Q1 2024 NetApp Inc Earnings Call
Good day and welcome to the net App first quarter of fiscal year 'twenty 'twenty four earnings call.
All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero.
After today's presentation there'll be an opportunity to ask questions. Please note. This event is being recorded.
I would now like to turn the conference over to Kris Newton Vice President Investor Relations. Please go ahead.
Everyone. Thanks for joining us with me today are CEO , George Kurian, 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 to our financial outlook and future prospects, including without limitation, our guidance for the second quarter and fiscal year 2024, our expectations regarding future revenue profitability and shareholder return and other growth initiatives.
I should've and strategies. These statements are subject to various risks and uncertainties, which may cause our actual results to differ materially for more information. Please refer to the documents we file from time to time with the SEC and on our website, including our most recent Form 10-K and Form 10-Q, we disclaim any.
Any obligation to update our forward looking statements and projections.
During the call all financial measures presented will be non-GAAP , unless otherwise indicated reconciliations of GAAP to non-GAAP estimates are available on our website I'll now turn the call over to George.
Thanks, Chris Good afternoon, everyone. Thank you for joining us today.
Q1 marks a solid start to FY 'twenty four in what continues to be a challenging macroeconomic environment.
We delivered revenue above the midpoint of guidance, while our operational discipline yielded operating margin and EPS above our guidance ranges.
That's all I have outlined on previous calls we.
We are focused on managing the elements within our control.
Reinvigorating efforts to drive better performance in our storage business.
And building a more focused approach to our public cloud business.
We are seeing positive early indicators from this plan to sharpen our execution delivered growth increased profitability and further strengthen our position for long term.
Looking at the results of the quarter.
I am, especially pleased with the reception to our recent product introductions.
The F. F. C series has been the fastest ramping all flash product launch in our history.
With strong demand across all products in the family.
Similarly, the F F. A $1 50, our entry level high performance all flash array.
Grew quickly in its first full quarter of shipping.
Our storage lifecycle program is also being good early uptake draw.
Driving longer term commitments to net up.
As we help customers future proof their environments with a world class ownership experience.
Building on this momentum we introduce more storage inhibition in Q1.
We announced the ESA E series a family of.
All flash arrays.
Reported by industry, leading data availability and efficiency guarantee these.
These systems are the only all sand storage arrays with virtual machine and application granular data protection mechanism.
Complementing our unified storage offering.
It belongs to expand on the tens of thousands of customers, who already use <unk> for block storage today and drive share gain in the $18 billion Tam market.
In addition to delivering on our innovation agenda.
We have implemented the go to market changes, we outlined on the Q4 call.
Focusing on our enterprise sellers on the flash opportunity.
And building a dedicated model for cloud.
In May we held our annual sales kickoff meeting the first time, we've gathered the global team in person.
Goodbye.
Everyone was energized by the innovation, we are bringing to market.
And the objective appropriately aligned.
Each team right.
Because many of the products, we've introduced open new Tam for US we are also including training to sharpen our attack on these opportunities.
The changes have been well received are already showing up in pipeline expansion and should help drive topline growth in the second half.
Q1 hybrid cloud segment revenue of $1 $3 billion was down 12% year over year.
Our all flash array business decreased 7% from Q1 a year ago.
Annualized revenue run rate of $2.8 billion.
The demand environment is unchanged from the last Apple FY2023 with headwinds from enterprise continues to weigh on product in assay revenue.
Additionally, as Mike will outline the first half of fiscal year 'twenty three benefited from elevated backlog impacting the year over year comparison.
In the past few quarters every conversation I've had with customers and investors.
You touched on artificial intelligence.
If you haven't read of AI, it's top of mind for everyone.
While still in the early innings of this opportunity.
It's not a new topic for us.
We have been a leader in storage for predictive AI and machine learning workloads. Since we introduced on Kathy I joined net up in Nvidia Rubin architecture in 2018.
Today hundreds of customers rely on netapp storage infrastructure and.
Data management for their AI workloads, including some of the largest pharmaceutical financial services and retail companies in the world.
Effective predictive and generate a b I project.
Depend on high quality, well managed unstructured data.
The data pipeline and workflow typically involved data from multiple file and object sources.
Across cloud and on premises.
I performance highly scalable hybrid cloud storage and data management is a core net up advantage and naturally positions us as a leader in this market and we will continue to benefit us as the journey I market evolves.
While early we are already engaged with customers who are interested in buying Julie large language model with their own data on premises as.
As well as those who are leveraging the hyper scaler Jenny I offerings on the public cloud together with the storage and data management capabilities of Netapp cloud volumes service.
Accelerated by the rise of AI data continues to grow in both volume and value.
A company's data is its most valuable asset.
Robust cyber resilience portfolio helps customers ensure that they have the right enterprise data protection and security on premises.
The cloud.
With built in features that protect and secure data.
And deliver a rapid recovery based on AI and machine learning our systems can proactively spot and counter malicious or anomalous actions.
Our confidence in our industry leading capabilities.
Underscored by the ransomware recovery guarantee be announced thank you Juan.
And demonstrated by the fact that Netapp is the only enterprise storage vendor.
On the NSE classified programs components.
Now turning to public cloud.
I want to acknowledge our cloud results have not been where we want them to be.
And I assure you we are taking definitive action on our approach and get back on track.
At the start of this year, we outlined our cloud sales specialists.
Our Hyperscale partners go to market structures.
Additionally, we are in the process of the strategic review.
And the focus of our cloud portfolio.
And on the success of.
First party services and improved subscription format.
We will have more details to share with you on our next call.
That said public cloud segments revenue in Q1 was the $154 million, an increase of 17% year over year public.
Public cloud D D N R R declined 207%.
Within these numbers.
Ranked in first party and marketplace consumption.
Well, it's masked by weakness in our subscription services.
Let me emphasize that our strategic focus is on first party cloud storage services, and we continue to see customer expansion and deepening partnerships as well as the revenue any of our growth in this part of our portfolio.
Our expectations for FY 'twenty for public cloud revenue.
Reflected in the guidance, Mike will walk you through.
First party storage services branded and sold by our cloud partners.
<unk> uniquely and represents our biggest opportunity.
Our partnerships with the cloud providers are strong and delivering growth.
Our close and long standing relationship with Microsoft Azure continues to deliver solid growth.
Likewise, our partnership with Google remained strong and in the coming weeks you can expect to hear exciting news about the expansion of our partnership.
Our relationship with AWS is also yielding positive results.
As expected we are starting to win large enterprise deployment with FX for net up on cap.
We were chosen to be the cloud storage infrastructure for a global sportswear manufacturer.
E on our deployment.
<unk> was the only storage service that could meet the company's mission critical so.
This level of availability and recovery requirement.
This is a large long term projects that will continue to develop and grow over the coming years.
Driving significant consumption of ethics and capacity.
Once completed it will be one of the largest S E T environment on AWS.
In the face of the challenging macro demand remains muted and sales cycles remain elongated.
Although customers continued to exhibit caution they are moving forward with strategic initiatives prioritizing investments in applications and technologies that drive business productivity and growth.
Our model approach to hybrid multi cloud infrastructure and data management enables organizations to leverage data across their entire estate.
Italy securely and sustainably.
Turning to net out to help them increase the performance and reliability of their digital and cloud transformation projects.
Looking forward our priorities are clear, we will continue to tightly manage the elements within our control.
Reinvigorate efforts to drive better performance in the storage business.
And continue to refine our public cloud business.
Early results indicate we are on track to drive margin expansion and earnings growth year over year, while yielding topline growth in the back half of fiscal year 'twenty four.
Before turning the call over to Mike I want to thank the Netapp team for their continued focus I.
I also want to remind you we will be hosting our insight user conference in person in Las Vegas. This October we hope to see you there.
Thank you George and good afternoon, everyone.
We executed a solid quarter in a challenging macro environment hitting or exceeding all our guidance ranges. We are delivering on our commitment evident in our solid Q1 results before I get into the financial details. Let me walk you through the key themes for the quarter.
Binder all numbers discussed are non-GAAP unless otherwise noted.
Our disciplined operational management and the strong customer acceptance of our innovation continues to pay off.
We expect improved execution and new products will drive growth and operating margin expansion as we move through the second half of the year.
As expected Q1 consolidated gross margin was strong.
Margin came in at 55%.
Given our expectation for competitive dynamics and product mix, we remain confident in our projection that product margin will hold at these levels through the remainder of the fiscal year.
Cash from operations was a first quarter all time high operating cash flow benefited from the reduction of premium as well as the wall were component pricing and incentive compensation payouts.
For the course of fiscal year 'twenty for cash flow should normalize with operating cash flow tracking relatively in line with non-GAAP net income.
We returned approximately 120% of free cash flow to stockholders through cash dividends and share repurchases.
Reducing Q1 fiscal 'twenty for share count by almost 4% year over year.
As we discussed during last quarters call, we intend to return 100% of free cash flow this year.
Nowadays the details of the court.
Q1, billings of $1.3 billion decreased 17% year over year.
Revenue of $1.4 billion decreased 10% year over year.
Challenging macro environment continue to pressure.
Spending however.
However, as George pointed out we are well aligned to our customers' priority investments and remain confident our go to market changes and product innovation will drive growth in the second half of fiscal year 'twenty four.
Hybrid cloud revenue of $1 $3 billion was down 12% year over year.
Product revenue of $590 million was down 25%.
Remember that first half fiscal year 2023 revenue.
Most notably product revenue benefited from elevated levels of backlog, which impacts the year over year comparison.
Support revenue of $611 million grew 2% year over year.
Public cloud AOR grew 6% year over year to $619 million public cloud revenue of $154 million increased 17% from Q1 a year ago.
First party and marketplace services grew as customers continue to choose solutions based on net App technology for mission critical and cloud native workloads.
This growth was offset by underperformance in subscription services as George noted earlier public cloud did not meet our expectations for the quarter and we are taking action to hone our approach.
Reaccelerate growth.
Q1, consolidated gross margin of 71% came in above our guidance up 400 basis points from a year ago and again, reaching an all time company high.
Product gross margin was 55% inline with expectations.
As we discussed on the Q4 call, we made strategic purchase commitments to lock in at a record low NAND pricing and mitigate rising prices in the future.
NAND prices continued to decline in Q1, and we are still positioned favorably versus the market.
The potential for increased price competition is factored into our expectations and we remain confident in our ability to whole product gross margin consistent at this level through the year.
Our recurring support business continues to be highly profitable with gross margin of 92%.
Public cloud gross margin improved to 67% from 66% last quarter.
As expected operating expenses of $703 million were flat year over year and grew 4% from Q4 'twenty three.
The sequential increase was driven by annual merit increases and a reset of incentive compensation as well as expenses related to our in person sales kickoff meeting.
Q1, again highlighted the strength of our business model and disciplined operational execution with operating margin of 22%.
Had all of our expectations.
EPS of $1.15 was also above the high end of our guidance.
Operating cash flow was $453 million in Q1, an increase of 61% year over year, driven by lower supply chain payments and variable compensation, partially offset by lower collection.
In Q1, DSO decreased to 41 and inventory turns improved to 13.
Free cash flow increased 94% year over year to $418 million helped by strong operating cash flow and lower capex.
During the quarter, we return.
$506 million to stockholders through share repurchase and cash dividend.
We ended the quarter with approximately $600 million in net cash.
We have approximately $1 billion remaining on our existing repurchase authorization.
Our balance sheet remains healthy.
Total deferred revenue as of the end of Q1 was $4.2 billion up slightly from a year ago.
We ended the quarter with approximately $3 billion in cash and short term investments.
Now turning to guidance.
We are reiterating our guidance for the full year. Our total revenue guide is unchanged with revenue down low to mid single digits year over year measured on a percentage basis.
Based on our Q1 results and update our projections, we expect public cloud revenue growth to come at lower than initially expected.
Primarily due to softness in our subscription services.
Minor weakness is expected to be at least offset by strength in our hybrid cloud revenue.
We continue to expect fiscal year 'twenty four consolidated gross margin to be roughly 70%.
Operating margin to be approximately 25% and EPS to be in the range of $5 65 to $5 and 85.
We expect Q2 revenue to range between 1.455 billion.
And 1.6 or $5 billion, which at the midpoint.
<unk> is a decline of 8% year over year.
If FX rates stay at the end of July levels, we would see nearly two points of FX tailwind to revenue.
As I called out earlier first half fiscal year 'twenty three revenue benefited from elevated levels of backlog due to last year's supply chain constraints, which impacts the year over year comparison.
We expect Q2 consolidated gross margin to be roughly 70% and operating margin to be approximately 24%.
EPS should be in the range of a dollar and 35 cents to.
Two a dollar and 45 shops.
In closing I want to thank our employees customers and investors for their commitment and investment in net out I.
I am confident in our ability to help our customers successfully achieve their digital and cloud transformation goals.
We are well aligned to priority.
Investments.
And are committed to deliver sustainable long term value for our stockholders.
I'll now turn the call over to Chris to open the Q&A.
Yes.
Thanks, Mike operator, let's begin the Q&A.
We will now begin the question and answer session.
To ask a question you May press Star then one on your telephone keypad if.
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Our first question is from Sidney Ho with Deutsche Bank. Please go ahead.
Oh, great. Thanks.
Thanks for doing the call. So last quarter, you guys talk about spending for large enterprises, we're cautious where obviously you guys are over exposed that doesn't seem like that has changed that much from your conversations with customers do you have a sense when demand starts picking up maybe based on utilization data or whatnot tourists.
US some historical context at what utilization rate level do you start seeing demand pick up and do you think that will be quite good at.
Different this cycle may very well.
You did talk about the trends in small and medium businesses as well thanks.
Yeah.
Overall, thank you for the question overall be spending environment.
Past quarter was unchanged from what we saw in the second half of the prior fiscal year.
Our mid sized enterprise business across the globe and public sector.
Then large enterprise.
Within large enterprise as we noted.
Same verticals remain cautious spending service provider high tech and to a lesser extent in financial services.
With regard to their spending criteria and they are spending large strategic projects.
A runny infrastructure broadly speaking hotter.
Meaning at higher levels of utilization than they typically do and what we typically.
Tell them is best practice that is.
Amen in such macro environment, but it's not a long term trend I think we expect them as we progress through the fiscal year for them to start to expand investment because they cannot run systems that hot.
As we noted in our prepared remarks and in prior calls we do not expect the macro could change substantially.
To support our guidance for the year our guidance for the year reflects our confidence both in the changes that we made in go to market as well as in our product portfolio that we've recently introduced.
Yeah.
Okay. Thank you.
Yeah.
The next question is from Mehdi Hosseini with S. I G. Please go ahead.
Yes. Thanks for taking my question I have two quick follow ups.
George I wanted to go back to the Big picture and revisit the topic of repatriation, how do you see generally the AI.
Strengthening this argument that there will be repatriation enterprises.
Ownership of the data that could actually have.
And a faster adoption is there any update is there any feedback from the.
Conversation from your enterprise customers that you can share.
Quick follow up can you provide the mix of the QL see NAND that you're procuring and how do you see that changing towards end of the calendar year.
With regard to Gen AI projects, which we are already engaged in a number of customers.
We see a mix of use cases, I would say there are three common patterns what is unstructured data.
Second is the need for consistent data management, both security and privacy are.
Our hot topics as well as the lineage of data so that they can keep track of which version of Gen. AI model is the best and most accurate and then the third is from a deployment architecture. We are seeing them engage in both the on Prem discussions as well as public cloud.
<unk>.
<unk> cloud the advantages are.
Much faster feature velocity as well as pre packaged models available on the public cloud with the on Prem environment. The major sensitivity is the data.
<unk> kept in a restricted location. So we intend to benefit from both I don't think that.
It is a meaningful.
Meaningful driver off repatriation at this point in the discussion maybe we're seeing a mix of public cloud and on premise environments.
And then hey, Andy its Mike <unk>.
We're not going to breakout specific numbers, but we would say we are procuring more of that we're starting to see the pick up we'll see how the rest of the year goes.
But we do expect that to continue as a percentage as we go through fiscal 'twenty four.
Great. Thank you.
The next question is from <unk> Chatterji with J P. Morgan. Please go ahead.
Hey, Thanks for the question. This is Joe Cardoso on for Sonic.
Just one question for me you know you were.
And is Congress margin performance in the quarter and I was just curious if you could quantify how much of the improvement or is it related to premium.
And if it's strategic purchases et cetera that you've highlighted and how should we should think about that tailwind as we progress through this year, including and excluding the expected price competition that you have embedded into the guide and then just real quickly clarification on that last part like are you guys actually seeing price competition currently.
From your competitors.
Hey, John It's Mike. So on your question, we've talked a lot about premiums and as we talked about last time, where we're at.
Super excited to not have to talk about them anymore. So largely in Q1 all of those premiums have gone away not only from a P&L perspective, but cash when you talked about that number was anywhere typically between call it $30 million to $40 million a quarter, sometimes it bumped up to 15, so call. It an average of about 40.
That a good bit of that we did not have to accrue in Q4, and then the rest of all the Q1. So you saw 55 last quarter 55 this quarter.
And now premiums are fully out of the number so as you look forward. It's one of the reasons why we feel confident in the 55% guide.
Hey, there has always been price competition.
See it in certain geographies or certain customers, we haven't seen any material change to that in our guide. We do expect that we will be we will need to be call. It marginally more.
Aggressive in certain situations, but certainly nothing significantly different than we are today.
Yeah.
Thanks for the color.
Yep.
The next question is from Aaron Rakers with Wells Fargo. Please go ahead.
Yes. Thank you you guys. This is Michael.
Sure.
I wanted to ask you you know your air or in the quarter our growth in the quarter slowed quite a bit and I know you guys had pushed out your $2 billion sort of target.
And I just wanted to take a step back and think about like your first billion you know what.
How would you describe the trajectory to getting there and maybe timing. If you can kind of just help us think about where we go from here. Thank you.
Yes, I think first of all we have to model in which we serve customers.
Assumption model, which is essentially a pay as you go utility.
Auto and then the subscription model, which is where the customer base for a certain amount of capacity or managed units or capability and then renews that on an annual basis, alright term basis.
Assumption part of our business has grown to about three quarters of our total business roughly speaking.
Our cloud business is subscription is that quarter.
And if you look at the last quarter's performance.
Cloud storage and consumption businesses continued to perform well.
We grew year on year.
Dollar based net retention rate.
At the industry average industry norms subscription is where we saw a challenge both a small part of cloud storage subscription as well as cloud ops and we are conducting a review and we'll get you an update at the next quarterly call about our plans for that part of our business.
Yes.
Okay. Thank you that's helpful and if I can just add one more I just want to understand your all flash business was down about 7% and I can appreciate the macro backdrop, there, but I'm wondering if you can just help me understand the share.
Trends in maybe your best estimate where that where that's been this quarter Alex.
How it's changing and kind of what your expectations are moving through the year. Thank you.
I think first of all the year on year compare.
For our flash product business is impacted by last year benefiting from elevated levels of backlog that we shipped in the comparable quarter last year. If you look if you remove that.
Backlog flash actually grew year on year this quarter and we saw strong growth from our capacity flash products. We expect the overall flash portfolio to grow as a percentage of our business through the course of the year.
The first quarter, you know customers are still qualify.
Capacity flash products the C series.
And so we weren't able to move all of our intended.
Customer environments over to all flash yet, but they are headed that way and so we feel really good about both the go to market changes.
Starting to reflect this pipeline expansion as well as in the flash product portfolio that we have.
And you should see that reflected the growth in the second half of the year with regard to share gains.
Our expectation based on what the others have guided is that we have picked up the second position in share in the market behind now.
Yeah.
Okay.
Yeah.
The next question is from Simon Leopold with Raymond James. Please go ahead.
Hi, This is Victor Chu in for Simon vehicles.
As noted that the product gross margin is expected to hold for the remainder of the year, but I think the latest industry forecast some commentary from NAND manufacturers implies that.
The market experienced a sharp overcorrection next year.
Can you help us understand how this impacts your expectations for the next fiscal year and whether you secured any pricing agreements for flash media beyond this fiscal year.
Yeah, Hey, Victor it's Mike So we haven't guided for fiscal 'twenty, five, but let US walk you to that as we talked about between pre buys and price locks. We have secured a large portion of our NAND purchases for fiscal 'twenty four not all of it you never want to hedge the whole bucket.
I feel really good about batch. In addition, some of those agreements do flow into fiscal 'twenty five it's not a majority at this point, so where we stand today is we feel really good about where we are in 'twenty four.
We have some of that rolling into 'twenty, five and we're certainly in booking for about what should we do we will do a lot more work on that call. It in the next 90 days and update you on the next call.
As you know.
So very changing market, we want to make sure it would be prudent and think through that but it is something that we are looking hard at.
Okay. That's helpful.
Just on the other side of that the legacy part of the business. The last several quarters have seen a pretty sharp declines in shipments of legacy spinning drives I know historically theres not very much correlation between storage media trends and storage systems, but more recently one of your competitors have asserted that there.
There won't be any new spinning disk drives manufactured in five years.
Do you have any.
View on this commentary do you agree with this perspective and you know how do you see this impacting that I thought I guess over the long run.
Listen I think we have the best in the media and the best Flash technologies in the market.
I think that's reflected by the richness of our feature set the flexibility of our operating system and increasingly better data security functionality that natively integrated into our offerings.
Thank you.
The outlines of what our competitors have talked about as a long time and so we give our customers choice and we will continue to invest in a broad range of technologies that meet the right price performance points. When you cannot support this type of technology like our competitors cannot then you have to throw grenades.
Say that technology doesn't say it doesn't exist because you frankly can't support it.
So do you think that that's an extreme view that the legacy is that spinning drives will be gone in five years.
The extreme in your opinion.
Five years is a long time in technology as we've all learned.
Yeah.
Okay. Okay.
Thank you.
The next question is from Assia merchant with Citigroup. Please go ahead.
Great. Thank you for taking my question.
Past I think you've got 8% linearity on first half versus second half.
I wanted to clarify if that still holds.
And they ran into it this year and just ask on the public cloud side of things I know are guiding to a little bit nowhere relative.
Prior expectations due to the subscription weakness.
How should we think about just the linearity I mean are you expecting these run rates to kind of continue or do you have any more in.
Sites into how we should think about the growth rates for the rest of the year and I'm just kind of looking at some things are we still expecting some year on year basis as the comps get easier in the back half of fiscal 'twenty four.
Two.
Cloud driving you to accelerate from this point thank you.
Yeah. Thank you for the question. So on the first question on linearity based on the midpoint of guidance, we're still assuming about 48% revenue in the first half and 52 in the second pretty close to rounding which is very consistent with what we did last quarter. So no big change there and now it's better.
Very consistent with the linearity that we've shown historically also our Q2 guide is up about 7% quarter on quarter, which is well within our historical linearity as well on the cloud revenue number. So we're not going to update the guidance. We had originally thought and four counts at somewhere around call. It mid <unk>.
<unk> growth in that cloud revenue business.
Even as you look at the historical numbers that cloud revenue and we're not forecasting it at well if it stays where it's at today, there would still be growth year over year because of the growth last year. So we have baked all of that into our full year number.
We feel good about where we are on that on that guide we will see how the rest of the year goes.
But at this point, we've reflected that in our full year.
Okay.
Great. Thank you.
Thank you.
The next question is from Krish Shankar with TD Cowen. Please go ahead.
Yeah, Hi, Thanks for taking my question I had two high level questions on AI for George.
Our understanding is that most of the benefit of storage as we put all flash unified violent Arctic solution.
Is that assessment accurate.
<unk> hybrid HDD solutions being used in AI workloads today, and secondly for unified file and object can you speak about your product portfolio, there and your competitive position compared to other solutions like flashlight from just storage and power came from Dell and also it's a unified file an optic solutions in what is expected to benefit from AI.
It's a market share that's similar to your market share and other storage solutions like blocking five thank you.
So I think that the first.
Comment that I would make is AI primarily operates today on structured data.
There is predictive AI using unstructured data to analyze images or audio files or generated by that Adam.
And various types of document formats unstructured data is the priority.
Second I think with regard to unified file and object listen we created unified storage and we have a really strong track record and unified across file block object and cloud and I think that is the new definition of unified rather than little systems. They tried to say they've got one protocol.
All of the other I think the third is you know when you talk about.
It's a broad topic and therefore, what customers typically are the <unk>.
<unk> soft data that the used trade different models.
Time that they are running the training.
Workload typically storage high performance landscape like other all flash system, but they keep those models available. So that they can go back and look at when they made changes to models and data sets and what the implications are for accuracy and so the our.
Hi, the lifecycle of that data is usually yard in this or on cloud and then I think the last point I would make is listen we are seeing clients use hybrid workflows. You know public cloud is a strong place where a lot of the developers and data science teams are beginning there.
Workflows, either vertex and Google our seat maker in Amazon.
Our solutions on public cloud gives us a strong position to start with the.
Data science team at the start of these projects.
Thank you Doug.
The next question is from David vote with UBS. Please go ahead.
Great. Thanks, Hey, George Hey, Mike I had some phone difficulty so I apologize if you addressed this.
On sort of the AI sort of strategy going forward versus like mass capacity storage. What are you hearing from your customers from the enterprise side in terms of what the priority looks like from an investment perspective I know.
Your mass capacity product seen some really strong traction out of the gate.
Over the longer term, how do you think the mix between high end high performance storage and mass capacity trends and then maybe just on public cloud real quickly I know this has been sort of fits and starts business for you.
When you think about how much of a maybe.
Impact that has on your management bandwidth how.
How are you thinking about that business longer term now I know you were talking about giving out.
Updated outlook, maybe next quarter.
But do you still think it has the same opportunity to be a key driver for the business or is it maybe a little bit less of.
A longer term opportunity today than you might've thought 90 days ago, or even a year ago at this point. Thanks.
Let me hit on those two points. So I think the first is with regard to AI again as I mentioned, it's a broad lifecycle off.
Tasks there are light portions of the lifecycle that run on extremely high performance systems and then there are portions of the lifecycle, where the data.
More fine tuned capacity oriented systems, because you wanted to keep versions of your models available and so I look at it like any type of workload. There's a portion of time, where the workload has data that's hot and then there is a portion of its lifecycle, where you wanted to keep a copy.
The data with regard to the overall arc flash array outlook listen I think we are one quarter and we are really pleased with the adoption of our capacity flash products.
Overall, what I see is our flash will grow at a higher fee than.
And then our total storage business.
Bigger part of our mix within our flash the capacity flash products will grow more quickly than performance flat products because.
One is attacking the next tranche of upgrades and refreshes, which is the turnkey drive market, while the high performance.
Products have already been in market for a long period of time. So I think that's probably break that out with regard to cloud I think that.
Listen the opportunity is strong we are excited about the growth of our cloud storage services all of the capabilities and the pace of customer adoption of those services.
More exciting news to come with Google around the work, we're doing with them both with regard to the expansion of our offerings as well as new use cases in the Google cloud.
That you will hear more about in the next couple of weeks and I think that our approach right now is to focus on the best parts of our cloud portfolio haven't dedicated go to market model that has been well received by the hyper scaler, we're one quarter in the cloud storage and consumption.
<unk>.
Performed well we have work to do on the subscription side will give you an update next quarter. Our overall view of cloud has not changed.
Great. Thanks, guys.
The next question is from Steven Fox with Fox Advisors. Please go ahead.
Hi, Thanks, Good afternoon, I just wanted to follow up on some of those last comments, George especially on subscription I guess I'm wondering you know there's obviously you know you want to grow faster in public cloud, but in the subscription business being down it seems like it's consistent with the type of macro or in so I guess I'm trying to understand more specifically.
Given all the other stuff that's going on in terms of public cloud in terms of refining the business why.
Subscription businesses, especially disappointing here as opposed to maybe riding it out until you start to see an up cycle. Thanks.
Yeah listen I, you know I think that we are not the only company in the world that had a subscription cloud.
Software business that got impacted when we saw the trends for optimization you generally see the consumption part of the business get optimized quickly because you are in a pay as you go on track I think the subscription part usually gets affected at the time of renewal offers.
Subscription order decisions to expand or not spanned a subscription and that doesn't excuse. The fact that we wanted to do better in the subscription part of our business I think we've got work to do to refine our portfolio sharpen the value proposition optimized pricing in certain cases to meet customers.
Rotation and we'll give you an update on that we're already working on those we will give you an update on that on the next call.
Great. That's helpful. Thank you.
The next question is from <unk> Mohan with Bank of America. Please go ahead.
Oh, yes. Thank you it sounds from your comments like you had at least seven to eight points of backlog related headwind from last year and FAA can you help us think through as the as the magnitude sort of similar in fiscal <unk> and for fiscal second half on the hybrid cloud side is it fair to.
Think that theres going to be a four to five point acceleration in growth in <unk>.
You as you look at the estimates of the Street's modeling, it's kind of that's kind of what is implied and I'm wondering if you could talk about.
What is the upside that you're seeing in hybrid that's offsetting the weakness in public given your relative overall guidance didn't change. Thank you so much.
Hey, it's Mike Thanks for the question so let's go through the numbers.
Yes, youre pretty close on the impact.
It was about.
So last quarter, we talked about if you adjust for the backlog benefit in the first half of fiscal 'twenty three.
And you compare our girls this first half with the second half of last year, when we declined about five or 6%.
The growth to be better than that still slightly negative.
It's about the same in Q1 and Q2, so Q2 has about the same impact.
Based on the midpoint of guidance, we do expect hybrid cloud than to have.
Growth in the second half the low single digit growth based on the guidance that we gave and we're still comfortable with that based on the progress that we saw in Q1, especially related to C series. The focus that we have on the new products as well as the go to market changes, we do expect those to bear more.
Fruit as we go into the second half and that's based on what we've seen not only in pipelines and that also sales activity. So overall, yes that would be accurate and that's what gives us confidence as we go into the second half.
Okay, great. Thank you so much.
The next question is from meta Marshall with Morgan Stanley . Please go ahead.
Great. Thanks.
Maybe it was the first question you noted that the storage and consumption piece of the business. You know you expected that that was growing about market rate. This quarter. I guess just is kind of the assumption there that essentially optimization has stabilized and we are starting to see growth again, I just kind of wanted.
To get a sense of where you guys are in terms of what you. If we're at kind of at the bottom of optimization that the growth again or if we're still kind of in that bottomed out period, and then as a second question. Just if there's any kind of surprises in terms of customer types or workload types that have been.
You know more interested N C series than kind of initially expected. Thanks.
On the first question Mitra I think that what we saw was continued good pace of customer additions, which means that there arent cloud projects and ongoing deployment of workloads on the cloud.
We saw the piece of optimization slowdown as customers have basically done the easy stuff and so now the probably are more cautious about what further to optimize within the latter bucket the customers that have been optimizing.
There are early signs of them starting to do new projects on our technology, but they haven't ramped to those projects yet so the benefit we saw within the quarter was new customers and new workloads as opposed to the ones that optimize.
Are we accelerating spending with regard to the second question capacity Flash.
We were selling.
Our high performance flash into use cases, where capacity flash was a better product.
Those were in two flavors, one would be more of a general purpose private cloud environments, where customers don't care about the performance of a particular application, but generally want good performance and so that was one and then smaller environment.
Where we had the 150 product that was also introduced at a lower price point than any other flash product both of them saw strength and I think we saw strength in the mid market segment broadly speaking across all of our products.
Great. Thank you.
The next question is from Amit <unk> with Evercore. Please go ahead.
Hey, Thanks for taking my questions.
I got cut off in the Middle I apologize. If this was addressed but on the public cloud can you just talk about what are the reasons that led to the Miss over here was it macro was any micro impact as well and then when you talk about the initiatives you're taking is it more around just aligning your specialist to the Hyperscale orders or are you taking any more incremental initiatives I, just love to understand macro versus micro.
Impact and then what are the initiatives, you're specifically taking to address them.
I think broadly speaking.
If you look at our cloud business.
Roughly three quarters this consumption and a quarter is subscription that mix has shifted in favor of consumption a meaningful amount over the last year as customers have preferred more of the marketplace first party offerings over some of our more traditional.
Subscription type bring your own license offerings I think the so the impact that we saw was more pronounced in subscription rather than consumption consumption.
Quite well.
And so I would point out that isn't that.
Order of the business and subscription then second with regard to whether it was macro or micro it was a mix of things, but I think it was in some customers clearly it was related to budget constraints, where upon renewal they say listen I want to use less of the product and only use it for the most mission critical.
Nickel environment some of our monitoring tools in other cases, it was the customer not being ready to deploy the product.
And so we've taken a couple of actions one action is.
As we said conduct a review of our products to make sure we have the right.
Products tailored to the right use cases that pricing is set up right.
The value share between us and the customer has been a price that is already underway. We've implemented some of those changes we will give you a more fulsome update and then with regard to go to market. We've as we noted implemented both a dedicated cloud specialist organization aligned with the iPhone.
Tillers and also implemented customer success, so that customers can get expertise from net out on how to use the products.
We've seen some good evidence of progress, but there's more work to be done.
Got it that's really helpful and Mike if I could just have you clarify all Q1 free cash flow was much better than what I had expected and what you would typically be in Q1, I think as well.
Could you just touch on maybe what drove that if there was a bit of a pull in or something with some of the stuff and any view on fiscal year free cash flow given the strong performance here.
Yeah.
Awesome. Thanks for the question on cash.
Quite a bit better than we thought there were three moving parts I would say you're seeing billings come in lower in the last two quarters. So collections were down year over year, but what really drove the operating and free cash flow was the reduction in our supply chain spending and that's not only <unk>.
<unk>, it's the quantity of components there came.
Came down significantly and then of course pricing came down as well. So that if you think about the rest of the year. We should expect to continue to see some of that benefit not as not as big as in Q1, because that compares to Q1 of last year. When we were still I'll call. It bulking up on inventory because we expect the growth before.
Things slowed down in the middle of the year. There was a one time benefit year over year, which unfortunately is we paid a good bit less of an incentive compensation. So that helped drive it as well and then lower.
Capex helped drive free cash flow as well, we didn't say hey, the $239 million. We spent last year, we expect to be the highest and we expect that to continue to come down as you look at the rest of the year. We do expect on a full year basis tend to track pretty close to a non-GAAP net income which at guidance as such.
We're around $1 2 billion I do want to note, though hey folks in Q2 and this happens every year keep in mind, it's just a quarter, we pay most of our taxes. So we pay almost $88 million and repatriation taxes, and then we make our U S federal tax payment as well so expect Q2 to be down.
Q1, and it's been like that every year and then in the back half following more typical trends. So thanks for the question.
Thank you.
And the final question today comes from Shannon Cross with Credit Suisse. Please go ahead.
Thank you very much I guess my first question George can you talk about untapped AI from a competitive standpoint are you seeing this ed.
An ability basically to volunteer existing customer base, who are using on tap and income you know comfortable with it in that or is this something that you know from a competitive differentiation standpoint can actually drive you know switchers too to net apps our product set and then I have a follow up thank you.
We sell on tap into data science team and AI teams.
Whether they are in our installed base, our net new accounts.
It's a very vertical item selling model. So for example in pharmaceuticals.
We work with teams on.
Rapid drug discovery clinical data analysis, so that they can apply really high performance Gpus from Nvidia with together with large scale data storage.
From net App, we could also do the same thing for example in <unk>.
Manufacturing, we are selling into.
You know advanced digital twin prototypes, where they are optimizing manufacturing yield and sort of accelerating development. So I think those are the key areas that.
We have.
Sort of a net new budget net new customer landscape, our advantages are high performance large scale.
At Best data management, the best in the industry and it's highly integrated into their data science tool kit of our customers and then increasingly we also now have the same versions of tool chain is running on all of the leading public clouds and you'll hear more about that in the next couple of weeks at the Goldman Conference.
Okay. Thank you and then I guess, we have to ask you about you know AI from sort of an opportunity standpoint, but how are you thinking about utilizing generative AI internally within that app to increase productivity save cost and maybe I don't know improve customer experience.
We already use AI tools in three ways one.
Is to accelerate software development.
And to increase the pace at which we can deliver more.
We ship to customers.
To integrate AI into our products and services. So that we can automatically detect for example of ransomware attacks.
Our impending risks from running systems hotter than they should be or various other things and give customers proactive rather than reactive response and then the third is across the range of our businesses everything from marketing collateral documentation.
Multilingual support as well as chat box.
In customer service, we have AI capabilities already being integrated in Jan AI is the next version of that so there are lots of exciting projects underway on that thank you Shannon. Thank you.
Yeah.
Let me close with this.
With a few comments the strong customer reception to the substantial innovation. We have brought to market has got in FY 'twenty four to a solid start despite the choppy macro backdrop.
We are laser focused on FY 'twenty four priorities to be prudent stewards of the business tightly managing the elements within our control.
To reinvigorate efforts to drive better performance in our storage systems business.
To build a more focused approach to our public cloud business.
Early results of this focus indicate we are on track to drive margin expansion and earnings growth, while yielding topline growth in the back half of the year.
I am absolutely delighted by the positive reception to our new products.
The differentiation and continued growth of our first party cloud public cloud storage services, and our exciting innovation roadmap I hope to see you and insight and look forward to updating on our continued progress on next quarter's call. Thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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