Perfect, everybody. I don't know if we've switched over this slide yet, but we have-
I can advance it.
Yeah. Exactly. We have Mike Berry, CFO of NetApp, here with us today. I'm Meta Marshall. I cover NetApp and a lot of the networking and storage names. I'm gonna kick off with the safe harbor, which I now realize Kris has now sent me three times. So, NetApp safe harbor. Today's discussion may include forward-looking statements regarding NetApp's future performance, which are subject to risk and uncertainty. Actual results may differ materially from these statements made today for a variety of reasons described in our most recent 10-K and 10-Q, filed with the SEC and available on our website at netapp.com. We disclaim any obligation to update information in any forward-looking statement for any reason. All right, perfect.
Thank you for that.
No problem. Mike, delighted to have you here today. You know, you guys had tremendous success in your fiscal Q2 results that you reported last week, seeing success with the C-Series and higher density products on the top line, as well as a number of margin benefits that we will kind of discuss. So just can you give an overview of what you're seeing in the storage demand environment currently, and, you know, just how your customers are thinking about 2024?
Sure. And again, thank you for having us. Thrilled to be here. And good afternoon, good evening to everybody. So, yes, we had a very successful Q2. We were super excited about it and the momentum going forward. As we talk to our customers in 2024, hey, it's still a challenging environment, still relatively soft IT spend, especially with the large enterprises. We haven't really seen any changes o ver the last couple of quarters. There's pockets. One country will do a little bit better, maybe, some movement in sectors, but largely consistent. But it has at least stabilized.
We are hopeful that 2024 is better. At this point, we're not planning on it. Our fiscal year goes through April, so it'll take about halfway through. So we are talking to our customers about their budgets into 2024. I think there's still a lot of movement as it relates to that. So our expectation now is not a lot of changes up or down as we go through the next calendar year.
Got it. You know, I just mentioned your gross margins were a standout at an all-time high in fiscal Q2 and up nearly 570 basis points year-over-year. A big question we're getting from investors is just how much of that margin strength is a result of attractive memory pricing environment versus a mix shift?
Yep. So as in, I'll do this quarter-over-quarter. Because year-over-year, there's so m-
Yeah.
Gosh, so many moving parts. So as we looked at Q2 to Q3, product margins, which are a part of our total margins of 70%, product came in at 61% in the quarter, versus 55% the previous quarter. And as we rank the different moving parts, we talked about mix capacity, some lower costs, and then pricing. Let's go through each of those. Mix was a big driver as w e fully expected when we introduced C-Series, and I know we'll talk about that part of our business. That is a flash product, QLC. It has higher margins than hybrid, w e did expect to see customers move to capacity flash. That did happen. It was a little bit faster than we thought.
Q1 was really good, and we talked about Q2 was really a very good quarter for capacity flash, which we're super excited about because it's really only the second quarter we had it available. So that was the biggest driver. Capacity as well, which is more memory and components in the units that we ship,
helped move it as well. So this is, we have different levels of purchases and different SKUs, so that was number two. We did see a little bit of benefit from inventory that we had bought previously. It wasn't a lot, but it was a little bit. Gave us a little bit of quarter-over-quarter benefit. And then pricing largely held stable, which is, which is a benefit as well. We had baked in always some room needed to be flexible around pricing, and while we were-
We didn't see that really roll through margins. So that in order, in Q2, and we have guided the rest of our fiscal year between 58 and 60 in product. We expect it to hold largely for the rest of the year, with building in, again, some flexibility on pricing.
Okay. So kind of circling back to the C-Series, which you just talked about, this kind of being the second full quarter you've had it released, what kind of customers are you finding traction with? And, you know, what differentiates NetApp from competitors on these flash products?
Yeah, so let's, let's take a step back and talk about the differentiation we have, and then we'll talk about flash and the other products. You know, we are really excited because we feel like we're at the forefront of the storage evolution. We are the only company that offers unified data storage with one operating system, and that gives our customers great ability for flexibility, for deployment, for optimization. It's all the same UI, everything. And that enables them to do, hey, any app, anywhere on-prem or in the cloud. So we're excited about that. We had clearly had a hole in our product footprint as we entered into 2024, especially around capacity flash. So we have hybrid and disk space, and then we had high-performance flash that uses TLC, and that's, that was largely the growth in our flash business.
Capacity flash was an area that we saw, especially in enterprises in that midmarket. Much more customer interest in that offering, and it, it is net new workloads for us either within our great customer base or net new logos, and that uses QLC technology, which we think is gonna be a big driver of growth... especially as it goes and replaces those 10K drives, again, in that huge mid-market segment. So we launched that at the end of 2023.
We had a great Q1 and an even better Q2. And again, it all runs on ONTAP. So a customer that uses any of our other FAS or hybrid products in A-Series is able to use it as well. It was the fastest-growing flash launch we've ever had, and great uptick. Our partners are super excited, our customers. You know, we talked about the $16 million deal in Q2,
which we won against another all-flash competitor. The big part about that is it's all within two quarters of the launch. So super excited about that, and as we look forward, we expect to see within the flash market. TLC did a great job replacing 15K drives and old FAS arrays, but it's largely mature.
There's still a great market for that, but we expect most of the growth to come with QLC, and again, that's gonna be for us, adds additional TAM.
We've also introduced our ASA series, which is a block solution, both high-performance and capacity. And then importantly, although it's not a huge bookings or billings number, is our A150, which is a lower, a lower scale version, which gets us into that market that we've not done that well at. So you'll hear this when we talk about cloud as well.
We now think we have the best portfolio that covers all the different use cases, as we enter the second half, and more importantly, next year.
Can you maybe just outline what applications are more equipped for that kind of C-Series versus kind of the higher-end portfolio you've traditionally had?
The higher end is gonna focus more on high-performance workloads databases, SAP, eventually as people move VMware as well. Capacity flash can largely cover everything else. Not quite as performance, much more, obviously more capacity and at a lower cost. And at one point, so we use TLC, QLC, probably now PLC, Penta, will come along at some point.
But we really think the big use case there is from a cost perspective. Now, the C-Series and a 10K drive are largely the same.
But from a total cost of ownership, flash is gonna last longer, plus the environmental benefits are so much more.
Correct.
We expect to see that really start to replace, and that's, from our view, the largest install base out there as those come up for refresh.
Okay, perfect. You know, your cloud business, you just alluded to, is just something that's been very differentiated within NetApp with native integration with the clouds. Can you just update folks on how these partnerships with the three major clouds have ramped? 'Cause they're all at different kind of timelines.
Yep. Even though cloud has gone through a little optimization, as we all know, we think it's still a long-term secular trend growth in cloud. They're all three great companies.
Obviously, some of the biggest companies in the world, but they all are a little bit different. So let's take it in order of how we rolled out the first party. So when we say first party, it's where they've taken our technology, embedded it, either in their data center or in their hardware, and then they offer those products as their own. So Azure's is called ANF, Azure NetApp Files. That's where we've actually deployed hardware and software in Azure data centers across the world. That focused on the high-end workloads, and gosh, they have almost every big enterprise.
It was really cross-sell into that. Now we're starting to also offer the full array, even the lower-end storage, because they have their own products as well. That's a great relationship. It's been the longest from a first-party perspective.
We launched FSx for ONTAP about a year and a half ago with Amazon. Amazon's actually our largest relationship of taking our product into the cloud, but that's the first party.
There, we deploy software on their white box. So they did not want to deploy hardware, so they take our software, and that was really focused around net new customers as well as secondary workloads.
Now, the performance is getting a lot better, and we can move upmarket. Just certified with SAP. At re:Invent, they talked about a new scale-out version that is, from our team, 9 times better in terms of resilience and speed. So we're super excited about that, and that's been a great net new customer adds.
GCP, just getting started. It's a great relationship, but it was mostly through the marketplace. Now we have the first-party service, Google Cloud NetApp Volumes, to get all those acronyms right.
And that's gonna be a combination of hardware that we'll deploy first, and then we immediately announced a lower-cost version based on software. So they're all in different phases.
Importantly, Meta, we have a different sales team for each of the hyperscalers-
Okay
that are faced off against them, and they are aligned with their customer hierarchy so that we can really service those, the hyperscalers, which are our customers, better.
I know you had announced that SAP, or ability to kind of transition those SAP workloads last year. Have you started to see traction of some of those migrations?
There have been t hat is a big push. We have seen traction, especially in ANF did a really nice job of focusing on that. They were the first ones certified. And then now, with FSx, that's certified as well.
Okay. You know, another part of some of your success this year has been changes with the go-to-market that you've made. Can you just outline what some of the changes to the go-to-market were?
Sure. So, like a lot of enterprise companies, and for all the right reasons, I'm gonna go back three years. I'll count this as, as one year. We wanted to make sure that the account rep t he core sales rep is the face to the customer. So we'll use Morgan Stanley as an example. You have an account rep from Morgan Stanley, and then they bring in the specialists.
Depending on the product, be it storage, flash, Cloud Ops, or cloud storage. We wanted to make sure that we didn't have competing factors in front of the customer, for all the right reasons. Then we said, "Hey, we're gonna split your compensation, call it 70/30, 70 on core and 30 on cloud." Then, as we pushed more and more into the cloud last year, we said, "Well, now we're gonna increase that to 60/40.
It, granted, coincided with the economy slowing down a little bit, but we realized, gosh, that's a lot to ask one person to do.
When you have two feet in both camps, there's a likely chance they're not doing either one as well as they should.
And it's super important that with the launch of C-Series, we also said, "Hey, that's not working, so we're gonna ask the core reps, 'Focus your time on hybrid cloud.'
Core storage, specifically flash, because that's where the market's growing." So we moved the compensation to materially comp that way, and then importantly, we took the cloud specialists that were underneath that account rep, and we broke them out and aligned them, as I mentioned, with the hyperscaler hierarchy. So if you're an Azure sales rep and you want to sell ANF, you know exactly, "Hey, I need to call Mike, not Meta.
Whereas before, I didn't know who to go to. And there was a lot of feedback from our partners, which is, "Hey, that's causing a lot of conflict." So we did those two things, and, hey, it's worked out really nicely. We're two quarters into it. It was the right thing to do now, and I'm sure we'll talk about cloud.
One of the things is the cloud storage, where our sales reps would sell them and get comped; we've seen that slow down a little bit b ut we're Life is trade-offs.
We're happy to take the trade-offs that we have in the core business.
Okay. So maybe turning to that, you know, you guys have done a strategic review around the cloud business. Just what, what was kind of the outcome that you came to, and what impact do you expect that to have to the business?
Yeah. As we went through 2023, and we realized going into 2024, it was not growing as much as we would like. It's made up of different parts, so we wanted to do a strategic review to make sure that we're investing in the right spot. Coming out of that, there were a couple of key findings. Number one is, if you look at the $600 million or so, approximately, of cloud ARR, about 60% is cloud storage, 40% is Cloud Ops. Within cloud storage, the biggest part of that is our first-party relationships and where our customers buy our product through the hyperscalers.
As you know, there's $hundreds of billions of unspent commit across those big three, and customers like to buy stuff through those marketplaces to burn that down. That part of the business grew 30% year-over-year, last quarter.
So we're gonna over-index focus on driving growth there because our customers have said, "We love your product, but we want to buy it from the hyperscalers. It's native, it's their product, it's their service, and if I'm working with one, I just want to be able to buy through that. Plus, I can burn down my commits." The other piece we realized is where we struggled the most is on the subscription business.
The two biggest pieces are in CloudOps. We have Cloud Insights, which is a homegrown solution that is a great storage monitoring tool.
Yeah.
We asked it to do a lot of other stuff that we, observability, network applications, where now all of a sudden, all these other companies, you run into a much bigger group. So we started to see renewal rates really come in much lower than we expected.
So we've reallocated and refocused that on go support storage, which is what you were originally intended to do. And then within cloud storage, there are two pieces. One is what we call bring your own license, where customers buy from us and then deploy in the cloud. We realize they don't want to do that. They want to buy from the marketplace. So we're gonna gently but very directly help push them to that consumption. And we also had some products in cloud storage that around data protection and privacy, that we sold as a standalone solution
That we're not gonna sell anymore. We're gonna take that functionality, which is important, and roll it into the core Cloud Volumes product. And then lastly, there were two small ARR products that we are gonna kill, or that we're gonna stop supporting, SaaS Backup and VDI, which is our CloudJumper acquisition. Take all of that together, and we've signaled for the last half of 2024, there's probably about a $55 million ARR headwind
that will be offset partially by growth in first party and marketplace. The great part about that is, yes, we'll enter the year most likely with a lower ARR number, but it'll be a healthier base.
Yeah.
It will be more overindexed to cloud storage and, and then sets us up much better for growth next year.
Are there any accompanying kind of OpEx savings from those moves?
Most of that's already been reflected-
Okay
because we've already shut down those two products, and then we will reallocate R&D. in some of those other ones to support first party and marketplace.
Got it. I mean, we've talked about it kind of casually here, but, you know, cloud optimization efforts over the last year have clearly been a headwind, you know, not only to the clouds, but to your kind of cloud storage business. Just how are you seeing the environment within that business? You mentioned 30% year-over-year growth, but is that what you're, you know, seeing as kind of stability, or are you starting to see an inflection there?
We've seen it. Certainly, it's a lot better than it was in fiscal 2023. We talked about it, we had some project-based workloads that were relatively significant, that we saw our customers basically stop those projects, and then the data went away. From an optimization perspective, we still see some of that in our larger customers, but it is largely now being offset by growth in the rest of it. So as we bring in those net new customers, that expansion has largely offset. So I think we're close to an equilibrium now.
Our hope is, again, our hope is, if the economy can pick up, that we'll start to see that, that net new workload growth increase, which has largely slowed down.
Okay. You talked most recently at your user conference about kind of the large opportunity you see within AI. Just what are some of the ways that NetApp can kind of capitalize on this opportunity, and just how do you see the timeline of that?
Yeah, so it's a great question, and it's probably the first one we get in every discussion. So-
Nobody's interested in AI.
No one's interested, yeah. So the great part about AI is, hey, we've been in it for a long time.
And because AI relies on data, and then NetApp runs on data, I think that that helps a lot. And again, it's all powered by ONTAP as well. So we feel really good about where we are there. If we talk about AI being predictive and then generative, we've been in the, as we call it, industrial predictive for five years at least, where pharmaceutical companies do new drug introductions, it's financial services doing risk scoring, it's oil and gas exploration driverless cars
autonomous cars. So we've been in that for a long time, and that's really what our A- Series powers. As we move to generative... And by the way, we've had a relationship, and everybody talks about their relationships, with NVIDIA for over 5 years. We have ONTAP AI, a reference architecture. I think we are still the fastest direct GPU to storage that's there-
'Cause, hey, if you're going to spend all that money on a GPU, you want speed. So we're super excited about that. As we go into generative AI, it's really built on unstructured data. That's where we are the leader. So it will come. It's not a question in our mind of if, but when. There's still a lot going on, and everybody knows it, in terms of: Where is the data? What are the use cases? Making sure that legally they do the right thing. I think there's a lot of money going into the compute part of it now.
At some point, that will generate storage. Probably going to be a mix of cloud and on-prem.
Yeah.
It likely changes the on-prem world, I think, going forward. Not in our fiscal 2024, but it's certainly something that we'll talk about as we guide for 2025.
Okay. I mean, then this may be a little bit out of your CFO purview, but, you know, as we think about it with, you know, do you see some of that revenue kind of before maybe we see all of these use cases? 'Cause people need to prep the data and kind of get the data ready, and then there's, you know, another wave that comes once there is more data. Or just how do you see the timeline of it with other AI investments?
So I'll lean over on this one Just a little bit. There's probably waves of this, only because I listen to Chris all the time, and she's really good at this. There's probably waves as we go through this. For instance, as someone is, if they want to run a large language model, they may have to take data that's in, basically in a cold tier.
and bring it back on-prem, because they need to aggregate it and make sure that they can access it. You probably have your, your data in the cloud, and but your models you want to run on-prem.
There's probably a wave of these, where they need to bring it together, they need to prep it, potentially add to the data. Internally, we've talked about doing forecasting. We don't just want our own internal data. We want all the external data country, GDP, taxes, everything, so we can build those. I think that that probably adds data as they start to build those models. It's probably a wave versus a step function.
Okay, perfect. You know, you guys have such a big opportunity. We've mentioned cloud, we've mentioned AI, you know, we've mentioned C Series, but you guys have also had a strong tradition of operating excellence. You know, just how do you guys think about the best way to invest, both from an OpEx standpoint and just from a capital allocation standpoint?
We'll do OpEx first a nd then we'll roll to capital, if we could. So from an OpEx perspective, like most companies, we did take a step back. We had a reduction last year.
That was really to streamline, especially in R&D and go-to-market, and focus on the most important pieces. G&A has stayed largely relatively consistent. As we look forward, we first always look at whether we can reallocate. You asked a great question: "Hey, you're shutting down these projects, but is there going to be OpEx savings?" We took most of that and reinvested it
to drive growth. So as we look at R&D, it's almost always tied to: What's the ROI? What's the new growth? And can we reallocate or optimize another group? Just like everybody else, we push a lot to offshore as much as we can and to optimize that. And then from sales and marketing, it's actually a little bit more straightforward because you can look at productivity, capacity. We likely know where we're winning and losing, so where we need to invest. And I know several years ago, I think just when I got here, the company added about 200 sales reps. I think we're pretty good across most of the world. There are some areas where we'd like to add some capacity.
But that, Meta, we can measure right away. In terms of pipeline build and productivity. And now flow that into capital allocation. In our last Analyst Day, a couple of years ago, we talked about 70% shareholder return, 30% acquisitions. We've largely taken a step back and said, "Let's do the strategic review. Let's get the cloud where it needs to be. We'll over-index on shareholder returns." Dividends have stayed relatively flat, so we've now spooled up and down the share buyback. We will reduce shares by 4% last year, and we've guided to another 4% net decrease. I think going into 2025, we'll pick we'll look more at M&A.
Likely they'll focus not on buying something that brings net new TAM, like Cloud Ops, but it needs to support storage first and foremost.
That will be tech and talent, where it's a roadmap accelerator or businesses that we can wrap around storage. We always look at big ones, just like everybody else. Never say never, but that will be the focus.
Okay, perfect. And then just finishing up, you know, what do you think investors sometimes miss about NetApp?
I'll go back to when I interviewed with George, and I said, "Hey, what, what's the secret sauce in NetApp?" And over dinner, he looked at me, he said, "Software. We're a software company." I think there's nd there's still a view, which is, and we have seen, unfortunately, some cyclical moves with the economy, that we're a hardware company. We're not. We're a company that monetizes our software through hardware, and, and we will get. We're excited about growth.
The cloud business, we added a good bit there in the race, I'll call it, for scale. Probably now realize quality is more important, so we are doing everything we can to control what we can't control. When I stood up at the last Investor Day, there was a lot of questions about, "What about the leverage in the model?
Well, we just set records for gross margin, operating margin, and now $6 of earnings per share, +$6. So, we're. There's leverage in the model. There's great TAM for us to go get. The C-Series adds a huge amount of TAM that we couldn't go get, and the go-to-market changes will make us more focused. So look, it's not a 20% grower, but we do expect that, hey, we'll be able to grow at or above the market.
Add cloud growth into that. We have an unparalleled cloud product with all three cloud portfolio, and now we feel great about the on-prem portfolio. So we're excited about the future, and we feel good about what we've done so far.
All right. Perfect. Well, Mike, thanks so much for being here today.
Thank you for having us.