NetApp, Inc. ($NTAP)

Hi, everyone. Thank you for joining us here on day 1 of BofA's Global Tech Conference. Delighted you could all join us here today. I'm Wamsi Mohan. I cover the IT hardware and supply chain space here for Bank of America. Thank you all for coming. I'm delighted to welcome Wissam Jabre, who is the CFO of NetApp. And I have to be careful because I've known him in other roles prior to that. So well, welcome Wissam, a pleasure to have you over here and excited to hear for the next 30 minutes that we've got with a short amount of time about your outlook on NetApp story.

Thanks so much, Wamsi, and happy to be here and excited to share more.

Yes. And we have Jeriel from IR as well. Oh yes, sure. We'll make sure that we have -- you want to go ahead and cover the disclosure or I can do it, too, if you'd like me to.

That's fine. I'll go ahead and do it. So hey, today's discussion may include forward-looking statements regarding NetApp's future performance, which are subject to risk and uncertainty. Actual results may differ materially from the statements made today for a variety of reasons described in NetApp's most recent 10-K and 10-Q filed with the SEC and available on our website at netapp.com. NetApp disclaims any obligation to update information in any forward-looking statement for any reason.

Excellent. Okay. With that out of the way, maybe I just want to point out Jeriel from IR is here, too, if you have any follow-up questions afterwards.

So what an exciting time to be in hardware, right? And I know you spent a lot of time on software resources within NetApp, and that's a differentiating viewpoint. But for infrastructure, maybe is the right word to use as opposed to hardware, but it is an exciting time to be in infrastructure. So maybe you can talk to our audience here a little bit about how is NetApp participating in this growth in infrastructure that is driven by AI?

So look, we've been sort of looking at and tracking our AI wins for quite some time. And as we disclosed most recently for Q4, we had around 500 of them. And what matters here is really the trend that this has followed. It's more than doubled year-on-year and continues to grow on a sequential basis. So it is a sign that there's more and more activity that is increasing in the enterprise AI space. And for us, this is very exciting because, obviously, it does, in some ways, lead to some of the improvement in IT or enterprise IT spending. As we look at the infrastructure or the offerings that we have, we do have basically high-performance all-flash solutions that -- where we could participate on the AI side. And we also have our new offering, AFX, which is our disaggregated architecture in combination with AIDE that could also be a good offering for the AI space.

So maybe to step back for a second, right, like you're involved in the domain of data storage, data protection, making sure that the infrastructure runs seamlessly based off all this data growth that's happening around -- we were talking earlier with some companies where we're talking about data growth that's maybe 25% to 30% off of very large numbers. So now we're talking about like some big deployments. So as you think about the market and your opportunity for growth, what should investors sort of think about in terms of the incremental maybe growth from baseline, growth that's provided by AI? And then where are we within sort of a more general replacement cycle for storage assets? It feels like a lot of the hardware assets are -- have been sweated for some time, and now it feels like they are ripe for a refresh. So I would love to get your thoughts on that.

I mean, look, we've been on that journey of moving towards the all-flash upgrades, if you like, from the 10K hard disk drive for quite some time. And we've seen our installed base basically as of almost churning approximately around 1% a quarter. We're now at around 48%. And so that sort of gave us a nice growth vector over the last few years. Now when you look at where AI comes in is I think we should expect to see that all-flash transition continue, even though now with the current prices on all-flash and the dynamics that could have a little bit of an impact given the increase in prices. But we have a very broad portfolio that -- where we could offer our customers many alternatives as well. But in addition to sort of that transition, we think that all-flash -- sorry, AI or adoption of AI in the enterprise, especially in the inferencing space and the data preparation, data lake modernization space could provide some nice tailwind in addition to what the industry has been experiencing so far.

Okay. So as we think about this memory pricing, right, and this has been sort of front and central for a lot of customers and organizations to deal with, how are you tackling the memory pricing issue?

I mean, for us, it's an input cost. And what we've done is we've basically had adjusted our prices. We increased our prices in the past quarter to pass the commodity costs as is customary in our space to our customers. And so we look at it from a portfolio perspective, and we adjust our prices depending on the various impact from an input cost.

Okay. And what has been the receptivity to that sort of price increases from your customer base? Are you seeing any change in the customer behavior in terms of maybe trying to accelerate some purchases, maybe pulling forward anything? Like what are you seeing in the behavior of your customer base as you're pushing together some fairly significant price increases, multiple price increases through the course of the quarter?

Yes. I mean in the past quarter, I would say we haven't necessarily seen much demand elasticity. And when you look at the way customers budget, they do budget in terms of dollars. So -- and they do spend their budgets based on dollars. Having said that, any time you have price movements or larger price movements, you'd expect some different behaviors in terms of some accelerated purchasing, for instance, and so on. But for us, in Q4, we really saw a minimal impact to our P&L from any of that accelerated demand. And then when you think of it, not all customers have the financial flexibility to do that.

Yes. Yes. No, that's fair. In your last earnings, you noted like that some large deals came through. I think you press released a relationship with Google that basically was multiyear. So how should we think about that relationship? And what is the way in which it flows into your P&L over a longer period of time?

Yes. So we did note the agreement with Google, which is on the Google Distributed Cloud side that gave us a bit of benefit in product revenue and product gross margin in the fourth quarter. That was really an expansion of an agreement in place that has been with Google since October 2024. And so the way to think of it is it does basically serve the Google Distributed Clouds in the sovereign and secure type of environments. And in Q4, we had some revenue associated with it. And as we think through -- it's a 4.5-year agreement. And so over the next 4.5 years, we will be recognizing some support revenue as we typically do in those types of engagements. And also, we would be recognizing product revenue when we ship the product associated with it. And so that's -- it is included in our Hybrid Cloud segment.

Yes. I can't hurt to see Google raising $80 billion overnight to put in AI infrastructure. So that's kind of nice. Maybe, Wissam, just to like now talk about product gross margins, right? So I think you guys spoke about this on the call that Q1, you see the lowest product gross margins that you expect for your next fiscal year and then it should improve from there. So can you talk about why that will be the case? And what are some of the things that give you the confidence that, that trajectory is the right trajectory?

Yes. Look, at this time, this is what we see. We see Q1 being the trough, and we expect gradual improvements for the rest of the year. And it's sort of -- again, I'm not expecting necessarily a step function improvements. I think gradual improvement. That's because as we progress through the quarter and as we get into the next quarter and beyond, we start seeing more and more of the effect of the price increases that we implemented in the past quarter take effect and flow through our P&L. It does take a bit of time lag typically. We -- historically, it's taken sometimes up to 3 quarters, but we've tightened a little bit our contracts to start seeing the effect a little bit earlier.

Okay. There's been some of these memory suppliers or basically every memory suppliers talking about longer-term agreements and the potential to sort of fix some level of both pricing and capacity out in time. Is that something that NetApp would be interested in undertaking? I know like typically, this is more hyperscale domain like to do larger deals that look out like over a longer period of time. Is that something that you would entertain? How are you thinking about supply, your ability to get capacity as you need it?

Yes. I mean we're in continuous discussions with our partners and suppliers to be able to secure the various parts of the components that go into our products. There's no doubt we're in a constrained supply environment. And there are -- and there's -- over the last couple of quarters, there's -- sometimes we experienced shortage in some areas, but also lead times are also extending. But we work very closely with our suppliers. And we're -- we engage with them depending on the different needs that we have, the horizon that we have and our volumes as well as the costs. And so we're open to various arrangements as long as it helps us sort of secure the supply we need for our products. Now when you look at where we are today at this time, we believe we have -- we can secure the adequate supply we need for our -- for the outlook we have for this fiscal year.

So as you think about this fiscal year, right, you have sort of an extra week dynamic in your fiscal 1Q and you have pricing flowing through as well at maybe a higher pace than what you already realized. So as you think about both of those and think about the seasonality of how this year plays out, how should investors calibrate to that?

So when you look at sort of our guide for Q1 and the guide for the fiscal year, yes, as you noted, Q1 has an extra week, which we've quantified to approximately $65 million. But then when you sort of factor that out and you look at the seasonality with respect to first half versus second half, we are anticipating a typical sort of historical pattern with respect to seasonality for first half versus second half. And then when you look at our Q2 to Q4, taking into account the midpoint of the FY '27 guide, you compare Q2 to Q4 FY '27 to the same period in FY '26, that basically implies around mid-single-digit percentage growth. So that captures what we see today with respect to how FY '27 and Q1 will shape up.

Okay. That's helpful. So why should -- so maybe conversely, right, like why should that be the right seasonality, especially as you're driving pricing increases? What's your underlying assumption about pricing as you go through the course of the year? Is there incremental price increases that are baked into that guide? Or is it something that you're only thinking about Q1 where those pricing impacts are taking place? And then as the market evolves, you will decide? How should we think about that?

So within sort of the fourth quarter, we saw some really good broad-based strength in demand. We did obviously talk about our price increases, but we also have seen some nice uptick in enterprise IT spending, part of it driven by added increased activity in the enterprise AI space. And when we look at the fiscal year '27 guide, it comprehend all of these various pieces that I just mentioned. In addition, the way to think of it is if we continue to see commodity costs increase, obviously, we won't hesitate to take pricing actions to mitigate the impact to our P&L and protect our profitability. But so all of this basically is how we think of the fiscal '27.

Okay. And just to be clear, like I mean, as you think about the environment, I mean, would you say that we're still expecting an inflationary environment for the rest of your fiscal year in terms of commodity pricing? And are there things that I know like 6 months ago, you were in a favorable inventory position, for example. Is there any opportunity for that at all? Are you leveraging your balance sheet in any way to take advantage of any maybe circumstances that might show up?

As I mentioned, we work very closely with various parts of our supply chain and our suppliers. And if there's a need for us to do things like that, we won't hesitate. At the end of the day, what we -- in terms of priorities, our first priority is to secure our supply. Of course, we work on balancing supply with cost and other types of activities as we think of our business. But yes, we won't hesitate if we need to.

When you think about -- you mentioned earlier like the breadth of the portfolio. And you have the opportunity to maybe shape demand a little bit with do you -- what are the configurations where you put people with an all-flash versus what you're putting in hybrid versus what you're putting in cloud? What are customers doing with respect to each of these at the moment given that flash pricing has increased so much? Are they making other choices? Are they making adjustments? What are your salespeople telling your customers to do here?

It's -- thanks for talking about our broad portfolio. It is really exciting to see the various options that we can offer our customers in this environment, right? In addition to all-flash, we have hybrid flash, which is based on basically hard disk drive as a media. In addition, we have Keystone Storage as-a-Service and our Public Cloud business that has done really great also over the last few years. And so when you look at Q4, we did see some nice increase in our all-flash business. But we also saw an uptick in the hybrid flash business, which is the -- based on other types of media like the hard disk drive, which is interesting because in the prior several quarters, we have seen sort of more or less a steady decline. And so that could be potentially driven by what the all-flash prices have done. But it's a little bit too early to tell. What's important, though, is our ability to serve our customers wherever they need to be. And so if they want to upgrade their hybrid flash data sort of infrastructure, we're happy to help there. And if they sort of don't want to do a big upfront CapEx investment and prefer to do more of a consumption-based approach, then we can offer Keystone Storage as-a-Service. And in some cases, if they also want to use ONTAP in the multi-cloud, Hybrid Cloud and Public Cloud environment, obviously, we can offer our Public Cloud solutions.

You've seen real strong growth on the Public Cloud side. I know the reported numbers were impacted by the spot divestiture for some period of time. You have lapped that now, like your growth looks very solid. The incremental profitability looks extremely strong. So -- and you've been moving up your profit targets, gross margin targets on the public cloud side. So can you just talk to us a little bit about what is the right growth trajectory to think about in this kind of a constrained environment, should we be expecting some kind of acceleration that can come in Public Cloud? And secondarily, like what is enabling such high gross margins and continued increases in those gross margin rates?

Yes. So the Public Cloud business has done really great. I mean when you look at fiscal '26, it grew 17%, 18% when you account for the Spot divestiture on a year-over-year basis. Within that, the first-party and marketplace, which is really the core growth of that business grew at around 30%. And so it's growing at a really fast pace. It did deliver in the last couple of quarters, slightly more than 85% gross margin. And our target gross margin for that business is 80% to 85%. So it's operating at sort of that high end of the target range and a little bit exceeding it. The outlook going forward is sort of a similar set of growth. I mean the growth is still sort of healthy. We expect it to continue to grow, especially in the first-party and marketplace. And sort of when you look at that it should help provide also a nice tailwind to the corporate gross margin given that, obviously, it is operating at a much higher gross margin than the corporate gross margin. With respect to what's driving some of the dynamics in the margin itself, there's really a couple of things. We had a bit of depreciation roll-off from the initial hardware that was installed over time. But also there's more software content as we continue to improve on the offering and make it more and more competitive. Obviously, some -- basically, there's more software content with that. And that shouldn't -- basically that type of dynamic should continue in the future.

Okay. And just on the Public Cloud side, right, your implementation across the various public clouds is slightly different. And I think you originally started off with NetApp Azure Files, which was like a fairly large part of that Public Cloud business. As you think about the -- maybe how much have we diversified today in terms of the various Public Clouds? And what is sort of like your expectation of which Public Cloud might be able to contribute the most in NetApp's growth if you look over the next, call it, 2 years?

Look, all 3 are doing great. I mean we have partnerships with all the top 3 hyperscalers where they offer our ONTAP software as a native software store software solution. And we see good traction in all 3 of them. And so the size, I would say, also depends on, obviously, where -- when the business started, but we see good growth in all 3 of them. And in terms of profitability, as I mentioned earlier, this business has been operating at really the upper end of the long-term target range for quite some time.

Yes. You guys have had a very consistent history of managing your OpEx really well. And in times where your revenue starts to accelerate, like you really get a lot of leverage in the model. And kind of as you look over the next couple of years based on your top line sort of growth expectations and maybe there's more upside with pricing. How should we think about the margin flow-through? How should we think about OpEx rates in general relative to the revenue growth rates?

Yes. I mean, look, we've made a concerted effort to maintain that operating leverage in our business. And you can see as we project revenue growth, we typically grow our OpEx at less than half of the revenue growth rate. Having said that, obviously, within that, we continue to invest in our sales capacity. We did add sales capacity in fiscal '26. We plan to do more in fiscal '27 as we see good momentum in the business. We continue to invest in our research and development. Obviously, we're investing in AI data solutions. But as we do this, we also deemphasize some areas. And so we look at focusing on the higher return areas and sort of deemphasizing lower return areas or areas we're not necessarily as focused on. And so overall, when you look at the -- how we think and how we execute our investments from an OpEx perspective, it still keeps a certain leverage in the model where basically every dollar of revenue should add a little bit more to the bottom line.

Yes. I mean, obviously, NetApp's had a fairly long history now as a public company. So when you talk about incremental sales resources, like what are the areas that you're targeting for incremental sales opportunities that were maybe not already exploited by the company?

I mean there's -- as you said, we have quite a bit of presence globally in the various markets, but there's always a need for us to rebalance resources sometimes or there's areas, for instance, where we're seeing faster growth where we sort of want to put more. For example, in the AI front, we're putting a little bit more AI specialists that would help push that and become much more sort of focused on growing that side of the business. We continue to invest in areas like Public Cloud, for example, to continue to sort of drive that nice growth that's very highly profitable for the company. And we balance different geographic areas as well depending on the needs. So these are some of the few examples.

Okay. Okay. That's helpful. Maybe just talking a little bit about cash generation, right? Like you guys have done an amazing job with free cash flow and free cash flow margins. As you think about the potential growth here, especially with enterprises potentially having to do a big storage refresh down the road with AI you could have much better economics flowing through to cash. So how are you thinking about potentially deploying that cash? How much focus, if any, is needed on M&A? And how are you thinking about overall shareholder returns?

Yes. We've had really a great free cash flow generation in fiscal '26. So we anticipate similar type of trends into fiscal '27. We -- and as you noted, I mean, if the refresh really happens, that should give us a very nice tailwind from a top line perspective. And so the way we look at our capital allocation is very much consistent with last year where we want to return up to 100% of our free cash flow to our shareholders through dividends plus share buybacks. And from -- we're also a technology company. And so we focus on making sure that we have a competitive portfolio. And if there's a need for us to do any tuck-ins or basically enhance our portfolio and that's a good use of our capital, we also look at these types of opportunities.

Okay. Well, we're coming up on time. We've only got a couple of minutes left. So maybe, Wissam, just to wrap. What do you think investors should be most focused on with respect to NetApp? Why do you think this might be a good time to invest in the company?

I mean, look, the -- we're seeing really broad-based strength in demand. Yes, we obviously recognize and acknowledge the potential risk of some of the accelerated orders. But essentially, we're seeing an underlying broad-based demand in our business driven by increased enterprise IT spending and partly driven by increased activity on the enterprise AI front. And so as we obviously progress throughout the year, we'll be updating more based on what we see.

Excellent. Well, thank you so much for being here. Really appreciate it, Wissam, and thank you all for joining us here today.

Thanks for having me. And excited to be here.

Thank you.

Thank you.