Q2 2021 NetApp Inc Earnings Call
Good day, ladies and gentlemen, and welcome to them that second quarter fiscal year 2021 conference call.
My name is moving and I will be your conference call coordinator for today.
At this time other teachers are and how much multimode late.
Later, we will conduct a question answer session and instructions will be given at that time.
I will now turn the call over Christmas and Vice President of Investor Relations. Please proceed and <unk>.
Thank you for joining us with me today are CEO, George Korean and CFO, Mike Berry. This call is being webcast live and will be available for replay on our website at <unk> Dot com.
During today's call, we will make forward looking statements and projections with respect for our financial outlook and future prospects such as our guidance for the third quarter fiscal year, 2021 or expectations regarding future revenue profitability and shareholder returns.
And our ability to return to growth gain share and scale, our cloud business, 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 of the COVID-19, pandemic and the capital spending environment as well as our ability to gain share and the storage market scale, our cloud business generate cash flow and execute our capital allocation strategy.
Please also refer to the documents we file from time to time with the FCC and available on our website specifically, our most recent forms 10-Q, and 10-K, including and the management's discussion and analysis of financial condition and results of operations and risk factor section and our current reports on form 8-K.
Okay.
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, Chris Good afternoon, everyone I hope you and your loved ones are safe and healthy. Thank you for joining us on our Q2 and like 21 earnings call.
Net up delivered another strong quarter with revenue operating margin and <unk>.
Yes on exceeding our guidance on.
I'm pleased with our continued progress in a non certain market environment.
The improvements we made to sales coverage and fiscal year when she and.
And our tight focus on execution against our biggest opportunities and.
She new to be on.
We saw strength in all geographies with larger customers accelerating their digital transformations with net and.
We will continue to explore and competitive transitions the growth on the on flash market and.
And the accelerating shift to cloud to expand our leadership position.
And what's the busy quarter for us.
We hosted an Investor day comes on.
And your customer conference and Inc.
And you significant new products and services.
Well, the Red Bend, our data fabric strategy.
I want to thank the team for their focus on execution and customer success.
Actually and these challenging times.
And our Investor day, we introduced our vision for a new net out.
<unk> data Center software company.
We're building the new net up on a strong foundation.
The other trusted partner to the worlds leading organizations, we're undertaking digital transformations, we have unique strategic partnerships with the leading flow, including deeply integrated technology and go to market efforts.
And we have a strong business model with a proven track record on turning market transitions to our advantage.
We lead on a plan to scale, our cloud business, while growing and gaining share and the storage market.
These foundational elements for.
And growth in our high margin software cloud services and recurring maintenance revenue stream.
This call and with our disciplined Opex management balance.
And the broached to investing for growth and so Steve capital returns will create significant long term shareholder value.
As you can see from our Q2 results we are successfully executing against that line.
Well, it's supposed to be on our grew to $260 million and increase of 200% year over year.
<unk> dollar based net retention rate remains very healthy and 207%.
We are pleased with the mix of new cloud service to its customers and growth and existing customers.
We saw continued success with Tom wants to net up.
He got program and important component of our strategy to gain new customers and win new workloads and existing customers on.
Our all flash business grew 15% year over year, two and annualized run rate of $2.5 billion.
We believe we gained share again and this important market.
At the end of Q2, 26% for installed system, we're all flash, giving us opportunity for continued growth by converting our installed base. In addition to winning new customers with our industry, leading all flash solutions group.
Growth in all flash drove momentum in software product revenue, which increased 14% year over year.
Recurring maintenance and cloud revenue, which increased 11% from last year.
And I discussed last quarter, we learn and thrive and the new normal of working remotely each other on customers and other partners.
We held our insights customer conference digitally.
And it was arguably on most successful once a day.
We were joined by industry luminaries from our partners and customers all talking about how net and give the world leading organizations the freedom to put data to work and be applications and elevate their business and.
And our commitment to helping customers exploring the opportunity on digital transformation by building data fabrics we.
We had a record number of attendees, including a dramatic increase in the number of prospects and for sometime attendees.
Why do we couldn't meet face to face with thousands of customer and partner engagements.
The interest in and excitement for our data fabric strategy and hybrid multi cloud solutions was non must speak about.
We bring enterprise grade data services to the cloud.
And the simplicity and flexibility on the cloud to the enterprise data Center.
We're helping customers manage their data far more effectively for digital transformation and tackle the challenges the hybrid cloud.
No matter, where internal organization is on its hybrid cloud journey, netapp and how could achieve its goals.
In the quarter, we announced dozens of industry leading innovations.
For other help customers digitally transform to thrive and a hybrid cloud world on.
Software driven portfolio allows companies to redefine our the managed data storage and infrastructure, whether in the cloud or on premises.
We introduced Silverline and storage with solutions for containers on.
Tom and hybrid cloud storage and data management and elastic scale for the modern workplace.
New spots services automated cloud infrastructure for casinos through the continuous analysis on how containerized applications use compute and storage.
Automatically adjust the infrastructure to the optimal blank.
Saving customers costs, and radically simplify and management.
Cloud manager provides a centralized console with food visibility and control to automate management the board Netapp hybrid multi cloud storage and data services, such as backup cheering and compliance and with our virtual desktop management service.
Companies and rapidly deliver comprehensive cloud based workplace solution with continuous optimization of resources.
We also on deals the latest version of our flagship operating system ONTAP nine dotty.
ONTAP is that the harder for approach to hybrid cloud we.
We enhanced the ONTAP data services to provide integrated caching across the widest range of workloads and physical data locations.
Enable flexible cost effective instant genius feel over for business critical applications and support object storage with S. Three protocol access.
Additionally, we introduced new and to win and B M system, San optimize systems and hybrid arrays to give customers a broad range of price and performance options.
Finally, we made updates to net up Keystone flex subscription, providing a fast flexible path to a cloud enabled data center.
With pay as you go subscriptions for cloud like experience on premises.
Keystone enables our customers to consume their data fabric with the cloud like experience and their data center.
As a managed service in addition to the public cloud.
Only netapp is able to offer customers this flexibility.
Together all of these innovations better enable enterprises to accelerate their digital transformation and adapt rapidly to one predictable business demands.
Let me share with you a couple of digital transformation story.
Illustrate how we're helping customers with their data to work to other beat their businesses and.
Leaving us health care provider using AI solutions from Netapp.
To improve patient care and experience are yeah, I control plane, and kubernetes integration and enabled us to displace Dell and.
And the early success of our initial deployment has resulted in expansion to additional workloads.
We are now the foundation for everything from patient checking.
Yeah, I beats radiology and pathology.
Other dominant U.S. based retailer Netapp was selected to support the work on 500 data scientists with plans to expand to a thousand.
These engineers are using data to create yeah, I do and recommendations to increase sales and improve customer satisfaction.
No not supported their need to quickly increase their online services.
During the pandemic as the foundation for a new year I'd service, so customers could virtually try new product.
It's clear that COVID-19 has reshaped the environment.
Digital transformation is now and the subsidy requiring speed and agility to respond to changing business conditions.
Cloud is the de facto waikiki architecture and digitally transform their enterprises for the foreseeable future.
Having and integrated.
Flexible data management Foundation is critical to the success of digital transformation efforts because of this data is growing and scale and importance and we believe that Netapp is the primary beneficiary of this trend.
I'm confident in both our long term opportunity and our ability to execute against it.
Our unique position and helping the world's leading organizations solve the challenge of managing their most critical data for.
Well on the ability to win in the market.
We are committed to driving disciplined growth extending a hybrid cloud leadership.
Actively expanding our business and ensuring that we remain well positioned for the future I.
Our growing margin rich software and recurring maintenance and cloud revenues support our ability to deliver value for customers and shareholders I'll now turn it over to Mike to walk you through the results for the quarter 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.
As George highlighted we delivered revenue operating margin and bps above the high end of guidance import.
Importantly, Steve.
Oh and execution across the company yield that Q2 billings of $1.46 billion up yeah.
Percentage year over year. This is our second straight quarter of year over year billings growth.
In Q2, net revenue of $1.42 billion increased 3% year over year, including a point of currency tailwind.
Our two key strategic focus areas.
Our industry, leading all flash storage business.
And public cloud services, both outperformed our expectations and the corridor.
When combined software revenue recurring maintenance and cloud revenue totaled $1 billion and increased 12% year over year, representing 72% of total revenue.
Ended Q2, with $3.7 billion and deferred revenue and an increase of 5% year over year for.
Third revenue is the leading indicator for future recurring revenue growth.
And as we highlighted at our recent Investor Day, All flash systems carry higher maintenance dollar content relative for the rest of our portfolio.
As George highlighted our all flash revenue of $632 million was up 50% year over year.
Positioning us for share gains for the second consecutive quarter.
On may 26% of our installed systems were all flash at the end of Q2, providing a very healthy runway for our flash business.
Public cloud services delivered an impressive $216 million and they are growing 200% year over year and 21% sequentially.
With organic how our growth accelerating for the second straight quarter.
We continue to see strong demand from our customer cohorts with Q2 dollar based net retention rate coming in at 207%.
We're on track to deliver on our commitment of $250 million to $300 million and cloud EHR are exiting fiscal 21 and remain confident and our ability to eclipse $1 billion in cloud day are in fiscal 25.
Total product revenue of $749 million decreased approximately 3% year over year.
And the quarter, we saw a good engagement from both enterprise and public sector accounts as customers continue to embrace digital transformation and hybrid cloud projects.
Software product revenue of $417 million increased 14% year over year, driven by an increase and mix of our high and all flash systems.
Recurring maintenance and cloud revenue of $599 million was up 11% year over year constituting over 42% of total net revenue.
Gross margin of 66.9% was at the high end of guidance on.
Gross margin was 53% up a 160 basis points sequentially and ahead of our expectations.
The outperformance was driven by better all flash mix.
We expect product margin to remain at this level throughout the remainder of fiscal 21.
Our recurring maintenance cloud and other services business continues to be a very profitable and growing business for us with gross margin of 82.6%.
Q2 operating expenses of $657 million were in line with our expectations.
Operating margin was 20.6% and EPS was one dollar and five cents demonstrating the strong operating leverage in our business model.
Cash flow from operations was $161 million and free cash flow was $121 million, representing 9% of revenue.
As a reminder, Q2 tends to be our seasonal trough for free cash flow.
On the quarter, we paid out $107 million and cash dividends, representing 88% of free cash flow.
As you know we paused on our share repurchase program the last two quarters because of the macro backdrop for more.
More recently, we have been encouraged by the stability in our business broader macro trends and the recent positive results of several COVID-19 vaccine trials.
And as a result, we plan to re initiate our share repurchase program during Q3, making progress towards our commitment to offset dilution from our equity plans.
We ended Q2 with $3.6 billion and cash and short term investments.
No on the guidance.
We expect Q3 net revenues to range between $1.34 billion and $1.49 billion, which at the midpoint implies a 1% increase in revenues year over year and includes a point of currency tailwind.
We expect consolidated gross margin to be approximately 67% and operating margin to be approximately 20% in Q3 I.
Assumed and this guidance on operating expenses of 660 $670 million. The sequential increase on Opex is being driven mainly by the annual reset and U.S. payroll taxes and health care benefits.
We anticipate our non-GAAP tax rate to be between 16 and 17%.
And we expect earnings per share for Q3 to range between 94 cents and one dollar and two cents per share.
Assumed and this guidance as interest expense of $15 million to $20 million.
In closing I want to thank the entire netapp team for the hard work and commitment and delivering another great quarter.
We remain well positioned to take advantage of the market transitions, George highlighted and capitalize on the big opportunity ahead.
I'll now hand, the call back to Chris to open the call for Q on day Kris.
Thanks, Mike well now open the call for Q and day, please be respectful of your peers and limit yourself to just one question. So we can get true as many people as possible operator.
Ladies and gentlemen, if youd like to ask a question at this time. Please press. The Star then the number one key on your Touchtone telephone to withdraw your question press the pound key.
Our first question comes from Tim Long with Barclays. Your line is now open.
Thank you and I just wanted a little bit more credit color on the cloud services.
Business could you just give us a little insight into.
How to have new customers contributed to that line and and also maybe.
How much are we seeing that are that are kind of cloud only deployments not not also carrying us from enterprise business with you and.
And just another part of that is there is there anything we should look to over the next.
Few quarters for that line is as far as new products or new new outlets to help.
Accelerate that that growth line, even further thank you.
[noise] <unk> continued to be very pleased.
Hi, many dimensions of our cloud business growth.
I think we've got expansion and green giant expansion and certifications for example, and Graham certification that allow us to some new industries, new customer segments and of course, the breadth of cloud service offerings with both Microsoft and Google We now so eight.
Huge range of applications everything from databases, and virtualized environments to windows that environments, and so on and so there's a very large opportunity in front of us and don't go far capture we are capturing a broad range of customers digital natives who are.
Born in the cloud companies that don't really.
Our data center, because all of the writing environments run on the cloud.
We are capturing a substantial number of net new customers, who are God, our data center business, but not with Netapp with our competitors and of course, you know on Netapp customers, who are expanding their IP footprints as they deploy a cloud based environments for that so we're pleased to cross on.
On the dimensions of our cloud business in terms of the innovation portfolio, we are innovating and cloud speed and you'll see continued updates from all of our team over the next few quarters.
Right. Thanks, Tim next question.
Our next question comes from Rod Hall with Goldman Sachs. Your line is now open.
Yes. Thank you for the question on.
I wanted to drill into the product revenue, the particularly the software product revenue, which grew really well on the quarter I know Mike you said in your prepared remarks that that was driven by high and if they so I wanted to come back to comments you made George earlier in the quarter, we talked to you about the competitive environment and.
Just ask whether you think you're taking share there and what's.
What's driving that revenue growth I also would love. It if you guys and comment on whether there is any delays in that line I. Just note that Dell storage revenue was down seven per se here and you guys are down less so curious about your thinking on share and competitive dynamics [noise].
Listen if you look at the results of all of our major competitors pure Dell and HP. There's no question, we have taken share I think our product portfolio and use the best in the market.
In the all flash arrays category, the richness of our software capabilities. The hybrid cloud integration on has driven advantage in that you know in the on Flasharray segment. The all flash array mix was up in the quarter and we didn't do you all flash configuration.
And the high end products, which carry a substantial amount of software and maintenance.
Which leads to the growth and deferred revenue as a part of our business model. So we're really pleased I think with regard to our you know.
Sort of outlook, we continue to be really bullish about on portfolio as I've said, we've got the best products on the market uniquely position to give customers. The hybrid cloud for road map and I feel very very good about our position there with regard to me at least on my comment.
Thanks, George and Rod as Mike. Thanks for the question So as George mentioned as we said in our prepared remarks.
Outperformance and product revenue and product margin and was driven by the high end flash system sales and as we noted up.
We expect product margins to remain right around that 53% for the rest of the year and as we talked about on the last two earnings calls, we're not guiding any E.L.A.'s going forward because they are such a small portion of our business, which is why we're not breaking those out.
Anymore any longer going forward.
Okay, great. Thank you.
Thanks, Rod next question.
Our next question comes from Karl Ackerman with Cowen. Your line is now open.
Carl you may be on mute.
Yes, sorry about that.
Is there a way to think about how much of the sequential or year over year growth you saw and all flash arrays was due to the implementation of your run to net up initiative for us is upgrading or installed base.
I ask because the 15% year for your growth rate is significant relative to peers and the context of your 9% CAGR you spoke about during your analyst day, and so I guess as we think about the sustainability of your growth rate for all flash arrays have you changed the way you incentivize your sales force for these run to net up initiatives on.
For upgrading to our installed base all flash thank you.
I just want to begin thanks for the question and I want to begin by saying that the 9% CAGR for two at the Investor Day was really market growth rates of all flash arrays. We have continued to outperform the market and as you noted correctly weve very.
Confident we are taking share in that market.
The products that we offer have leadership and performance efficiency hybrid cloud connectivity and on a scale on architecture that our competitors cannot match the run to net up campaign, which is a competitive migration program had another very strong quarter.
For in Q2, and as we noted we are focused on attacking the competitive product transitions and some of our competitors and taking share and we feel very very good about the progress to date.
If you look at the installed base you know, we're at 26% penetration of the installed base, which means that we still have a very large amount of room to continue to expand the flash footprint in our installed base. So net net strong corner be feel excellent.
About our product portfolio. We think we can continue to take share as we said at the analyst day, and demonstrating that and our competitors have real challenges and executing get product transitions that we are taking advantage off.
Hi, Thanks next question.
Our next question comes from Mehdi Hosseini with if I take your line is now open.
Yes, thanks for all the detail around all Flasharray M, but.
Actually I have one follow up trying to dig and is there any way you can give us qualitatively or quantitatively Dan mix of software and they say in the October quarter, and how does it compare on a year over year and acute acute basis. So we can better understand the trends there and what enables you to gain market share.
Market share.
[noise] and Matt and Mike. So thanks for the question. If you take a look at our our non-GAAP supplemental disclosures, you'll see that on a quarter over quarter basis and year over year. The software portion of product revenue grew substantially so on a year over year basis. It was up 14%.
Commensurately hardware was down 18% a lot of that was driven by the growth and all Flash. In addition, based on the book on the billings number of 10% and as I say growing faster than that you can see that the other portions of our portfolio.
Shrunk year over year, so Dan Thats going to put a lot more and software and as George mentioned.
And support as well because you also see billings growth of 10% revenue growth of 3% and a lot of that everything that doesn't go to revenue growth for the balance sheet, which is great for our future support.
So hopefully that helps in your question.
Yes, thank god and to the color on why are we taking share and the all flash business. I think there are two things. There. One is we are more focused and executing better at least take note, where we have you know and put emphasis on winning with the strongest box on.
Our portfolio against the biggest opportunities and the Psoc and I think is cold and I think has really accelerated and our customers there and thinking about hybrid cloud deployments and we have clear leadership and you know in helping our customers.
And hybrid cloud architectures and I.
I think both on the two elements. In addition to having a really strong product portfolio that gives us the ability to take share.
Thank you.
And study next question.
Our next question comes from Amit Daryanani with Evercore. Your line is now open.
Thank you for taking my question congrats on a nice quarter.
Yes. My question is on all flash array as well and maybe two parts it but ill all price growth that 15% is fairly impressive so I'd love to understand the sustainability of the double digit growth as we go forward and then assuming this mix keeps shifting towards more and Fay I'm somewhat surprised by the commentary on product gross margins will remain flat for the.
On the up because I would imagine all flash arrays have a better gross margin structure with the worst for the rest of the product sales just touch on the sustainability of this growth, we see and all flash arrays and then why are we seeing a better flow through and product gross margin and mix is getting better. Thanks.
Let's talk about the first part of your question on it. Thank you and then I'll give it to Mike to talk about the product gross margin with regard to the on Flasharray business. We see as we said at Investor day, This being a multiyear transition in the storage market we.
See that because we are still in the early innings of the technology curve in the all flash array market and we think that there are more technologies coming online over the next 18 to 24 months debt will move more and more of the disk based market to the on.
Flash market, we don't think that all of the beef market moves to all flash, but as we said a substantial percentage of the total storage market, meaning, let's say 70 to 80 per cent will be and all flash array and portfolio. We are in the early stages you know we think.
And we as we said in our installed base as an example, we had a 26% after many many years though.
Driving all flash and there's a long way to go just to upgrade our entire installed base to all flash with.
Regarding to the ability to continue to drive share gains. It's about focus it's about innovation and its about meeting customer expectations. We think we're doing a good job and we're going to continue to keep doing that with that let me hand, it to Mike.
For talk about gross margins.
Thanks, George and thanks for the question. So a couple of pieces on this that I would focus on as we talked about earlier today and on the <unk> and the prepared remarks. The majority of the outperformance on gross margin came from the high end of our all flash that was something that we had not expected going into the quarter our guidance for the rest of the.
A year assumes that that normalizes, a little bit still growth and all flash, but as you get into the high and you get even a little bit better margins because of the higher percentage of software. So we're forecasting and now to come back and normalize a little bit still growth and all flash just not so much on the high end index.
[music].
Perfect. Thank you.
Thanks, and then next question.
Our next question comes from Aaron Rakers with Wells Fargo. Your line is now open.
Hi, guys. This is Mike on behalf of there thanks for taking the question.
I just have a quick one last quarter I think you disclose 44 million or they are attributed to your recent acquisitions of cloud jump for spot talent and could you give us an idea of what that was this quarter.
Hey, Michael its by Barry, Yes, So we are not going to disclose D.A.R. from the acquisitions going forward I would tell you that they have continued to grow.
We didn't disclose that the growth rate on the organic a our accelerated as well during the quarter. So still all good on the acquisitions, but going forward, we're not going to break those out separately.
Got it okay. Thank you hi, Andrew Thank you Michael next question.
Our next question comes from on and Loop capital. Your line is now open.
Hi, Good afternoon, guys, congratulations on solid execution and thanks for taking the question.
Yes, just one just might be for for both for you guys could give us a sense of.
How you guys are viewing sort of spending recovery right now I'm really afraid to the industry and.
And that and is there anyway to.
[noise] anecdotally give us a sense and how much of the other strength and performance.
As Ben.
You know from from industry recovery and.
So the reopening the sales force initiatives George some of what you talked about which is just the strength of the portfolio is both look and maybe stand on incremental hybrid.
Just trying to get a sense of all of that and really get a sense of how much more there maybe to go from a structural sense for you guys. Since you have 70 and they see that's going on right now thanks a lot.
You know I think first of all we are in an extraordinary time and you know I want to applaud our customers our team for being able to continue to execute in such a difficult time.
I would tell you that we have had a great first half.
And that is primarily because of our focus on execution right. I think the macro has been choppy I think if you're not going to deteriorate further and stabilized, but if you look and the results of our business against those of our competitors. There's no question, we took share and be out executed them.
In a relatively tough market I think within the customer base I want to highlight three things first enterprise customers are beginning to move their businesses forward because they realize that they have to transform to meet the moment and to thrive and the moment and so the transformational projects, especially in.
The larger customers are moving forward our business mix is key is tilted towards debt and we are benefiting from that the second and I think is that listen we're pleased with the vaccines and the news about the vaccine we think that the economy has mostly stabilized and needle.
Go forward.
And it should get better from here, but.
We're on a mid stuff and nationwide locked down we have locked down and many other parts of the world. We are in for a few months here between November and January and so we're being prudent about our outlook for the next few months. We think we are extremely well positioned for when the market turns it will overtime.
Hi.
Mike you want to add any color on no nothing to add.
Okay, that's great interest.
Yes, you got an on site.
Blogs for that any any update on how the impact the sales force has been able to make so far.
You know, we said that we were adding capacity about 200 heads we had from wanted an update that we had met our expectations on that Irene one quarter and have time in Q4 of fiscal year 20, New fans are on board. They are driving really good results. It takes about.
For corners for a rep to be fully productive so it'd be fair.
This fiscal year is the payout for that investment we're pleased with the progress and we're going to keep our head down and keep executing.
Great. Thanks, Thanks, guys.
Thanks, Amanda next question.
Our next question comes from Matt Sheerin with Stifel. Your line is now open.
Yes, Thank you and your commentary you highlighted the Keystone as a service model can you provide more color on the kind of traction you're seeing there from customers the kind of customer mix on growth projections and given that most of your competitors are offering similar as a service programs. How is the net of that program to for.
And Jason Thank you.
You know I think first of all thanks for the question.
Keystone is an element of how we offer customers.
Ability to have an outcome as a service you know there are financing vehicle that we and other people off for which I'm really procurement vehicles. We've always had them. They are a part of our selling motion and you know what I think they are going to continue to be a part of everyone selling motion go forward.
With regard to what we do with Keystone is offered to customers, who don't want to deploy and manage infrastructure, but just want to have an outcome and the service we have many ways to fulfill that type of demand from customers.
Really our cloud solutions on the first and most effective weighted to meet those expectations. Because you can instantly spin up environment and instantly spend them down and you got them deployed on all of the world's leading public cloud with the best operating system and the world. The second is Keystone.
On service us from net.
And similarly, Keystone like services from our wide range of service provider and managed service partners. So we have a good number of ways to meet the customer demand I'm excited at the pipeline of Keystone and the wins, we're having they are enterprise customers lot of Denmark competitive footprints.
Takeouts and day, our net new environment and so we're not in the business. So going after brownfields, we're looking at net new environments, new cloud and customer deployments. So its early you'll hear more about that from us over the next few quarters. Thanks.
Thank you.
Thank you Matt next question.
Our next question comes from George and Mike with Oppenheimer. Your line is.
Okay.
Thank you for taking my question Hi, George following up on your comments regarding the and the current environment can you maybe give us a sense for the puts and takes if there is continued Serge maybe here and the U.S. and then globally, what you've learned on both last quarter from a.
Well that perspective.
You know I think we.
We do believe that the next few months as I said earlier are going to be a challenging set of months right. I think you see that in the news every day and.
What we are seeing is that companies have begun to move towards the new normal right, Steve optimize the other operating model to deal with a hybrid or even more working model. They realize that they have to get moving on projects that were historically stalled and so on so we do.
I think that they are better equipped to deal with the search.
If there is one.
The human challenge and the cost of doing so is high right and so we're being appropriately carefully and our outlook for the next few months, we think that has to be said for.
For the most part I think we see every sign that things have stabilized they're not back to the new normal they'll be improvements overtime to get there, but I think sort of the further downward trajectory mostly stabilized.
Hi, Thank you George next question.
Our next question comes from Steven Fox with Fox Advisors. Your line is now open.
Thanks, Good afternoon, and George just one more on the market share gains you highlighted how all flash arrays and sort of a stimulus for not just the upside in the quarter, but also driving more software sales can you just sort of talk about why you sort of sort of the higher and revenues and how much you're able to sort of shape that going forward as oppose.
And just benefiting from certain workloads. Thank you.
You know I think first of all flash arrays have a higher mix of software the software in the off Flasharray M is what makes it so much more efficient in terms of.
Workload consolidation infrastructure management automation, and so on and our all flash arrays, certainly carry a very rich software portfolio with regard to the mix it really depends on the customer type and the customer use case, if there are big consolidation.
And environments, they generally tend to do.
A larger system, so that they can deploy fewer systems to consolidate more environments. If it is more on a project based make they typically have a more you know midrange type of model that the deployed so its really dependent on customers I think we.
Feel very good about our competitive position across all the elements you know mid range high and entry and we're going to stay focused on selling the right solution to customers I would also say what's unique about net out is we also have a really good hybrid flash portfolio that allows us to sell down a right product for the <unk>.
Thank you Keith and customers.
Great. That's very helpful. Thank you.
Thank you Steve next question and.
Next question comes from that coupled with credit Suisse. Your line is now open.
Yeah. Thank you looks like you guys had a a good quarter and U.S. public when are you just talk a little bit more about what drove that strength and and how sustainable you think tailwinds are in that segment going forward.
You know I want to thank our U.S. public sector team and our public sector leader. We it was good execution in the public sector business as we've said on prior calls we have continued to broaden the range of for our public sector business both to be more and.
For the program type spending that is distributed over the course, so for year rather than the typical public sector, you know year and in the federal agencies as well as to grow our state local and higher education business, which for US is a smaller percentage of our.
Total business than a typical you know a company our size and I think we've done well across all those dimensions. We've had some really good wins on slide we have a broad book of that not in the public sector and I feel good about where we are.
You have a new administration coming in and you'll have to wait to see what the administration's priorities are but I'm confident that our team will adjust and adapt appropriately and so we'll take it a good quarter at a time and we're pleased with the progress.
Thank you.
Thank you Matt next question.
Our next question comes from New MRR show with <unk>. Your line is now open.
Okay. Thank you on that similar note it looks like Europe was a seasonally strong and.
Maybe even a little bit stronger than U.S. commercial so just any reason why in comparison to last year and no seasonality is changing a lot. These days on comparisons to last year and.
He was commercial with a little bit stronger, but you had a strong Europe this year.
Then if you just look at the first half of this year. The U.S. business has done really well I'm pleased with the progress I think you know and I look at puts and takes between Q1 and Q2 deals move around between the quarters. So I wouldn't draw any unusual conclusion on few like you know.
We did see a much stronger book of business in Q2 across all the geographies. So I feel really good as we talked about and my prepared remarks, the breadth of the business is encouraging and we're going to continue to stay focused and execute.
Good luck on the second half.
Thank you. Thanks for your next question.
Our next question comes from Jim Suva with Citigroup. Your line is now open.
Thank you very much and George Congratulations to you and your team on if my memory is correct I think your sales force you know whats all and placed about a quarter ahead of time, which means by now they're kind of fully on boarded email got their health care benefits done shadowing and are out there and.
And if so it seems like the second half of your fiscal year should even be stronger than this first half plus for kind of getting hopefully true krona virus, which on vaccines and other countries opening up is that a logical way to think and things that the second half this year could even be and stronger or are there. Some things that kind of we should kind of pause or be aware.
For the just seems like everything's really striking and and in sync and and quite well and net apps I just want don't want to get too far ahead of myself, but it seems like second half should even be stronger than first half.
Jim. Thank you for your question and for the comments listen you know Youre correct about the sales force hiring having been completed a quarter ahead of time in Q4 of fiscal year 20, and you know and we said we are you know enabling them and it takes about for quarters two.
Good on Rep fully up to speed you know we had a great first half we delivered on our key strategic initiatives for growing all flash revenue taking share continue to scale, our cloud franchise as I've said before we love our market position, we have competitive transition the pipeline is healthy.
The cloud platform is clearly you know expanding with the big Hyperscalers and you know as I said, we see the macro Steve utilizing the vaccine trial should you know.
Give us all incremental confidence we're trying to balance the sobering reality and what the next few months looks like right or businesses for families.
The locked down not only in the U.S., but in many many parts of the world and so we're trying to balance the reality with the fact that our customer engagement and even in Q3 and compare and when the continued to be very constructive. So we're trying to do and take a prudent view of what the near term looks like given the uncertainty.
But we feel very very good about our position year to date my.
Mike you want to add and so.
I just had a couple of things Jim. Thanks for other question ill as George talked about we do feel good about the business that is one of the reasons why were reinstituting our share buyback as we look forward.
We do expect that still going to be a couple of months of a difficult times. Unfortunately for all of US the other thing to keep in mind too and some of the great questions earlier as when we give revenue guidance keep in mind as well Jim that based on the changing mix and the business that we do expect billings growth and continue to be ahead of revenue growth as we do.
New more ethane cloud so I'll just as you look at the second half keep that in mind as well please.
Thank you so much and congratulations.
Thanks, John next question.
Our next question comes from Nick <unk> with Longbow. Your line is now open.
Yeah. Thanks, Congrats on great quarter guys George.
George and Mike I think you guys are seeing nice progress on on the cloud data services business is accelerating and you're probably tracking towards the high end of your fiscal 20 on guidance you talked about some other factors, but I guess can you give us some update or what are you. The white listing that it's that that was a corridor.
Oh hunger and said a lot raised or file is still in place and maybe can you give us some color on what percentage of the net new net up Cts customers ahead, when existing on premise environment versus what percentage of those are born in the cloud.
[noise] you know with regard to the progress of the cloud data services business.
Yeah, we feel really good I think the last couple of quarters have really demonstrated the progress in our business both in our organic business, which continues to accelerate and the inorganic portfolio, especially spot.
Well, we have a strong value proposition for customers, helping them optimize both compute and storage and the cloud for both traditional workloads as well as cloud native workloads containerized workloads, Silverlink computing and so on and so really good rock position and the market.
With regard to our business mix you know as I said, we are getting a broad range of customers. Both cloud native customers, who are born in the cloud companies as well as enterprises that did not buy from Netapp that have data center footprint.
With our competitors you know I think all of these are vehicles for us to go displaced overtime or expand our share of wallet app customers overtime, Mike you want and any comments.
No.
Nothing to add.
Thanks, you know maybe I can just hit on your comment about white listing this and white listing is a capability that's put in place it requires for customers to essentially register before they deploy a workload on our service and.
And given the kinds of workloads that we deployed on the public cloud platforms High performance computing mission critical and run the business workloads like Sep and mission critical data base environments like Oracle rack, we are going to continue to monitor.
We're making progress towards the removal of white listing, but we're going to keep it in place for as long as we need to make sure that our customers have left flawless customer experience.
Thanks.
Thank you Nick next question.
Our next question comes from Eric Martinuzzi with Lake Street. Your line is now open.
I wanted to better understand the sequential revenue and the hardware maintenance and pro services. So historically I would expect that to Kevin and chip Q1 to Q2, New I know, it's composed of about 80 per cent hardware maintenance and about 20% Pro services. What can you tell me about the Q on Q2 and then.
Our expectation for Q3.
Yeah, Hey, Hey on.
Eric and I keep in mind that Q1 had the extra weekend. It. So when you look quarter on quarter that was about 40 million of incremental revenue that we recorded simply because of the extra week coming off the balance sheet and was about half and half between software and hardware pretty close so you need to when you look.
Quarter on quarter, Backout that increase or that amount in Q1. When you do that you actually see a nice growth still sequentially and hardware maintenance.
Okay, and the expectation for Q3 that continues.
As long and that depends entirely on the conversation. We just had earlier Eric in terms of the mix. If the mix holds are consistent with what we saw in Q2 than there would be really no reason to believe.
I believe it would be different keep in mind too that.
$3.7 billion, a deferred revenue like most software and technology companies, 80% to 90% of ours, our maintenance revenue comes off the balance sheet. So you don't get a lot of impact and the quarter outside of FX.
Got it thank you.
Thanks, Eric next question.
Our next question comes from Simon Leopold with Raymond James Your line is now open.
Hi, guys. This is Victor Chiu interest line and Leopold and never conversations we've had suggested that.
Dell's mid range power store refreshes.
Refreshes fall and somewhat short of markets expectations is this consistent with what you've observed and is this a significant piece for the share shift that's contributing to the net and types of results.
You know I think a couple of things there first of all we continue to believe that the mid range from modular architecture like net I have is the sweet spot in price performance across the entire landscape. There are customers that will buy a high end architecture like a power Max on.
For our high and systems, but the vast majority of the customer workloads are going to transition to a mid range clustered system and.
And I think and not only we have observed but many of our competitors have also observed the mid range from our debt has not met expectations. He does an incomplete product. It is hard to build a new mid range system and so its going to be some time before they can to make sure that and me.
And then a real system and you bet, we intend to take share from them during that transition we have seen the execution and the impact of that and not run to net up campaign and we're going to pay for it on.
Great.
So that's very helpful. Thank you.
Thank you Victor next question.
Our next question comes from me Hitachi with Northland Capital. Your line is open.
Yeah, Thanks, good quarter by the way.
And one of the Paula.
Question here for you answer to George where do you talk about confidence that a shift to all flash arrays is going to continue due to flash innovations coming down and the next 18 to 24 months could you detail what are those flush innovations and then the other question real quickly and so what are the pieces and on software a tense attached more.
To all flash arrays and hybrid arrays.
You know with regard to the innovations and the all flash array market. There are more cost effective technologies coming in the all flash array segment price like quad level cell technology that continues to erode the value proposition.
And no performance drives you know 10-K drives that transitions underway, we think they will be more and more on that market that will transition to all flash arrays.
The second is with regard to the software contribution what we do with software and the all flash arrays are all flash arrays is to make them much more efficient.
In terms of data and reduction data compression and so on and the second is to allow them to protect their data in more and more ways. Given that you have eight on off day, that's sitting on on all flash system. So the economics, so for all flash on our benefited.
By using software based data management and those you know configurations as a result have a higher percentage of their value and software Daniel disk based system.
Thank you.
Thank you now next question.
Our next question comes from Shannon Cross with Cross Research. Your line is now open.
Thank you very much just question on component cost I'm curious is what you're seen H.P. and it's not necessarily it exact overlap obviously, but mentioned that some other backlogs and sold with higher cost components and they're seeing some price increases is that something you're you're looking at and how do you feel about the opportunity to pass through.
And that's something I can product cost.
Increases that were expecting it's as you go into 2021 and Dan. Thank you.
Hey, Shannon, it's Mike So what we saw and Q2 as we did see higher component cost specifically related to Ssds, we do expect and the second half of our fiscal year to see some of that pricing pressure ease. So we do expect some lower pricing and we do expect that.
Likely will continue into 22 and a lot of that depends on the economy.
As you know a lot of that other assets. These are also consumed by some consumer products mobile phones, we're seeing a lot of that demand I'll.
Drop as we go into the second half of our fiscal year, we expect that to go and and 22, we'll see how the economy rebounds, so but overall, we do expect component costs to be a little bit of a help and the second half and then hopefully going into 22, but we'll have to see how other supply and demand comes out, especially on ssds.
Thank you and.
You Shannon next question.
Our next question comes from Katy Huberty with Morgan Stanley. Your line is now open.
Thank you congrats on the quarter George you gave a few examples of customer adoption of AI use cases, do you have a sense for what.
What percentage for new orders for new deals tied to AI workloads and is this a driver of that strength and high end, all flasharray demand and the corridor.
Thanks.
Thank you Katie we saw we are focused in our game plan on T. I M solutions that are tied to specific industries I think in health care. We are seeing a good adoption on AI, where does trends you know employees, whether they are really on.
Adjusted so whether they are patient administration personnel are being helped by AI techniques and.
And we also are focused and manufacturing and in select parts. So financial services on the use of AI. So were seeing good returns from that I think with regard to why we are succeeding with AI techniques and day I solutions is because video and audio.
Ill analysis image analysis. For example is now a mature and effective and <unk> technique and image and video and audio files. They sit on net on file storage and so were you know and excellent platform for free I for them.
Thank you and.
You Katy next question.
Our next question comes from Paul Cheng with JP Morgan. Your line is now open.
Hi, guys. Thanks for taking my questions. So just a quick one on free cash flow and so are we going to see you know a large harvesting of working cap as you know, we typically see and the.
The second half for the fiscal year I didn't notice you know and less investments and working cap in the first half relative to kind of past year. So maybe not as large of a kind of seasonal swing and the second half just just your thoughts there.
Hey, Paul its Mike Thanks for the cash flow question [laughter] always fighting a cold [laughter] great question, Hey, So keep in mind last year, two big movers on cash flow to note that and you side and the numbers in Q2 of last year that the tax payments were pulled for really into Q2, we paid about 100 million.
And more and taxes last year and Q2, then this year I know that because we will still pay those they'll just fall into the second half. The other part is as it relates to working capital as you saw on the cash flow statement, we did do better in Q2 and collections you saw that and the cash generated.
By deferred revenue and they are so as long as billings continue at the level that were and I would expect to see that and the second half as well, but as you think about second half. Please keep in mind those tax payments that will be the biggest swing factor on working capital.
Thank you.
Thank you Paul next question.
And last question comes from Rupert to.
And with Bank of America. Your line is now open.
Yes. Thank you its a lots here would be if say congrats on the strong quarter guys. George it sounded like you're expecting some demand elasticity given the pricing advantages of QLT. Just curious what gives you the confidence given that the last and then pricing downturn did not really show that elasticities and and that out.
Net revenues actually declined so what will it be that's different than this and the cycle that you see thank you.
We are actually saying that are you know Q well see first of all it's not in the market yet it will be over time right I think that what we are seeing is you will see make the and.
Advantage off and all flash array and relative to eight 10-K performance drive even better. So today there are customers buying all flash arrays. When they are roughly three times the cost on for hard drive.
And with you won't see that number gets a lot closer to one and a half to two times and so the advantage will be even more material I think we got to compete and win share and be on flasharray transition that that drives right plain and simple I don't think that it's going to you know not to require us to execute we.
I think that more workloads will come onto all flash and to the extent that we execute and that all flash transmission and gives us a chance to pick up share.
All right well, thanks on C. I'll now pass it back to George for final comments.
Thanks, Chris Thank you to everyone. In summary, we delivered another strong quarter successfully executing against our plan to scale, our cloud business, while growing in the storage market we.
We are a primary beneficiary of the increasing importance of data and are uniquely positioned to help customers and hybrid cloud environments and with their digital transformations I am confident in our ability to drive long term growth extend on hybrid cloud leadership and deliver value for our customers.
Our credit and share holders. Thank you too on a few I hope you all Steve safe and sold for your loved ones and families have a wonderful holiday season see you soon.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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