NetApp, Inc. (NTAP) Earnings Call Transcript & Summary

Good afternoon, everyone. Asiya Merchant. Day 1 of Citi's conference, just after lunch, midafternoon. Actually, there's been a couple of sessions after lunch. But the afternoon of day 1 Citi conference. Asiya Merchant here. I lead the tech sector on the hardware and tech supply chain. Really happy here to have NetApp's CFO, with Wissam Jabre as well as IR, VP of IR, Kris Newton here. We have a bunch of questions. We're going to be doing this fireside. If you have any questions at the end, we're going to leave a few minutes here for investors to ask questions, please do raise your hand so we can bring the mic to you. All right. Well, thank you for coming. I'm going to first give it over to Kris. She has a few comments

Thanks for having us. 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 our most recent 10-K and 10-Q filed with the SEC and available on our website at netapp.com. We disclaim any obligation to update information in any forward-looking statement for any reason.

All right. Well, Wissam, Kris, you guys just reported earnings. It was not even a week ago. right? And you took your -- you had very strong results for fiscal 1Q coming out and then you did raise your whole fiscal year outlook as well, almost 2x, right? I think one of the questions that investors here were asking and have been asking something I've been asking all my companies, especially on the enterprise OEM side of things, like what gives you confidence that this is not -- this is durable, right? I mean you still have three quarters to go, and it's not just customers, double ordering. You guys have backlog demand outlooks like it's not just customers double ordering and trying to get a secure spot in place given the constraints that are out there.

Thanks, Asiya. First, happy to be here. Thank you for having us. Look, we had a stellar start to the year, as you mentioned, we reported last week. And when it comes to Q1, we saw some really good broad-based strength in demand driven by AI adoption and infrastructure modernization. There's also many ways that we typically monitor our business. We look at pipeline, we look at orders, we look at backlog and we monitor it that way. And so far, we haven't seen anything out of the ordinary. And so we do think that -- we do see an underlying strength in demand that basically also gave us enough confidence to increase the guidance for the fiscal year. As you noted, we basically increased the guidance for fiscal year '27, doubling roughly the growth rate year-on-year relative to where the guidance was 90 days ago, and that also goes to EPS more than doubling that. And so there's other -- the last point I would say in terms of our business, we don't have -- our business goes directly to sort of -- it's linked to end customer demand. And so we don't -- there is no stocking in the channel for this type of dynamics that works in it.

Okay. And then while we're on the topic of demand, maybe just you're pretty well exposed, you have exposure to commercial, of course, enterprise, also government. Maybe if you can talk a little bit about demand? Was it a pretty broad-based -- that was underpinning your revenue outlook, was it pretty broad-based? And then you also have first-party services on cloud as well.

Yes. So we -- in Q1, we experienced broad-based demand. We saw growth across various geographic regions, and we saw growth across the various types of customers and across types -- various types of industries. And when it comes to our public cloud business, which is where really the three top hyperscalers are our customers, and they offer our software as a native storage software solution. We've also experienced some really nice growth. We had -- we reported around 28%. But then when we adjust to -- for the extra week that we had in Q1, it was around 19%. And so the growth was fairly broad-based.

Okay. And then given that supply, you guys have to have supply in order to underpin your demand outlook. I think at the start of the year, a lot of questions were around supply, do the OEMs have the supply in order to underpin the demand outlook here. You guys are doubling your demand outlook. So what's changed on the supply side? Have you signed LTAs that gives you access to supply? Just help us on the supply side.

Yes, we've always worked very closely with our suppliers on not only understanding what the supply situation is, but also sharing with them what our outlook looks like. And so that sort of has been our mode of operation for quite some time. Where we are now, we basically have -- I mean, at this time, we have -- we feel comfortable about the supply we have to be able to deliver the outlook we guided. We have different types of arrangements with different types of suppliers. In some cases, we have LTAs, and others, we basically have agreed upon sort of commitments and so on, but we feel comfortable from a supply perspective at this time to be able to deliver our outlook.

Okay. And outside of supply, Wissam, are there things? I mean you have a range, right, when you provide the outlook as well, both for the quarter and for the year. Like what would it take for -- what are outside of supply, are there other gating factors that we should think or other factors that could cause you to upside on that side? And maybe we can also talk about the risks maybe towards the lower end of your guide then?

Yes. I mean when you look at the guide, we basically take into account all the information we have at the time when we build our outlook on which the guidance is based. And so we're one quarter in the year, and so we'll wait until the end of this quarter, and we'll be able to provide a better update for the rest of the year.

Okay. And what about pricing? Because I know people often do the P x Q. I know Kris during the quarter to talk about this at P x Q, when people look at the bids that you're shipping, but of course, pricing has gone up quite meaningfully for not just for yourself, for your entire OEM space. So how much is pricing factored into that outlook? I mean how -- and if we do continue to see uptick in pricing, is that upside to your guide? Is that how we should think about it?

So it's pretty normal and understandable and inflationary environment for pricing to be a factor. But what's most important is that what's underlying the growth and the outlook is more of a strength in the business driven by what I mentioned earlier with respect to AI adoption in the enterprise as well as well as infrastructure modernization.

Okay. And then your growth rate, though, obviously, you had a pretty meaningful growth in fiscal 1Q. You're guiding for strength in fiscal 2Q. And then there was the extra week in 1Q, I get that. But then your -- the implied guide at least was a little bit of deceleration here as we get into the back half of your fiscal year. What's underpinning that? Is it just you're just being very prudent, given you're just one quarter into the fiscal year? Are there other factors that we should think about, maybe supply, et cetera, that's kind of baked into a deceleration in growth rates in the back half?

Yes. So when you look at the guidance, it is important to note that the guidance for the full year relative to 90 days ago is higher and their guidance for the second half also is higher than what we had 90 days ago. So when we looked at the full year guidance, we basically updated the guidance in total and both the first and the second half year sort of are incrementally better than what we thought they would be 90 days ago. Now when you look at the seasonality of the business and you factor in the extra week in Q1, it looks like roughly the revenue at the midpoint, roughly the revenue is split almost 50-50, 50% first half, 50% second half. Now it's slightly -- in fact, it's slightly less than 50%, if you sort of want to go to the first decimal point, but it is, let's call it 50-50, which is not necessarily far from sort of the split that we've had for multiple years.

Okay. All right. Okay. And then a little bit on margins because, obviously, product gross margins, you talked about component inflation here. They are expected to moderate in 2Q, and I think you said about towards the low 50s, if I'm not mistaken, for the product gross margins. I mean can you talk a little bit about what's -- well, how should investors think about that? I mean components typically are passed through for you guys. At what point do you see component inflation sort of moderating here maybe even reversing?

So look, it's -- we are operating in a tight supply chain environment. So it's too early to sort of make a call on the component pricing. But when it comes to product gross margin, it is the -- what we guided for Q2 and for the rest of the year, so think of Q2 to Q4, is slightly better product gross margin than we had expected 90 days ago. Now when it comes to the full year gross margin, the number is -- the guide is slightly lower, but that's solely driven by the richer product revenue mix. All the margin lines are either similar to what we thought they would be 90 days ago or better.

Right. Okay. But on the product gross margin side, you are seeing more mix towards flash, right? In general, the product is mixing more towards flash. Your flash revenues are very strong year-on-year. Typically, those associated with higher-margin product margins because there's more software component in there. So just walk us through sort of what -- that puts and takes to product gross margins as you continue to maybe see more demand mixing towards flash, which carry typically higher software components.

Yes. I think your comment is accurate for Q1, Asiya. Would it see a higher flash mix in the overall revenue relative to the hybrid flash side. For the forward-looking numbers, we typically don't break it out as such. I mean to the extent it happens, maybe, but it's too early to tell.

I would call out strength in the hybrid flash business. So as we look forward, that could come through, and I wouldn't necessarily assume that the historical kind of relative margin performance of different product classes stand in this current environment.

And then to mitigate the cost headwinds, right? I mean we've talked -- what are additional tools? Some of it just pass-through of pricing. What other tools would you have to mitigate some of the costs?

Yes. So the first one is, as you mentioned, we tend to focus on -- and it's very customary in our space to pass through the component cost inflation, which we've done for now a couple of quarters. We've sort of built also certain agility in the business to enable us to do that in a faster way, meaning sort of the -- whether it's the duration of our quotes, et cetera, to enable us to be -- to react faster in the event we have to -- we are encountering component cost increases, and we have to increase our prices. We also have many other ways to -- where we work with our suppliers. So for most of the commodities we purchase, we have more than one supplier. And so that helps us work on securing the supply but in some cases, also it helps a little bit on the cost side. But in -- from the business itself, when you look at our portfolio, we have a very broad portfolio, so we don't only necessarily carry only all flash. We have old flash. We have hybrid flash. We have Keystone, and we have the public cloud business. And so we're happy to help our customers solve their problem regardless which service we offer. And so for customers that tend to really want to focus on very high performance, for instance, they may want to choose an all-flash array solution where capacity is probably more important or maybe they're much more cost sensitive and capacity is more important than we're happy to offer a hybrid flash, which is hard disk based. For customers who want to sort of -- who have limited budgets and prefer to split their spending over multi-years, we could offer Keystone, which is our Storage-as-a-Service solution. And for customers who are comfortable doing a consumption approach, we're happy to offer our public cloud business. So there are some ways we address it through the supply side, through the cost side. There's other ways we address it also by offering different solutions. And as Kris mentioned, now from a hybrid flash versus all-flash, we don't have much of a differential on the margin side as well.

Okay. All right. That's good to know. And then AI wins. I know NetApp often talks about the AI wins per quarter, and people track, that's a KPI that you shared on the call. Fiscal 1Q number showed a little bit of deceleration, but I think the size of these deals are getting larger. Just help investors understand like are you seeing as these AI wins are coming through and we talk about it, even that's one of the focus at this conference as well about enterprise adoption. Are you seeing much more storage being attached to all these AI wins as you're talking to your customers, what kind of storage? Just help us understand what you're seeing as your customers are talking about these AI wins that you're then communicating to the investor base?

Yes. I mean what we disclosed for Q1 was much higher than what Q1 '26 was in terms of the number of AI wins. That's what we disclosed. What we've noticed in Q1 also is that the average size of the deal is now bigger than before. And so for some of the proof-of-concept type of deals that we had, let's say, a year ago, we're starting to see more of a production type of deals now. And that sort of helps explain that larger average size deal. This just basically demonstrates that our customers, once they put -- once they test the product, they're happy. In terms of the AI workloads, they're happy with it and they come back for larger deployments.

Okay. And then when you think about some of your compute vendors or competitors, for example, in the ecosystem, they're talking about very, very strong, a lot of strength in the traditional servers for CPU-based servers, AI workloads. As you're thinking about storage attach, like you said, it's being reflected in the size of these deals. Like are you seeing that inflection where compute and storage may be more closely aligned versus compute, which is obviously, first, we had a lot of GPU spend. Now we're seeing a lot of CPU spend. Are you starting to see storage being more and more attached to these agentic AI workloads and how meaningful could it be in the next couple of years?

I mean there is, as I mentioned earlier, certain broad-based strength in demand. And so some of it, I would imagine has to do with some of the CPU server deployment because ultimately, after all these servers are deployed, they will need to have some form of storage attached to them. It's a bit too early to tell the magnitude, but it is -- I would imagine that typically, it would be a tailwind to our business.

Okay. I know you said it's difficult to size it right now, but any -- like when you talk about these deals that you're winning and tracking, like is there any way to carve out how big it could be over the next 2 or 3 years, like in terms of percentage of revenues that have come from just these AI wins?

I mean, look, we know that AI is giving us a tailwind on the top line, right? And the one thing to note is there's the AI sort of workloads, but there's also other types of infrastructure modernization that could be related to or associated with AI workloads that are also happening at the same time since AI could generate other types of applications and infrastructure needs. And so I think over time, the line between AI and non-AI could become blurry like if you think of -- you mentioned 2, 3, 4 years down the road, that could become a little bit of a [indiscernible].

Right. On the other hand, if you look at sort of the -- just talk about the broader industry TAM, right? As you think about the AI whether it's data modernization, whether it's this incremental workloads. Is there any way the way you guys think about the TAM? Like how big could enterprise storage become over the next 2 to 3 years as we're starting to see AI workloads now?

I mean it's clear that we're -- at least today, based on what we reported and what we're seeing in the market. It's clear that we're experiencing a certain TAM growth. And so -- it is too early for us to tell where this could be 2 to 3 years from now. But what's clear is that there's certain underlying demand that's driven from the AI adoption and from infrastructure modernization.

Okay. And then just your own competitive dynamics here, like how do you think like you could grow share within this expanding to? And where do you feel most comfortable? Is it on the flash side? Is it on the hybrid side? Is it on cloud storage, Keystone, which is Storage-as-a-Service. Where do you feel like you have the biggest opportunity to gain share in a growing TAM?

When we look at our numbers and how we're looking at sort of the next few quarters, they basically all parts of the business are doing well. In Q1, for instance, the all-flash array business grew by 47%. And in Q1 also, we saw a small uptick in the hybrid flash revenue year-on-year, which is the second quarter in a row, we see that after several quarters of several -- like many quarters of decline. We also saw some nice uptick on the public cloud business, as I mentioned earlier, the business, excluding the extra week, was up 19%, if you sort of dissect that and look at the first party and marketplace within that revenue, it grew at a much faster pace than this. Just for reference, the first party and marketplace portion of the public cloud business last year grew at around 31%. So there's real high growth there. And when you look at the Keystone Storage-as-a-Service, in Q1, we experienced similar types of year-on-year growth as we've seen in Q4, is still growing rapidly and expanding.

You guys made a couple of acquisitions during the quarter, I think, DataPelago and Jetstream. I hope I'm pronouncing that correctly. Just -- I think there are tuck-in acquisitions more than transformational. So just help us understand like what's the reasoning for these acquisitions? How do you think it's going to change what attracted you to these acquisitions to in a quarter, is that -- would it be greater looking forward? Like where are you guys focused on in terms of technology acquisitions?