we need to meet demand, right? And I think that is the place we continue to do the work.

Speaker 2

We feel that it's Stabilizing, but supply is still behind demand.

Speaker 3

Hey, Amit, on the EPS number, as you Appropriately noted, we actually are raising the full year number when you take into account the incremental FX impact. And when you flow that Lou, I think that you're going to see that there is actually a slight raise in EPS as well, although albeit not as much as revenue. So we feel good about the year. We have talked several times about reiterating the EPS as well as the operating cash flow number in an uncertain time. So we feel good about that range.

Speaker 3

As George said, hey, we'll see how the rest of the year goes. We'll take a look at it. But we are certainly Very disciplined around our spending and targeted to make sure that we hit both profit and cash goals.

Speaker 1

All right. Thanks Amit. Next question?

Operator

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

Speaker 8

Yes. Thank you. It looks like your all flash ARR growth rates slowed somewhat from last quarter. It was up 7% Versus up 12% last quarter. Anything to read into that as far as trends and the transition to all flash from customers?

Speaker 8

Or was it just up against tough comps, Supply constraints or other reasons? Thank you.

Speaker 2

It's a combination of some supply constraints And also, we have an FX headwind to our product revenue. I think given the Percentage of our total book of business being all flash, you would assume that FX would affect it the same as our total book of business. So substantial headwind. I also think it's too early to comment, but at times like this in the past, we have seen customers Choose to buy more economic configurations in certain cases. So we had a strong quarter in our hybrid flash segment, which is really targeting customers who have want to buy the most cost effective configuration.

Speaker 2

And so we'll continue to monitor that. It's 1 quarter in, so I wouldn't call that a trend yet.

Speaker 8

Thank you.

Speaker 1

All right. Thanks, Matt. Next question?

Operator

The next question will come from Samik Chatterjee with JPMorgan. Please go ahead.

Speaker 4

Hi, this is Angela Jin on for Sonic Cattergy. I just wanted to dig into the comment you made about over 100% growth in AR from AWS, Azure and Google Cloud combined. I'm guessing the majority of that contribution comes from ANUP just given its scale right now. But do you mind parsing through how each one is trending and where you're Seeing the greatest traction and where you might see it going in the future.

Speaker 3

Hello, Angela, it's Mike. As we've talked about, ANF is the largest portion of CBS. All three of the products with the hyperscalers are performing well. We're not going to go into the trends individually. They're all at a different part of their stage in terms of go to market and product, but all 3 of them did well in the quarter relative to how they were.

Speaker 3

And Yes, A and F continues to be the largest portion of that and A and F performed quite well in the quarter.

Speaker 1

All right. Thanks, Angela. Next question?

Operator

The next question will come from Mihdi Hosseini with SIG. Please go ahead.

Speaker 9

Yes. Two follow ups. Within your cloud data services, how should I think about the current mix of cloud storage Versus cloud up? And how would this mix change over the next 4 to 6 quarters? And I have a follow-up.

Speaker 2

In cloud storage, as we said, is 60%. And we think that the mix should stay relatively stable over the next several quarters.

Speaker 9

Okay. Because I'm looking at your AFA of FlashArray commentary you mentioned, and It seems like if I were to just take your fiscal year 2020 3 guide, the AFA growth would deaccelerate. FY 2020 to AFA growth was 20% this year tracking to low teen. And I was just trying to better understand if Cloud data services will provide an uplift in addition to installed base that is upgrading.

Speaker 2

Listen, we solve customer challenges in multiple ways, right? I think unlike some other players in the market, We can solve it through a cloud based solution. We can solve it through hybrid flash solution as well as managed service offerings. So we're going to do what customers want and we're going to give them the full range of our portfolio. I think our flash offerings are strong.

Speaker 2

We have certainly been affected by the macro. But as we have shared before, the vast majority of our cloud growth comes from outside our on premises installed base. Most of those customers are not buying our AFAs. They're buying new stuff.

Speaker 9

Got it. Thank you. Thanks for calling.

Speaker 1

All right. Thanks Mehdi. Next question?

Operator

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

Speaker 10

Yes. Hi. Thanks for taking my question and congrats on the great results. I have 2 quick ones. First one for George, how much visibility do you have into FY 2023?

Speaker 10

Because Typical lead times of storage products is about 2 to 3 months. But if FY guidance reiterated, is it safe to assume you're starting to have some visibility into the back half Of FY 2023. So any color on the visibility would be helpful. And then a quick one for Mike. Conversely, given the uncertain macro, Especially heading into calendar 2023, how to think about your operating leverage?

Speaker 10

I understand you have some ARR and subscriptions, But if product revenues are down, SIPC a number down 10% hypothetically, how to think about margins and earnings in that environment, Mike? Thank you very much for

Speaker 2

With regard to visibility, listen, we are engaged in conversations with customers. And as I said in my prepared remarks and what we see within customers is there are transformational projects That continue to receive the benefit of spending, right? These could be digital business process enablement. It could be Data and analytics to better understand and target the customer base, it could be cloud migrations and accelerated application deployments. Those are all getting funded, right?

Speaker 2

And we get to participate in all of those. I think we have certainly more visibility into some Of the larger accounts and spending plans just because of the range of engagements we have with them, then maybe the smaller accounts, which are A smaller part of our total business. With regard to what we see going on, it's steady demand. As we said, some of our clients Are recovering from 2 years of COVID pandemic. So while they may not be as excited about what the Next year hold.

Speaker 2

They're still recovering from 2 years of delayed spending and so these projects are moving forward. And so we continue to work with our customers on their planning not only for this year, but also for the first half of next year, which Comprises the finish of our fiscal year.

Speaker 3

Hey, Krish, on your last question, the way I would answer that is, we certainly look at different scenarios. You mentioned 10% down. No one on this call has said that that's what we think it would be. We've looked at our operating expenses, where we spend our money, where we would Look to reallocate or reduce if we saw a different scenario than we're calling for the year. Also, hey, keep in mind one important note, which is the majority of the Most profit is still being generated by support, which we feel very good about and cloud continues to be a bigger part of that.

Speaker 3

Based on the midpoint of the guidance, by the end of the year, cloud will be about a little over 10% of the revenue and that of gross profit as well. So that provides a nice So we're looking at all those things as we go into the year. Nothing certainly that we would pull the trigger on unless we saw different scenarios rolling out.

Speaker 10

Hopefully not Thanks a lot, George. Thanks, Mike. Yes, that was super helpful. Thank you very much.

Speaker 1

All right. Thank you, Krish. Next question?

Operator

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

Speaker 11

Hi, guys. This is Victor Chu in for Simon. In doing some back of the napkin math here, the public cloud NRR of 151% this quarter seems to Implies strong public cloud ARR contributions from new customer bookings in the quarter relative to renewal expansion contributions. Is that an accurate assumption? And if so, were there specific drivers behind that this quarter?

Speaker 11

And how should we think about this dynamic going forward if we assume NRR continues to trend down as it has over the last several

Speaker 2

Listen, we've said that dollar based net retention rate would come down over time. I think we said we've kind of stabilized around 120%, but we feel really good about The book of business we're adding, it will bump around a bit. New cohorts certainly are showing strong expansion trajectory, But I don't read anything particular into our book of business, right? I think we have really strong growth across The crowd portfolio and we are acquiring a good new set of customers, especially with our hyperscaler routes to market. So there's plenty of opportunity ahead.

Speaker 2

We're going to continue to balance expansion with net new customer additions.

Speaker 11

Okay. Okay. So but is it right to That baked into your

Speaker 5

kind of outlook

Speaker 11

that new bookings kind of play a bigger role. Is that kind of No, correct.

Speaker 2

I mean, listen, I think that as the installed base and cloud gets to be a bigger and bigger number, The amount of new additions, if they are very strong, will naturally become a smaller part of the total business. So We're not we don't feel badly about the new customer additions at all. It's just it's the law of large numbers catching up with you.

Speaker 11

Okay. Okay. Thank you.

Speaker 1

Thank you, Victor. Next question?

Operator

The next question will come from Nehal Chukwu with Northland Capital Markets, please go ahead.

Speaker 2

Yes, thank you.

Speaker 5

Congrats on strong solid results and Effectively, the guidance rates here. George, you talked about some of your customer wins, and I believe this is One of the first times, if not the first time, where you talk about data on tap enabling better AI workload data management and being a key portion of these wins. Can you Double click into that and talk about what's inherent in ONTAP that enables such better AI workload data management?

Speaker 2

Yes. First of all, it isn't the first time we have talked about AI. It's been a strong contributor to our business Over many quarters now, we have three things that we're excited about. First is The technology underpinning AI works great on file based data. Image analysis, Natural language processing, those are all tied to analyzing files.

Speaker 2

The second is AI requires high performance Training infrastructure to make the algorithm smart. And so high performance file storage, We are the market leader without question in that part of the market. And I think over the last year, the third point I'll raise is we have done really good work Over the last few years with NVIDIA to build reference designs that combine their technology, software vendors And our infrastructure. So I'm super excited about the opportunities ahead in that part of the market. And as you saw from my prepared remarks, We can not only address it on prem, but uniquely address it on the cloud as well.

Speaker 5

Great. Thank you very much.

Speaker 1

Thank you, Nehal. Next question?

Operator

Your next question will come from Steven Fox with Cross Research. Please go ahead.

Speaker 5

Hi, it's Steve Fox with Fox Advisors. One quick question for me. Can you just talk About the hybrid storage arrays a little bit more, it looks like they grew double digit year over year. I'm not sure the last time that happened. And It sounded like that mix was happening in the prior quarter as well.

Speaker 5

How much more do you think you have to deal with that negative mix shift In the product sales, especially since you're starting to see a loosening up of NAND and DRAM? Thanks.

Speaker 2

Listen, I don't see hybrid flash strength as a negative. I just think that we offer a broad range of capabilities for customers. In certain workloads, hybrid flash is obviously the right answer because it gives you the combination of Large amounts of capacity at a really cost effective price point and with caching technology, the ability to generate Good enough performance for those use cases. So we actually feel like having cloud, all flash arrays, Capacity flash arrays and hybrid flash arrays is the right answer for customers. And we do that not just File and block, but also increasingly in object.

Speaker 11

Okay. Thank you.

Speaker 1

Thank you, Steve. Next question?

Operator

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

Speaker 12

Hey, guys. This is actually George Wang on behalf of Tim Long here. Congrats again on the quarter. So I have two questions. Firstly, just kind of honing on the cloud ops in terms of future tuck in acquisitions.

Speaker 12

Last time, you guys talked about the pausing in the first half. Just given kind of a valuation has come in rapidly for the private market companies, is there any sort

Speaker 3

of shift in the strategy

Speaker 12

in terms of maybe kind of pick up some privates kind of near term.

Speaker 2

Listen, we are disciplined acquirers. We have done well with the start to the year. That doesn't mean that we don't have more work to do to integrate the acquisitions we've already completed, Especially both CloudCheckr and Instaclustr, right? So we're deeply involved in doing that work. That Work should be wrapped up soon, right, at least the preponderant majority of that work.

Speaker 2

And we continue to monitor the landscape. We won't rule out Doing things that they are massively advantaged, but we're also just trying to be balanced, disciplined acquirers so that We can make sure that the acquisitions we already have done are off to strong starts.

Speaker 12

Great. So my follow-up is Just if you can unpack on the billings and the before I have both our company metrics. So when I look at the billings, sort of decelerated by 3%, but that's probably Kind of FX, you guys mentioned also some maybe some seasonality, some tough compare versus quarter last year, but it's good to see deferred rev actually Accelerated. So maybe you can unpack it a little bit, maybe talk about any update you saw from kind of software support and renewal fronts.

Speaker 3

Sure, George. So, hey, a couple of answers to that. So thanks for asking about billing. So keep in mind that it was 13% this quarter, but 18% on a constant currency basis. So it actually did accelerate quarter over quarter.

Speaker 3

I believe it was So it actually did accelerate quarter over quarter. I believe it was 16 last quarter. If I missed that, I apologize. What drove the billings growth mostly in Q4 of last year was, as you know, it's revenue plus Change in deferred, most of that growth was from support. We had a very good support quarter in Q4.

Speaker 3

You saw that in the deferred revenue results. This quarter, it was nice. Support did well again, but really it was cloud that drove a good bit of the billings growth. So the 13% as reported, cloud was about 7.5% of that. So it was a big driver.

Speaker 3

And a lot of that was what George talked about us Getting our feet under us again around cloud ops because that's where you'll end up doing subscription arrangements. So That is to compare our billings. Again, keep in mind, on an FX adjusted basis, really strong billings quarter.

Speaker 5

Okay, great. Thanks.

Speaker 1

Thanks, George.

Speaker 2

Thank you. The

Operator

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

Speaker 13

Yes, thank you. On the public cloud ARR, can you Just pass through what was organic versus inorganic in the quarter. And last quarter, you had noted that you were expecting the trajectory to Accelerate as you go through the course of the year. Is that still your view? Or do you expect that You sort of turned it around a little bit faster than you thought and that trajectory sort of maybe doesn't really accelerate from here.

Speaker 13

And I have a quick follow-up on gross margins.

Speaker 3

Sure. So hey, Wannsee, thanks for the question. So let's go through the ARR results in the quarter. So as we expected, Insta cluster came in right around $34,000,000 $35,000,000 And as we talked about, we expected to see good growth through the year, a little bit of acceleration in the second half. That's still where we are.

Speaker 3

So organic, I would I'm going to define that as everything except for Instaclustr because we had CloudCheckr in Q4, Grew by $45,000,000 and then Instaclustr was about $34,000,000 to $35,000,000 That gets you to the $585,000,000 That's about a 9% Growth quarter on quarter, we would expect Q2 to be, call it, between 10% and 11% growth On the $584,000,000 and then the second half right around 11%. So a little bit more, not much, it's certainly nowhere near Well, maybe it's an old hockey stick where they weren't curved at all. But, so a little bit of growth, but not much. And that gets us to about The $800,000,000 midpoint, so we feel really good about the rest of the year and how we need to grow that on a quarter on quarter basis.

Speaker 13

Okay. That's really helpful color, Mike. And then on gross margin, your fiscal 2Q gross margin guide, It's roughly flat quarter on quarter, but you are getting significant positive revenue leverage and 5% sequential at the midpoint. You got positive mix From federal potentially. So what would you say are some of the key offsets outside of FX?

Speaker 13

Or do you see the opportunity to potentially deliver some upside to those gross margin numbers? Thank you.

Speaker 3

Yes. So thanks for the question. The big mover there is that On a quarter on quarter basis, keep in mind, hey, the USPS had a really good Q1. That's much more of a programmatic spend now versus a big bump that you used to see in Q2. We expect premiums to continue to be relatively consistent.

Speaker 3

And then, well, again, we expect the memory places to help. That's really a second half of the year because we have to work through some of the inventory that We very appropriately put on the balance sheet before. So we feel good about that number. We'll see and here's the big thing, mix Really matters, our gross margin, not only within the product, but also within those products, in terms of entry level versus Some of the higher ones. So there's a lot of moving parts.

Speaker 3

We feel good about it. Again, we expect the second half to see that product margin increase as we go through the year.

Speaker 13

Thank you so much.

Speaker 1

Thank you. Thank you, Wamsi. Next question?

Operator

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

Speaker 8

Yes. Thanks. Thanks for squeezing me in. I guess, George, I wanted to ask you about The environment that we're in right now in terms of whether it's had an impact on demand for spot relative to the Last couple of years, like have you seen any acceleration in interest? Maybe it's not actual ARR yet, but it's pipeline.

Speaker 8

It's just I know a lot of customers are scrutinizing cloud costs right now and it seems like Spot is a really perfect type of tool for them in this type of climate.

Speaker 2

Yes. Clearly, the spot portfolio, which helps with both resource constraints in terms of talent with automation as well as the raw cost of cloud spend and kind of keeping track of where you're spending In the cloud, it's perfectly set up for this environment. We are off to a good start to the year with our Spark portfolio. We intend to widen and broaden customer engagement in line with the pattern that you just appropriately identified.

Speaker 8

Okay. So I guess, is that does that mean that you have seen an acceleration in interest? I guess, I didn't catch the I think, listen,

Speaker 2

customers are appropriately scrutinizing their cloud spend. And I think As they begin to understand that we have a toolset to help with them, we're seeing good proof of concepts, Good trials going on in the spot portfolio. Okay.

Speaker 3

All right.

Speaker 6

All

Speaker 1

right. Thank you. I'll turn it back over to George.

Speaker 2

Thanks, Chris. In summary, Q1 was a great start to the year, setting company records for Q1 billings, revenue, gross margin dollars, operating income and EPS. Despite the uncertain macro, the enterprise spending environment has remained steady, driven by priority investments in digital and cloud Our ability to address the challenges created by these initiatives with a broad portfolio drives our growing relevance with organizations globally. We will continue to maintain our focus on our top priorities, while driving disciplined execution and operational management to deliver increasing shareholder value. Thank you.

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Earnings Conference Call
NetApp Q1 2023
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