Good day, and welcome to the NetApp First Quarter of Fiscal Year 2024 Earnings Call. Please note this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President, Investor Relations. Please go ahead.

Hi, everyone. Thanks 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. During today's call, we will make forward-looking statements and projections concerning our financial outlook and future prospects, including our guidance for the second quarter and fiscal year 2024; expectations regarding future revenue, profitability and shareholder returns; and growth initiatives and strategies. These statements are subject to various risks and uncertainties, which may cause our actual results to differ materially. For more information, please refer to the documents we file with the SEC and on our website. We disclaim any obligation to update our forward-looking statements. All financial measures presented will be non-GAAP unless otherwise indicated. Reconciliations of GAAP to non-GAAP estimates are available on our website. I'll now turn the call over to George.

Thanks, Kris. Good afternoon, everyone. Thank you for joining us today. Q1 marks a solid start to FY '24 in what continues to be a challenging macroeconomic environment. We delivered revenue above the midpoint of guidance, while our operational discipline yielded operating margin and EPS above our guidance ranges. As I have outlined on previous calls, we focus on managing elements within our control; reinvigorating efforts to drive better performance in our storage business; and building a more focused approach to our Public Cloud business. We are seeing positive early indicators from this plan to sharpen our execution, deliver growth, increase profitability, and further strengthen our position for long-term success. Looking at the results of the quarter, I am especially pleased with the reception to our recent product introductions. The AFF C-series has been the fastest ramping all-flash product launch in our history, with strong demand across all products in the family. Similarly, the AFF A150, our entry-level, high-performance all-flash array, grew quickly in its first full quarter of shipping. Our Storage Lifecycle Program is also seeing good early uptake, driving longer-term commitments to NetApp as we help customers future-proof their environments with a world-class ownership experience. Building on this momentum, we introduced more storage innovation in Q1. We announced the ASA A-series, a family of SAN-specific all-flash arrays, supported by industry-leading data availability and efficiency guarantees. These systems are the only all-SAN storage arrays with virtual machine and application-granular data protection mechanisms. Complementing our unified storage offerings, they enable us to expand on the tens of thousands of customers who already use NetApp for block storage today and drive share gains in the $18 billion SAN market. In addition to delivering on our innovation agenda, we have implemented the go-to-market changes we outlined on the Q4 call, focusing our enterprise sellers on the flash opportunity and building a dedicated model for cloud. In May, we held our annual sales kickoff meeting, the first time we've gathered the global team in person since the pandemic. Everyone was energized by the innovation we're bringing to market and the objectives appropriately aligned with each team's strengths. Because many of the products we've introduced open new TAM for us, we're including training to sharpen our attack on these opportunities. The changes have been well received, are already showing up in pipeline expansion, and should help drive top-line growth in the second half. Q1 Hybrid Cloud segment revenue of $1.3 billion was down 12% year-over-year. Our all-flash array business decreased 7% from Q1 a year ago to an annualized revenue run rate of $2.8 billion. The demand environment is unchanged from the last half of FY '23, with headwinds from enterprises continuing to weigh on product and AFA revenue. Additionally, as Mike will outline, the first half of fiscal year '23 benefited from elevated backlog, impacting the year-over-year comparisons. In the past few quarters, every conversation I've had with customers and investors has touched on artificial intelligence. Generative AI is top of mind for everyone. While still in the early innings of this opportunity, AI is not a new topic for us. We have been a leader in storage for predictive AI and machine learning workloads since we introduced ONTAP AI, a joint NetApp and NVIDIA-proven architecture, in 2018. Today, hundreds of customers rely on NetApp's storage infrastructure and data management for their AI workloads, including some of the largest pharmaceutical, financial services, and retail companies in the world. Effective predictive and generative AI projects depend on high-quality, well-managed, unstructured data. The data pipeline and workflow typically involve data from multiple file and object sources across cloud and on-premises. High-performance, highly scalable hybrid cloud storage and data management is a core NetApp advantage and naturally positions us as a leader in this market, which will continue to benefit us as the Gen AI market evolves. While early, we are already engaged with customers who are interested in fine-tuning large language models with their own data on-premises, as well as those who are leveraging the hyperscalers' Gen AI offerings on the public cloud together with the storage and data management capabilities of NetApp Cloud Volumes services. Accelerated by the rise of AI, data continues to grow in both volume and value. A company's data is its most valuable asset. Our robust cyber resilience portfolio helps customers ensure that they have the right enterprise data protection and security on-premises and in the cloud. With built-in features that protect and secure data and deliver rapid recovery based on AI and machine learning, our systems can proactively spot and counter malicious or anomalous actions. Our confidence in our industry-leading capabilities is underscored by the ransomware recovery guarantee we announced in Q1 and demonstrated by the fact that NetApp is the only enterprise storage vendor on the NSA's classified program components list. Now, turning to Public Cloud. I want to acknowledge that our cloud results have not been where we want them to be and assure you we are taking definitive actions to hone our approach and get back on track. At the start of this year, we aligned our cloud sales specialists to our hyperscaler partners' go-to-market structures. Additionally, we are in the process of a strategic review to sharpen the focus of our cloud portfolio, expand on the success of first-party services, and improve subscription performance. We will have more details to share with you on our next call. That said, Public Cloud segment revenue in Q1 was $154 million, an increase of 17% year-over-year. Public Cloud DBNRR declined to 107%. Within these numbers, strength in first-party and marketplace consumption services was masked by weakness in our subscription services. Let me emphasize that our strategic focus is on first-party cloud storage services, and we continue to see customer expansion, deepening partnerships, as well as revenue and ARR growth in this part of the portfolio. Our expectations for FY '24 Public Cloud revenue are reflected in the guidance Mike will walk you through. First-party storage services, branded and sold by our cloud partners, position us uniquely and represent our biggest opportunity. Our partnerships with the cloud providers are strong and delivering growth. Our close and long-standing relationship with Microsoft Azure continues to deliver solid growth. Likewise, our partnership with Google remains strong. And in the coming weeks, you can expect to hear exciting news about the expansion of our partnership. Our relationship with AWS is also yielding positive results. As expected, we are starting to win large enterprise deployments with FSx for NetApp ONTAP. We were chosen to be the cloud storage infrastructure for a global sportswear manufacturer's SAP HANA deployment. FSxN was the only storage service that could meet the company's mission-critical service level, availability, and recovery requirements. This is a large, long-term SAP project that will continue to develop and grow over the coming years, driving significant consumption of FSxN capacity. In the face of the challenging macro, demand remains muted, and sales cycles remain elongated. Although customers continue to exhibit caution, they are moving forward with strategic initiatives, prioritizing investments in applications and technologies that drive business productivity and growth. Our modern approach to hybrid, multi-cloud infrastructure and data management enables IT organizations to leverage data across their entire estate simply, securely, and sustainably. Customers turn to NetApp to help them increase the performance and reliability of their digital and cloud transformation projects. Looking forward, our priorities are clear. We will continue to tightly manage the elements within our control, reinvigorate efforts to drive better performance in the storage business, and continue to refine our Public Cloud business. Early results indicate we are on track to drive margin expansion and earnings growth year-over-year while yielding top-line growth in the back half of fiscal year '24. Before turning the call over to Mike, I want to thank the NetApp team for their continued focus. I also want to remind you that we'll be hosting our INSIGHT user conference in person in Las Vegas this October. We hope to see you there.

Thank you, George, and good afternoon, everyone. We executed a solid quarter in a challenging macro environment, hitting or exceeding all our guidance ranges. We are delivering on our commitments, evident in our solid Q1 results. Before I get into the financial details, let me walk you through the key themes for the quarter. As a reminder, all numbers discussed are non-GAAP unless otherwise noted. Our disciplined operational management and strong customer acceptance of our innovation continue to pay off. We expect improved execution and new products will drive growth and operating margin expansion as we move through the second half of the year. As expected, Q1 consolidated gross margin was strong. Product margin came in at 55%. Given our expectations for competitive dynamics and product mix, we remain confident in our projection that product margin will hold at these levels through the remainder of the fiscal year. Cash from operations was a first quarter all-time high. Operating cash flow benefited from the reduction of premiums, as well as lower component pricing and incentive compensation payouts. Over the course of fiscal year ‘24, cash flow should normalize, with operating cash flow tracking relatively in line with non-GAAP net income. We returned approximately 120% of free cash flow to stockholders through cash dividends and share repurchases, reducing Q1 fiscal ‘24 share count by almost 4% year-over-year. As we discussed during last quarter's call, we intend to return 100% of free cash flow this year. Now, to the details of the quarter. Q1 billings of $1.3 billion decreased 17% year-over-year. Revenue of $1.4 billion decreased 10% year-over-year. The challenging macro environment continued to pressure IT spending. However, as George pointed out, we are well aligned with customers' priority investments and remain confident our go-to-market changes and product innovations will drive growth in the second half of fiscal year ‘24. Hybrid Cloud revenue of $1.3 billion was down 12% year-over-year. Product revenue of $590 million was down 25%. Remember that first-half fiscal year 2023 revenue, most notably product revenue, benefited from elevated levels of backlog, which impacts the year-over-year comparisons. Support revenue of $611 million grew 2% year-over-year. Public Cloud ARR grew 6% year-over-year to $619 million. Public Cloud revenue of $154 million increased 17% from Q1 a year ago. First-party and marketplace services grew as customers continue to choose solutions based on NetApp technology for mission-critical and cloud-native workloads. This growth was offset by underperformance in subscription services. As George noted earlier, Public Cloud did not meet our expectations for the quarter, and we are taking action to hone our approach and re-accelerate growth. Q1 consolidated gross margin of 71% came in above our guidance, up 400 basis points from a year ago, and again reaching an all-time company high. Product gross margin was 55%, in line with expectations. As we discussed on the Q4 call, we made strategic purchase commitments to lock-in record low NAND pricing and mitigate rising prices in the future. NAND prices continued to decline in Q1, and we are still positioned favorably versus the market. The potential for increased price competition is factored into our expectations, and we remain confident in our ability to hold product gross margin consistent at this level through the year. Our recurring support business continues to be highly profitable with a gross margin of 92%. Public cloud gross margin improved to 67% from 66% last quarter. As expected, operating expenses of $703 million were flat year-over-year and grew 4% from Q4'23. The sequential increase was driven by annual merit increases and a reset of incentive compensation, as well as expenses related to our in-person sales kickoff meeting. Q1 again highlighted the strength of our business model and disciplined operational execution with an operating margin of 22%, ahead of expectations. EPS of $1.15 was also above the high end of our guidance. Operating cash flow was $453 million in Q1, an increase of 61% year-over-year, driven by lower supply chain payments and variable compensation, partially offset by lower collections. In Q1, DSO decreased to 41 and inventory turns improved to 13. Free cash flow increased 94% year-over-year to $418 million, helped by strong operating cash flow and lower CapEx. During the quarter, we returned $506 million to stockholders through shares repurchased and cash dividends, ending the quarter with approximately $600 million in net cash. We have approximately $1 billion remaining on our existing repurchase authorization. Our balance sheet remains healthy. Total deferred revenue as of the end of Q1 was $4.2 billion, up slightly from a year ago. We ended the quarter with approximately $3 billion in cash and short-term investments. Now turning to guidance. We are reiterating our guidance for the full year. Our total revenue guide is unchanged, with revenue down low to mid-single-digits year-over-year, measured on a percentage basis. Based on our Q1 results and updated projections, we expect Public Cloud revenue growth to come in lower than initially expected primarily due to softness in our subscription services. We continue to expect fiscal year '24 consolidated gross margin to be roughly 70%, operating margin to be approximately 25%, and EPS to be in the range of $5.65 to $5.85. We expect Q2 revenue to range between $1.455 billion and $1.605 billion, which at the midpoint implies a decline of 8% year-over-year. If FX rates stay at end-of-July levels, we would see nearly 2 points of FX tailwinds to revenue. As I called out earlier, first-half fiscal year ‘23 revenue benefited from elevated levels of backlog due to last year’s supply chain constraints, which impacts the year-over-year comparisons. We expect Q2 consolidated gross margin to be roughly 70%, and operating margin to be approximately 24%. EPS should be in the range of $1.35 to $1.45. In closing, I want to thank our employees, customers, and investors for their commitment and investment in NetApp. I am confident in our ability to help our customers successfully achieve their digital and cloud transformation goals. We are well aligned to priority IT investments and are committed to delivering sustainable, long-term value for our stockholders. I’ll now turn the call over to Kris to open the Q & A.

Thanks, Mike. Operator, let’s begin the Q&A.

We will now begin the question-and-answer session. Our first question is from Sidney Ho with Deutsche Bank. Please go ahead.

Great. Thanks for doing the call. So last quarter, you guys talked about spending for large enterprises being cautious, where obviously you guys are overexposed. That doesn't seem like that has changed much. From your conversation with customers, do you have a sense of when demand could start picking up, maybe based on utilization data or whatnot? First, just give us some historical context at what utilization rate level do you start seeing demand pick up, and do you think that will be quite any different this cycle? I mean, while you’re at it talk about the trends in small and medium businesses as well? Thanks.

Overall, thank you for the question. The spending environment this past quarter was unchanged from what we saw in the second half of the prior fiscal year. Our mid-sized enterprise business across the globe and public sector did better than large enterprises. Within large enterprises, as we noted, the same verticals remained cautious in spending, specifically service providers, high-tech, and, to a lesser extent, financial services. Regarding their spending criteria, they are spending on strategic projects but are running infrastructure at higher levels of utilization than they typically do and what we typically tell them is best practice. That is common in such macro environments, but it's not a long-term trend. As we progress through the fiscal year, we expect them to start expanding investment because they cannot run systems that hard. Our guidance for the year reflects our confidence in the changes we've made in go-to-market as well as our product portfolio that we recently introduced.

Okay, thank you.

The next question is from Mehdi Hosseini with SIG. Please go ahead.

Yes. Thanks for taking my question. I have two quick follow-ups. George, I want to go back to the big picture and revisit the topic of repatriation. How do you see generative AI strengthening this argument that there will be repatriation, as enterprises have better ownership of the data that would actually help with faster adoption? Is there any update? Is there any feedback from your conversations with your enterprise customers that you can share? And a quick follow-up. Can you provide a mix of QLC NAND that you're procuring? And how do you see that changing towards the end of the calendar year?

With regard to Gen AI projects, which we are already engaged in with a number of customers, we see a mix of use cases. I would say there are three common patterns. One is unstructured data. The second is the need for consistent data management; both security and privacy are hot topics, as well as the lineage of data to keep track of which version of Gen AI model is the best and most accurate. The third is from a deployment architecture, as we see them engage in both on-prem discussions as well as public cloud discussions. In public cloud, the advantages are much faster feature velocity and prepackaged models available. However, in on-prem environments, the major sensitivity is the data being kept in a restricted location. So we intend to benefit from both, but I don't think it is a meaningful driver of repatriation at this point in the discussion maybe. There we're seeing a mix of public cloud and on-prem environments.

Hey, Mehdi, it's Mike. On the QLC, we're not going to break out specific numbers, but we would say we are procuring more of that. We started to see a pickup. We'll see how the rest of the year goes, but we do expect that to continue as a percentage as we go through fiscal '24.

Great. Thank you.

The next question is from Samik Chatterjee with JP Morgan. Please go ahead.

Hey, thanks for the question. This is Joe Cardoso on for Samik. Just one question from me. You reported a strong gross margin performance in the quarter, and I was just curious if you could quantify how much of the improvement was related to premium benefits, strategic purchases, etc., that you've highlighted, and how we should think about that tailwind as we progress through this year, including and excluding the expected price competition that you have embedded into the guide? And then just real quickly, a clarification on that last part: are you guys actually seeing price competition currently from your competitors? Thanks.

Hey Joe, it's Mike. So, on your question, we've talked a lot about premiums, and as we discussed last time, we're super excited to not have to talk about them anymore. So largely in Q1, all of those premiums have, I would say, gone away, not only from a P&L perspective but cash. We talked about that number being typically between about $30 million and $40 million a quarter, sometimes bumping up to $50 million, so call it an average of about $40 million. We got a good bit of that, and we were not required to accrue in Q4, and then that rest held to Q1. So it's 55% last quarter and 55% this quarter. Now that premiums are fully out of the number, as you look forward, it's one of the reasons why we feel confident in the 55% guide. There has always been price competition. We see it in certain geographies or certain customers. We haven't seen any material change in our guide. We do expect that we will need to be marginally more aggressive in certain situations, but certainly nothing significantly different than we are today.

Thanks for the color.

The next question is from Aaron Rakers with Wells Fargo. Please go ahead.

Yes, thank you, guys. This is Michael on behalf of Aaron. I wanted to ask about your ARR in the quarter. Your ARR growth in the quarter slowed quite a bit. I know you guys have pushed out your $2 billion sort of target, but I just wanted to take a step back and think about your first billion; how would you describe the trajectory to getting there and maybe timing? If you can kind of just help us think about where we go from here? Thank you.

Yes, I think first of all, we have two models in which we serve customers: the consumption model, which is essentially a pay-as-you-go utility model; and then a subscription model, where the customer pays for a certain amount of capacity or managed units or capability and then renews that on an annual basis or a term basis. The consumption part of our business has grown to about three quarters of our total business, roughly speaking. Of our cloud business, the subscription is the quarter. If you look at last quarter's performance, the cloud storage and consumption businesses continue to perform well. They grew year-on-year, and their dollar-based net retention rate was at industry norms. Subscription is where we saw a challenge, both a small part of cloud storage subscription as well as CloudOps. We are conducting a review and will get you an update in the next quarterly call about our plans for that part of our business.

Okay, thank you. That's helpful. And if I can just add one more, I just want to understand your all-flash business is down about 7%. I appreciate the macro backdrop there, but I'm wondering if you can just help me understand the share kind of trends? And maybe your best estimate where that's been this quarter? How it's changing? And kind of what your expectations are moving through the year? Thank you.

I think first of all, the year-on-year compare for our flash product business is impacted by last year benefiting from elevated levels of backlog that we shipped in the comparable quarter last year. If you remove that backlog, flash actually grew year-on-year this quarter, and we saw strong growth from our capacity flash products. We expect the overall flash portfolio to grow as a percentage of our business through the course of the year. The first-quarter customers are still qualifying our capacity flash products, the C-Series. Therefore, we weren't able to move all of our intended customer environments over to all-flash yet, but they are headed that way. We feel really good about the go-to-market changes that are starting to reflect in pipeline expansion, as well as in the flash product portfolio that we have. You should see that reflected in growth in the second half of the year. With regard to share gains, our expectation based on what the others have guided is that we have picked up the second position in share in the market behind Dell.

The next question is from Simon Leopold with Raymond James. Please go ahead.

Hi, this is Victor Chiu in for Simon Leopold. You guys noted that the product gross margin is expected to hold for the remainder of the year, but I think the latest industry forecasts and commentary from NAND manufacturers imply that the market experiences a sharp overcorrection next year. Can you help us understand how this impacts your expectations for the next fiscal year and whether you've secured any pricing agreements for flash media beyond this fiscal year?

Yes. Hey, Victor, it's Mike. We haven't guided for fiscal '25, but let us walk you through that. As we talked about between pre-buys and price locks, we have secured a large portion of our NAND purchases for fiscal '24, not all of it, you never want to hedge the whole bucket, but we feel really good about that. In addition, some of those agreements do flow into fiscal '25, but it's not a majority at this point. So where we stand today, we feel really good about where we are in '24. We have some of that rolling into '25, and we are certainly looking for about what we should do. We'll do a lot more work on that in the next 90 days and update you on the next call. As you know, it's a very changing market. We want to make sure to be prudent and think through that, but it's something that we are looking hard at.

Okay, that's helpful. And just on the other side of the legacy part of the business, the last several quarters have seen pretty sharp declines in shipments of legacy spinning drives. I know historically, there has not been much correlation between storage media trends and the storage systems, but more recently, one of your competitors has asserted that there won't be any new spinning disk drives manufactured in five years. Do you have any view on this commentary? Do you agree with this perspective, and how do you see this impacting NetApp, I guess, over the long-run?

Listen, I think we have the best spinning media and the best flash technologies in the market. I think that's reflected in the richness of our feature set, the flexibility of our operating system, and increasingly the data security functionality that natively integrates into our offerings. The outlines of what our competitors have talked about is a long time, and so we give our customers choice and continue to invest in a broad range of technologies that meet the right price-performance points. When you cannot support a type of technology, like our competitors cannot, then you have to throw grenades and say that technology doesn't exist because you frankly can't support it.

Okay, so you believe that the idea of spinning drives disappearing in five years is an extreme viewpoint?

Five years is a long time in technology, as we've all learned.

Yes. Okay, okay. Thank you.

The next question is from Asiya Merchant with Citigroup. Please go ahead.

Thank you for taking my question. Previously, you indicated a certain linearity between the first half and the second half of the year. I wanted to confirm whether that still applies for the remainder of this year. Additionally, regarding the public cloud sector, I understand the guidance has been adjusted downward compared to previous expectations due to subscription weaknesses. How should we approach the linearity of this situation? Are we anticipating that the current run rates will persist, and can you provide any insights into growth rates for the rest of the year? Are we still expecting cloud revenues to accelerate on a year-over-year basis from this point? Thank you.

Yes, thank you for the question. On the first question about linearity, based on the midpoint of guidance, we are still assuming about 48% revenue in the first half and 52% in the second, pretty close to round numbers, consistent with what we did last quarter. So, no big change there. Our Q2 guide is up about 7% quarter-on-quarter, which aligns with our historical linearity as well. On the cloud revenue number, we had originally forecasted mid-teens growth in that cloud revenue business. Even if that cloud revenue stays where it's at today, there would still be growth year-over-year due to last year's growth. So we've baked all of that into our full-year number, and we feel good about where we are on that guide. We'll see how the rest of the year goes, but at this point, we've reflected that in our full-year number.

Great, thank you.

Thank you.

The next question is from Krish Sankar with TD Cowen. Please go ahead.

Yes, hi, thanks for taking my question. I have two high-level questions in AI for George. Our understanding is that most of the benefit of storage, as we put all-flash unified file and object solution; A, is that assessment accurate? Or are you seeing hybrid HDD solutions used in AI workloads today? And second, for unified cloud and object, can you speak about your product portfolio there and your competitive position compared to other solutions like FlashBlade from Pure Storage and PowerScale from Dell? And also, if unified filing object solutions are more expected to benefit from AI, is a market share that's similar to market share in other storage solutions like block and file? Thank you.

Listen, I think that the first comment I would make is that AI primarily offerings today are on unstructured data. Whether it's predictive AI using unstructured data to analyze images or audio files or generative AI that analyzes text on various document formats, unstructured data is the priority. Second, regarding unified file and object, listen, we created unified storage, and we have a really strong track record in unified across file, block, object, and cloud. I think that is the new definition of unified rather than just little systems that try to say that they've got one protocol or the other. I think the third is that when you talk about AI, it's a broad topic. Therefore, what customers typically have are versions of data they used to train different models. At the time that they are running the trading workload, that data is typically stored on a high-performance landscape like an all-flash system. However, they keep those models available so they can reference when changes are made to models and datasets and understand the implications for accuracy. Therefore, the archival lifecycle of that data is usually on disk or on cloud. Finally, we are seeing clients use hybrid workflows. Public cloud is a strong place where many developers and data science teams are beginning their workflows, either on Vertex in Google or SageMaker in Amazon, and our solutions on public cloud give us a strong position to start with the data science team at the onset of these AI projects.

Thank you, guys.

The next question is from David Vogt with UBS. Please go ahead.

Great, thanks. Hey, George. Hey, Mike. I had some phone difficulties. So I apologize if this was addressed. On sort of the AI strategy going forward versus mass capacity storage, what are you hearing from your customers from the enterprise side in terms of what the priority looks like from an investment perspective? I know your mass capacity product is seeing really strong traction out of the gate. But over the longer term, how do you think the mix between high-end, high-performance storage and mass capacity trends? And then maybe just on Public Cloud real quickly, I know this has been kind of a fit-and-start business for you. When you think about how much of an impact on your management bandwidth, how are you thinking about that business longer term now? I know you're talking about giving an updated outlook maybe next quarter. But do you still think it has the same opportunity to be a key driver for the business, or is it maybe less of a longer-term prospect than you might have thought 90 days ago or even a year ago at this point? Thanks.

Let me address those two points. First, regarding AI, as I mentioned, it's a broad lifecycle of tasks. There are light portions of the lifecycle that run on extremely high-performance systems. And then there are portions where the data sits on more capacity-oriented systems because you want to keep versions of your models available. I assess it like any type of workload, where there's a period when the workload has data that's hot and then a time where you want to keep a copy of the data. Regarding the overall all-flash array outlook, listen, we have one quarter in. We are really pleased with the adoption of our capacity flash products. Overall, I see the all-flash segment growing at a higher rate than our total storage business, and it will be a bigger part of our mix. Within all-flash, the capacity flash products will grow more quickly than the performance flash products that have been in the market for quite a while. That summarizes how they will break out. Regarding cloud, we are excited about the growth of our cloud storage services, all the capabilities, and the pace of customer adoption of those services. We have more exciting news to come with Google concerning our work with them, including the expansion of our offerings and new use cases in Google Cloud that you'll hear more about in the next couple of weeks. I think our current approach is to focus on the best parts of our cloud portfolio with a dedicated go-to-market model, which has been well received by our hyperscalers. We're a quarter in. The cloud storage and consumption offerings performed well. We have work to do on the subscription side. We'll provide an update next quarter. Our overall view of cloud has not changed.

Great, thanks guys.

The next question is from Steven Fox with Fox Advisors. Please go ahead.

Hi, thanks. Good afternoon. I wanted to follow up on some of the comments, George, especially regarding subscription. I'm curious about your plans to accelerate growth in public cloud. Given that the subscription business has declined, it appears to reflect the current macro environment. I’m trying to understand in more detail, considering all the factors affecting public cloud and the refinement of the business, why the subscription business is particularly disappointing at this time instead of possibly waiting for an upturn. Thanks.

Yes. Listen, we are not the only company in the world to have a subscription cloud software business that got impacted. When we saw trends for optimization, you generally see the consumption part of the business get optimized quickly because you are on a pay-as-you-go contract. The subscription part usually gets affected at the time of a renewal or the decision to expand or not expand a subscription. That doesn't excuse the fact that we wanted to do better in the subscription part of our business. I think we have work to do to refine our portfolio, sharpen the value proposition, and optimize pricing in certain cases to meet customer expectations, and we'll provide an update on that. We're actively working on those improvements and will update you next call.

Great, that's helpful. Thank you.

The next question is from Wamsi Mohan with Bank of America. Please go ahead.

Yes, thank you. It sounds from your comments like you had at least 7 to 8 points of backlog-related headwinds from last year in AFA. Can you help us think through is the magnitude sort of similar in fiscal 2Q? And for fiscal second half on the Hybrid Cloud side, is it fair to think that there's going to be a 4 to 5 point acceleration in growth? Based on the estimates that the Street's modeling is kind of what's implied, and I'm wondering if you could talk about what is the upside that you're seeing in hybrid that's offsetting the weakness in public, given your relative overall guidance didn't change? Thank you so much.

Hey, Wamsi, it's Mike. Thanks for the question. Let's go through the numbers. Yes, you're close on the impact. It was about 8 points. So last quarter, we talked about, if you adjust for the backlog benefit in the first half of fiscal '23 and compared our growth this first half with the second half of last year when we declined about 5% or 6%. We expect growth to be better than that, still slightly negative. That is about the same in Q1 and Q2, so Q2 has about the same impact. Based on the midpoint of guidance, we expect Hybrid Cloud then to have growth in the second half, the low-single-digit growth based on the guidance that we gave. We’re still comfortable with that based on the progress from Q1, especially related to C-Series. Our focus on the new products, as well as the go-to-market changes, should yield more fruit as we go into the second half, and that’s based on what we've seen in pipeline expansion and sales activity. Overall, yes, that would be accurate, providing us confidence as we enter the second half of the year.

Okay, great. Thank you so much.

The next question is from Meta Marshall with Morgan Stanley. Please go ahead.

Thank you. For my first question, you mentioned that the storage and consumption segment of the business is expected to grow at about the market rate this quarter. Is the assumption that optimization has stabilized, and are we beginning to see growth again? I want to understand if we have reached the bottom of optimization and are now experiencing growth or if we are still in this bottoming-out phase. For my second question, have there been any surprises regarding customer types or workload types that are more interested in C-Series than you initially anticipated? Thank you.

On the first question, Meta, what we saw was continued good pace of customer additions, which means there are cloud projects and ongoing deployments of workloads in the cloud. We observed the pace of optimization slow down as customers have effectively done the easy stuff. Now they are cautious about what further to optimize. In that group of customers optimizing, there are early signs of them starting to do new projects on our technology, but they haven't ramped those projects yet. So the benefit we saw was from new customers and new workloads rather than ones that have optimized re-accelerating spending. As for the second question, capacity flash has seen strong sales where we were selling high-performance flash into use cases where capacity flash is a better product. These use cases include general-purpose private cloud environments that seek good overall performance without focusing on a specific application and smaller environments, where we launched the A150 product, which offers a lower price point compared to other flash products. Overall, we noted high strength in the mid-market segment across our offerings.

Great, thank you.

The next question is from Amit Daryanani with Evercore. Please go ahead.

Yes, thanks for taking my questions. I got cut off in the middle, so I apologize if this was addressed. But on the Public Cloud, can you just talk about what are the reasons that led to the miss here? Was it macro or were there any micro impacts as well? And then when you talk about the initiatives you're taking, is it more about aligning your specialists to the hyperscalers? Or are you taking any more incremental initiatives? Just love to understand macro versus micro impact? And then what are the initiatives you're specifically taking to address them?

I think broadly speaking, if you look at our cloud business, roughly three-quarters is consumption and one-quarter is subscription. That mix has shifted in favor of consumption a meaningful amount over the last year as customers have preferred more of the marketplace and first-party offerings over some of our more traditional subscription type, bring-your-own-license offerings. The impact that we saw was more pronounced in subscription rather than consumption, which performed quite well. I would point out that it's in that one-quarter of the business that subscription is, that we were affected. Therefore, whether it was macro or micro, it was a mix of both. In some cases with customers, clearly budget constraints played a role, where upon renewal, they decided to use less of the product for only the most mission-critical environments, such as some of our monitoring tools. In other cases, it was that the customer wasn't ready to deploy the product. We've taken a few actions. One is to conduct a review of our products to ensure we have the right products tailored to the correct use cases, that pricing is set up correctly, and the value share between us and customers is appropriate. This review is already underway. We implemented some changes and will provide a more comprehensive update soon. Additionally, in terms of go-to-market, we've established a dedicated cloud specialist organization aligned with hyperscalers and implemented customer success initiatives to provide expertise on how to use our products. It's early, but we've seen good evidence of progress, though there's more work to be done.

Got it. That's really helpful. And Mike, if I could just have you clarify Q1 free cash flow, I think was much better than what I had expected and what you typically see in Q1. Can you just touch on maybe what drove that, if there was a bit of a pull-in or something? And any view on fiscal year free cash flow, given the strong performance here?

Yes, thank you for the question regarding cash. Yes, it was quite better than expected. There were three moving parts. Amit, billings have come in lower the last two quarters. Thus, collections were down year-over-year. However, what really drove operating and free cash flow was the reduction in supply chain spending. Additionally, that's not only premiums; the quantity of components significantly decreased, and pricing came down as well. If you think about the rest of the year, we should expect to continue seeing some of that benefit, though not as big as in Q1, since that quarter compares to last year's Q1 when we were bulking up on inventory in anticipation of growth before things slowed down mid-year. We also had a one-time benefit year-over-year, as we paid significantly less in incentive compensation. Lower CapEx also helped drive free cash flow. As you look at the rest of the year, we expect on a full-year basis to track pretty close to non-GAAP net income, which guidance is around $1.2 billion. I do want to note, in Q2 we typically see our tax payments, so expect that quarter to be down from Q1, as it has been every year, while the back half will follow more typical trends.

Thank you.

And the final question today comes from Shannon Cross with Credit Suisse. Please go ahead.

Thank you very much. I guess my first question, George, can you talk about ONTAP AI from a competitive standpoint? Are you seeing this as an ability to sell into your existing customer base who are using ONTAP and are comfortable with it? Or is this something that from a competitive differentiation standpoint, can actually drive switchers to NetApp's product set? And then I have a follow-up.

We sell ONTAP AI into data science teams and AI teams, whether in our installed base or in new accounts. It's a very verticalized selling model. For example, in pharmaceuticals, we work with teams on rapid drug discovery and clinical data analysis to apply high-performance GPUs from NVIDIA along with large-scale data storage from NetApp. We could do the same in manufacturing by selling into advanced digital twin prototypes, optimizing manufacturing yield, and accelerating development. These are key areas where we target net new budgets and customers. Our advantages include high performance, large scale, advanced demo management, and it's highly integrated into the data science toolkit of our customers. Additionally, we now have the same versions of our offerings running on all leading public clouds, and you'll hear more about that in the next couple of weeks at the Google conference.

Okay. And then I guess we've asked you about AI from an opportunity standpoint, but how are you thinking about utilizing generative AI internally within NetApp to increase productivity, save costs, and maybe improve customer experience? Thanks.

We already use AI tools in three ways. One is to accelerate software development and increase our pace to deliver more innovation to customers. The second is to integrate AI into our products and services, enabling us to automatically detect ransomware attacks or impending risks from running systems harder than they should be, providing proactive advice rather than reactive responses. The third usage is across various businesses, including marketing collateral, documentation, multilingual support, and chatbots. In customer service, we are already integrating AI capabilities. Gen AI is the next version of that, so we have many exciting projects underway. Let me close with a few comments. The strong customer reception to the substantial innovation we have brought to market has set FY '24 on a solid start despite the choppy macro backdrop. We are laser-focused on our FY '24 priorities to be prudent stewards of the business, tightly managing the elements within our control, driving better performance in our storage systems business, and building a more focused approach to our Public Cloud business. Early results of this focus indicate we are on track to drive margin expansion and earnings growth while yielding top-line growth in the back half of the year. I am absolutely delighted by the positive reception to our new products, the differentiation and continued growth of our first-party public cloud storage services, and our exciting innovation road map. I hope to see you at INSIGHT and look forward to updating you on our continued progress in next quarter's call. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.