NetApp Inc (NTAP) 2019 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

Welcome to NetApp's Third Quarter Fiscal Year 2019 Financial Results Conference Call.

(Operator Instructions) I will now turn the call over to Kris Newton, Vice President, Corporate Communications and Investor Relations.

Thank you for joining us on our Q3 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 Q3 earnings release for the applicable periods, 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 fourth quarter and full fiscal year 2019; our expectations regarding future revenue, profitability, cash flow and shareholder returns; and our ability 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 from our statements and projections 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.

Thank you, Kris, and thanks to everyone joining us today.

In the face of an uncertain macroeconomic environment, we focused on the variables within our control and delivered a strong third quarter.

Although I am disappointed with revenue being at the low end of expectations, our operational discipline delivered gross margin, operating margin and EPS that were above the high end of our guidance ranges.

Regardless of the demand headwinds, we remain well positioned for the long term as we address the growth areas of the market and drive efficiency in our business.

I'd like to address the challenges we saw in Q3 head on.

The macroeconomic environment is outside of our control but I remain exceptionally confident about our strategic position and operational focus to deliver profitable growth and shareholder value.

After a normal close to the calendar year, we saw a slowdown in purchasing across-the-board in January, driven by deteriorating outlooks for the global economy as well as uncertainty around trade policy.

In the face of these headwinds, our largest customers became more cautious in their purchasing behavior and sought more information on the implications for their businesses of slowing economies.

We did not see any real change in the competitive environment.

Our win rates stayed constant, and our pipeline remains healthy.

Our customers' purchasing decisions continue to be based on our features, capabilities and future-proofed cloud integration strategy.

Even in the face of softening demand, we were able to further expand product margins in the third quarter by focusing on the value our solutions bring in addressing customers' largest IT imperatives.

Like any company, we do not have perfect visibility into all the reasons for purchasing slowdowns.

However, we are deeply involved in the strategic planning and purchasing process of our large customers, and have good visibility into how they deploy us and where we fit into their IT strategies.

We remain tightly engaged with them, and as such, are confident that we have the right product set and the right go-to-market strategy to continue capturing a greater share of our customers' IT wallet.

Our unique customer value is reinforced by digital transformation initiatives, which are fueling data center modernization projects and cloud first strategies.

To succeed in the data-driven digital economy and radically improve business performance, customers need to accelerate digital innovation, generate real-time insights and secure access to their data across multiple clouds and on-premises.

This requirement for hybrid multicloud capabilities is creating 3 significant market transitions: disk to flash, traditional IT to private cloud, and on-premises infrastructure to hybrid clouds.

It is in these key strategic battlegrounds that we have substantial opportunity to exploit the advantages created by the NetApp Data Fabric and take share.

We are driving the market transition from disk to flash as we help customers modernize, simplify and improve application performance.

We are displacing competitors' complex equipment, gaining share in new workload deployments and upgrading our installed base with cloud-connected all-flash solutions.

In Q3, our all-flash array business, inclusive of All Flash FAS, EF and SolidFire products and services, grew 19% year-over-year to an annualized net revenue run rate of $2.4 billion.

We are overindexed in the large and growing all-flash market, with a significantly higher all-flash array share than in the total storage market.

Our advantage here will continue as the market shifts to flash, and we expect that shift to accelerate with ongoing NAND price declines.

All-flash arrays carry a higher ASP, which benefits not only product revenue, but also recurring services revenue.

With only 15% of our installed base currently running all-flash arrays, the runway for this secular transition remains in the early innings.

The second major market transition we're exploiting is the shift from traditional IT to private cloud.

SolidFire and NetApp HCI are the building blocks for private cloud deployments, enabling customers to bring public cloud like experience and economics into their data centers.

In the third quarter, we announced new validated and proven architectures that simplify the design, deployment and support of on-demand services and applications as well as support hybrid cloud workflows with an on-premises S3-compatible Object Storage.

Customers are embracing our unique value that couples extreme ease of use with enterprise scalability and quality of service.

And as a result, the momentum in our private cloud business that began in the October quarter, accelerated in Q3.

The shift from on-premises infrastructure to hybrid clouds is the third key market transition that we are taking advantage of to expand our business.

Only NetApp is building a comprehensive set of cloud data services available across multiple clouds.

We help customers extend on-premises environments to the cloud, deploy enterprise workloads in the cloud and build and refactor primary workloads for the cloud, with tools to optimize hybrid cloud workloads and cost.

Based on the last month of Q3, our cloud data services annualized recurring revenue is approximately $33 million, up 22% from Q2.

As we've said before, this is a foundational year for our cloud data services, during which we are focusing on operational readiness and deployment with the hyperscalers.

We are excited by the feedback that we are receiving from the growing number of customers who are in controlled production with us.

While still in early phases, we are well positioned for when these services soon become broadly available.

Roughly 2/3 of early Cloud Volume Service customers are new to NetApp.

This, coupled with the strong customer interest we are experiencing, gives us tremendous confidence in the potential of this part of our business.

In closing, we are confident in our position for long-term success, we are a leader in the large all-flash array market.

We are seeing accelerating momentum with our private cloud solutions, and our public cloud solutions are positioned to deliver strong growth in FY '20.

We are playing into the big market transitions from a position of strength.

Flash and cloud integration enables us to protect and expand the installed base of our core ONTAP business.

Our private and public cloud solutions enable us to reach new buyers.

Our flash, hybrid cloud infrastructure and AI solutions are serving as pillars of customers' new architectures, and we are seeing adoption of our cloud offerings as part of our customers' foundation for moving applications and data to the cloud.

These factors combined give us confidence in our ability to reaccelerate growth as customers become more comfortable with the external environment.

We have demonstrated discipline in managing the business, and will continue with a keen focus on the factors within our control.

We are paying close attention to execution to maximize our opportunity in an uncertain macro.

We again expanded gross margin, and increased profitability in the quarter, despite the slight moderation in customer buying behavior.

I would like to thank the NetApp team for their commitment to a high level of discipline, execution and customer focus.

With that, I'll now turn the call over to Ron to walk through our Q3 financial performance and go-forward expectations.

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.

As George highlighted, in Q3, we delivered strong margins and operating leverage in the face of caution from our customers around the macro environment.

This is a solid testament to the strength of our underlying business model.

Despite the market uncertainty, we are confident in our product leadership and strategy to reaccelerate growth going forward, and we remain sharply focused on execution and managing the variables within our control.

Consistent with our commitment to shareholders, we again improved gross margin, operating margin and delivered outstanding free cash flow.

In Q3, despite a slower demand environment experienced in January, net revenues of $1.56 billion were within our guided range and grew 2% year-over-year, including about 1 point of currency headwind.

Product revenue of $967 million increased 2% year-over-year, reflecting our shift to all-flash arrays and growing traction in our private cloud solutions, offset by about 150 basis points of currency headwinds.

There were no ELAs in the quarter.

Moving down the P&L.

Software maintenance and hardware maintenance revenue of $531 million increased 2% year-over-year driven by our continued growth in our installed base and to a lesser extent, our cloud data services business.

Gross margin of 63.7% was above the high end of our guided range.

As expected, we saw the normal seasonal sequential decline in product margin from Q2 to Q3.

Product gross margin came in at 52.6%, which is an increase of about 100 basis points year-on-year, reflecting continued sales force discipline in the face of macroeconomic uncertainty and about 50 basis points of currency headwinds.

This was the eighth straight quarter we increased product margins year-over-year.

The combination of software and hardware maintenance and other services' gross margin of 81.7% increased about 50 basis points year-over-year.

Operating expenses of $629 million were down 2% year-over-year, coming in lighter than anticipated largely due to lower variable compensation.

We remain committed to strong OpEx discipline and continue to expect operating expenses for fiscal 2019 to be roughly flat year-over-year.

Operating margin of 23.5% came in solidly above the high end of guidance, and represented a new company record.

EPS of $1.20 was above the high end of our guided range and increased 14% year-over-year.

We closed Q3 with $4 billion in cash and short-term investments.

Similar to Q2, we again saw healthy growth in deferred and financed unearned services revenue, which increased 7% year-over-year and was up $151 million sequentially.

Deferred revenue growth continues to be a strong leading indicator of the health of our installed base.

Our cash conversion cycle remained extremely healthy at a negative 11 days, which was roughly flat year-over-year.

Cash flow from operations was $451 million.

Free cash flow of $420 million represented 27% of revenues, while year-to-date free cash flows of $804 million represents 18% of revenues.

Q4 has historically proven to be a strong seasonal period for free cash flow conversion.

As such, we remain committed to driving free cash flow of 19% to 21% of revenues for the full fiscal year.

Our confidence in our long-term vision and execution is reflected in our capital allocation strategy.

During Q3, we repurchased 8.1 million shares at an average price of $67.84 per share for a total of $550 million.

Weighted average diluted shares outstanding were 255 million, down 21 million year-on-year, representing an 8% decline.

We have $2.4 billion remaining on our current share repurchase authorization, and we'll continue to be aggressive given NetApp's free cash flow yield and return on invested capital profile.

During the quarter, we paid out $99 million in cash dividends.

In total, we returned $649 million to shareholders, representing 155% of free cash flow generated in the quarter.

Now onto guidance.

Customer caution around the macro backdrop has heightened as we entered the new calendar year.

As a result, we expect Q4 net revenues to range between $1.59 billion and $1.69 billion, which at the midpoint, implies flat revenues year-over-year.

It is worth noting that our Q4 revenue guidance includes 200 basis points of currency headwind and is off a very challenging Q4 '18 compare where we grew total revenue by 11% year-over-year.

Consistent with the normal seasonal sequential decline in gross margin from Q3 to Q4, associated with product revenue being a larger portion of the overall revenue mix, we expect Q4 consolidated gross margins to range between 62% and 63%.

We expect Q4 operating margin to be between 23% and 23.5%.

We expect earnings per share for the fourth quarter to range between $1.22 and $1.28 per share.

The midpoint of our Q4 revenue guidance implies total fiscal '19 revenue growth of 4.6%.

Our Q4 guidance also implies fiscal '19 gross margin of 64.3%, operating margin of 22.7% and EPS growth of 28%.

As we look out to FY '20 and beyond, I am confident in our ability to reaccelerate growth and deliver on our long-term profitability targets.

We remain diligently focused on both disciplined execution and continued innovation.

In the face of a slower demand environment, our business model leverage and the secular tailwinds created by the 3 key market transitions, flash, private cloud and cloud data services, will enable us to continue to deliver on the commitments we've made to shareholders, partners and customers.

With that, I'll hand it back to Kris to open the call for Q&A.

Kris?

We'll now open the call for Q&A.

(Operator Instructions) Thanks for your cooperation.

Operator?

(Operator Instructions) Our first question comes from the line of Andrew Nowinski with Piper Jaffray.

Maybe I'll just ask a question as it relates to kind of your guidance that you gave at Analyst Day regarding fiscal '20 and '21.

I'm curious, just given the results that we saw today and your guidance for Q4, would you say you're still expecting to deliver at least 15% earnings growth over the next 2 years?

And then also, on the revenue, is that mid-single digit still valid?

Hi Andy, yes.

That is our plan and you're seeing in FY '19, we're going to do well above that.

And yes, our long-term guidance still is mid-single digits on the top line, absolutely.

Our next question comes from the line of Rod Hall with Goldman Sachs.

Pardon me, Rod Hall, please check your mute button.

Okay.

Our next question comes from the line of Matt Sheerin with Stifel.

Just relative to the weakness that you're seeing from your large enterprise customers, it looked like your direct business was down 12% year-on-year.

That was the first time in I think 6 quarters that you were down, but your channel business was actually up mid-single digits.

What do you think the difference is in terms of the tone of smaller customers versus large customers?

Because if you look at all the channel partners that have reported, they all talked about fairly strong growth and still good outlook for this year.

Our largest customers are the ones that we serve through a direct pathway.

The broad range of customers are served through a channel model.

The largest customers are the ones that are most affected by some of the uncertainty, both economic and political uncertainty, around the globe.

And you saw incremental caution in their buying behavior in January.

Matt, the other thing that's a little misleading, just to factor in is, in Q1 and Q2, we did have ELAs, which show up in direct revenue.

So they skew the direct number a little bit higher.

If you adjust for that, we're always within the last, say, 8 quarters, 20, 80.

And again, that's where the demand is fulfilled, not necessarily where it's created.

Okay.

And in terms of the ELAs, you didn't have any revenue.

You've had some good revenue there in the last few quarters.

Is that more of a timing issue and related to the weakness that you're seeing from your large customers?

No.

It has nothing to do with that.

Nothing at all.

It's just -- as we said when we first started talking about ELAs, they tend to be difficult to predict and lumpy.

And there weren't any we had in the quarter or anticipated to have.

Our next question comes from the line of Rod Hall with Goldman Sachs.

Rod, please go ahead.

Let's move on to the next question.

Our next question comes from the line of Wamsi Mohan with Bank of America.

Ron, can you talk about the gross profit at a product level?

If you could bridge that sequentially from last quarter to this quarter, the 150 bps sequentially?

And given the revenue deceleration that you have seen, do you think that you can hold a 50% product gross margin over the next year or so, especially when the competitive environment becomes a little tougher with -- around the mid-range storage product launches that are anticipated to happen later in the year?

Yes.

Thanks, Wamsi.

Yes, I mean, if you look at the last 8 quarters, we've grown product margin each of the last 8 quarters year-over-year.

And our intent is still to do that.

The target we gave you was 55% to 56% and we still plan to do that.

The bridge from Q2 to Q3 on the product side, remember, this is always a seasonal thing that happens with the public sector quarter being Q2.

And then typically, we have a falloff in that business.

So that's very traditional, we saw this each of the last 5 years, so we had some of that seasonality, FX was a headwind and then we had no ELAs in the quarter.

We had in the last quarter, and then that's offset with some benefit from NAND pricing.

Okay, great.

And George, just a quick clarification for you.

I think you noted that elasticity of demand could sort of kick in given these NAND prices.

Is there typically a 3- to 6-month lag that you expect to see this elasticity of demand with the macro environment sort of clouding maybe that elasticity of demand from kicking in faster?

We think that over time, as NAND prices continue to decline, that customers will shift the mix of their business from disk-based systems to flash-based systems.

We saw good acceleration in our flash system counts through the course of the quarter.

We saw some incremental caution in terms of how much capacity customers were buying, which could be correlated to buying for today's needs as opposed to building out for their entire future requirements.

So we saw a little bit of that.

It's reflective of a bit to the macro environment.

We believe that as NAND prices continue to move favorably, it gives us an opportunity.

We are well positioned in the flash market.

We have strong differentiation with software, which has allowed us to preserve and even grow gross margins.

And if you look at the ASPs of a flash-based system as opposed to a disk-based system, they are actually higher.

So we think that's a good trend for us to capitalize on.

Our next question comes from the line of Aaron Rakers with Wells Fargo.

First of all, could you just help us understand, I mean, the rate of deceleration that you saw during the month of January?

And as you thought about the guidance for this current quarter, your assumptions how maybe February played out?

And how -- what assumptions you're making relative to what you saw in January as far as any kind of improvement?

And I have a quick follow-up.

I would say that we felt very good about where we were within the quarter, sort of heading into the Christmas holiday.

And things changed materially through the last week of December and really January.

I think that we did not see any change in the competitive dynamic, win rates or any of those aspects.

We just saw an increased amount of scrutiny in terms of spending within our customers, them requiring more approvals and just buying for today as opposed to buying the full scope of what they plan to buy with us.

I think that, with regard to some of our largest customers, the global customers that are exposed to geographies around the world as well as to public sector, there will be time before they come back to their normal course of spending, right?

Some of that is related to sort of clarity on how their business is impacted, and some of that, like in public sector is, it takes time to get the workforce back and into normal operating cadence, which is reflective of our caution in Q4.

Okay.

That's very helpful.

And then on the NAND pricing front, can you just help us understand at what -- what rate of declines you're currently seeing on the flash side?

And how you would characterize your ability to hold flash pricing in the market?

Yes.

The price declines we're seeing are not perfectly linear.

They continue to go down.

I think what we -- you got to remember is, the storage industry in our company's history is predicated on decreasing commodity pricing.

So in many ways, as George said earlier, it catalyzes demand for new use cases and drives the never-ending appetite for increasing data consumption.

So it's something we're predicting.

It's why we have an over-rotation on flash.

We know that, that's the growth area.

The price reductions help that growth.

As George said, you see the elasticity between the different types of media, and so as NAND prices come down, more workloads move to all-flash.

And we are seeing that.

If you look at system counts and capacity counts through the course of this fiscal year, they have been both quite up substantially.

I think what we noted this quarter, especially in January was, a little bit of a step back in caution around capacity.

System counts continue to be really good.

Our next question comes from the line of Ananda Baruah with Loop Capital.

Hey, George and Ron, any greater context you can provide on what your large customers are using as signposts?

I mean, you mentioned, George, I think in the prepared remarks, that they're looking at their end business.

And then just quick follow-up to that, do you have any sense of, if they're pausing, on how broad it is?

Are they pausing on new implementations?

Or are they milking -- not milking, but they sort of raising capacity on existing projects.

You mentioned that they might be adding less capacity on new projects like that.

Would just love any more context around those 2 things.

I think it's just too early to draw broad conclusions.

I would say that January represents a new budget cycle for a lot of our customers.

And as they get their planning in place, I think they took a little bit longer this year than typical, because of the uncertainty.

I think we saw the transformational projects that have multi-quarter implementations continue apace.

I think in the next new projects, so I think people were probably a little bit more cautious waiting for clarity in terms of how their business rolled out.

I would say, in terms of our book of business, all of the strategic areas of focus for us, all-flash arrays, private cloud and our cloud data services, we feel good about our progress across all of those dimensions.

They really reflect the strategic aspect of our discussion with customers, and we feel good about the progress on all of those dimensions.

Just keep in mind, even if you isolate Q3, it's really -- we were off 2% from the midpoint.

And if you look at the full year based on the midpoint of the Q4 guide, we're off maybe a little over -- almost 2 points in the full year.

So in the scope of the greater scheme of things, we're still pretty much on exactly what we thought, from mid-single digits.

Our next question comes from the line of Katy Huberty with Morgan Stanley.

Ron, for you on gross margin guidance, as I look back at the last 2 fourth quarters, total company gross margins were actually up a little bit sequentially, despite the fact that the lower margin product business was growing very fast.

And you didn't have as much help from NAND.

So can you just talk through why this year, you think total company gross margins are down sequentially?

So Katy, I think the better compare is really year-over-year.

I think that's a more meaningful compare.

And then remember, what we typically see sequentially is -- and you see this from Q1 to Q2, Q2 to Q3, generally, and Q3 to Q4, the higher weight of product margin and product revenue which grows, carry just a slightly lower margin than the services margin, so that always puts pressure.

That's a mix issue that we see all the time.

Okay.

And then just George, just as a follow-up, I think 1 year ago, you talked about exiting this fiscal year with, perhaps...

I think we lost Katy.

Sorry, sorry.

Just a follow-up for George, at about 1 year ago, you talked about exiting this year with $6 million of cloud services revenue.

And it looks like you're tracking a little bit below that.

Why do you think that is?

Or is that not the right way to think about it?

We are in the foundational year of our cloud data services business.

I would say, we are a bit behind where we expected to be in terms of the operational readiness of our service offerings with our cloud providers.

We are, as we said, generally available with AWS.

We are in controlled pilot production projects with both Azure and Google, and we expect them to be available imminently.

I would say that, we are probably 0.5 basis point towards -- below where we guided for the full year revenue.

But we are excited at the results that we're seeing.

It confirms all of our expectations in terms of differentiation.

We have broadened the range of use cases and workloads that we serve.

And so as soon as we get to generally available with these cloud providers, we feel very good about our ability to inflect the business and return and accelerate that.

In terms of our long-term model for cloud data services, we're not backing off the projections we had.

As Ron mentioned, we feel confident about our long-term model for the whole business as well as for our cloud data services.

The next question comes from the line of Steven Fox with Cross Research.

Just one other question on the slowdown you saw in January.

Is there -- could you isolate it to what verticals maybe were more -- where you saw it more in terms of the slowdown?

Or geographic regions?

And given we're talking about longer-term start-up projects, like what would you say would be the extended decision timeline versus what you previously thought for these things closing or starting to ramp at this pace you originally anticipated?

I would say that, one of the areas that we talked about as having some decisions pushed out was in U.S. public sector, where we said in Q2 some decisions pushed out.

We saw the recapture of a preponderant majority of those decisions in Q3, and we were able to move those projects forward.

With regard to the broader macro, I don't think there were any specific industry trends that we noticed.

I think that, clearly, those industries with specific exposure to China and public sector were incrementally more cautious.

But I think, there weren't any other specific trends that we could draw out.

With regard to the U.S. public sector, as we said earlier on the call, we think that it will take some time for the government to get back to full-fledged operations.

And so we don't have perfect visibility into how projects shape out through the course of the coming quarters, so we're being incrementally cautious there.

Our next question comes from the line of Mehdi Hosseini with SIG.

One question for George.

How do you see the replacement cycle for 10K RPM playing out for the remainder of 2019?

Is it going to be more of a -- late in the year?

Or we should think of this cycle kicking in next year?

And for Ron, how -- I know this is a little bit far out, but as we look into fiscal year '20, how aggressive are you going to be in managing your OpEx?

Let me take the 10K RPM drive question.

I think there's still work to be done to get a viable solution to replace some of the capacity points that 10K drives were focused on.

If you notice the majority of the 10K drives that are still being deployed are actually lower capacity points than some of the TLC NAND solutions that are available in the market at comparable effective dollar per gigabyte price points.

So you can see some customers that say, "listen, I want to strategically move to all-flash for its benefits." That increasingly start to look at that as an option.

But I think for the full transformation to happen, you will need quad layer cell or the next sort of capacity price point in the NAND cycle.

And we're working on that, but it'll take some time.

So Mehdi, on your OpEx question, yes, it's a little bit early for that.

But I'll remind you what we said at Analyst Day last April.

So I guided this year to be roughly flat in OpEx and actually next year as well.

But remember, we're still actively doing a ton of transformation, so we're still doing a lot of investment, and a lot of disinvestment.

So it's not as if we're just staying flat and not doing anything.

We're really working on getting a lot more efficient.

In terms of -- just to underscore that point, we have made all of these bets into the new parts of the market, private cloud, all-flash arrays, cloud data services and new pathways to market, while simultaneously improving operating margins to a record.

This quarter, operating margins are the highest -- been the highest in the company's history, right?

So we will continue to stay disciplined on the operating expense side of the business, but we're not going to forego strategic opportunities for short-term gain.

I think we're -- maintain discipline, and you'll see us continue to invest into the future opportunities, while being prudent about overall spend.

Our next question will come from the line of Alex Kurtz with KeyBanc Capital Markets.

George, just on hyperconverged, I know this has been a big area of investment for the company over the last couple of years.

I know it's still kind of working its way through the channel and with the sales organization, but if we were looking to fiscal '20, are you prepared at this point to provide kind of a run rate that you think is reasonable?

Or a percentage of product revenue?

Or just sort of a contribution to the overall product side of the business?

That'd be helpful to understand.

Our overall private cloud business, meaning, SolidFire deployed standalone or as part of a hyperconverged model, for large customers, they deploy it standalone.

For smaller and mid-market customers, they deploy it as hyperconverged.

As well as Object Storage, which are deployed for cloud native applications in a private cloud form, were a substantial contributor to NetApp's revenue this quarter.

I'm not prepared at this point to break it out, but I can tell you that they performed in a really good pattern across customer counts, revenue contribution, units, strategic wins, you name it, we got it.

And we think that as we look forward to fiscal '20, it gives us a really strong second leg foundation to our growth, right?

So we're already a leader in the all-flash array market.

We are seeing accelerating and materially accelerating momentum in the private cloud game.

So stay tuned, we'll tell you more as we head into fiscal '20.

Our next question comes from the line of Tim Long with BMO Capital Markets.

Ron, you talked a little bit about the installed base when referring to the software, hardware maintenance and services.

Just give us -- if you can just give us a little more color there?

It was up a little bit year-over-year.

It looks like it was down a little bit sequentially, so is there a seasonal pattern there as well?

And when do you think we could expect to see that line with a little bit more sustainable growth?

Is it dependent on just all-flash array being a bigger piece of the overall base?

Or cloud data services?

Or what do you think will help move that line higher, more sustainably?

Yes.

So as we talked about, we continue to grow system counts in the installed base.

And remember, up until 2 years ago, we had, I think, 13 quarters of sequential decline in a row on the product side.

So we've really got to get back to 13 quarters of year-over-year increases in the installed base to really get back to where that, you'll see that grow again.

So we're probably several quarters away from that.

We don't -- as you know, we don't guide that discretely, Tim, so even though we'll give guidance on the next call for FY '20 I won't guide it specifically.

I'll give some general color, though.

Our next question comes from the line of Simon Leopold with Raymond James.

I wanted to see if you could talk a little bit about what's happening in your competitive environment?

And to what degree your growth is driven by your customer base upgrading their base of NetApp platforms versus to what degree are you dependent on basically taking footprint from others in the marketplace?

We did not see any change in the competitive dynamic through the quarter.

I would say that when you look at our all-flash array business, it is expanding wallet that we used to not have within our traditional enterprise customers as well as through our cloud solutions, both private cloud and certainly public cloud solution, we are expanding to net new customers.

I'll simply give you some data which says that, of all of our cloud customers that we are engaged with, either through the hyperscalers or through our own cloud software offering, 2/3 of them are net new to NetApp, so they are opening up new relationships and new logos for us to acquire.

So we do not see any fundamental change within the competitive landscape.

We think that as the market transitions from disk-based to flash-based systems, given that we are a leader in all-flash with a substantially higher market share percentage than we are in disk, there are a lot of weak, large players in disk-based systems that we will take share from, IBM, Hitachi, Fujitsu, Oracle, HP, there's a lot of them.

And even Dell has a challenged midrange portfolio and high-end portfolio.

So we feel good about our opportunities.

We've got to execute to capture them.

Our next question comes from the line of Jason Ader with William Blair.

George, Cisco just reported, and they didn't see the macro issues that you guys apparently did.

So I'm just wondering, how do you explain that, number 1. And number 2, do you think there might be something else going on, in terms of maybe NAND pricing, causing some customers to delay just because they want to see where prices go in the market?

We did not -- I can't comment on what Cisco saw or not, so I would leave that to Chuck to comment.

I think with regard to our business, what I can tell you is, we maintain discounting through the end of the quarter, so it's not a matter of hey, if you offered a lower price, customers would step forward and transact.

I would tell you, based on being involved deeply in many of these transactions, we saw an increased level of scrutiny on transactions, where you would have to get more purchasing approvals or provide for greater explanation of ROI or business case or things like that.

And so I would just tell you that, if it were as easy as providing a discount to deal with forward-priced NAND contracts, we have the vehicles to do that, and we would have applied those.

Okay.

And then 1 quick follow-up for you, George.

Just on AWS re:Invent this year, Andy Jassy spent like a half an hour talking about Amazon's new file-based storage offerings.

And I was just wondering, what impact you think that might have on your offering through AWS?

We continue to see really good uptake of our cloud volume software through AWS.

And so I'm sure he has his own offerings, but that hasn't had any impact on NetApp.

Our next question comes from the line of George Iwanyc with Oppenheimer.

George, Europe looked -- behaved a little bit differently, it looked relatively strong.

Can you give us an idea of what's happening there?

And just a quick follow-up as well.

It was really good execution by European team.

We are the leader in all-flash arrays in many parts of the European market.

We have big strategic relationships with customers.

There is volatility in the European political landscape.

We did see some GDP changes.

We're being cautious about the overall environment, but I just want to say that our team executed well and stayed in control of the business till the end.

Okay.

And can you give us an update on your Lenovo partnership?

I mean, if that's helping in China.

It's too early to comment about the success of the partnership.

We are in the market.

We are seeing wins that are additive to the NetApp footprint.

It's too early for me to characterize them in terms of size or color except that, listen, this is additive to NetApp.

I think with regard to China, it gives us a pathway into that market that is isolated from some of the trade tensions.

The NetApp team finished the NetApp quarter well, and executed well and I want to thank them for that.

And we're looking forward to the joint venture getting off the ground soon enough, and we'll keep you posted as the news of that and the operational readiness comes online.

So we feel like the China approach that we have is positioned well to endure all of the challenges that might exist between the geopolitical -- in the geopolitical relationship, and it allows us to focus from a branded channel perspective on the rest of the world, while Lenovo helps us with their enormous resources in China.

Stay tuned.

Our next question comes from the line of Paul Coster with JPMorgan.

The macro uncertainty that you saw in January that was manifested in the slight change in behavior of your large customers.

Was that also true of the cloud service providers, either as partners or even as customers?

We don't -- the 3 major hyperscalers, meaning, Amazon, Google and Microsoft, do not buy hardware from us.

They work with us where we deliver a service through their data centers to customers.

So they're more like a partner.

We saw no evidence of them backing off.

In fact, the range of use cases and the deployments that we have with them are widening rather than narrowing.

There are other cloud service providers who we sell to, and sort of not the superjumbo hyperscalers.

And across them, there was a variety of puts and takes.

I think many of them are being careful to prioritize the investments around their best opportunities.

For example, 5G wireless, right?

So I would just say, they're going through one of these evaluation of priorities process, and so we did see some changes in that mix.

Okay.

And then the other sort of big secular thing that's happening, of course, is more and more workloads and data is being pushed to the edge.

Are you seeing any manifestation of that through your business?

Yes.

We are pleased by the growth of the use cases that we are deploying in the edge, so we have software-defined solution that are part of ruggedized environments that are deployed at the edge in industrial and public sector use cases, we saw good traction.

We saw good traction with our Object Storage portfolio, providing a private cloud for certain advanced telemetry use cases, in autonomous driving.

We saw good adoption, early, but still good adoption of some of our A.I. solutions to crunch the data that is generated at the edge and brought back to the core.

So we remain optimistic that our solution portfolio is good and differentiated, and the number of growth engines we have, as the macro stabilizes, is certainly broadening from even a year ago.

Our next question comes from the line of Jim Suva with Citi.

George, I think you've been very clear about the demand environment and a lot of questions on that.

So maybe I'll switch the -- a question over to Ron.

Ron, in the past few quarters, there were several ELAs that came up, and then none this quarter.

I think some people were thinking that ELAs might just kind of be a normal course of doing business.

So with none this quarter, is the normal course of doing business, at a 1 or 2 a quarter, kind of not really how it's going to turn out or were there a couple of customers who signed ELAs and just other people that don't want that?

Or any type of behavior change on kind of the topic of ELAs?

Or just simply, is it lumpy and we shouldn't expect it to be 1 per quarter or something like that?

Yes.

It's a good question.

Last quarter, I mentioned it's hard to anticipate when they're going to land, so I gave a full year view this year and the next year as you should expect roughly 2% of revenue as ELAs.

It is lumpy.

They're hard to predict.

There will be quarters when they're 0, there will be quarters when they're quite a bit more than that.

So it's just a really difficult thing to predict, and I can only give a full year guide on it.

It's going to make some quarters difficult compares.

This quarter -- this year in Q1, we had a very robust ELA quarter.

That's going to be a difficult compare.

Hey Jim, we did not anticipate ELAs, nor did we see them.

So it performed according to plan.

Yes, I just wanted to make sure there's no change in behavior.

It was more just the timing of it and things like that.

That's right.

And remember, we did about $90 million in Q1 and about $20 million last quarter, in Q2.

So we really don't have much left to do to get to that full year 2% guide.

Our next question comes from the line of Karl Ackerman with Cowen and Company.

George or Ron -- well, I guess Ron, looking at product gross margins, excluding ELAs, with enterprise SSD prices declining roughly 20% this quarter and the next, would you expect to see a massive whip higher in your product gross margins beyond April?

And you continued to improve hardware maintenance margins.

That's certainly an impressive feat, for sure.

What do you think has been the biggest key contributor to that improvement in hardware maintenance margins?

And why would I be wrong to conclude that business couldn't have, perhaps, an 8 handle on gross margin over the next few years?

Yes.

So the first part of your question, we are seeing some benefit in total margin for NAND.

But it's really more of a focused effort, really, over the last 8 quarters, not just in the last couple of quarters.

So it's hard to anticipate what might happen, and I'm not going to telegraph what I think might happen, other than I'm confident we'll get back to 55% or 56% eventually on product gross margins.

I've been pretty clear about that.

On the hardware maintenance margins, I think you've got to be a little careful.

We do have competitors in that space.

We have to be careful what our margins are and what we charge, and we need to make sure that customers feel that we can provide a quality service at a reasonable price.

And they can see those gross margins as well.

So you got to make sure they're not ridiculous.

Our next question comes from the line of Steve Milunovich with Wolfe Research.

George, you talked about the importance of executing in the future.

Could you talk about the evolution of your go-to-market?

And one thing I've heard is that, NetApp may not be as good as some competitors in selling to new customers, not as comfortable selling up to the CTO, the CIO, the CFO and I know that this is also part of your selling value to get that 55%, 56% product margin, so on -- kind of update on go-to market?

I think it's a place that we continue to work to improve our capabilities, right?

I'd say that over the last 1.5 years, 2 years, we've opened up new pathways to market.

For example, with Lenovo, into parts of the world that we have historically not had a lot of footprint, with the hyperscalers, into the top of the accounts, where big digital transformation projects are and have expanded the total addressable market as the result of solutions like our private cloud solutions.

We have continued to optimize our sales coverage model, so that we can align resources to go after net new accounts and net new workloads.

And we believe there's substantial total available market for us to go address.

And so this is an area where we have to improve, and we're going to continue to try to do so every quarter.

Our next question comes from the line of Eric Martinuzzi with Lake Street.

A question for George.

The -- in your prepared remarks, you talked a little bit about the installed base being such a terrific opportunity, because I think it was only 15% had gotten their -- purchased the all-flash array.

In some ways, that's encouraging, because it shows the wide open opportunity.

But in some ways, we've heard that number, at least I can recall hearing it several quarters now.

I'm just wondering, what is it that's got the installed base, maybe reluctant is the wrong word, but what can you do to enhance the adoption of all-flash in the installed base?

The installed base is a very, very large number of systems.

And so what -- as we are growing our flash systems, we are also simultaneously growing our installed base, right?

So both numerator and denominator are growing.

The things that will help catalyze the movement are really consolidation and economic projects to improve that installed base.

As flash gets cheaper, it certainly makes it a more viable prospect to help customers upgrade their installed base, as some of these next-generation data center projects get underway in our customers, there is opportunity to certainly improve that conversion.

But it will take time, just given the magnitude of that installed base.

Do you have any, like a 2- to 3-year horizon where you expect that 15% could become 25% or 30%?

I don't have any forecast at this point.

I do think it'll follow the trend of our flash opportunity.

And we're mindful of the fact that, hey, our installed base is an opportunity.

Our next question comes from the line of Nick Todorov with Longbow Research.

It sounds like you're rightfully cautious on the large customer side in the U.S. public sector.

But I just want to understand your underlying guidance assumptions for the channel business.

Are you guys as rightfully as cautious as there?

Or is -- there's a little bit more optimism into that end of the market?

And overall, what is the outlook for 2019?

How we're spending that you're getting from the channel business?

We have roughly 80% of our business fulfilled through the channel, and that's the number that we break out in the categorization of our financial metrics.

That number has stayed relatively stable for a very long period of time, and we don't foresee a substantial mix shift this coming quarter nor next year, right?

I think within that channel number, there are a set of customers that the channel fulfills for large customers, and others for small.

The small, medium customer segment performed better this past quarter.

We continue to believe they are a growth opportunity for us given our share in that market.

We're more cautious about the large customers, who have global businesses.

Our next question comes from the line of Rod Hall with Goldman Sachs.

I wanted to zero in on the year-over-year growth rate, on the revenue.

I just -- I'm looking at the trend here, back in April of '18, it was 11%, 11.6%, then 7.2%, then 1.6% in January and then you're guiding for basically flat, maybe down just $1 million or $2 million.

And so I guess, what I wanted to ask is whether you believe this April guided quarter is the bottom on that trend?

And if you don't believe that, why not?

And if you do believe it, why do you believe it's the bottom?

So I think what you got to remember is, the guide we gave, which looks roughly flat year-over-year has 2 points of currency headwind.

The 11% you mentioned last year had 2 points of currency tailwind.

I would think it would be, we're going to do mid-single digits next year, that's the guide, I can tell you right now.

So I don't know how that will quarterize, but obviously, that has to be -- we have to be growing from where we're ending Q4.

So Ron, you'd be just saying that, then the January quarter's the bottom and if you add the 2 points back, you're kind of -- well, you're kind of flatlining on the growth that you saw in January, and then from here, we can guess what the trajectory might be?

That's right.

That's right.

Our next question comes from the line of Nehal Chokshi with Maxim Group.

So I think DSOs were up 5 days year-over-year.

So presumably, that means that things were a little bit more back-end loaded than usual, yet you talk about how you did see a slowdown at the back end of the quarter.

So A, can you help bridge that, perhaps maybe you saw a loosening up of that demand at the end of the quarter, but not enough to make up for the shortfall at the beginning of January?

Yes, Nehal, it was really odd.

It was not back-end loaded.

We saw kind of that demand as we talked about, kind of wane in January, so that's not the issue.

When I dissect the reason for the escalation in DSOs, which is not significant.

It's just a mix of customers that had slightly different terms than they did last year.

Wherever you end up with collections at the end of the quarter, based on that group of customers could be different than the prior year compare -- or prior quarter compare.

I would point out that we're still -- we still have a very negative cash conversion cycle, so I'm pretty happy about that.

Go ahead, Nehal.

Yes.

George, you mentioned that you're a bit behind on the operational capability to the cloud services, which are cloud service providers.

Can you delve into why it's behind?

And then also, there has been some management shakeups at some of these cloud service providers.

Does that create some opportunity for NetApp as well?

Well, we've got really good long-standing relationships with them.

We are performing deep technical integration of our technology into their service delivery platforms, and we're going through tests to get certification, right?

So we are going to be imminently available, and we look forward to that.

We are excited at the production pilots that we have going on with their customers.

So stay tuned.

I think we have an expanding range of opportunities through those cloud providers.

And now I'll pass it back to George for some final remarks.

Thanks, Kris.

Despite the near-term demand headwinds, created by the uncertain macro, we were able to beat on gross margin, operating margin and EPS.

We continue our strong discipline in managing the business.

As the economic uncertainty abates, we are well positioned to reaccelerate our positive momentum by capitalizing on the key market transitions created by digital transformation.

We are playing into these transitions from a position of strength.

Our solutions allow us to reach new buyers, while growing our installed base.

We are a leader in all-flash.

The momentum in our private cloud business is accelerating.

Our public cloud solutions with large hyperscalers are poised to deliver strong growth in fiscal '20.

All of this supports our confidence in our long-term model for mid-single-digit top line growth.

Thanks for your time.

I look forward to speaking to you again next quarter.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a wonderful day.