Netapp Inc (NTAP) — Q4 2019 Earnings Call Transcript

Thank you for joining us on our Q4 and fiscal year 2019 earnings call. With me today are our CEO, George Kurian; and CFO, Ron Pasek. This call is being webcast live and will be available for replay on our website at netapp.com. As a reminder, we adopted the new accounting standard, ASC 606 in Q1. Our historical financial results have been restated to conform to the new revenue recognition rules. Reconciliations of our previously reported GAAP results to the restated 606 GAAP results as well as our 606 GAAP to non-GAAP results are included in our Q4 earnings release for the applicable period, which is posted on our website, along with our financial tables and guidance, a historical supplemental data table and the non-GAAP to GAAP reconciliation. Unless otherwise noted, we will refer to non-GAAP and 606 numbers. 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 the first quarter and full fiscal year 2020. Our expectations regarding future revenue, profitability, cash flow and shareholder returns, and our ability to focus our resources to grow and expand our opportunities, and address the key market transitions, 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 global, political, macroeconomic and market conditions, and our ability to expand our total available market, introduce and deliver new and differentiated products and services without disruption, manage our gross profit margins, capitalize on our market position and cloud strategy, maintain execution and continue our capital allocation strategy. 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 for fiscal year 2018 and our Current Reports on Form 8-K. During the call, all financial measures presented will be non-GAAP, unless otherwise indicated. I'll now turn the call over to George.

Good afternoon, everyone. Thank you for joining us. We made significant progress across key strategic aspects of our business. This was masked by execution issues in the fourth quarter. Along with foreign exchange headwinds, these issues resulted in revenue coming in at the low end of our guidance range. This is not how I'm used to showing up, and we’re taking concrete actions to quickly address the issue. Our opportunity is large and growing, but we need to do more to capture it. I'll start by reviewing the areas in which we had challenges and our remediation plans and then talk about the substantial progress we’ve made in our key growth areas. Our execution challenges manifested in three areas. First, we were inconsistent in our go-to-market execution. We are addressing this by improving our focus and coverage. We have efforts underway to shift investments to market and customer segments with higher return on investment. We enabled our European distributors to lead in smaller countries where they are better positioned for success, so that we could focus our resources against the largest markets. We are also increasing the number of sales resources dedicated to acquiring new enterprise accounts to broaden our customer reach. We are making trade-off decisions within the bounds of our financial models to improve our ability to execute in our targeted growth areas. These investments take time to pay off, but we expect to see their benefits over the course of fiscal 2020. Second, we did not execute well on renewals in Q4. However, the asset count in our installed base is growing, and we are making the necessary organizational and process changes to improve our execution. Finally, our OEM business has been a periodic headwind to our overall business. While OEM is still a relatively small part of our revenue, it was down significantly in Q4. We do not expect it to recover and are resetting our expectations. OEM will be materially lower in fiscal year 2020 and will create a slight headwind to growth in the first three quarters of the year. The data center buying behavior of large customers that we saw in January continued through Q4. Customers are buying, but deals are taking longer and require greater effort to close. We have a good sense of the industry trends and are confident that these events are not the result of competitive dynamics. Our strong gross margins in the quarter are indicative of our differentiation and the value customers find in our solution. We are well positioned in the market and are taking action to capitalize on our opportunity by increasing our focus and investing in targeted sales coverage. Now, let's turn to the areas where we made solid progress. We gained share in the all-flash market, growing that part of our business 25% from fiscal year 2018. We saw strong momentum in our private cloud business, delivering large enterprise wins and a number of competitive displacements. Our public cloud services are poised to deliver significant growth in fiscal year 2020 with Azure NetApp files expected to become generally available in our first fiscal quarter. In Q4, our all-flash array business, inclusive of All-Flash FAS, EF and SolidFire products and services, grew 11% year-over-year to an annualized net revenue run rate of $2.7 billion. I am disappointed by the performance of our all-flash array business in Q4. The issues we experienced in the quarter were felt most acutely here. This is also the place where investments in focus and sales coverage will have the earliest positive benefit, and I remain confident in our position and opportunity for continued success in this market. We have a leading efficiency guarantee, highest performance, and most complete cloud integration in the industry. The runway for this secular transition is still in the early innings, and we expect the shift to flash to accelerate with ongoing NAND price declines. Moving to our private cloud solutions, SolidFire, NetApp HCI, and StorageGRID are the building blocks for private cloud deployments, enabling customers to bring public cloud-like experience and economics into their data centers. The momentum of our private cloud business that began in Q2 continued through the year, delivering triple-digit year-over-year growth in each of Q2, Q3, and Q4. Our private cloud business, inclusive of SolidFire, NetApp HCI, and StorageGRID products and services, achieved an annualized net revenue run rate of over $600 million in the fourth quarter. These solutions are a significant contributor to our fiscal year 2020 growth expectations. Turning to cloud data services. Our NetApp cloud data services enable enterprises to deliver meaningful business outcomes quickly and cost-efficiently, eliminating lengthy IT processes and complexities. Our partnerships and solutions with the hyperscalers are unique. Only NetApp offers a comprehensive set of data services available across multiple clouds. I'm honored that NetApp was named the 2018 Google Cloud Technology Partner of the Year for Infrastructure at Google Cloud Next 2019 for our achievements in the Google Cloud Ecosystem, helping customers build and run applications on the Google Cloud quickly and at scale. Based on the last month of Q4, our cloud data services annualized recurring revenue accelerated to approximately $51 million, up 55% sequentially from Q3. We continued to see a healthy mix of customers new to NetApp in our cloud data services and expect that they will continue to drive new customer acquisition. We remain confident in the fiscal year 2021 exit run rate revenue target we gave at our April 2018 Investor Day. As with private cloud, this business is a significant contributor to our fiscal year 2020 growth goal. Our opportunity is fueled by digital transformation initiatives, which are driving data center modernization projects and cloud-first strategies. Each of our solution groups is highly competitive individually, but the true value of NetApp is in the strength of our integrated portfolio in our data fabric strategy, which radically simplifies the management of a customer’s hybrid multi-cloud environment. Enterprises increasingly view NetApp as a strategic partner who can enable their digital transformations and meet their needs from the edge to the core to the cloud. Our data fabric strategy and expanding portfolio of data services is driving deeper and more strategic engagements with customers and will ultimately lead to growth and share gains in the cloud and on-premises. In closing, I want to emphasize that we’re moving quickly to do the work needed to return to growth. We are examining every aspect of our business execution by driving focus and aligning resources against the biggest strategic markets while staying within the bounds of our financial model. Throughout FY 2020, we will continue to evaluate initiatives that enable us to maximize our market opportunity. I’m confident in our position as we move into fiscal year 2020. We expect to gain momentum as our investments and focus and coverage play out. We will keep you updated on the progress of these initiatives on future calls.

Thanks, George. Good afternoon, everyone and thank you for joining us. As a reminder, I'll be referring to non-GAAP numbers unless otherwise noted. Despite some of the execution issues George highlighted, we again improved gross margins and delivered strong free cash flow with continued momentum in both our cloud data services and private cloud businesses. Before discussing our full-year results and guidance, I'll provide detail on our Q4 performance. In Q4, net revenues of $1.59 billion were within our guidance range and down 3% year-over-year, including over two points of currency headwind. Product revenue of $1 billion decreased approximately 2.5% year-over-year and would have been flat if not for currency headwinds. Moving down the P&L, software maintenance and hardware maintenance revenues of $526 million decreased 3% year-over-year. As George noted, we did not execute well on our maintenance renewals. However, our asset base continues to grow. Deferred revenue, which was up over 9% year-over-year in Q4, continues to be the best measure of the health of our maintenance business and our customer’s long-term commitment to NetApp. As a result, we expect maintenance revenues to grow in fiscal 2020. Gross margin of 65.2% was above the high-end of our guidance range and includes a 0.5 point of currency headwind. Product gross margin was 55.3%, which is an increase of more than 2.5 points year-over-year. The product margin expansion was driven by continued sales force discipline, growth in our software-only products, and approximately $30 million of ELAs. ELAs benefited product margins by less than one point. The expansion in product margin was offset by more than a point in currency headwinds. Q4 2019 was the ninth straight quarter with increased product margins year-over-year, even when adjusting for the benefit of the ELAs. Strong performance in gross margins reinforces our confidence in achieving our long-term targets provided at our Analyst Day. The combination of software and hardware maintenance and other services gross margin of 81.9% increased by 100 basis points year-over-year. Q4 operating expenses of $680 million were flat year-over-year but came in higher than anticipated, largely due to variable compensation associated with product-specific sales incentives. Operating margin was 22.5%, up 50 basis points year-over-year. EPS of $1.22 was at the low end of our guidance range and increased 9% year-over-year. We closed Q4 with $3.9 billion in cash and short-term investments. Our cash conversion cycle was a positive 3 days, up 17 days year-over-year. DSO of 70 days was up 12 days as revenue shipments were usually backend loaded. The underperformance in revenue in the quarter drove DIO to 21 days, up 3-day increase. Given the transitory nature of these impacts, we expect to return to a negative cash conversion cycle in fiscal 2020. Despite the cash conversion cycle headwinds, cash flow from operations was $399 million, free cash flow was $364 million, representing 23% of revenues. Our confidence in our ability to execute and long-term vision continues to be reflected in our capital allocation strategy. During Q4, we repurchased 7.3 million shares at an average price of $68.97 for a total of $500 million. Weighted average diluted shares outstanding were $249 million, down $24 million year-on-year, representing a 9% decrease. We have $1.9 billion remaining on our current share repurchase authorization and we'll continue to be opportunistic given NetApp's free cash flow yield and return on invested capital profile. During the quarter, we paid out $97 million in cash dividends. In total, we returned $597 million to shareholders, representing 164% of free cash flow generated in the quarter. Today, we also announced a 20% increase to our quarterly dividend, which will now be $0.48 per share per quarter. Turning to our full-year 2019 results, Net revenues of $6.1 billion increased 4% year-over-year, including one point of currency headwind. Gross margin of 65% was up 1.5 points compared to fiscal 2018 and was above our original guided range of 63% to 64%. Operating margin of 22.6% improved 3 points versus fiscal 2018 and was above our original guidance of 22%. EPS of $4.52 increased 27% year-over-year, demonstrating the operating leverage in our business model. Fiscal 2019 represents the third consecutive year of 25% to 35% growth in EPS. We generated free cash flow of $1.2 billion in fiscal 2019, which represented 19% of net revenues. We continued to deliver on our capital allocation strategy with $2.1 billion in share repurchases and over $400 million in dividends, representing a total shareholder return of 215% of free cash flow. Over the last three years, our capital allocation strategy has returned $4.4 billion to shareholders. Now on to guidance for fiscal 2020. We expect revenues to grow at the low end of our mid-single-digit range, driven by continued momentum in our private cloud business and an inflection in our cloud data services as solutions on Azure and other services become more broadly available. We also expect to reaccelerate growth in all-flash arrays. These fiscal 2020 growth drivers will be somewhat offset by a decline in our OEM business. Sequential growth within the year will be consistent with our normal seasonal patterns, except for the volatility introduced by ELAs. We expect gross margin to be in the range of 64% to 65% and operating margin to be in the range of 23% to 24%. Implied in this guidance is our expectation that operating expenses will remain roughly flat year-on-year in fiscal 2020. We are committed to delivering low teens EPS growth without buybacks and expect our effective tax rate to be approximately 19.5%. Additionally, we expect to continue to generate meaningful free cash flows in the range of 19% to 21% of revenues. We managed our supply chain to minimize the impact of China tariffs, and as a result, we do not expect tariffs to have a material impact on our business in fiscal 2020. Please note that we will be adjusting the definition of our strategic mature product categories in fiscal Q1 as planned to better align them with how we manage our business. Now on to Q1 guidance. We expect net revenues to range between $1.315 billion and $1.465 billion, which at the midpoint implies a 6% decline in revenues year-over-year. It is worth noting that our fiscal Q1 revenue guidance includes over a point of currency headwinds with no ELAs. The Q1 2019 comparison is very challenging as we grew the revenues by 12% year-over-year, including $90 million in ELAs. Adjusting for currency and ELAs, our fiscal Q1 total revenue guide implies a 1% growth year-over-year. In Q1, we expect consolidated gross margins to be approximately 65% and operating margin to be between 17% and 18%. We expect earnings per share for the first quarter to range between $0.78 and $0.86 per share. To address the execution opportunities George highlighted, we conducted workforce realignments in both Q4 2019 and Q1 2020 as we continue to focus investment dollars towards the best market opportunities in key growth initiatives. The realignment charges are GAAP-only and do not affect our non-GAAP results. As we look out to fiscal 2020 and beyond, I remain confident in our ability to grow and deliver on our long-term profitability targets. We have diligently focused on improved execution, and the secular tailwinds created by market transitions to flash, private cloud, and public cloud will enable us to continue to deliver on the commitments we’ve made to shareholders, partners, and customers.

We'll now open the call for Q&A. Please be respectful of your peers and limit yourself to one question so we can get to as many people as possible. Thanks for your cooperation.

This is R.K on behalf of Rod, thanks for taking my question. Given that some of your competitors are also reporting weak results; could you comment on the overall demand environment? And what could be driving the weakness, and also talk about when you aim to return to a product revenue growth?

I think if you look at the overall demand environment for data center spending, I think it reflects two broad themes. In some parts of the world where there are notable changes in the macroeconomic outlook people are taking a bit longer to define their annual budget plans for building a contingency budget model and buying for what they need or requiring a greater number of approvals for larger transactions. Like we said last quarter, we saw some of that reflected in our European business this past quarter. In other parts of the world where the economy is stronger we do see people looking at sort of their data center priorities and looking at what they would refresh within their data center or what they would consider moving to public clouds. We are well positioned to capitalize on that trend using our data fabric strategy, as reflected in some of the acceleration of our data services results this quarter. We plan for next year for a low growth environment, as Ron mentioned, the investments we’re making to capitalize on the strength of our portfolio should pay off through the course of the year. For the whole year, you should see strength in the product revenues materialize, especially in the back half of the year. I feel like this is an environment that we are particularly well set up for. We have demonstrated our ability to execute against our topmost priorities, we are entering fiscal 2020 with a much stronger portfolio than we’ve had in years past, and we are demonstrating our ability to meet the financial targets we set out by carefully prioritizing with trade-off decisions across the company.

Thanks R.K. Next question?

Hi, thank you for taking my question. In regards to your outlook, I think your implicit guide of $4 or $5 plus in EPS for fiscal 2020 does assume a fairly sizable increase or ramp beyond the July quarter. I'm curious what EPS in revenue contributions are you assuming for ELAs for the full year? And I guess how would you characterize your own level of visibility into the channel and at key OEMs? Thank you.

So, yeah, Carl, we didn't guide EPS explicitly but you're right, your calculation is probably roughly correct. What we saw this year was about 2% of revenue for ELAs; it wasn't evenly spread by quarter, as you noticed. We would assume that for next year, in the Q1 guide, there are no ELAs right now, so you have to assume that the other 2% of total year occurs in Q2, Q3, and Q4.

With regard to your question about visibility to the channel and the OEM, I think in the OEM business we are prioritizing our focus on a few players and are restructuring our agreements with the smaller OEMs, which is why we have indicated that OEM will be a materially lower business going forward. Regarding our distribution channel, we have a broad-based distribution channel that covers a large part of the market. We have a lot of access to our largest customers. We probably cover 95% of the Fortune 1000, and a high number of the Global 2000’s are customers of NetApp, with a majority of them being strategic customers, meaning they buy large amounts from us. So we are very close to them and the channel, and we expect that we'll be able to see any turn faster than most people.

Thanks Carl. Next question?

Great, thank you. I want to ask a question on cloud data services, so you mentioned that Azure will be generally available in Q1, and I think Amazon is already GA, so is Google. If you could just give us any color as to when Google will be GA?

We are in beta with Google and we are seeing good success with them. I think we will have to update you on when we expect that we will be generally available at the right point in time. We are doing all of the necessary things to get that service to general availability, and it does not preclude us from being able to take revenue-generating customers on the Google Cloud platform. Ultimately, the general availability of these services is determined by the hyperscalers, and we do everything necessary to make them comfortable to make it generally available, but it's in their hands.

Thank you.

Thanks Andy. Next question?

Thank you. If my numbers are right, America's commercial was up about 12%, public was down 11%, Europe was down 17%. You said a little bit about Europe, but can you give us some more color on each of those and kind of what you expect going forward?

Let me characterize each of them. I think in the Americas business our strength in the portfolio as well as the opportunity to invest more in the Americas enterprise segment continues to give us real good confidence about the performance of our business. We had really good traction with our largest customers through the course of the year with these strategic agreements. I think with the public sector business, we’ve been transitioning some of our investments over to opportunities like Flex, state and local education, as well as healthcare, and those transitions have paid back with really strong results this year. We are going to expand the range of offers that we have for the public sector market. We are working with both the hyperscalers to offer Fed ramp services and will update you when they're available, as well as we’re focused on bringing our ECI products that meet the public sector certification requirements to market in time for this buying season. I think those two should contribute to further strengthen our public sector business this year. In EMEA we saw a couple of things: some transformations at some of our biggest customers, which were exposed to both specific situations as well as the broader economic landscape in EMEA. I think there is also a 500 basis points currency headwind on the EMEA results in quarter. We prioritized our resources to the biggest, most attractive customer segments and markets through the course of the last quarter, which was something we had been planning to do, and we exited some of the smaller countries so we can prioritize NetApp sales resources to leverage our portfolio in the biggest market. We expect to have good results this coming year in EMEA.

Thanks, Steve. Next question?

Yeah, thank you. Just wondering if you can talk a little bit about the wider competitive environment and just if you've seen any changes to the pricing behavior as demand has become a little bit more challenging?

You know, I think there has been no material change to the overall competitive environment. On any particular transaction, you always see some players resorting to irrational pricing, but we have the discipline to walk away from loss-making transactions. I think the overall strength of our portfolio is demonstrated in product gross margins. It is the ninth consecutive quarter where we have grown product gross margin, and it's reflective of the differentiation in the portfolio, the power of our data fabric strategy, which is the long-term differentiator for us in any situation, as well as the increasing contribution of software to our product mix. All things that we have strategically been working on, and it’s paying off for our shareholders and for our customers.

Thanks, Matt. Next question?

Hi guys, this is Victor Chu in for Simon Leopold. Regarding the decline in the hardware maintenance revenue, can you help us think about the broader implications here? Is this reflective of shifts in customers’ plans, maybe shifting to the hybrid public cloud or new architecture that you are planning on deploying, or maybe competitive issues here? Just help us a little bit with some more color around the decline this quarter.

Yeah, Victor, we told you in FY 18 it was a headwind, but we could tell from the waterfall that in FY 19 it wouldn't be. Through the first three quarters, we did execute reasonably well and was not a headwind at all; in fact, we grew slightly. We had some execution issues in Q4 which I wouldn’t put on our customers; I would put that squarely on our shoulder. We know what we need to do. We're making some needed changes in that area, and we believe very strongly that since the asset base is growing, FY 2020 will be a growth year for maintenance.

I think one thing you should note is that we look at the maintenance business in aggregate between both software and hardware. A few years ago, we made a strategic pricing change to reflect the value of our offerings more in software, so when you look at the mix of hardware and software, it would trend towards software, and I would ask you to just understand our business in aggregate rather than as piece parts.

Thank you. Our next question is from Lue Miscotia with Tiva.

Okay, thank you. If you could actually go into the all-flash array area, why do you think you grew lower than your expectations? And then, obviously, if you look to the first quarter and the first half of next year, why do you think you need to start to get back on track with that as you've mentioned that should be something that you think you could do?

The issues we experienced in the quarter were three specific items we talked about: We had to reprioritize sales resources to offset some of the slower spending in our largest customers, and it took longer than we needed to do that. The second issue was the OEM business, which has a material component that is solid-state storage, and then the third was our renewals, which also has a significant weight on solid-state. I think all of those issues were felt acutely within the ASA segment. I think if you look at what actions we are taking to increase sales coverage and align those resources against our biggest customer opportunities, we have seen results from moves we made earlier in the year, prioritizing certain segments over others that have paid off. I am really confident that as we continue to do more of that, the first place it should return to growth is actually ASA.

Thank you. Next question comes from Jim Suva with Citi.

Thank you very much. George, in your opening comments, you mentioned some execution issues internally. I know you had mentioned that you're making changes, and that's great to hear. What are the changes? What were the challenges? So investors can feel more comfortable that they are quick solvable or maybe they take a long time to solve? If you could help us understand that, thank you.

Absolutely. You know, first of all, I take execution particularly seriously. I think we have demonstrated a strong track record of it. I’m disappointed at the quality of the execution this quarter. As we said, there were three fundamental issues. The first one we have is certain customers taking a longer time to make purchasing decisions. I think all of that data center players or multiple of them are reporting that. We have the opportunity, however, given the strength of our portfolio, to relocate and make investments in higher growth areas and particularly attractive segments. For example, we reprioritized some resources within public sector from Fed to Sled or Fed to healthcare, and we saw a strong return on that through the course of the year. We didn't do enough and we didn't do it fast enough to react to what we saw in January, and so I am disappointed. But I'm confident that the moves we are taking should pay off through the course of fiscal 2020, which is why we have an outlook that is quite good for fiscal year 2020. The second issue is in the renewals. We've made organizational changes and process changes to drive much deeper inspection of our ability to capture the full asset portfolio that we have available for renewals. As Ron mentioned in his remarks, the total asset count is growing in our installed base and deferred revenue was up 9% year-over-year. So it's really a matter of execution on renewals within the quarter, and you'll see us drive that with a lot more intensity. The third issue was the OEM business. Here we do not forecast a return to where it was. I think what we are doing is really prioritizing a couple of the big OEMs and really staying close to them. For the rest, we are going to take down our outlook going forward. I think it is the lower priority use of NetApp resources. We have many other attractive opportunities to focus and execute against. We will give you updates on the progress of our execution plans as we come back to you through the course of next year.

Yeah, my question has to do with the workforce realignment. What was the headcount, maybe you gave it but I missed it, what was the headcount ending the fiscal year 2019, and then where are we sort of post realignment?

Yeah, let me get you the numbers, but this is not a reduction in force in a traditional sense. As we have told you we are going to start initial transformation. We will be making adjustments very surgically. We did some last year, we did some in Q4, and we are going to do some in Q1. We should not think about a reduction as much as a realignment of resources for the right skill set in the right places. Our total headcount as of the end of the year was 10,541, with a slight increase year-over-year: again, not significant. In many cases, we added heads in lower-cost locations, so it didn’t increase our overall cost base.

As Ron mentioned, we continue to see phenomenal opportunity with our portfolio of all-flash arrays, private cloud, and public cloud data services. We are entering fiscal year 2020 with that portfolio materially stronger than it was in fiscal 2019. What we are doing and what we are going to continue to do through the course of the year is to prioritize coverage and investment against the most attractive market segments and market opportunities. To fund that, we are going to stay disciplined and reprioritize investments away from lower-value activities and lower-value smaller countries, and that's really kind of what we did with the changes we've made.

Okay so just a recap here based on your comments about the operating expenses not changing much in fiscal 2020. We would expect the headcount to be relatively similar to that 10,541.

That's correct. It may change around the world; we may see more heads in lower-cost locations, but the overall headcount number would not change dramatically.

Thank you.

Yes, thanks for taking my question. I apologize I joined the con late in case the question has already been asked. George, I want to better understand your forecasting in some more details that gives you the confidence that for the revenue on a year-over-year basis is going to rebound. What I have seen over the past six months is some of these forecasts have not really materialized. It seems like your enterprise customers have already upgraded what they need to upgrade. The whole cloud migration, hybrid cloud has already reached a plateauing. In that context, what is it out there that you see that gives you the confidence that this time your forecast is actually going to materialize?

I think first of all, we have close relationships with most of the largest customers in the world, and for those that we don't, we are going to put direct NetApp resources to cover them. You will see those investments being made within the financial envelope of our long-term operating model, and I think that's prudent; it’s a part of our ongoing portfolio management and portfolio optimization. A couple of things give us confidence. First, cloud data services which has been a work in progress for quite a while is now generally available. I think if you saw the performance of our business in the second half of this year in cloud data services, it has been strong. I would just say that cloud migrations have not really been completed. I think of the low-value workloads, yes, those might have migrated, but the enterprise workloads have not yet moved. We are well positioned to capture that because of the capabilities we now bring to the hyperscalers that enable that, allowing us to go after a bigger wallet rather than just the NetApp installed base. We are seeing a good percentage of our cloud customers being new customers. The second is our private cloud portfolio, which customers are prioritizing in their own data center strategies. Although that might be diminished relative to last year, they are still prioritizing private cloud build-outs, and I think we are well positioned for that. I don't dispute the fact that we have to go and prove our execution out, but I do feel that next year's outlook is against muted comparisons given this year. So we are being balanced in terms of how we run the business, investing against known areas of strength.

Thank you. On the NetApp HCI product, I think you gave - I don’t think you ever given numbers for private cloud. Maybe I'm wrong, but you said $150 million in the quarter, $600 million run rate. First of all, is that accurate?

Yeah, that is accurate. It's for NetApp private cloud, which is SolidFire, NetApp HCI, and NetApp StorageGRID optic storage.

Got you. Could you give us some ballpark amount or ballpark percentage that HCI is at 10%, 20% just on ballpark, like give a wide range?

I'll just tell you that we are pleased with all of them. They performed really well through the course of the year and are a material contributor to our growth outlook. We will give you more color on that through the course of the year. I'll just say that HCI is growing as a share of the overall business.

Okay. Great. I just have a quick follow-up. Do you have any updated data indicating whether NetApp HCI is impacting the core storage business?

It's too early for me to comment on that. I feel like it's an opportunity for us to gain net new customers. We’ll give you more color on that as we understand customer buying behavior through the course of the year. You’ll see us provide more clarity on some of these areas through the course of the year, and I'm extraordinarily pleased with the progress through the course of this year. For three consecutive quarters, we have done really well reflecting the strength of all the elements of those portfolios, betting on the hypothesis that enterprise-grade hybrid cloud infrastructure is displacing first-generation hyper-converged. We are seeing that happen.

Yeah, thank you. Where should I put operating margin plans that's down 450 basis points year-over-year? Could you parse that between OpEx and gross margin?

Yeah, so most of it if you remember in Q1 2019, we had $90 million of ELAs, which was very beneficial to gross margin and our margin—so most of that is actually gross margin.

Got it okay, and if I may, through new execution issues, is that constraint to a particular protocol or type of a ray, or is it broad-based?

No, it's broad-based.

Thank you. Our next question comes from Nikolay Todorov with Longbow.

Hey guys, good afternoon. Recent industry announcements for cloud services kind of validate your approach in the market and you guys have a first mover advantage. Can you talk about how you see the market evolving from over here? And also can you share if you have a cloud services AIR target for existing fiscal year 2020?

We don't have one broken out for fiscal year 2020. I want to say that we are confident in our target for fiscal year 2021. We expect that the general availability of Azure NetApp Files will be, should be a step function increase in our opportunity with cloud data services. We have room to really accelerate that business this year. I would say we are differentiated on multiple fronts: the number of offerings we have and the way they have integrated with cloud providers, on the ability for us to build truly hybrid cloud workflows given the uniqueness of some of our data movers like SnapMirror and others. We are a first leader—first mover advantage. We have world-class technology and we are really excited about the work we're doing with hyperscalers. This is an area of material improvement to our business this coming year.

Thank you. George, you talked earlier about the issues you're seeing with large enterprise customers taking longer to pull the trigger on deals, and certainly some of your competitors are saying the same thing. Are there any particular reasons that you can point to those issues? And as you look toward the rest of the fiscal year, expecting a return to growth, is that lumpiness still factored into your guidance and your outlook?

We continue to be cautious. I think that's reflected in our outlook. We see two particular reasons for that: the lumpiness or the slow approvals of data center spending. The first is in some parts of the world, there are economic considerations that are affecting specific customers undergoing their own transformation. When they do that, they put spending on hold until the shape of that transformation comes into play. We saw that in some parts of our European business. The second is in other parts of the world; they are going through the evaluation of their hybrid cloud journey. I think that's both an opportunity for us because of the unique positioning of our offerings, but we may have seen more of it given that we are one of the few players who can offer solutions on either side. What customers are starting to do is take that journey first with our platform. I think this is both an opportunity and an area that we are following keenly. We have seen that when we make investments to cover the market broadly, given the strength of our portfolio, they do pay off. We've seen that through the course of this year. As I said, we stepped out of China early in the year, which is off to a good start. We stepped out of certain countries in Europe this past quarter and refocused our resources within the public sector markets. We've made targeted moves to places where we saw healthier spending patterns, and you'll see us continue to do that through the course of this coming year.

Thank you for taking my question. Ron, when you look at seasonality, I think you mentioned that you expected the relatively normal contributions for the full year. What are the puts and takes given the way that you've started? Do you expect maybe a little bit higher peak at the end of the calendar year or is this being made up a little bit more at the end of the fiscal year?

It's hard to say. I think the ELAs, as I noted, tend to come in based on customer demand. So, as you noticed last year, almost half of the ELAs came in Q1. That could happen in any given quarter. The base business is going to be a fairly traditional seasonal pattern, with each quarter being larger than the prior one, and then the thing you'll lay on top is some amount of ELAs, which right now I can't see in Q1. Quite frankly, I don't have any specific targets for the other quarters as well, but we do believe those will still be at roughly 2% of revenue as they were this year.

Thank you.

Yes, thank you. For cloud data services, there are some hesitancy here to guide fiscal 2020, where you spoke about a very strong exit for the last months, sounded like you did about $17 million in this year. Is there a way that you could benchmark? And why is there a hesitancy just given that you have significant amount of confidence looking at fiscal 2021? Knowing that I can be helpful from a modeling perspective to understand where that trajectory is even if you could give us some guideposts, if not exact numbers very specifically, some ranges that we can think about would be helpful. And secondarily, the half-over-half growth in cloud data services and private cloud, how does that look? I mean, it seems like there is a lot hinging on that based on second half versus first half. So any quantification there also would be helpful. Thank you.

Listen, I don't think you should have any indication that we don't have confidence in these offerings. We don't guide below the one single revenue number. We've never done that and we're not going to do that going forward. But that has zero correlation with our confidence in these platforms. I think that we have demonstrated really strong results through the year, and we have a track record when we say we're going to do something to be disciplined about going and doing that. I think we are just being cautious about the outlook for next year. All of those factors have been factored into the guidance that we are giving.

In closing, I'd like to leave you with a few thoughts. We have met our commitments on financial results and shareholder returns each year that I've been CEO, a track record that I intend to keep going forward. Customers and partners choose NetApp because of our data fabric strategy, which is aligned with their IT roadmap. This creates the opportunity for strong market share gains on-premises and in the cloud. What we're doing in the cloud also drives wallet share gain on-premises. We have three strong and differentiated growth engines where we see the biggest opportunity: flash, private cloud, and public cloud data services. We expect our flash business to reaccelerate and private and public cloud revenue to grow substantially in fiscal year 2020. We are moving quickly to improve our execution and to capitalize on this opportunity while staying within the boundaries of our financial model, and continue to deliver strong shareholder returns. We started these investments in fiscal 2019 and we'll continue them in fiscal year 2020, and I'm confident that they will pay off in fiscal year 2020 and beyond. Thank you again, and I'll speak with you next quarter.