Good afternoon, ladies and gentlemen. Welcome to the NetApp second quarter fiscal year 2022 earnings call. At this time, all participants are 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 call over to Kris Newton, Vice President, Investor Relations.
Thank you for joining us. With me today are our CEO, George Kurian, and CFO, Mike Berry. This call is being webcast live and will be available for replay on our website at netapp.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 third quarter fiscal year 2022, our expectations regarding future revenue, profitability, and shareholder returns, the value we bring to customers, our ability to drive growth in our hybrid cloud segment and scale our public cloud segment, and our ability to manage through the current supply chain environment, all of which involve risk and uncertainty. We disclaim any obligation to update our forward-looking statements and projections.
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-19 pandemic, including resulting supply chain disruptions and the IT capital spending environment, as well as our ability to gain share in the storage market, grow our cloud business, 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 Forms 10-Q and 10-K, including in the Management's Discussion and Analysis of Financial Condition and Results of Operations and Risk Factor 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.
Thanks, Kris, and welcome everyone to our Q2 fiscal year 2022 earnings call. We delivered another strong quarter with results all at the high end or above our guidance. Building on the momentum of last year and the previous quarter, revenue grew 11% year-over-year, with Public Cloud segment revenue growth of 85% and Hybrid Cloud segment revenue growth of 8%. Product revenue grew 9% year-over-year, the third consecutive quarter of year-over-year growth. Gross margin, operating margin, and earnings per share are all at record highs for the first half of the fiscal year. Our performance reflects continued broad-based customer demand created by the sizable and long-term trends of cloud and data-driven digital transformation, where NetApp is playing an increasingly important role in helping customers achieve their business and hybrid cloud transformation goals.
NetApp is uniquely positioned to solve organizations' most significant challenges in both modern and traditional applications, on premises, and in hybrid multi-cloud environments. As I've said many times, our public cloud services not only allow us to participate in the rapidly growing cloud market, but they also make us a more strategic data center partner to our enterprise customers, driving share gains in our hybrid cloud business. We are seeing this play out in the strong results from both our public cloud and hybrid cloud segments. In Q2, we had a number of announcements that further solidify our leadership position as we continue to drive growth in our hybrid cloud segment while scaling our public cloud segment. Public cloud revenue grew 85% year-over-year, driven by Azure NetApp Files, Cloud Insights, and Spot by NetApp.
Public cloud ARR grew to $388 million, an increase of 80% year-over-year, and public cloud dollar-based net revenue retention rate remains healthy at 179%. During Q2, we advanced our cloud agenda significantly, and we remain confident in our ability to achieve our goal of reaching $1 billion ARR in FY 2025 with a gross margin profile that is accretive to the corporate average. In Q2, Amazon Web Services, AWS, announced the general availability of Amazon FSx for NetApp ONTAP, a native, fully managed AWS storage service powered by ONTAP. This new first-party product is fully integrated into the AWS console and is sold, supported, run, and built by AWS, making it easy and cost-effective for customers to take advantage of NetApp's suite of enterprise-grade data services while running in an AWS-native experience.
As we saw with Azure NetApp Files, it will take time for FSx for NetApp ONTAP to ramp, but we are extraordinarily pleased with the early indicators and the number of customers piloting this service. Additionally, Google Cloud announced that NetApp will provide storage infrastructure for its Google Distributed Cloud Hosted, where data resides in customer-owned data centers and colocation facilities. Google is previewing the integration of Google Cloud VMware Engine with NetApp Cloud Volumes Service, a fully managed service that helps organizations meet their needs for storage and disaster recovery. We also expanded availability of Cloud Volumes Service in the Google Cloud.
Much like any other Google Cloud native service, Cloud Volumes Service can be provisioned and consumed against existing Google Cloud agreements, making it easier for customers to expand their cloud engagements with both Google and NetApp. Finally, Microsoft announced that whitelisting has been removed from Azure NetApp Files.
Azure NetApp Files has been generally available since May 2019, with customers around the world relying on it to run their most demanding enterprise workloads in the Azure cloud. Now customers can instantaneously leverage Azure NetApp Files to accelerate the deployment of mission-critical applications to Azure. Additionally, we expanded the backup restore service and cross-region replication capabilities for Azure NetApp Files. We now have fully integrated services with all the major public cloud providers to give organizations the benefits of our storage and data management expertise and experience, no matter which cloud they choose. We have deepened each partnership and co-engineered services directly with the cloud providers, enabling their customers to buy directly from them. This level of integration streamlines purchasing, billing, operations, and support and eliminates the complexity of additional contracts, product installations, or patching.
Importantly for NetApp, these partnerships create a new and massive go-to-market growth engine as three of the largest and most innovative companies in the world are reselling our technology. Each of these announcements represent years of hard work, partnership, and continuous innovation, bringing ONTAP to the cloud at cloud speed and represents the opportunity for continued expansion. We're now the first and only storage environment that's natively integrated into each of the major public cloud providers. We also made significant enhancements to the Spot portfolio. We introduced Spot Security, a new product designed to keep cloud infrastructure secure. Delivering continuous, automated AI-based security, Spot Security analyzes, detects, and prioritizes threats to surface the most critical vulnerabilities and provides actionable compliance, remediation, and prevention.
We also released Intelligent Traffic Flow, a new functionality to Spot Elastigroup, which further enhances our customer's ability to optimize their applications by intelligently managing and controlling incoming network traffic for optimal instance utilization and high performance. Additionally, we announced Spot PC, a fully managed, secured, and continuously optimized desktop service built together with Microsoft to provide a complete solution for Windows 365 and Azure Virtual Desktop. At the beginning of Q3, we closed the acquisition of CloudCheckr, whose industry-leading cloud billing analytics and cloud configuration management, monitoring, and assessment solutions will augment the full suite of Spot services. In addition to being a solid technology acquisition, CloudCheckr will enhance our partner strategy for cloud, and we will leverage the CloudCheckr platform to build and extend distributor and partner businesses in both the private and public sectors.
Also in Q2, we held our annual flagship customer event, INSIGHT, with more than 10,000 attendees, and we introduced NetApp TV to stay engaged with customers throughout the year. At INSIGHT, we announced enhancements to our hybrid cloud portfolio with the latest version of ONTAP that delivers even better performance for SAN and modern workloads like AI and analytics, expanded capabilities for object storage, increasingly automated storage system management, and autonomous ransomware protection based on machine learning. The strength of our storage offerings was recognized by Gartner, which named NetApp once again as a leader in the 2021 Magic Quadrant for Primary Storage. Gartner called out our robust product and cloud service portfolio as well as Keystone Flex Subscription, our comprehensive and flexible storage-as-a-service offering.
We were also recognized among this year's top vendor solutions evaluated in the 2021 Gartner Critical Capabilities for Primary Storage across all use cases. Growth in our hybrid cloud segment was driven by strength in object storage for the rapidly growing unstructured data and analytics use cases and our all-flash array portfolio. In Q2, our all-flash array business reached a record high annualized run rate of $3.1 billion, an increase of 22% year-on-year. All-flash arrays now compose 30% of our installed base systems. We see substantial headroom to continue to help existing and new customers modernize their storage environments. Based on our continued strong revenue growth, I am confident that we once again gain share in the enterprise storage and all-flash array markets. Like everyone in our industry, we are faced with a challenging supply environment.
While the situation is dynamic and continues to evolve, we are doing everything we can to mitigate the supply chain headwinds. We believe that we can continue to manage through them and address the substantial customer demand. As Mike will explain, we have factored the ongoing supply chain uncertainty into our guidance for Q3 and the full year. I am pleased with how we have navigated these challenges and want to thank our suppliers for their support and the NetApp team for their hard work in this environment. In summary, our Q2 results reflect healthy momentum, a clear vision, and exceptional execution across our business. As we close the first half of fiscal year 2022, I'm proud of our team and what we have accomplished. We continue to bring industry-leading capabilities to market, further enhancing our differentiated position in cloud and software.
As our customers accelerate their digital transformation and their adoption of hybrid cloud and hybrid work strategies, we believe we are well-positioned to capture the sizable opportunity ahead. Before I turn the call over to Mike, I want to invite you all to join us for our Investor Day on March 22nd, 2022. Please mark your calendars and stay tuned for more information. I'll now turn it over to Mike.
Thank you, George. Good afternoon, everyone, and thank you for joining us. As a reminder, I'll be referring to non-GAAP numbers unless otherwise noted. 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 one, Q2 was another strong quarter, with results at the high end or above our guidance. Number two, our business model continues to show significant operating leverage as we grow our operating profitability and margins. Number three, our cloud business had another outstanding quarter as we march towards the $1 billion ARR target. Number four, we are increasing our full year guidance for revenue, EPS, and public cloud ARR, driven by the outperformance in Q2, the addition of CloudCheckr, and a healthy demand pipeline for the second half of our fiscal year. Now to the details.
In fiscal Q2, we delivered strong revenue, gross margin, and operating leverage across the entire business. Outstanding execution by the NetApp team yielded Q2 billings of $1.55 billion, up 7% year-over-year. Revenue came in at $1.57 billion, up 11% year-over-year. Our solid Q2 results were driven by healthy demand across both our hybrid cloud and public cloud segments. Gross margin, operating margin, and EPS all came in above the high end of guidance. Total hybrid cloud segment revenue of $1.48 billion was up 8% year-over-year. Within hybrid cloud, we delivered product revenue growth for the third consecutive quarter and expect this momentum to continue throughout fiscal 2022. Product revenue of $814 million increased 9% year-over-year.
Consistent with the trends we've seen over the last year, software product revenue of $475 million increased 14% year-over-year, driven by the continued mix shift towards our all-flash portfolio. Total Q2 recurring support revenue of $590 million increased 7% year-over-year. As George highlighted, our all-flash revenue run rate, which includes both product and support revenue, eclipsed $3 billion for the first time in the company's history and was up 22% year-over-year. Public cloud ARR exited Q2 at $388 million, up 80% year-over-year and 15% sequentially, driven by strong growth in Azure NetApp Files, Spot, and Cloud Insights. Public cloud revenue recognized in the quarter was $87 million, up 85% year-over-year.
The growing scale of our public cloud platform continues to positively impact the overall growth profile of NetApp, delivering three of the 11 points in revenue growth. Recurring support and public cloud revenue of $677 million was up 13% year- over- year, constituting 43% of total revenue. When combined, software product revenue, recurring support, and public cloud revenue totaled $1.2 billion and increased 13% year- over- year, representing 74% of total revenue, up from 72% in Q2 2021. We ended Q2 with $3.9 billion in deferred revenue, an increase of 6% year-over-year. Q2 marks the 15th consecutive quarter of year- over- year deferred revenue growth, which is the best leading indicator for continued recurring revenue growth. Total gross margin was 68%, reflecting the value of our software portfolio and public cloud platform.
Total hybrid cloud gross margin was also 68% in Q2. Within our hybrid cloud segment, product gross margin was 55% and benefited from the continued mix shift towards software-rich all-flash systems. Our recurring support business continues to be very profitable, with gross margin of 92%. Public cloud gross margin of 71% was accretive to the overall corporate average. We expect public cloud gross margins to continue to trend towards our long-term goal of 75%-80% as an increasing percentage of our public cloud business will be built on software-only solutions. We recently introduced the new FSx for ONTAP product with AWS and also closed the CloudCheckr acquisition. Both are software-only offerings and support our long-term margin goal. Q2 highlighted the tremendous leverage in our operating model with operating margin of 24%, an all-time company high.
EPS of $1.28 was up 22% year-over-year and also represented a new quarterly record for the company. Cash flow from operations was $298 million, and free cash flow was $252 million. DSO in Q2 was an impressive 38 days, highlighting a strong collections process and healthy linearity throughout the quarter. Year to date, free cash flow of $443 million is up 43% year-over-year. During Q2, we repurchased $125 million in stock and paid out $112 million in cash dividends. In total, we returned $237 million to shareholders, representing 94% of free cash flow. We closed Q2 with $4.5 billion in cash and short-term investments.
As you all know, the dynamic supply chain headwinds have intensified recently. Our excellent supply chain and procurement team continues to work closely with our partner ecosystem with the goal of meeting as much customer demand as possible. Towards this goal, we will continue to invest incremental dollars into inventory and longer-term commitments. That said, we do anticipate the supply chain challenges facing the overall technology industry to impact our product revenue and product gross margins in the second half of fiscal 2022. These supply chain headwinds and our ongoing actions to mitigate them have been factored into our Q3 and updated full year guidance. With our strong execution in Q2, the addition of CloudCheckr, and a healthy demand pipeline for the second half of our fiscal year, we are raising our fiscal 2022 revenue guidance.
We now expect revenues to grow 9%-10% year-over-year, even with the challenging supply chain environment. We also have growing confidence in our expanding public cloud opportunity, driven by enhanced go-to-market activities, deeper and broader cloud partnerships, and continued product innovation. As a result, we are raising the guidance on our organic public cloud ARR with a new range of $475 million-$500 million. As you know, we closed the CloudCheckr acquisition early in Q3. We anticipate CloudCheckr to contribute an additional $35 million-$40 million in public cloud ARR exiting the year. In total, our new guidance for exit fiscal 2022 public cloud ARR is $510 million-$540 million, which, at the midpoint, implies a 74% increase year-over-year.
For FY 2022, we continue to forecast total gross margin to be approximately 68%. However, the current supply chain challenges with temporarily higher freight and expedite charges will pressure product margins in Q3 and Q4. We now anticipate product margins to be approximately 54% for the full year. We are reaffirming our full year operating margin guidance of 23%-24%. We are forecasting operating expenses to range between $2.795 billion-$2.815 billion, driven by investment in revenue-generating activities, including expanding our public cloud portfolio and investments in both our cloud and customer success sales teams. Our new OpEx guidance also includes $10 million per quarter from CloudCheckr. As we discussed at our Investor Day last September, we remain committed to growing revenue faster than operating expenses. We are raising our FY 2022 EPS guidance.
We now expect EPS to range between $4.90 and $5.10, representing 23% year-over-year growth at the midpoint. Implied in this guidance is our expectation that other income and expense will be negative $60 million, and our effective tax rate will remain at 19%. We remain committed to delivering more than $1.2 billion in free cash flow in fiscal 2022 as our hybrid cloud business continues to fund the growth in our public cloud platform. Now on to Q3 guidance. We expect Q3 net revenues to range between $1.525 billion and $1.675 billion, which at the midpoint implies a 9% increase year-over-year. We anticipate consolidated gross margin to range between 67% and 68% and operating margin to be approximately 23%.
Assumed in this guidance are Q3 operating expenses of $705 million-$715 million, which includes CloudCheckr. We expect earnings per share for Q3 to range between $1.21 and $1.31 per share. Assumed in our Q3 guidance is our expectation that other income and expense will be a negative $15 million and our tax rate will be approximately 19%. In closing, I want to thank the entire NetApp team for the outstanding execution in the first half of our fiscal year. The team stayed focused on our core priorities, and were not distracted by external events out of their control. We are excited to build on that momentum as we continue to scale a truly differentiated public cloud platform while maintaining an unwavering focus on the hybrid cloud business.
As George mentioned, we plan to host an Investor Day in the spring, where we will further discuss the long-term value drivers for our shareholders, customers, and partners. I'll now hand it back to Kris to open the call for Q&A. Kris?
Thanks, Mike. Let's open the call for Q&A. Please keep to just one question so we can get to as many people as possible. Operator?
Thank you. Ladies and gentlemen, as a reminder to ask the question, you will need to press star then one on your telephone. To withdraw your question, press the pound key. Again, that's star one to ask the question. Please stand by while we compile the Q&A roster. Our first question comes from the line of Jason Ader with William Blair. Your line is open.
Yeah, thanks. Hey, guys. My question for you, George, is as we think about the cloud services business, there's a lot of different elements within there. You had just announced the Amazon FSx for NetApp ONTAP. Obviously, Azure NetApp Files is going well. You have the whole Spot by NetApp business and now CloudCheckr. I guess it's hard to figure out from our perspective, I think, which are gonna be the most important, let's call it, you know, three- five years from now. How would you help us think about that just in terms of magnitude? In particular, I'm curious about the Amazon FSx business. I mean, how should we be thinking about how important that particular service will be to your cloud services ARR over time?
I think first of all, we saw strong performance this past quarter from all three important pieces of our cloud portfolio. Cloud Volumes, which is cloud storage services, Cloud Insights, which is monitoring, and our Spot portfolio, which is dynamic optimization of compute and storage in the cloud. All of them had really strong quarters, and we're really pleased. In terms of FSx for ONTAP, I will just say that it's very early days, but we are extraordinarily pleased. Listen, if you look at the cloud file storage market, the public data suggests that Amazon Web Services is the dominant player in that market. Having a native first-party ONTAP enterprise file storage service in the Amazon Cloud is an enormous opportunity. We are doing the innovation and the enablement work to scale that business.
We're really pleased with the early results, but we have a long, you know, kind of, we'll see that play out over the next several quarters, right? Just like Microsoft Azure NetApp Files is now a really stellar product for us.
Thanks.
Thank you. Our next question comes from the line of Katy Huberty with Morgan Stanley. Your line is open.
Yes. Thank you, Mike. You sized the profit impact of the supply chain constraints, but what is the impact to product revenue in the back half? And should we think of any shortfall on revenue just contributing to fiscal 2023 growth?
Sure. Thanks for the question, Katy. Hey, let's put it in context a little bit as we did the guidance for the full year. We feel really good about how Q3 and the fiscal year is shaping up, coming off a really strong Q2. We've raised the revenue growth even with the tougher supply chain situation, and we're calling for growth across both product and cloud. As we said in the prepared remarks, we've baked all of that into our guidance. We'll work very diligently with our supply chain team, our customers, our partners, to make sure we're able to fulfill as much as we can. We're not gonna break out, hey, what was the implication of supply chain? Candidly, we don't wanna have two guidance numbers. We fully bake that in.
You know, as it relates to fiscal 2023, we'll have to see how the second half goes, really in terms of does it continue into our fiscal 2023, at what level, and how does it work its way through the rest of this fiscal year?
I think broadly speaking, our team has managed the environment really well. I think if you look at the second half guidance, my expectation is you should see a continued progression of the first half trends with product and cloud services growing quickly and, you know, our services business growing a little bit slower than that in the overall revenue mix.
Thank you.
Thank you. Our next question comes from the line of Rod Hall with Goldman Sachs. Your line is open.
Yeah, great. Thanks for the question. I wanted to dig back into the cloud services, George, a little bit. A couple of questions from me. One thing we've seen in the industry kind of emerging is direct hardware sales into some application in hyperscalers for low-cost flash storage. I know that you're amortizing hardware, you know, as a service sort of in some of these instances. But I wonder if you see an opportunity to maybe directly sell hardware into some of these things for specific applications. I'm also curious just strategically. I know the question was asked earlier, you know, what of these three services are gonna be bigger, but where do you take this strategically?
Can you know, give us some way to think about, you know, kind of where you're taking the as a service part of the business, where the opportunities lie, you know, where you think the most opportunity is? Thanks.
Listen, I think with regard to our approach to serve customers together with the cloud providers, we look at a broad range of opportunities. I think they don't exist solely in the public cloud. I think you could see, for example, in my prepared remarks, the commentary on working with Google around a distributed cloud platform. You'll see us continue to broaden the range of innovation opportunities that we deliver with the hyperscalers so that we can truly build a hybrid multi-cloud data management and infrastructure services management platform with them. I think within the public cloud, there are gonna be continued opportunities for substantial growth. I think, as I said, you know, we feel really, really good about the progress towards the billion-dollar ARR targets that we had laid out.
We will share more about the specific, you know, updates to our long-term plans at our analyst conference, right? Let me just say, cloud storage is a massive opportunity. Cloud file storage alone is a very rapidly growing multi-billion-dollar opportunity, and we are positioned at the sweet spot of that alongside the biggest three cloud providers in the world. Second, cloud compute management and cloud cost management is another massively important customer priority, and Spot plus CloudCheckr gives us a differentiated platform to go after that set of use cases. We see more and more types of workloads collapsing onto these two important elements of infrastructure as a service. Cloud Insights, our monitoring platform, helps customers not only deploy those infrastructure services, but also monitor them. I feel really good about our cloud progress.
Great. Thank you.
Thank you. Our next question comes from the line of Karl Ackerman with Cowen. Your line is open.
Yes. Thank you. I was hoping you could discuss how you plan to integrate CloudCheckr into your Cloud Insights and Spot portfolio. As you address that question, you know, as you grow the cloud business toward this $1 billion target and drive gross margins in the high 70s, should we expect the cloud business can achieve operating margins maybe in line with the corporate average, or could that actually happen earlier given the go-to-market appears to be shifting to your cloud partners rather than relying simply on your own sales force? Thanks.
Listen, I think with regard to CloudCheckr, what Spot allows customers to do is to optimize their cloud spend by dynamically deploying cloud computing and storage environments on the most efficient platform available, right? We address about 70% of the customer spend using the Spot technology. What CloudCheckr allows customers to do is to first be able to analyze and prioritize which of those environments they should move to Spot first and most quickly so that they can get the best savings, and then subsequently also gives them an integrated bill for their entire environment now optimized with Spot. We're excited about what CloudCheckr brings from a technology perspective.
From a route to market perspective, it has a strong footprint in public sector and in managed service providers who use it as an integrated billing and analytics platform for all of their downstream customers. It expands our reach into the marketplace. With regard to cloud operating margins, today, we don't break out operating margins. I would just tell you that we are a highly leveraged operating model for the company. If you look at the first half of this year, more than 50% of total revenue growth fell to the bottom line. We see the opportunity in cloud to be a fast-growing, high gross margin opportunity, and we are going to invest to capture that, but we are doing so while continuing to drive the operating margin profile of the total company.
I'm excited about the possibilities ahead and the continued increase in margin-rich software and cloud services in our portfolio. Mike, do you have anything else?
Yeah. Thanks, George. Karl, I would just add a couple things to what George said. We do benefit in a couple ways as it relates to the cloud business. One is there's a lot of synergies in R&D because as you know, ONTAP goes across both of those. That will help, as you called it, the operating margin, even though we don't break it out. The other thing we've talked about is, yes, the route to market and the hyperscaler sales channel certainly helps. We also have our own sales team as well. They will get more and more efficient, especially as we build up that customer success team. As we look at that billion-dollar target, as we've talked about, you look at the comps that have about $1 billion of ARR, and certainly those operating margins are very near our corporate average today.
Thank you.
Thank you. Our next question is from the line of Steven Fox with Fox Advisors. Your line is open.
Hi. Good afternoon. Just one more cloud question for you. George, you talked about how you now have fully integrated services with all the cloud service providers. How do you think you start to leverage that? Can you sort of give us a roadmap for how that builds upon itself, and where you would see initial success from having that full portfolio and then maybe later success? Thanks.
Yeah, certainly, you know, we have three ways that we drive success in the cloud business. The first is technology certification and workload expansion. We work with the cloud providers to qualify more and more and more workloads that can be best served using our technology. An example that I cited recently is the VMware, you know, cloud in Google now being certified to use NetApp Cloud Volumes as a primary data store, which has enormous benefits to VMware customers of NetApp and VMware to be able to now expand to the cloud, as well as new customers that want to deploy mission-critical environments on the VMware Clouds, right? That's one, workload certifications and expansions. The second is additional regions, you know, and enablement for the go-to-market engines.
You've seen us grow the Azure NetApp Files business steadily and very successfully over a period of time. You know, Amazon and Google are behind that, but we know the recipe, and we're working to scale that. Then finally, you know, cross-selling and upselling a customer once they get on our service. Dollar-based net retention rate is a very healthy 179%. It's early days in our customer base, so over time, that should come down, but it shows that once a customer uses one of our services, they expand dramatically, and then we get to sell them a portfolio of more services. Lots of ways to grow our cloud business ahead. We're super excited. We worked really, really hard to get here, and we're gonna capitalize on the opportunity.
Thanks for that. That's very helpful.
Thank you. Our next question comes from the line of Simon Leopold with Raymond James. Your line is open.
Thanks for taking the question. I wanna see if you could maybe unpack a little bit of the trends you're seeing in the traditional storage market. In particular, we're seeing very strong growth from your all-flash business, which would imply that there are aspects that are declining. At least one of your competitors seems to be suffering some steep declines at the high end. I'm wondering if maybe mid-range and flash is encroaching on more high-end performance and how you see the sub-segments trending for NetApp? Thank you.
Yeah, absolutely. I think we have said for a long time that mid-range systems with clustering software will cannibalize the high-end frame array business of some of our competitors, and you are seeing that play out. The mid-range systems offer the sweet spot from a price-performance standpoint for customers. With clustering, you can build enormously large environments to consolidate a range of different workloads. We expect that trend to continue going forward. You know, the days of the frame array are over, to be completely transparent. We'll continue to see that trend going on over time. With regard to how these, you know, within our business, all-flash arrays will have an important and growing part of the customer's data center. Hybrid flash arrays will continue to have a long-term position in the data center.
Today in our install base, for example, all-flash is about 30% of the install base. We expect, you know, as more flash technologies come to play, that number to grow to about 70% over time. I think, however, we do not subscribe to the theory that hard disk drives no longer have value. They will have enduring value for certain sets of workloads that they are built for. Capacity-oriented workloads, you know, backup and archival, media retention, images, things like that. We feel good about our position in the market. We're gonna stay focused and continue to execute against our all-flash array business and our object storage business as priorities for the enterprise storage environment.
Thank you.
Thank you. Our next question comes from the line of Nikolay Todorov with Longbow Research. Your line is open.
Yeah, thanks, and congrats on another great quarter. Another question on the hybrid cloud side. It sounds to me that you're seeing accelerated demand there. The question is, given the supply chain challenges, how much visibility do you have from a pipeline perspective? I think you talked about seeing a very strong second half. Also, are you seeing any abnormal backlog at this point? What kind of impact do you think that could have on your model in second half and forward? Thanks.
Hey, Nick, it's Mike. Thanks for the question. Yeah, we feel very good about the demand environment as we look at the second half. We certainly have a much better view at this point now of pipeline going into the second half. As we've talked about, a lot of what's baked into the guidance is really a result of supply chain. Again, we feel really good about the overall demand environment. As we look at backlog, there's really been no significant shift there. I do also want to make sure and note we haven't seen, you know, any what I would call unusual pull-ins either as it relates to purchasing behavior. On a quarterly basis, there's always pull-ins and push-outs. We haven't seen anything unusual there either.
Going into the second half, feel really good about what the pipeline looks like, and the buying behavior of our customers. Hopefully that continues as we go forward in the next year.
Sounds great. Thanks, guys. Good luck.
Thank you. Our next question comes from the line of Jim Suva with Citigroup. Your line is open.
Thank you. George and Mike, now as hopefully society is getting back to a little bit of more normalcy post the pandemic, hopefully, can you compare and contrast like the purchasing trends that you're seeing, you know, pre versus post? Is it longer lead times 'cause of supply chain? Do you think that might be here for good or more of a push to cloud or all-flash away? I'm just trying to compare and contrast of what you saw maybe pre-pandemic versus now in the discussions you're having with customers. Thank you.
We see continuing trends for digital transformation, hybrid work, and hybrid IT. Those have been our long-term perspective on how business architectures and technology architectures evolve. That has certainly come sharper into focus with COVID, but they have always been part of the long-term roadmap of our customers. We have seen the acceleration of, you know, cloud-based environments for certain workloads, especially workloads like virtual desktops or, you know, in schools for the ability for teachers to be able to use cloud-based environments to conduct classrooms, and we think those will continue and endure going forward as the future of work remains hybrid. Within the enterprise storage environments, we've always believed that flash will have a growing part of the customer data center as the economics of flash and the ability to consolidate and simplify your data center environment grows.
That being said, there are workloads, like I've mentioned earlier in the call, that will continue to stay on hard drives, and I think the big early shift to flash is now sort of stabilizing, and people understand what flash is gonna be used for and understand what HDDs are gonna be used for, and so we see a more steady pattern there. With regard to, you know, lead times and transactions and things like that, as Mike mentioned, we didn't see anything unusual. We have been able to meet customers through a variety of mechanisms, digital conferences, you know, using video conferencing mechanisms, as well as now starting to meet some customers in person. We expect that to continue going forward for a period of time at least.
Thank you so much, and congratulations to you and your teams.
Thank you.
Thanks.
Thank you. Our next question comes from the line of Tim Long with Barclays. Your line is open.
Thank you. I was hoping you could talk a little bit about the pricing environment and strategy given, you know, commodity moving prices and obviously inflation that you're facing on the supply chain side. Could you talk a little bit about how you see that kind of flowing through the model over the next few quarters here, and what do you think competitors will be doing, and will there be any, you know, differentiation in how some of you, NetApp and some of the other your peer companies are gonna, you know, tackle these challenges in a market where sometimes pricing is somewhat of a factor? Thank you.
Hey, Tim, it's Mike. Yeah, so thanks for the question. We have not seen much of a change in the pricing environment. As we've talked about before, it's still a relatively rational market. Every once in a while, somebody does something to grab a customer or keep one, but that's gonna certainly be an unusual event. As we've looked forward, I won't speak for any of our competitors. I think everybody's looking at their business saying, "Hey, costs have gone up across the board, especially in freight component costs. We're all dealing with that." I do expect that you'll continue to hear folks talk about doing price increases. I think a lot of this depends on how long we're in this situation. Again, from a NetApp perspective, you know, we've looked at that.
We have implemented a price increase, so we do expect that to start to have an impact later in our fiscal year. I would expect to continue to see that across our competitors, but again, I don't wanna speak for them. I think a lot of this depends on how long this short supply chain shortage lasts, and as well, our component manufacturers, how they approach the market as well.
Okay. Thank you.
Thank you.
Thank you. Our next question comes from the line of Sidney Ho with Deutsche Bank. Your line is open.
Thanks for taking my question. I have a question on the free cash flow. Based on your full year guidance, it would imply about 60% of the full year free cash flow will happen in the second half of the fiscal year. That's below the five-year average of, call it, about 70%. It's definitely the lowest since, maybe 2015. First of all, is my math right? Second, if so, anything you would highlight that may change this cash flow seasonality, and particularly do you expect supply constraint being a factor in terms of cash flow generation? Thanks.
All right. Hey, awesome. Thanks for the cash flow question, Sidney. Yeah, let's talk about it. Hey, let's start at the top. We did guide for free cash flow $1.2 billion or greater. Let's do operating cash first. That would imply full year operating cash of, call it, $1.425 billion. To your point, we've already generated $540 million. What you saw in Q2 was a record for us low DSOs. We had a great collections quarter in Q2. That did pull forward some collections into Q2.
As we look at the second half of 2022, you should expect to see the seasonality, as you called it, be a little bit lower in the second half because of the really strong Q2, still getting to at least that $1.4 billion operating cash number. As to your question about supply chain, we have baked in an assumption that we'll continue to invest in inventory. You saw that our inventory turns went from 17 in Q1 to 13 in Q2. That was planned. We talked about that with you folks as well for the last couple of quarters. We have baked that into our assumption. Going forward, I think you should expect to see kind of the seasonal averages return.
Again, it was just in a very, very good Q2 from a collections perspective, and I wouldn't expect that to continue into the future. Again, thanks for that question. Hopefully, that answers your question.
It does. Thank you.
Thank you. Our next question comes from the line of Nehal Chokshi with Northland [Securities]. Your line is open.
Yeah, thanks, and congrats on the strong public cloud services. That's great to see. On the overall business, billings did decelerate pretty materially on a year-over-year basis. Can you talk to what were the dynamics behind that, and then why do you say you feel good about the pipeline given the billings?
Sure. Thanks for that, Nehal. As we talked about in Q1, billings grew by about 20%. In Q2, billings grew by about 7%. Keep in mind that on a year-to-date basis, right around 12%-13% growth. That number's gonna jump around a little bit each quarter based on the dynamics of deferred revenue as well as FX. We calculate billings as net revenue in the quarter and then quarter-over-quarter change in deferred, excluding the impact of FX in deferred. That's gonna move the numbers a little bit. There's a little bit of seasonality to that. Looking forward, we would expect to continue to see billings overall grow at or above the revenue number.
Again, I would encourage you to, hey, take a look at the year-to-date number or the trailing twelve months. Billings will jump around a little bit based on the components of our billings, mix matters as well as seasonality.
Got it. Great. Thank you.
Thank you.
Thank you. Our next question comes from the line of Wamsi Mohan with Bank of America. Your line is open.
Yes. Thank you. On your guide for Q3 and Q4, maybe you can express this a little differently on the puts and takes from Q3 to Q4 trajectory. Are you expecting component issues to be resolved through Q3, and that drives better seasonality Q3 to Q4? Or is there something else like a better pipeline? Or for Q4, Mike, you also mentioned increased pricing as well. Maybe you could bridge Q3 to Q4, that'd be helpful.
You know, Q4 is the finish of our fiscal year. As you might know, we run a semiannual plan, and so, you know, we had a strong Q2, and we'll have a strong Q4. That reflects the seasonality in our business, driven by our compensation planning as well as customer buying through the year. I think with regard to margins, I'll have Mike cover that in terms of, you know, the supply chain and the margin profile. I would just tell you, we do not expect a near-term resolution of the supply situation. What we have seen through excellent execution with our teams and our partners is that component costs for the full year are largely flat year on year. You know, there are some elements of the components that are up year on year and others that are down year- on- year.
As we have said before, component costs are largely, you know, flat on a year-over-year basis. I think what we see is really the expedite and freight costs that are, you know, at a premium now. You know, that is reflected in the pricing lift that we have implemented at the start of November, and which will take some time to flow through our systems. I'll let Mike characterize.
Great. Thank you, George. Just to add to that, on the specific question, Wamsi, if you go from Q3 to Q4, a couple of things to keep in mind. One is, hey, the services revenue will continue to grow. You're gonna see cloud support, hopefully professional services. That adds to that quarter-on-quarter growth. As we look at Q4 versus Q3, to George's point, always want our seasonally high quarter. We're doing a lot of work not only in supply chain, but in engineering and other things to make sure that we can deliver as much as we can in Q4. Then certainly the price increase, it'll take a little bit of time to work its way through the system. Add all those together, and that's what added up to our guidance, our implied guide for Q3 and Q4.
Thank you.
Thank you.
Thank you. Our next question comes from the line of Amit Daryanani with Evercore. Your line is open.
Yeah, perfect. Thank you, and thanks for taking my question. You know, I guess the questions around the cloud services business. You know, George, I was just wondering how, when you think of the AWS partnership, and I know it's somewhat in the early stages, how would you stack that up against Azure at this time? Just anything in terms of number of pilots or the workload that you're doing with AWS right now versus what you did with Azure. Then really, when I think about this billion-dollar roadmap that you'd given us, you know, a while back, did you envision a AWS partnership, especially how fully integrated NetApp is on the console and the fact that AWS is proactively selling NetApp? Did you envision all this in the billion-dollar roadmap, or is this incremental to that narrative?
Listen, I think first of all, AWS and Azure have enormous scale and reach into the customer base. These are trillion-dollar corporations with enormous impact on the IT market, and we are honored to work with both of them. They have different approaches to the customer base and different ways and different strengths, and so we're excited to work with, you know, Amazon and Microsoft. I think the overall opportunity set reflects their scale in the market, right? Amazon has massive, you know, market presence and market share. I think in the file space, they are a very large part of the files market. The fact that we have a play with them gives us enormous scale into the file storage market. I think, you know, we've learned a lot over the last few years.
We know what it takes to scale a business, and we've done that in partnership with Microsoft. We continue to scale that with innovation and go engineering and, you know, go to market. We are also taking some of those lessons learned into how we can scale other services more quickly. With regard to the billion-dollar plan, listen, we always believed that we would, you know, be working with multiple hyperscalers. You know, I don't think you should assume that we were cocky enough to say that we had that in the bag, but we had that as part of our roadmap, and we're honored to have the partnership with AWS. I think, you know, as I said, I feel very, very good about where we are in our roadmap to $1 billion.
We'll tell you more about the timing and the mix and all of that when we get to Analyst Day, right? I feel really good about where we are.
Thank you. Our next question comes from the line of Ananda Baruah with Loop Capital. Your line is open.
Hey, good afternoon, guys. Thanks for taking the question. Yeah, George and Mike, I guess, mine's on the business model. How do you guys think about the interplay or the trade-off maybe, you know, now that the margins continue to expand? I think you guys are actually absorbing like 100-200 basis points of operating margin, you know, sort of expense, supply chain, you know, kind of components, et cetera, which really has the margins already be in the mid-20%, and of course, 25% or so. How do you guys think about the interplay between investing in growth, investing in M&A as the margins continue to go up, you know, seemingly towards 30%? Appreciate it. Thanks.
Sure. Hey, [Ananda], great question. As we've talked about for the last couple of years, our goal is to continue to invest in the business to drive growth, being fully cognizant of investing in operating expense and COGS at a lower rate than revenue to drive up margins. You saw an incredible really operating leverage so far this year. If you take the midpoint of the guide, you know, revenue's up almost $550 million year-over-year on a $118 or a $120, pick your favorite number, OpEx number. We're continuing to drive really good scale while investing in the business. We will continue to do that going forward. Very much focused not only on where we need to invest, but what is that return.
That's why we're so focused on cloud as well as incremental sales and product development. You should expect to see us continue to invest going forward. Now, outside of OpEx, we've talked about it before, we will continue to be active in M&A, and we're still allocating at least 30% of our free cash flow, plus we have a very nice cash balance and a lot of flexibility on the balance sheet to fund acquisitions. Yeah, you should expect to see us continue to increase OpEx to drive growth as well as be active in the M&A market.
It sounds like an opportunity to keep accelerating revenue growth, expanding margins, and get bigger in M&A as the free cash flow goes up, Mike.
Doesn't that sound like fun? That's exactly what we're focused on.
Thanks, guys.
Thank you.
Thank you. Our final question comes from the line of Samik Chatterjee with JP Morgan. Your line is open.
Hi. Thanks for taking my question. I guess my question was just following up on the pricing discussion earlier. You mentioned you've taken some pricing and the flow through would take a bit of time. Just how should we think about the stickiness of those price increases? Are they as supply chain kind of eases, do those price increases get competed away? I'm just trying to think how much of a benefit can they be to like the next fiscal year as they take time to flow into the P&L or how sticky can they be? Thank you.
Great question. As you look at the rest of this fiscal year, and I'll work it into next year, you shouldn't really expect to see much of a benefit in Q3. There's a lot of quotes in flight. It takes a while for that to take effect. We expect to start to see some of that in Q4. Hey, as we roll into 2023, I think it depends on a lot of things. The earlier question on what are your competitors doing? What's the overall pricing environment? What happens with component costs and freight?
I think there's a lot in that for us to be able to say, "Hey, we think X amount sticks." Certainly, we are very disciplined around our pricing, and we wanna ensure that we are doing the right things for our customers while we are taking care of covering our costs as well. We'll be very focused on it. We'll talk to you as we guide to next year on the impact of that. I did wanna be clear just on the impact of 2022. Thank you.
Thank you. We have delivered a solid first half with great operating leverage in our business model as we grow revenues and margins. We're gaining share in the key markets of all-flash and object storage, while rapidly scaling our public cloud business. The innovation we bring to market and our unique and deep cloud partnerships position us well to execute against the significant opportunity ahead. We increased our full year guidance for revenue, EPS, and public cloud ARR, driven by the outperformance in Q2, the addition of CloudCheckr, and a healthy demand pipeline for the second half of our fiscal year. Thank you. I look forward to speaking with you all again next quarter and at our upcoming Investor Day in March.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.