Netapp Inc (NTAP) — Q4 2021 Earnings Call Transcript

Thank you for joining us. With me today are our 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 the first quarter and fiscal year 2022; our expectations regarding future revenue, profitability, and shareholder returns; and our ability to continue overall growth, gain market share, and scale our cloud business, 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 the continuing impact and uneven recovery of the COVID-19 pandemic; and the IT capital spending environment; as well as our ability to gain share in the storage market, grow our cloud business, 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 Forms 10-Q and 10-K including in the 'Management’s Discussion and Analysis of Financial Condition and Results of Operations' and 'Risk Factors' 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, Kris. Good afternoon, everyone. Thank you for joining us today. Before we get started, I want to take a minute to acknowledge that it’s been over a year that we have all been working remotely. I’m encouraged by the public health and economic improvements in many parts of the world, but the recovery is uneven. As you know, we have a large team in India. Our thoughts are with them, as they deal with a distressing surge in COVID cases. Thank you to the entire NetApp team for your dedication, focus, and execution throughout this challenging year. Now to the results of the quarter. We delivered strong fourth quarter results, capping off a solid year of growth. Our results were all above our Q4 guidance ranges. I am most excited by the return of product revenue to growth, the strength of our public cloud ARR, and an all-time high free cash flow. Our performance was broad-based, as certain verticals, the U.S., and parts of Europe and Asia are recovering faster than many expected. Cloud and digital transformation initiatives have been accelerated by the pandemic and companies look to NetApp to support these key initiatives. Going into FY21, we had two clear priorities: returning to growth in our storage business powered by share gains from our industry-leading file, block and object software and scaling our highly differentiated public cloud services business. As I reflect on the past year, I am proud of what we have achieved during a globally challenging period. We remained focused in executing our strategy and extending our innovation. In Q4, product revenue grew 6% and our all-flash array business grew 11% year-over-year. Based on our growth, I am confident that we have gained share in the storage and all-flash markets. We advanced our hybrid cloud portfolio with the introduction of ONTAP 9.9 and Astra. This innovation will support continued product revenue growth and share gains through fiscal year '22. Additionally, we continue to make good progress with Keystone, with many new wins, including our largest ever Keystone deal. We are reaching more customers than ever before with our public cloud business. Over the course of fiscal year '21, we added approximately 1,500 new-to-NetApp customers with public cloud services and grew our total cloud customer count by 137% from Q4 fiscal year '20. In addition to adding new cloud customers, existing cloud customers are expanding their spend with us. Our dollar-based net revenue retention rate increased to 252% in the fourth quarter. Cloud Volumes, Cloud Insights, and Spot all performed well in the quarter, driving our public cloud services ARR to $301 million exiting fiscal year '21, an increase of 171% year-over-year. As we have said repeatedly, our cloud strategy strongly advantages NetApp. I’ll use a customer example to illustrate how cloud helps us to acquire new customers and drive growth in our on-premises solutions. As a part of its digital transformation strategy, a leading car manufacturer decided to migrate workloads from its on-premises data centers to the Azure cloud. Despite never having used NetApp previously, the customer chose NetApp Cloud Volumes to host its file-based data and NetApp Cloud Sync to rapidly move data from its Dell EMC systems to the cloud. In addition to delivering a high-performance data store in the cloud, Cloud Volumes provides out-of-the-box cross-region replication of production data to a secondary cloud environment, high availability to meet the service level requirements of critical applications, and cost savings through automatic tiering to Azure Blob Storage. Because of the breadth and depth of the value NetApp delivered, the customer is now looking to deploy a hybrid cloud environment and plans to use NetApp on-premises, as well as increase its NetApp usage in the public cloud. As I noted earlier, the pandemic accelerated and elevated the importance of customers’ cloud and digital transformation initiatives. We expect that this trend will be ongoing, and that NetApp will continue to benefit from it. Customers appreciate the value we bring as a cloud-led, data-centric software company to simplify and modernize existing data centers, to quickly and confidently deploy applications, and to securely manage data on the public cloud. We have long been recognized for our industry-leading enterprise data management technology; our cloud solutions drive further differentiation, expand our addressable market, and enable us to reach new customers. We began our cloud journey seven years ago, with the introduction of Cloud ONTAP, now, Cloud Volumes ONTAP. Our initial focus was to leverage the cloud to deliver backup and disaster recovery services to our installed base. We saw that enterprises wanted to move workloads to the cloud. To address that need, we began working with the leading cloud providers to deliver Cloud Volumes Service, a fully managed service with the application certifications required to support mission-critical, production workloads in the cloud. We then recognized the opportunity to expand beyond storage management and optimization to infrastructure monitoring and compute management and optimization services, which led to the development of Cloud Insights and the acquisition of Spot. These services, Cloud Volumes, Cloud Insights, and Spot, are now the primary growth engines of our public cloud services business. They are well established for enterprise applications, and we are taking each of them into the cloud native world, further expanding our market opportunity. NetApp Astra offers application-aware data management that protects, moves, and manages data-rich Kubernetes workloads. Spot Ocean automates cloud infrastructure for containers, automatically scaling compute resources to maximize utilization and availability while minimizing costs. Cloud Insights for Kubernetes provides simplified infrastructure monitoring to quickly identify performance issues and resource constraints. Together, our public cloud services give our customers, and especially their CloudOps and DevOps teams, a robust suite of multi-cloud infrastructure management services. We plan to press our advantage here by focusing our efforts on enhancing our go-to-market activities, deepening our cloud partnerships, and delivering best-in-class organic and inorganic innovations. We intend to leverage our deep infrastructure expertise and our credibility with the cloud providers to expand our multi-cloud infrastructure management services. My confidence in our ability to reach our goal of $1 billion in public cloud ARR in fiscal year '25 is further enhanced by the strength and uniqueness of our cloud services position. Our focused execution last year has set us up well for fiscal year '22. We have returned to growth, we are gaining share in key storage markets, and our public cloud services are at a scale where they are positively impacting total company billings and revenue growth. Our momentum underscores our value to customers in a hybrid, multi-cloud world. In fiscal year '22, we plan to accelerate our public cloud services and continue to grow our hybrid cloud business. I am excited about the year ahead and confident in our ability to deliver top line growth by supporting our customers on their cloud and digital transformation journeys. Before I turn it over to Mike to walk through our financial results, I want to take a moment to thank Brad Anderson, who let us know that he intends to retire at the end of fiscal year '22. Brad has been instrumental in leading the maturation of our Hybrid Cloud Group, and we will continue to leverage his leadership and expertise this year. We are actively engaged in identifying his successor to ensure a smooth transition. With that, I’ll turn it over to Mike.

Thank you, George. Good afternoon, everyone, and thank you for joining us. As a reminder, I’ll be referring to non-GAAP numbers unless otherwise noted. As we look back on what was an unprecedented year, I cannot help but be incredibly proud of the focus, execution, and commitment of the entire NetApp team. We delivered billings of $5.9 billion, an increase of 9% year-over-year, while revenue of $5.7 billion grew 6%. We delivered free cash flow of $1.2 billion, up 25% year-over-year, while continuing to aggressively invest in our public cloud franchise. We finished the year strong, with Q4 billings of $1.7 billion, up 12% year-over-year, while revenue of $1.6 billion was up 11% year-over-year. Both were solidly ahead of our expectations, driven by accelerating enterprise demand throughout the quarter. Gross margin, operating margin and EPS all came in above the high-end of guidance. Q4 free cash flow of $521 million was an all-time high for NetApp. As George highlighted, public cloud ARR of $301 million was up 171% year-over-year and an impressive 27% sequentially. In fiscal '21, the scale of our cloud franchise really started to impact the overall growth profile of NetApp, delivering 4 of the 9 points in billings growth and 3 of the 6 points in revenue growth. In addition to the strong cloud ARR performance, we are excited that we exited the year with cloud gross margins near our overall corporate average. Given the growing impact on our total company performance, we anticipate sharing more detail on our public cloud business in fiscal '22. When combined, software revenue, recurring support and cloud revenue totaled $1.1 billion and increased 18% year-over-year, representing 72% of total revenue. For the first time in company history, we ended Q4 with over $4 billion in deferred revenue, an increase of 8% year-over-year. Deferred revenue continues to be a leading indicator for future recurring revenue growth. Product revenue returned to growth in Q4; importantly, we expect this trend to continue throughout fiscal '22. Product revenue of $840 million increased 6% year-over-year. Consistent with the trends we have seen throughout fiscal '21, software product revenue of $480 million increased 18% year-over-year, driven by the continued mix shift towards our all-flash portfolio. Recurring support and cloud revenue of $641 million was also an all-time company high and was up 17% year-over-year, constituting 41% of total revenue. Gross margin of 67.3% was at the high-end of guidance. Product gross margin was 54.3% and benefited from the higher all-flash system mix. Our recurring support, cloud, and other services business continues to be a very profitable and growing business for us, with gross margin of 82%. Operating margin of 23% was nicely ahead of our expectations, while EPS of $1.17 came in above the high end of guidance, despite a $0.05 headwind from a higher than forecasted tax rate. Cash flow from operations was $559 million and free cash flow was $521 million, representing 34% of revenue. Cash flow came in higher than expected in part due to strong collections, as evidenced by the DSO metric of 55 days. Full-year fiscal '21 free cash flow of $1.2 billion was up 25% year-over-year and represented 20% of revenue. We closed Q4 with $4.6 billion in cash and short-term investments. Given recent developments in the broader technology supply chain, I want to reiterate our confidence in our ability to meet end-demand as we head into Q1. We have an excellent supply chain team and they have been working closely with our partner ecosystem to ensure backlog and customer lead-times remain at normal levels throughout fiscal '22. Towards this goal, we will be investing incremental dollars into inventory and longer-term commitments to help mitigate the risk of supply shortages. Given our strong balance sheet and low cost of capital, we feel good about this investment. Now to guidance. In fiscal '22, we expect revenues to grow 6% to 7% year-over-year, with billings expected to outpace revenue given the continued strength in recurring support contracts and cloud services. In fiscal '22, we expect continued momentum and share gains in our cloud-connected all-flash portfolio. We will also continue to grow and invest in our diversified public cloud services portfolio. We are raising the low-end of our fiscal '22 guide and now expect to exit fiscal '22 with public cloud ARR of $425 million to $500 million, driven by enhanced go-to-market activities, deeper cloud partnerships and continued product innovation. Similar to the seasonal pattern we experienced in fiscal '21, we anticipate Q2 and Q4 to be our strongest quarters for net new public cloud ARR. This seasonal cadence is driven by our semi-annual sales compensation plans. As George noted, we have increased confidence in our ability to eclipse $1 billion in public cloud ARR in fiscal '25. In fiscal '22, we expect gross margin to be roughly flat year-over-year at 67% to 68%, as improving cloud margins are balanced with strong demand for our hybrid cloud products. We anticipate operating margin to range between 21% and 22%, as we continue to invest in our growth initiatives, while delivering strong operating leverage. Implied in this guidance is our expectation that operating expenses will be between $2.75 and $2.8 billion. The year-over-year increase in our expense base is being driven by continued investment in revenue generating activities, including expanding our cloud portfolio, targeted investments in sales resources and continued investment in our customer success sales team. Moving down the P&L, we expect interest expense to be $65 million to $70 million and our effective tax-rate to be approximately 19%. While we get a bit of deleveraging below the operating income line, as a result of the higher interest expense and tax rate, we are committed to delivering $4.45 to $4.65 in fiscal '22 EPS, representing 12% year-over-year growth at the mid-point. We expect to again generate over $1.1 billion in free cash flow in fiscal '22, as our hybrid cloud business continues to fund the growth in our cloud services franchise. Factored into the year-over-year free cash flow generation is a step-up in CapEx to $225 million to $235 million. Our public cloud partners, in particular Azure, are driving us hard to build out additional global capacity for our cloud offerings. Even with this added investment, we expect cloud gross margins to become accretive to our corporate average as we move through fiscal '22. Generating over $1.1 billion in free cash will allow us to continue to deliver on our capital allocation commitments, while also investing in our key strategic areas. The dividend will remain the first call on capital. As you saw today, we raised our quarterly dividend to $0.50 per share. Share repurchases will also continue to play a key role in our capital allocation strategy. Towards this goal, our Board approved an additional $500 million in buyback authorization. In fiscal '22, we expect buybacks to offset dilution from our equity plans. For modeling purposes, we expect share count to remain flat at 229 million shares, exiting fiscal '22. Consistent with NetApp’s long history of disciplined M&A, the remaining 30% of free cash generation will go towards our acquisition strategy, which will remain focused on bolstering our strategic cloud services roadmap. Now on to Q1 guidance. We expect Q1 net revenues to range between $1.37 billion and $1.47 billion which, at the midpoint, implies a 9% increase in revenues year-over-year. We expect consolidated gross margin to be approximately 68% and operating margin to range between 19% and 20%. Assumed in this guidance are Q1 operating expenses of $680 million to $690 million. We anticipate our tax rate to be approximately 19%. And we expect earnings per share for Q1 to range between $0.89 and $0.97 per share. Assumed in our Q1 guidance is interest expense of $15 million to $20 million. In closing, I want to thank our partners, customers and investors for their unwavering support this past year. And most importantly, a huge shout out to the entire NetApp employee base for redefining what it means to work as a team during what was a challenging year in so many ways. We are more confident than ever in our ability to capitalize on the industry transitions and market opportunity ahead.

Thanks, Mike. Let’s open the call for Q&A. Please keep to just one question so we can get to as many people as possible. Operator?

Thank you for taking my question. Congratulations on the strong performance. I would appreciate it if you could elaborate a bit more on the cloud data services business. I would like to understand what specifically contributed to the upside this quarter compared to the guidance of $260 million to $290 million that you had previously shared. Additionally, regarding the full year projection of $425 million to $500 million, I noticed that the lower end appears to have increased by $20 million to $25 million. What gives you confidence in this business as we approach next year? Also, how crucial is it for you to expand beyond Azure in order to meet the fiscal year targets you've set?

Thank you for the question. We have been working on multiple innovation parts of our portfolio, all of which performed extremely strongly. Cloud Volumes for storage; Cloud Insights for monitoring; Spot for compute management, all had really strong Q4s and overall, really strong years. We saw good expansion in the number of customers and strong growth in the number of new-to-NetApp customers. We saw customers spending against their digital transformation and their cloud programs throughout the quarter. So, it was a smooth trajectory through the quarter. And I think that sets us up well for next year. I think, if you look at our dollar-based net retention rate, you can see that our organic business grew strongly this year, and we had about $60 million of this year being inorganic from acquisitions of Spot, Talon and CloudJumper. So, when you back that out, we expect next year’s growth rate to also continue the acceleration of our organic portfolio and continued strength of our inorganic portfolio. We have a really good and differentiated portfolio of services. We have deep partnerships and are expanding the range of things we do with the hyperscalers. And we are growing our customer base of people who are doing many business-critical projects on the public clouds with us. So, I’m really excited with every confidence. We’ll tell you more about our cloud business, as Mike indicated, as we go through the year, giving you more details on it.

I have a couple of questions and clarifications. First, regarding ARR, I'm interested in understanding what the potential ceiling is, given your strong performance. Could you provide some insights into the growth prospects? Secondly, I need clarification on the EPS calculations for the full year guidance. We're arriving at a number lower than the range you provided, specifically around $4.41. I'm unsure why there's a discrepancy based on the inputs you mentioned. If Mike or someone could shed light on this, I would appreciate it. Thank you.

Thanks, Rod. With regard to the cloud portfolio, listen, I think the heavy lift in terms of getting the innovation portfolio to be in really good shape is behind us. I think, we have, as I said, three really strong innovation engines, and we are bringing out cloud-native innovations across those lineups as well through the course of the summer. We are making investments, as we indicated last quarter, to accelerate and expand the range of things we’re doing in the cloud portfolio. With regard to what’s it going to take to further accelerate the course of the business, it’s all the things that we’re doing, right? We’re expanding the number of sellers and revenue-generating teams facing customers. We’ve seen really good success with Microsoft in terms of their route to market. We’re working with the other hyperscalers to also train and expand the range of ways we take our products to market with them. And we’re building our customer service and customer success teams. I feel even more confident that we have the range of capabilities to achieve the $1 billion target in ARR that we indicated. And the customer use cases that we are deploying on our public cloud portfolios, these are run the business applications, mission-critical, highly differentiated business value-creating application. So, I feel really, really good about where we are at the year. Mike, do you want to take the other part of the question?

Sure. Thanks, George. Hey, Rod. I just want to clarify that we can discuss this further with you and your team. It’s important to note that gross interest is not the same as net interest, and it may also be included in the OIE calculation. There’s a significant sensitivity regarding that figure. It’s likely that this is below operating income, which differs from our model. We’re happy to go over this with you in more detail later.

Mike, just for the call, could you maybe say what that OI&E number is? Then people can just plug that in.

Yes. We indicated a range of 65 to 70 for the interest. The OIE we mentioned includes factors beyond just interest, and that number can vary significantly.

Yes. Thanks for taking the question. And congratulations on the quarter, clearly confident in kind of how the story is progressing. I know you touched on this in your prepared remarks a little bit. But, I just wanted to go back to kind of the component environment. There’s a lot of discussion out there around SSDs and some controller constraints, and pricing moving upward on flash and SSDs in general. Just help us maybe appreciate the confidence that you have in component supply and how you’re reacting to any kind of inflationary pricing dynamic? Thank you.

Sure. Hi Aaron, it’s Mike. Thank you for your question. We have definitely considered the challenges in the supply chain when setting our gross margin guidance for the first quarter and fiscal year 2022. Our supply chain teams have performed exceptionally well throughout the year, collaborating closely with our suppliers. We are confident that we can maintain this performance in the coming year. As you know, we are a cloud software company and we expect our product margins to continue benefiting from higher-margin software-rich configurations. We are also putting in significant effort to improve our services margin. As mentioned, we anticipate that cloud margins will continue to enhance over the year, with additional benefits from the usage of deployed systems and growth in our Software-as-a-Service offerings. While there are always unexpected challenges that may arise, we feel optimistic about our current position. Regarding our total component cost, we expect a slight advantage in the first half of the year. However, based on current pricing and potential changes, we may face a bit of a disadvantage in the second half when incorporating this into our guidance.

With regard to our technology portfolio, as Mike said, we have a range of configurations that we can support our customers with all the way from 900 gigs to 16 terabytes. And so, we have plenty of capability to given the flexibility in our software operating system to qualify the right components to meet customer needs and support them. With regard to the demand environment and gross margins, listen, as Mike said, we’ve operated through a tough year and done a really good job. I think that you’ll see us continue to remain prudent, balancing end-user demand with margin management as we go through the year.

Yes. Thanks, and congrats from me as well on the great results. George, I do appreciate the full year guide. I’m just wondering if we can double click maybe on the revenue outlook, 6% to 7% growth. Can you give some more color around the assumptions there? Maybe if you can talk how much of that comes from share gains versus the market or any breakdown between the drivers of product or CDS or software? Thank you.

As we progress through the year, we are noticing ongoing improvements in public health and the overall demand landscape. We have been gaining from cloud and digital transformation initiatives throughout the year. We are not observing any significant rebound in government or enterprise spending. Instead, we are benefiting from long-term trends and strategic projects that are important to our customers. More countries, particularly the U.S. and certain areas in Western Europe, are becoming more active as we move through our fiscal year, with the U.S. likely to see this in the first half and Europe in the latter half. We are confident that our product portfolio stands out, and we expect product revenue to continue to grow at a faster pace than services revenue, bolstered by the strength of our cloud portfolio. Our cloud business now has a much larger customer base and a wider range of application certifications that we introduced last year. Overall, we feel very optimistic about the upcoming year.

Yes. Thank you. I was wondering if you can give an update on the ramp of the 200 quota-bearing heads that you’ve added over the past, I think it was 18 months or so. Just where they are in their ramps relative to full productivity? And as we’re heading into fiscal '22, just how you’re thinking about investments in sales capacity for the next fiscal year and beyond?

I think the normal sales productivity ramp occurs over four quarters. The 200 representatives we started adding in fiscal year '20 are now fully productive and have integrated into NetApp teams. We've already seen some positive outcomes from their performance, especially in the Americas business, which has been very strong and positions us well for what we anticipate will be a robust recovery in the American market over the next 12 months. Regarding further additions, as Mike mentioned and we've noted previously, we're being cautious about where we expand our teams, choosing locations where we see strong demand and favorable environments. We added some personnel to our customer success and cloud teams this past quarter, and you can expect us to continue doing this to support the growth of our cloud portfolio. Mike, would you like to add anything further?

Yes. Thanks, George. So, I would just underline the additions that we talked about last quarter and this quarter as well into specific areas around cloud, and then the customer success team which is, as you all know, in a cloud business super important in terms of upsell, cross-sell renewals. So, we do continue to make investments there. And I think you’ve seen some of the results in the ARR results this quarter.

Thank you. Public cloud profitability is ramping faster alongside the better revenue performance. Is that purely due to revenue scale, or have you tuned the business model in any way to capture cost efficiencies? And then, Mike, just as a follow-up to that, can you clarify whether we should expect cloud margins for the full year 2022 to be dilutive, neutral or accretive to the model? Thank you.

Sure. Thanks for the question, Katy. Let me answer the last part first. We indicated that throughout the year, we anticipated cloud margins would contribute positively to the overall Company average, especially by the end of the year. Moreover, we've observed a much larger increase in our cloud margins than we initially projected. Scale, particularly revenue scale, plays a significant role here. However, I also want to commend the team for their efficiency in utilizing both hardware and supporting resources related to people and processes. So, it's a combination of factors, but definitely, the growth in ARR is the main driver, followed closely by the team's effective margin management.

Katy, I believe we have numerous ways, as we've discussed, to continue enhancing the gross margins in our cloud business. Our portfolio of software-only offerings is expanding, including Spot, Cloud Insights, and various versions of our Cloud Volumes offerings. Mike highlighted the importance of hardware utilization. We have introduced new versions of our ONTAP operating systems that are increasingly efficient in data management and storage. Therefore, we are optimistic about our ability to further improve cloud gross margins in alignment with what Mike outlined.

You mentioned some seasonality in Cloud ARR throughout the year, with Q2 and Q4 generally being higher. I was curious if it would be correct to assume that the net organic growth sequentially should be at least at a higher level compared to last year, despite the potential seasonality as we enter Q1. Additionally, could you provide some insights on these cloud deals, specifically the proportion that was generated by NAV versus partners? Thank you.

Yes, regarding organic growth, this is Mike. I want to highlight the dollar-based net retention number, which accelerated quarter-over-quarter. This indicates that the organic business is performing very well. As George mentioned, many of those offerings contribute to the organic business. We don't separate the contributions from the hyperscalers and the core NetApp business. However, the seasonal increase you typically see in Q2 and Q4 is influenced by our sales teams, along with the hyperscalers. I want to emphasize that when you prepare your models for next year, it's important to consider that seasonality. Don't simply take the increase in ARR and divide it by four. There is significant seasonality in this business, as you've observed over the last two years.

George, I was just wondering, when I listened to everything that you said, you talked about improving market share. It sounds like a better mix as you go through the year. You had accelerating digital transformation engagements during the quarter and into this quarter. And then, when I look at the full year guidance, it seems to imply when I look at the market, you’re expecting some sort of deceleration as you go up throughout the year, even when I take into account some of the tougher comparisons. Am I thinking about that conservatism right, or is there anything else you would say on the markets? Thanks.

Listen, I think when we look at the full year guidance for next year, we’ve guided 6% to 7% in terms of revenue growth. I think that what you see from us is real confidence in the business. The second half of the year is on a compare basis compared to a stronger second half this year as enterprise spending came back online through COVID, right? So, it isn’t an expectation of us having a deceleration in terms of our ability to grow cloud or gain share. It’s just a kind of a realization that the second half of this year is a stronger compare than the first half of this year.

Thank you. My question and it’s kind of a clarification, but also related forward-looking is, can you clarify for this quarter, how much of the revenues were organic versus acquisition? And then, the outlook, George, I know you mentioned $1 billion run rate. Is that based upon all organic? I assume that’s the case. But I just wanted to clarify because I think Mike mentioned about 30% of cash flow could be used for M&A. But I just kind of want to clarify organic versus M&A as you sit today, reported and as you look out. And again, congratulations on the great results and outlook.

Hey Jim, it’s Mike. Regarding the organic contribution to revenue, it was very small, less than 0.5 percentage point of growth. It was not significant at all, and this is related to the cloud acquisitions made earlier in the year, which had very little impact. In this quarter, it was minimal.

Hey Jim, when we examine the business, we are quite optimistic about our portfolio capabilities that will help us reach that $1 billion ARR target in fiscal year '25. We won’t differentiate between organic and inorganic growth at this point. We believe we have fully integrated our key acquisitions, Spot, CloudJumper, and Talon, and we are confident that our core strategies are solid for this year. We will keep looking for inorganic acquisitions to enhance our portfolio. We are starting off strong in a unique position within the cloud market and are very confident in our capabilities. We will share more details as we grow our cloud business. I want to emphasize three key points: we are expanding our cloud business while also growing our core business, gaining many new customers, and accelerating both our organic growth and our inorganic acquisitions. I feel very optimistic about our overall business. As Mike mentioned, cloud gross margins are close to the corporate average and are expected to contribute positively to company gross margins next year. I'm very positive about our cloud opportunities and the efforts our team has put in with cloud providers, and we plan to invest further in this area.

Congratulations.

Thanks, Jim. Next question?

Thank you very much. I had a question on cash flow. I understand that you guided to over $1.1 billion and this fiscal 2022 is going to have pressure from inventory and higher CapEx. But, as you think about the model on a longer term basis, should we expect that when you don’t have to buy excess inventory, we’ll start to see cash flow growth that maybe more closely mirrors what you’re able to do in terms of earnings, or will the increased CapEx be a drag for a longer period of time? Thank you.

Hey Shannon, it’s Mike. Thanks for the question about cash flow, happy to address that. Over the last four years, the operating cash flow results at NetApp have closely followed our non-GAAP operating income, at about 107% of that figure. We anticipate that over time, operating cash flow growth will outpace earnings due to the working capital effects from expenses in 2021, which we've mentioned in our script. Regarding free cash flow, we view next year's capital expenditures as likely being the peak. We continue to install hardware in data centers to support our cloud business, and as George noted, we are excited about several software options in this area. Additionally, next year includes around $50 million in capital expenditures for two facility projects: one at our Wichita site and, to a lesser extent, our new San Jose building. While we have some facility-related capital expenditures, that amount is significant for next year, which is why we believe we can keep capital expenditures below the $200 million figure I mentioned in the script. I wanted to explain these factors. Overall, I do think operating cash flow will closely align with operating income over time, even with some fluctuations each year primarily caused by working capital.

Hey, everyone. Congratulations on the strong results. Thank you for taking my question. I wanted to ask George and Mike about the new sales force. Is there anything significant that these initiatives can collectively contribute going forward? I'm thinking broadly, not just in terms of cloud but also with new customers and how you're repositioning the approach to customers from a solution standpoint. That's all. Thank you.

I think, we’ll continue to be careful about where we add sales teams. I think, we constantly rebalance to areas of opportunity, both in terms of the composition of the sales force and the locations where we put the headcount. I think, as I’ve said before, the recovery will be at different rates in different geographies. And I think as the public data indicates, the Americas is the place where we expect the recovery to be more pronounced this coming year, Europe lagging 6 to 9 months thereafter, and the rest of the developing economies maybe 6 to 9 months after that. So, we’ll prioritize any additions in accordance with how we see the end user demand. With cloud, we have been adding, step-wise. I think one of the important things that we’re focused on this year is to get our frontline sales teams to be balanced with selling cloud and our systems in customers’ data centers. And so, I feel like, listen, we’re not going to have a stepwise addition in our investment. We’ll do it as the business comes. And we feel very good about the disciplined approach we’ve taken and the payoffs for those investments in fairly short order.

George, are the current additions fully optimized at this point?

I think regarding the 200 hires, as we have mentioned, they are fully productive and integrated into the NetApp sales team. We have added some cloud personnel in the last quarter and expect to add more this year. As the business progresses, it will take some time for them to become fully productive, but their productivity ramp is comparable to that of our traditional sales team. From our guidance for the coming year, you can expect revenue growth to exceed the increase in operating expenses, which will provide more leverage in our business model. This reflects our disciplined investment strategy where we see opportunities.

I joined the call late. So, I apologize if I’m repeating the question. I noticed your inventories are at a two-year low. And I want to see what’s your strategy and how aggressive are you going to be out there buying key components, especially storage? And I have a quick follow-up.

Sure. Hi Mehdi, it’s Mike. We had very good inventory turns at the end of Q4. As I mentioned earlier, we’ve already started a few programs and will continue with them. One of these is focusing on key components related to our storage products to ensure we have sufficient resources, which is something we’ve always done and will keep doing. We’ll also add some safety stocks to address potential global issues, allowing us to respond appropriately. Additionally, we will extend our purchase orders throughout the year. We’re making every effort to ensure we have enough inventory. I expect that in Q1, you will see those turns returning to the 12 to 14 range. With the lower cost of capital, our goal is to always have product availability to meet customer demands, which we believe is a solid investment. So, you should see inventories increase and inventory turns decrease in Q1, likely continuing through the rest of fiscal '22.

Great. And just a quick follow-up. Your cloud services margins is becoming accretive. But is that higher cost of component that is capping the gross margin?

Listen, I think with regard to component costs, as Mike said, as we look out the next year, we see that the component cost in aggregate for the full year is going to be relatively flat to this year with some puts and takes in terms of the mix. I think that with regard to cloud gross margins, it’s really reflecting the balance of certain regions getting more heavily utilized and seeing customer consumption of the installed footprint, while we make investments in other regions to continue to expand our business. And that trade-off between investing to continue to expand the business with the growth in ARR is the balance we walk. I think as I also mentioned, we have several other avenues to continue to drive gross margins in cloud. The software mix in the portfolio is growing with solutions like Spot and Cloud Insights and some versions of our Cloud Volumes products being software-only. The second is we continue to drive efficiency in the software, in ONTAP operating system software. So, there are lots of avenues to continue to accelerate cloud gross margins. Team has done a good job this year. And we expect it to be accretive to company gross margins as we go through next fiscal year.

Maybe one more question on gross margin. In the past, you talked about a target to get product gross margin back to the mid-50s. You are at 54 and change already this quarter. Should we expect this gross margin to continue to improve over the next few quarters, given the mix shift towards the software heavy side products, or should we think about hardware and software margins both still have room to grow? And it sounds like higher component costs may not have an impact in the near term, but I just want to confirm that. Thanks.

Yes. Hey Sidney, it’s Mike. We have guided in our fiscal '21 in our Q1 numbers, product gross margins to be relatively consistent with how we exited Q4. Again, component costs over the full year, at this point, as we sit here today, relatively flat. It will move on a little bit by quarter, but keep in mind as well, mix matters a lot in that as well. Also in Q1, we talked about 68% gross margins. Keep in mind that there’s a much bigger component of revenue in Q1 that’s services versus product. So you also get that bump in margin. You saw that in the last couple of Q1s as well. So, as we sit here today, we don’t see a lot of movement in the gross margin numbers. Again that’s based on the component costs that we see today. Mix does matter in the quarter, but we’ve largely stayed relatively consistent with how we’re exiting Q4.

Thank you. And congrats on a great quarter and great guidance. And also, thank you for providing the extra visibility in PCS in terms of profitability with the gross margin comment, which is actually quite impressive about the scale. But, I always want more. So, my question here is, what about the operating income profitability of the PCS division? And/or maybe you can comment on where on the Rule of 40 is PCS operating at right now?

So, I want to make sure I understand the question. You’re not talking about gross margins. You’re talking about operating margins, Nehal?

Correct, correct. And then, maybe if you want to put that into the context of Rule of 40?

Yes. So, at this point, as you said, you always want more. We feel good about talking about our gross margins. We’re not going to go down to operating margins in that business that gets into a lot of allocations and things. So, what we’re going to do is we’re going to focus the business on gross margin. Do we certainly look at OpEx? And where we spend the money? Yes, we do. So, in terms of the Rule of 40, again, we have to go down the operating income. We won’t do that. We will keep it at the gross margin discussion. What I would say is, hey, tune in after the Q1 call, and we’ll talk about what we’re going to disclose going in '22.

Yes. Thank you. Your latest run rate all-flash array revenues are near a record of $2.9 billion and your year-over-year growth exceeded most peers. And so, I was hoping you could provide some parameters, at least qualitatively, around your fiscal '22 expectations for all-flash array growth, and maybe how the mix of your installed base plays into those expectations? Thank you.

Listen, I feel really good about our flash business. We are focused, differentiated and executing in the market. I think, our strong position in the sweet spot of the storage industry, which is the midrange part of the market, is clearly evident, and it is affecting the growth rates of our competitors. We have taken share for the last several quarters, and we see every confidence that we will continue to do that going forward. What we said at the Analyst Day was that over the next few years, the all-flash array market will grow at about 7.5% CAGR, and we expect to outpace that this coming year. We expect that the storage industry will grow around 4%, and our revenue picture expects us to outpace the growth of the storage industry overall. So, we feel really good. And ONTAP 9.9 coming out gives us even more confidence in our differentiation.

All right. Well, thank you, Karl. That’s our final question. So, I’ll hand it over to George for some closing remarks.

Thanks, Kris. In closing, we delivered a great end to a strong year. And we are well-positioned as we move into fiscal year '22. I want to reiterate that our public cloud business is at a scale where it is contributing meaningfully to revenue and billings growth. And the innovations we deliver to our hybrid cloud business will support continued product revenue growth. In fiscal year '22, we expect to grow the top line, deliver operating leverage and generate significant free cash flow, all while investing in growth initiatives. I am excited by and confident in our ability to capitalize on the industry transitions and the market opportunities ahead. I look forward to speaking with you again next quarter. Thank you for joining us. And a special thank you to our NetApp team.