NetApp, Inc.

Good day and welcome to the NetApp second quarter fiscal year 2023 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Chris Newton, Vice President of Investor Relations. Please go ahead.

Hi, 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 NetApp.com. During today's call, we will make forward-looking statements and projections with respect to our financial outlook and future prospects, such as our guidance for third quarter and fiscal year 2023, our expectations regarding future revenue, profitability, and shareholder returns, our alignment with industry megatrends and expectations regarding the future growth in number of cloud customers and their usage of cloud services, our ability to deliver innovation and focus on strategic growth opportunities while optimizing our operating costs, and our ability to drive sustained growth in both our hybrid cloud and public cloud segments in a turbulent macroeconomic environment. 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 inflation, rising interest rates, and foreign exchange volatility, the continuing impact and uneven recovery of the COVID-19 pandemic, including the resulting supply chain disruptions, and the IT capital spending environment, including the focus on optimization of cloud spending, as well as our ability to keep pace with the rapid industry, technological, and market trends and changes in the markets in which we operate, execute our evolved cloud strategy, and introduce and gain market acceptance for our products and services, and manage our gross profit margins and generate greater cash flow. Please also refer to the documents we file from time to time with the SEC and available on our website, specifically our most recent Form 10-K and Form 10-Q, including in the management's discussion and analysis of financial condition and results of operations and risk factor sections. 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, and welcome, everyone, to our Q2 FY23 earnings call. Coming off a strong Q1, our team delivered a solid quarter with all-time highs for Q2 billings, revenue, gross profit dollars, operating income, and EPS. We remain focused on disciplined operational management and the execution of our strategy, which is tightly aligned with customer priorities. On today's call, I will walk through four topics. One, We delivered a good quarter in a dynamic environment. However, we are disappointed with the deceleration of growth in our cloud services. Our conviction in the cloud opportunity and our ability to execute against it is unwavering. Two, we are aligned with the durable megatrends of data-driven digital and cloud transformations. We continue to deliver innovation that furthers our already strong position. Three, we believe strongly in the opportunity ahead, but have slightly tempered our revenue outlook for the remainder of the fiscal year due to near-term macro headwinds. Four, we understand the imperative to deliver shareholder value in a slowing environment and will focus on our strategic growth opportunities while continually optimizing our operating costs. Let's start with the first point, our performance in the quarter. Due to public cloud segment revenue increased 63% year over year to $142 million, and dollar-based net revenue retention rate remained healthy at 140%. However, public cloud ARR of $603 million fell short of our expectations. As our cloud partners discussed on their earnings calls, growth has slowed as customers look to optimize cloud spending. This macro-related optimization caused some slowing of growth in our cloud storage services as well. Additionally, we had a few customers with very large project-based workloads, like chip design, that came to their natural conclusion resulting in capacity reductions in those environments. We expect these customers to kick off new projects early next calendar year. As the number of cloud customers and their usage of our cloud services grows, the impact of this type of workload will be smoothed over a much broader customer base. In our cloud operations portfolio, Spot is benefiting from the same desire to optimize cloud spending that was a headwind to our cloud storage services. Spot's value proposition is a strong engine for new logo acquisition, and Q2 saw an acceleration of new Spot customer additions from Q1. As we've discussed on past calls, we continue to refine our approach to cloud insights and are seeing early positive signs with the growth of new Cloud Insight customers in Q2. We continue to see healthy growth of new to NetApp customers and of existing NetApp Enterprise customers adopting our cloud services. And those customers are growing in scale as well. The number of customers with greater than $1 million in ARR has more than doubled from Q1 last year. Our public cloud services are highly differentiated and create customer preference for NetApp. We have a multi-year advantage over our traditional competitors in this critical market, positioning us well to deliver sustained growth. Compared to Q2 a year ago, hybrid cloud revenue grew 3%, and our all-flash-array business increased 2%, to an annualized revenue run rate of $3.1 billion. Adjusting for the significant FX headwinds, hybrid cloud grew 8%, and all-flash grew 7% in constant currency. All-flash penetration of our install base grew to 33% of installed systems. Our lower-cost, capacity-oriented all-flash arrays and PaaS hybrid flash arrays both performed well. On to the second point, our alignment to the industry megatrends and our continued innovation. The world's moving faster than ever, raising data-driven digital and cloud transformations to business necessities. NetApp helps meet these objectives with a modern approach to hybrid multi-cloud infrastructure and data management that we term the evolved cloud. We provide customers the ability to leverage data across their entire estate with simplicity, security, and sustainability, which increases our relevance and value to our customers. We believe strongly in the sizable, durable, and growing opportunity created by these megatrends. As many of you know, we bring significant value to customers running VMware environments on-premises. With a series of announcements made in conjunction with VMware, we are now able to bring that same value to customers in the cloud. Our native cloud storage services integrated with VMware helps customers quickly, easily, and cost-effectively migrate enterprise workloads to the cloud and accelerate modern application development using Kubernetes. We are the only certified and supported third-party cloud storage solution for VMware Cloud, which creates significant new opportunity for us. As those VMware environments move to the cloud, we can capture the data that resides on competitors' on-premises systems. At the start of November, we introduced BlueXP, the next big step in fulfilling our vision to give customers the simplicity, security, savings, and sustainability needed for an evolved cloud. It delivers true hybrid multi-cloud operations by bringing storage and data services together in a single unified control plane. BlueXP is a highly differentiated solution that enables customers to deploy, discover, manage, and optimize not only infrastructure and data, but supporting business processes across multiple clouds and on-premises environments. In addition to bringing forward technical capabilities, we are helping customers achieve their environmental goals by creating energy-efficient products. We've added power and temperature reporting in Cloud Insights to give customers a real-time view into energy expenditure, and our carbon footprint reports provide a reasonable estimate for the carbon impact of their NetApp systems. We enhanced our storage efficiency with a four to one efficiency guarantee for SAN workloads to help customers minimize their storage footprint and lower energy usage. We not only help customers practice sound environmental stewardship, we practice it ourselves. I'm proud to announce that EcoVadis, the leading evidence-based ESG rating agency, awarded NetApp a gold ranking, placing us within the top 7% of evaluated companies. Now the third point, the macro environment and our business outlook. As we move through the quarter, we saw increased budget scrutiny, requiring higher-level approvals, which resulted in smaller deal sizes, longer selling cycles, and some deals moving out of the quarter. In Q2, we felt this most acutely in the America's high-tech and service provider sectors. We see no change to our underlying opportunity and are confident in our position. However, current economic realities and unprecedented FX headwinds are and will continue to impact IT spending, causing us to temper our revenue expectations for the second half. And finally, point four, driving shareholder value. In response to the slowing top line, we are being agile and taking action to lower operating expenses. Already, we have implemented a broad-based hiring freeze and are reducing discretionary spending, as well as further optimizing our real estate footprint. We will remain disciplined as we continue to shift resources away from lower yield activities to our biggest opportunities. In closing, we are clearly aligned with our customers' strategic priorities and remain confident in our long-term opportunity despite the current external headwinds. By focusing on what we can control, we will aggressively seek to maximize the near-term return on our product and services portfolio, while leveraging our leadership position in all flash, cloud storage, and cloud infrastructure optimization. I would like to thank the entire NetApp team for delivering a strong first half. In a challenging environment, we remain focused on innovation, execution, and operational discipline. I'll now turn the call over to Mike.