NetApp Inc (NTAP) Q4 2022 Earnings Call Transcript

NetApp Inc (NASDAQ: NTAP) Q4 2022 earnings call dated Jun. 01, 2022

Corporate Participants:

Kris Newton — Vice President – Investor Relations

George Kurian — Chief Executive Officer

Mike Berry — Executive Vice President and Chief Financial Officer

Analysts:

Jim Suva — Citigroup — Analyst

Amit Daryanani — Evercore — Analyst

Samik Chatterjee — JPMorgan — Analyst

Bala Reddy — Goldman Sachs — Analyst

Meta Marshall — Morgan Stanley — Analyst

Nik Todorov — Longbow Research — Analyst

Sidney Ho — Deutsche Bank — Analyst

Tim Long — Barclays — Analyst

David Vogt — UBS — Analyst

Simon Leopold — Raymond James — Analyst

Wamsi Mohan — Bank of America — Analyst

Aaron Rakers — Wells Fargo — Analyst

Nehal Chokshi — Northland Capital — Analyst

Jason Ader — William Blair — Analyst

Presentation:

Operator

Good afternoon, ladies and gentlemen, welcome to the NetApp Fourth Quarter and Fiscal Year 2022 Earnings Call. [Operator Instructions]

I would now like to turn the call over to Kris Newton, Vice President, Investor Relations.

Kris Newton — Vice President – Investor Relations

Thank you for joining us. With me today are our CEO, George Kurian; and CFO, Mike Berry. This call is being webcast live and will be available for replay on our website at netapp.com.

During today’s call, we will make forward-looking statements and projections with respect to our financial outlook and future prospects, such as our guidance for first quarter and fiscal year 2023, our expectations regarding future revenue, profitability and shareholder returns, the value we bring to customers, our ability to drive continued growth in both our Hybrid Cloud and Public Cloud segments and our ability to manage through the current supply chain environment, all of which involve risk and uncertainty. We disclaim any obligation to update our forward-looking statements and projections.

Actual results may differ materially for a variety of reasons, including macroeconomic and market conditions, such as the continuing impact and uneven recovery of the COVID-19 pandemic, including the resulting supply chain disruptions and the IT capital spending environment, as well as our ability to gain share in the storage market, grow our cloud business and generate greater cash flow.

Please also refer to the documents we file from time to time with the SEC and available on our website, specifically our most recent Forms 10-Q and 10-K including in the Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors sections.

During the call, all financial measures presented will be non-GAAP unless otherwise indicated. Reconciliations of GAAP to non-GAAP estimates are posted on our website.

I’ll now turn the call over to George.

George Kurian — Chief Executive Officer

Thank you, Kris. Thanks, everyone, for joining us this afternoon. Our solid fourth quarter results cap off a strong year. We made sustained progress against our strategic goals, successfully achieving our commitment to grow the business, while delivering operating leverage in fiscal 2022. We gained share in enterprise storage with strong growth in all-flash array and object storage products. We expanded our Public Cloud business with robust expansion of customers, ARR, innovation and routes to market. And most notably, we delivered record levels of gross margin dollars, operating income and earnings per share.

While the demand environment remains strong, macroeconomic uncertainty, including supply constraints, rising interest rates, inflation and geopolitical conflict has increased since we last spoke with you at our Investor Day in March. Navigating this complex and dynamic environment is testing our teams, and we are sharply focused on managing what is in our control. Backlog is elevated due to supply constraints despite our excellent supply chain management, helping us meet as much of the demand as possible. I want to thank our global team for their disciplined execution and agile response to changing conditions. That we achieved all-time highs for gross margin dollars, operating income and earnings per share in the face of these headwinds demonstrates our disciplined operating management.

The turbulent environment also creates challenges for our customers, raising the urgency for data-driven digital and cloud transformations. We sit at the intersection of these megatrends, as the complexities created by rapid data growth, multi-cloud management, and the adoption of next-gen technologies such as AI, cloud native and modern application and data infrastructures create a sizable opportunity for us.

At our Investor Day, we outlined our objective to deliver long-term value through sustained growth and that thesis remains unchanged. Our critical role in helping customers achieve their transformation goals underpins our strategy and drives confidence for future growth. Public Cloud ARR of $505 million grew 68% year-over-year, and the Q4 dollar-based net revenue retention rate remains strong at 159%. Before I get to the many highlights of the quarter, I want to address the fact that our Public Cloud ARR came short of our expectations.

Demand for our Cloud Storage solutions was strong in Q4. We also saw a healthy number of new customer additions across both Cloud Storage and cloud operation services in the quarter. Unfortunately, these tailwinds were not enough to offset the lower than expected growth, created by higher churn, lower expansion rates and sales force turnover in our cloud operations portfolio. We understand the root causes of these temporary headwinds, and in FY ’23, our focus will be on returning these services to the growth trajectory we saw in the first three quarters of the year.

We have made organizational changes to increase focus on renewal and expansion motions, and we’ll continue to refine our go-to-market activities to better address the cloud operations market. Additionally, we have refreshed the sales organization and strengthened the leadership team. We believe strongly in the sizable opportunity created by our cloud operations portfolio, where we bring differentiated enterprise capabilities to cloud infrastructure management, built on our long experience, supporting a broad range of applications. Our differentiation in this space continues to receive third-party validation, Spot by NetApp was recognized as a leader and the only outperformer in GigaOm’s Radar for Cloud Resource Optimization.

As I noted earlier, our Cloud Storage services continue to perform well. Azure NetApp Files remains the standout here. Cloud Volumes Service for GCP and FSx for NetApp ONTAP also had strong growth in ARR and customer additions, albeit off small basis. We continue to deliver significant innovation to help customers get the most from their Cloud Storage environments.

AWS announced FSx for ONTAP support for single availability zones, lowering storage costs and improving performance, as well as its inclusion in the EC2 launch wizard, streamlining the selection of FSx for ONTAP as file storage for customers, creating a new compute instance. These new capabilities unlock new use cases, expanding the opportunity for FSx for ONTAP.

Our Cloud Storage and data management services are complemented by our cloud operations, infrastructure management and optimization functionality. Together, these capabilities deliver an industry-leading portfolio of multi-cloud infrastructure services, for stateful and stateless workloads. Now we’re enabling customers to deploy applications quickly, easily and cost effectively on that multi-cloud infrastructure, for big data applications with Spark on Kubernetes, for managed desktops with Spot PC and for open source database, data pipeline and workflow applications with our most recent acquisition, Instaclustr.

Instaclustr delivers open source data and workflow applications as a fully managed service. Instaclustr will leverage our best-in-class infrastructure services, Cloud Volumes’ storage optimization, Spot’s compute optimization and Cloud Insights’ monitoring and troubleshooting to make it easier and faster for customers to build, deploy and operate cloud applications. This will enable us to deliver more value to cloud operations teams and capture more revenue from those same buyers by delivering new services, as well as through the significant synergies with our Cloud Storage services. I am excited to welcome the Instaclustr team to the NetApp family.

Overall, fiscal year ’22 was a good year for our cloud business. We doubled Public Cloud segment revenue from $199 million in fiscal year ’21 to $396 million in fiscal year ’22. We expanded our cloud partnerships and routes to market, introduced new organic innovations, and we completed a number of acquisitions that position us well for the future.

In the coming year, we will prioritize the integration of these services. To underscore our commitment here, we plan to slow the pace of acquisitions and re-prioritize our use of cash in FY ’23 to favor shareholder returns. Mike will provide the details in his commentary. I want to underscore that we remain convinced of the opportunity, the strength of our position and our ability to achieve $2 billion in ARR exiting fiscal year ’26.

Now turning to Hybrid Cloud. Demand for our Hybrid Cloud solutions remains high. Despite supply constraints that again impeded our ability to meet all customer demand, we grew product revenue 6% in the fourth quarter and 10% in fiscal year ’22. All flash array annualized revenue run rate, grew 12% year-over-year to $3.2 billion. Thanks to strong unit growth in FAS hybrid arrays,,all flash penetration remained flat at 31% of installed systems.

In Q4, we further enhanced our position in Hybrid Cloud with new innovations and recognition. We updated our object storage solution with security and compliance enhancements, Google Cloud integration and faster performance for analytics workloads. We also announced the next generation of our collaboration with Cisco, FlexPod XCS for hybrid multi-cloud deployments. Additionally, Business Intelligence Group recognized NetApp AI as a winner of its Artificial Intelligence Excellence Award.

Looking forward, our priorities are clear. We remain focused on capturing the substantial opportunity ahead, as we scale our Public Cloud services, while continuing to drive growth in our Hybrid Cloud solutions. The long-term thesis we presented at our Investor Day of delivering value through sustained growth remains intact. The strong fundamentals of our business, including our alignment to customer priorities, strong balance sheet and prudent operational management put NetApp in a position of strength. I want to underscore my confidence in our strategy, our execution and the value we bring to all our stakeholders.

With that, I’ll turn the call over to Mike.

Mike Berry — Executive Vice President and Chief Financial Officer

Thank you, George. Good afternoon, everyone, and thank you for joining us. As a reminder, I’ll be referring to non-GAAP numbers unless otherwise noted.

As we look back on fiscal ’22, I am incredibly proud of the results the team delivered in an environment with such fluid and complex supply chain challenges. We delivered billings of $6.7 billion, an increase of 13% year-over-year, and grew revenue 10% to $6.3 billion. Within our Hybrid Cloud segment, all flash revenue grew 20% and object storage revenue grew 49%.

We finished fiscal ’22 with $505 million in Public Cloud ARR with Public Cloud revenue growing 99% for the full year. We balanced strong growth in our key strategic areas with another year of disciplined investment, delivering record operating margin of 23.7%, up more than three points from last year, with an all-time high EPS of $5.28, up 30% year-over-year.

In Q4, despite supply constrained shipments, elevated freight and logistical expense and component cost headwinds, we delivered solid revenue with both gross margin and operating margin coming in above guidance. Strong execution yielded Q4 billings of $2 billion, up 16% year-over-year. Revenue came in at $1.68 billion, up 8% year-over-year including a two point headwind from FX. Our solid Q4 results were driven by continued strong demand for our all flash and object storage solutions. Our cloud portfolio continues to positively impact the overall growth profile of NetApp, delivering 3.5 of the 8 points in revenue growth.

Hybrid Cloud segment revenue of $1.56 billion was up 5% year-over-year. Within Hybrid Cloud, we delivered product revenue growth for the fifth consecutive quarter and expect this momentum to continue into fiscal ’23. Product revenue of $894 million increased 6% year-over-year. Software product revenue of $530 million increased 10% year-over-year, driven by the ongoing mix shift towards our all flash portfolio. Total Q4 recurring support revenue of $590 million increased 2% year-over-year, highlighting the health of our installed base. Public Cloud ARR exited Q4 at $505 million, up 68% year-over-year, driven by strength in Cloud Storage, led by Azure NetApp Files.

Public Cloud revenue recognized in the quarter was $120 million, up 82% year-over-year and 9% sequentially. We didn’t end the year as expected for Cloud ARR, but are confident that we remain well positioned to deliver on the long-term Public Cloud opportunity. While it is not unusual for hyper growth assets to hit air pockets along their journey, we are using this moment to learn and continue to improve the operational rigor across the CloudOps products. Towards this goal, we are laser-focused on using fiscal ’23 to strengthen our field and customer success go-to-market motions, while integrating our CloudOps product portfolio. Recurring support and Public Cloud revenue of $710 million, was up 11% year-over-year, constituting 42% of total revenue.

We ended Q4 with a record $4.2 billion in deferred revenue, an increase of 6% year-over-year. Q4 marks the 17th consecutive quarter of year-over-year deferred revenue growth, which is the best leading indicator for recurring revenue growth.

Total gross margin was 66% and came in solidly ahead of our guidance, reflecting better than expected product margins. Total Hybrid Cloud gross margin was 65% in Q4. Within our Hybrid Cloud segment, product gross margin was 51%, as the supply chain team did an amazing job of mitigating a portion of the component cost headwinds, and our sales team was very focused on capturing our recent price increases. Our growing recurring support business continues to be very profitable with gross margin of 93%.

Public Cloud gross margin of 68% was again accretive to the overall corporate average. The sequential decline in Public Cloud gross margin was driven by lower than expected cloud revenue and incremental capex investment for Azure NetApp Files, which is a healthy leading demand signal. We remain confident in our long-term Public Cloud gross margin goal of 75% to 80%, as we continue to drive scale in Cloud Storage and an increasing percentage of our Public Cloud business being built on software solutions.

Q4 highlighted the strong leverage in our operating model with operating margin of 23% despite the ongoing supply chain headwinds. EPS of $1.42 was up 21% year-over-year and even excluding a onetime tax benefit of $0.12, represents a new Q4 record for the Company.

Cash flow from operations was $411 million and free cash flow was $343 million. The ongoing supply constraints resulted in shipments being pushed to the end of the quarter leading to the highest ever accounts receivable balance of $1.2 billion exiting the year, an increase of $431 million from Q3. As a result, we expect healthy cash collections in the first half of fiscal ’23, which will be a tailwind to operating cash flow for the full year.

During Q4, we repurchased $250 million in stock and paid out $111 million in cash dividends. In total, we returned $361 million to shareholders, representing 105% of free cash flow. We closed Q4 with $4.1 billion in cash and short-term investments.

Now to guidance. In fiscal ’23, we are guiding revenues to grow 6% to 8% year-over-year, which includes a two percentage point headwind from FX. In fiscal ’23, we anticipate sustained demand for and continued share gain momentum in both our all flash and object storage solutions, which we expect to drive product revenue growth in the mid-single digits. We will also continue to grow and invest in our Public Cloud business.

We expect to exit fiscal ’23 with Public Cloud ARR of $780 million to $820 million, which includes approximately $40 million from our recently closed acquisition of Instaclustr. At the ARR midpoint, we expect our Public Cloud segment to drive four points of total Company revenue growth in fiscal ’23. As George noted, we remain confident in our ability to deliver $2 billion in Public Cloud ARR exiting fiscal ’26.

In fiscal ’23, we expect gross margin to range between 66% and 67% as elevated component costs and logistical expenses from supply constraints continue to weigh on product margins. We expect first half product margins to be roughly consistent with Q4 levels. As we have previously disclosed, we believe these cost headwinds are temporary in nature, and we believe that Q4 ’22 is the trough for product margins.

As you all know, the timing of getting completely through these supply chain challenges remains fluid, but we do expect cost improvements coupled with our recent price increases to be a modest tailwind to product margins, as we head into the back half of fiscal ’23.

We anticipate operating margin to range between 23% to 24% for the full year, as we continue to invest in our growth initiatives, while maintaining a disciplined approach to spending. Our commitment is to, again, grow revenue faster than operating expenses in fiscal ’23.

Moving down the P&L, we expect net interest expense to be approximately $30 million and our effective tax rate to be in the range of 21% to 22%. Despite the considerable headwind to earnings, as a result of the higher tax rate, we are committed to delivering $5.40 to $5.60 in fiscal ’23 EPS.

We expect to generate greater than $1.4 billion in operating cash flow in fiscal ’23, as we continue to drive incremental profitability in our Hybrid Cloud segment to fund the growth in our Public Cloud business.

Free cash flow is expected to exceed $1.1 billion for the full year. Factored into the year-over-year free cash flow growth is a step-up in capex to approximately $250 million to $300 million. The higher capex forecast is being driven by three key items, one, additional capacity deployments in Azure and GCP; two, higher cloud software capitalization; and three, growing pipeline for our Keystone offering. As we’ve discussed before, additional capacity deployments within Azure and GCP are a healthy leading indicator for Cloud Storage demand.

Generating over $1.1 billion in free cash flow will allow us to continue to deliver on our shareholder return commitments, while also investing in our key strategic areas. From a capital allocation perspective, we expect to hit pause on CloudOps acquisitions for the first half of fiscal ’23, as we focus on strengthening our field and customer success go-to-market motions, while integrating our CloudOps product portfolio. As a result, we plan to return 100% of fiscal ’23 free cash flow to investors through dividends and share repurchases.

We expect our quarterly dividend to remain at $0.50 per share throughout fiscal ’23, with the remainder of free cash flow allocated to share repurchases. We plan to front-end load these share repurchases with $500 million coming in the first half of the year, which will reduce share count by 2% to 3%, as we go through fiscal ’23.

Now on to Q1 guidance, we expect Q1 net revenues to range between $1.475 billion and $1.625 billion, which at the midpoint implies a 6% increase year-over-year. We expect consolidated gross margin to be approximately 67% and operating margin to be approximately 21%. We anticipate our tax rate to be between 21% and 22%. And we expect earnings per share for Q1 to range between $1.05 and $1.15 per share. Assumed in our Q1 guidance is net interest expense of $10 million to $15 million and a share count of approximately 224 [Phonetic] million.

In closing, I want to thank the entire NetApp team for the outstanding dedication, focus and hustle in delivering strong fiscal ’22 results in a very fluid environment. We remain disciplined and committed to the long-term thesis we shared with you, as we continue to navigate the dynamic supply challenges to meet as much customer demand as possible. We are confident, enthusiastic and incredibly focused on our long-term strategic priorities and the tremendous growth opportunity we see over the next several years.

I’ll now hand the call back to Kris to open the call for Q&A. Kris?

Kris Newton — Vice President – Investor Relations

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

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question will come from Jim Suva with Citigroup. Please go ahead.

Jim Suva — Citigroup — Analyst

Thank you. Based upon the results and your competitors, who’ve also reported, it looks like NetApp has been gaining significant share, which is great. Is there anything in there that we should think about that would cause us to kind of pause or downshift that like any big recent design-ins or acceptances or on the other hand, with your sales force now fully ramped and the additional capex and things that Mike laid out, is there actually the potential you’re looking at actually upselling or upshifting it to even a higher share gain in the future quarters? Thank you.

George Kurian — Chief Executive Officer

I think if you look at the dynamics of this past year, demand was strong and consistent throughout. We were gated by supply, particularly in the back half of the year. That certainly was true even in Q4. We feel very good about our competitive position, as we outlined at our Financial Analyst Day, and we continue to see Cloud Storage has been a really strong addition to the portfolio, the number of net new to NetApp customers, meaning those that do not have our storage on-premises that bought Cloud Storage continues to be strong. So we get to cross-sell additional on-premises workloads in the future. And I think with regard to the performance of our flash portfolio throughout the year and the growth of object, the second growth engine in our on-premises portfolio, we feel really good. So thank you for the question, Jim.

Jim Suva — Citigroup — Analyst

Thank you, and congratulations.

George Kurian — Chief Executive Officer

Thank you.

Operator

Thank you. Our next question will come from Amit Daryanani with Evercore. Please go ahead.

Amit Daryanani — Evercore — Analyst

Yeah. Thanks a lot for taking my question. I guess, George, I was hoping you talk a little bit about some of the headwinds that you saw in the cloud services side that impacted the ARR number this quarter, I know you talked about three issues, maybe you can just elaborate on kind of what these things were and really the important part would be to understand your ability and conviction to resolve these and the time line to resolve these.

And my follow-up, just related to the same question around is, when I think about the 60% growth rate you’re implying on the cloud services for fiscal ’23, is there some linearity that I should be thinking about maybe the back half of travel versus [Phonetic] the first half, that would be helpful as well? Thank you.

George Kurian — Chief Executive Officer

Mike — thanks for the question, Amit. I’ll have Mike to start walking through the specifics, I’ll talk about the remedies, and then we’ll come back to guidance.

Mike Berry — Executive Vice President and Chief Financial Officer

Perfect. Thank you, George. Amit, thanks for the question. So hey, when we talk to you folks in February, and we’re looking at Q4, we have raised our expectations on the strength of Q3. We had expected Q4 to be largely consistent with what we saw in Q1, Q2 and Q3 and we expected to see some continued growth in Spot and Cloud Insights. We did know that there were some significant renewals in Cloud Insights.

So as we went through the quarter, especially as we got into April, we saw increased churn in Cloud Insights. As you know, a good bit of the sales there are helping our customers move from their OCI, their on-prem solution to the cloud solution and some of them are still trying to find their way there. Spot, we saw lower expansion, as you know. We see — we have seen in the first three quarters, a good bit of expansion in that business, as they’ve deployed more into the cloud and that didn’t come through as expected. And then we did see higher sales and customer success turnover especially in the Spot Group. So that’s what happened in CloudOps. I’ll now turn it back to George, and then, I’ll come back on your question on seasonality.

George Kurian — Chief Executive Officer

I think with regard to the remedies and the overall portfolio, listen, we feel good about the customer adds across the portfolio. Cloud Storage was a strong number. With regard to specifically how we’re addressing the CloudOps portfolio, we have refreshed the sales team. So a lot of the churn in the sales organization is behind us. We do have a newer set of members, so it will take time to ramp them.

We have brought on a new experienced leader for our Spot portfolio, who led enterprise sales at Splunk. We have brought on, as you might have seen, a new Senior Vice President for Customer Success, who was a Senior Executive at Informatica and a leader for our renewals and customer success motion in the field, who was the leader of that renewals and sales at Palo Alto. So much stronger team at the top with a focused mission around our CloudOps portfolio and driving renewals and customer success.

A couple of other things that we’ve learned, right? We’ve learned that we need to integrate these acquisitions more quickly particularly on the go-to-market side, and we are taking that lesson learned and applying that to our Instaclustr acquisition, as well as the work that we’re doing to integrate the product portfolio more quickly, so that it’s easier for customers to buy.

Now, I’ll have it back to Mike, to talk about how that impacts guidance for next year.

Mike Berry — Executive Vice President and Chief Financial Officer

Thank you, George. So Amit, on the numbers, I just want to walk that for you. So we ended the year total ARR at $505 million. The midpoint of guidance is $800 million, that does include $40 million from Instaclustr. So let’s do the organic business first, $505 million to $760 million at the midpoint, which implies about a 50% growth during the year, and then you add the $40 million exiting the year from Instaclustr, that gets you to the $800 million. And as we go through the year, we feel really good about several drivers of growth that we should start to see accelerate, as we go through fiscal ’23.

Number one, we have added a good bit of sales capacity, you see it in the opex numbers not only in ’22, but we will in the first half of ’23. We are excited about the ramp of FSx for — FSx ONTAP, as well as GCP, as we go through the year, have those become more meaningful contributors. As I talked about in my prepared remarks, we continue to invest a lot in the capacity for ANF specifically. And then a smaller pieces just as we resolve some of the items we talked about with CloudOps, we think that, that will help the second half. So you should expect to see acceleration, as we go through the year into the second half and we feel really good about the $760 million number.

Amit Daryanani — Evercore — Analyst

Perfect. Thank you very much for all the clarity.

Mike Berry — Executive Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question will come from Samik Chatterjee with JPMorgan. Please go ahead.

Samik Chatterjee — JPMorgan — Analyst

Hi, thanks for taking my question. I guess, George, in relation to your Public Cloud, sort of the air pocket that you’re seeing, it does look like you’re implying that most of the headwinds have stemmed from a go-to-market sort of execution. Just wanted to sort of maybe ask for a bit more color there of what gives you confidence, it’s just go-to-market approach here, you have to serve [Phonetic] the decision to stop acquisitions, what gives you the clarity at this point, there is not a sort of additional services that you need to add to round out the portfolio sort of what’s giving you that clarity, it’s just a go-to-market execution at this point. And I have a quick follow-up, for Mike? Thank you.

George Kurian — Chief Executive Officer

We saw strong adoption of our services. I think as we mentioned in the prepared remarks, the strong number of customer additions. I think the places, where we can do a better job is really customer success and cross-sell and up-sell, which is work that’s in front of us. I think that’s also required some integration work in the product portfolio to make it easier for the sales organization to do that cross-sell and up-sell, some of that integration work is completed.

Others is in process, and you will see us integrating Instaclustr quickly into the NetApp portfolio, so that it can take advantage of all of our differentiated infrastructure services, storage, Spot, Cloud Insights, so that they can — we can hit the ground running pretty quickly with all of that differentiated platform behind them. So I would say within the quarter, it was mostly go-to-market execution. I think to aid the go-to-market team, we also have work to do on the product side, which we’re accelerating and trying to accelerate the integration of Instaclustr into NetApp.

Samik Chatterjee — JPMorgan — Analyst

Got it. And Mike, just a quick follow-up on gross margin sort of trajectory through the year, is the improvement that you’re implying sort of as you get into the back half, is that just more a function of the Public Cloud margins improving, as you scale those revenues or are you expecting a similar improvement in Hybrid Cloud and how much of that has to do with sort of pricing actions coming more materially through the P&L?

Mike Berry — Executive Vice President and Chief Financial Officer

Yeah. Thanks for the question, Samik. So it’s both of those. Let’s take Hybrid Cloud, first. So we do expect the margins — the product margins in Hybrid Cloud in the first half to be relatively consistent with Q4. We did say, hey, we thought Q4 was the trough, we still feel that way as we go through the year, and then seeing some expansion in the back half driven by both the pricing actions that we took, as well as all the work that’s going on around supply chain. So both of those go into that number.

And then from a Public Cloud perspective, there are several drivers of that increased gross margin that we talked about hey, scaling that business as ANF scales and utilizes those assets better, more software and growth in that business. So it’s both of those that will add to the margin and that breaks that apart. You’ll also see if you go through — when you go through the numbers, hey, that the cloud gross margins are starting to be a pretty significant contributor to the growth, as we go into ’23 and beyond. So thank you for the question.

Samik Chatterjee — JPMorgan — Analyst

Okay. Thank you very much.

Operator

Thank you. Our next question will come from Rod Hall with Goldman Sachs. Please go ahead.

Bala Reddy — Goldman Sachs — Analyst

Hi, thanks for taking my question. This is Bala Reddy on for Rod. I want to start with the price increases. So it looks like they are starting to kick in and from memory, I remember the price increases magnitude is to the tune of high single digits or maybe 10% or in that range. Given this price increase, I’m wondering why wouldn’t product revenues grow more than mid single digit in fiscal ’23 maybe, there is an element of cautiousness in that guide, given the current macro uncertainty. I just thought you would help us understand a little bit better, better color [Phonetic]?

George Kurian — Chief Executive Officer

First of all, customers buy in dollars and so, whether we raise prices or not, their budgets are determined in dollars. And so if we raise prices, they’ll buy fewer systems for the same dollars, right. I think that’s the first.

I think the second is, listen, we feel good about — really good about the work that our supply chain team has been doing all year. We’ve had two successive quarters, where we’ve been gated by supply rather than demand. We see a steady demand picture next year, this coming year, and which is being realistic about how fast the supply chain constraints ease. So buying in dollars and supply chain continuing to be work in progress for us through the course of the year.

Bala Reddy — Goldman Sachs — Analyst

That helps, George. And just to make sure I get it right, so you’re not really baking in any macro slowdown or anything in the back half of the year or actually just much a function of supply chain shortages.

George Kurian — Chief Executive Officer

At the moment we see demand to be steady, and we are gated by supply. And so, yes we understand the economic environment is uncertain. We’re managing what we can control. Our demand outlook has so far been really solid and we’re gated by supply.

Bala Reddy — Goldman Sachs — Analyst

That’s helpful. And a quick follow-up if I may. I was looking at America’s commercial mix, revenue mix in the quarter, it looks like it’s only flat quarter-over-quarter, whereas it’s typically up in Q4, and on the other hand, Asia Pacific has done really well in the quarter. I’m just wondering are you seeing any kind of divergence or more of a magnitude of — more of a function of allocating supply to different places?

Mike Berry — Executive Vice President and Chief Financial Officer

Yeah. Hey, Bala, it’s Mike. So I guess, it’s really the supply chain gaining [Phonetic] that revenue generation and it varies by geo in terms of the product. So no significant changes from a geo perspective. Those what you see there is really supply chain gaining [Phonetic] that revenue.

Bala Reddy — Goldman Sachs — Analyst

Got it. Thanks so much.

Operator

Thank you. Our next question will come from Meta Marshall with Morgan Stanley. Please go ahead.

Meta Marshall — Morgan Stanley — Analyst

Great. Thanks. You know, you guys noted some success in hiring new sales reps during the quarter. Just wanted to get a sense of whether that was more backfilling or whether you’ve had some success on some of the [Phonetic] hiring for the higher level solution sales like or sales execs that can help with the cross-sell and up-sell.

And then maybe just kind of on the second point around the replacing some of the sales execs that have left, just what do you see as the ramping timeline for some of the new hires to productivity? Thanks.

George Kurian — Chief Executive Officer

I think the majority of our investment is focused on new sales reps with cloud backgrounds, we call them Cloud Sales Specialists. So the types of execs, Meta, that you mentioned that know how to sell some of our applications portfolio and CloudOps portfolio. So that’s the majority. We also have had to replace some attrition in our front-line sales teams as well. And we continue to manage through that. It’s a normal sort of course of business, right. I think the specific areas that we saw higher than anticipated attrition were really in our CloudOps portfolio, and I think we’ve done a good job sort of refreshing the team and also bringing on the new leadership team.

I think when you look at the ramp time, it takes a few quarters, and that’s why I think there’s already been activity underway. We see that there will be some improvements through the first half, and then certainly in the second half of the year, we should see the team being fully productive.

In addition, given the ramp of our cloud business and the expectations of the ramp, we are continuing to invest in additional capacity, for example in Cloud Storage and other areas. We will of course in line with our disciplined operating management philosophy, we don’t see the growth tap on the brakes. But right now, we feel that’s a good investment to make.

Meta Marshall — Morgan Stanley — Analyst

Great. Thank you.

Operator

Thank you. Our next question will come from Nik Todorov with Longbow Research. Please go ahead.

Nik Todorov — Longbow Research — Analyst

Yeah. Thanks, and then congrats on the strong results, particularly given the supply chain headwinds. George, a question maybe, how have — just curious, how have the conversations been over the last, especially couple of weeks when you talk with customers regarding their IT budgets in this environment? I think clearly there is a lot of headwinds, like you talked to macro and supply chain and inflation, but there has been some recent third-party surveys showing that budgets for IT are actually ticking up and not down and even if inflation pressure kind of persists. So just curious, what is the feedback that you’re getting from CIOs and CFOs on those discussions around the IT budgets? Thanks.

George Kurian — Chief Executive Officer

I think, IT is continuing to be seen as we have said, is core for the transformation of the business. And so there are the strategic projects around customer experience transformation, business process automation, a variety of those projects that are analytics continue to move forward. AI/ML projects, for example continue. We had a strong year and continue to see a strong outlook for that part of our business. So, so far, as we’ve said, the demand picture has been steady and we recognize that there is increased uncertainty. But I think so far the demand picture for IT spending within our customer base has remained steady.

Nik Todorov — Longbow Research — Analyst

Okay. Great. And if I can follow up, Mike, on the price increases, I just want to understand, do you envision incremental price increases, especially if you see further cost pressures through the year or you think that you’ve kind of front-loaded the price increases and you just need to realize those as the year progresses?

Mike Berry — Executive Vice President and Chief Financial Officer

Yeah. So thanks, Nik. My answer to that would be, we are intently focused on realizing the ones that we put in place. We’re still working through those. So at this point, that’s our focus. We’ll see and what the rest of the year holds, never say never. But our focus right now, Nik, is realizing those other two price increases.

Nik Todorov — Longbow Research — Analyst

Got it. Thanks, guys. Good luck.

Operator

Thank you. Our next question will come from Sidney Ho with Deutsche Bank. Please go ahead.

Sidney Ho — Deutsche Bank — Analyst

Thanks for taking my question. In terms of your billings, obviously very strong billings with over $2 billion for the quarter. It’s always strong in the second half of the fiscal year and that’s also the case this past year. Are there any trends within the billings that you would highlight that suggest maybe customers are putting in orders longer than they did historically because of maybe some concerns of supply constraints? Maybe just ask differently, how do you monitor the health of these billings? Thanks.

Mike Berry — Executive Vice President and Chief Financial Officer

Hey, Sidney, it’s Mike. So great question. So thank you. So in Q4, we saw billings growth of 16%. As you know, billings is revenue plus change in deferred. Largely on a quarterly basis when you see billings and revenue come in differently, it’s going to be driven by the timing of support not only on point of sale, but also renewals and that’s exactly what happened in Q4.

Keep in mind that a lot of our initial transactions will come with three years of maintenance. So you will get some variability on when those renew. So if you bifurcate the 16%, about 12% of that growth came through support renewals, and thankfully, a lot of that was in software support, so that bodes well for all of us. And that was really based on the timing of some renewals not only initial sales, but also renewals. So we watch that very carefully. We watch duration.

And when you look at deferred revenue, you see some of that did go into long-term, so we did see some longer term renewals typically related to initial sales. But we’ve seen that short-term and long-term deferred revenue percentage stayed remarkably consistent. So that will jump around a little bit by quarter. Nothing to be concerned about on this. It was a great quarter of billings. And the nice part is that will translate into cash flow next year. So hopefully that helps.

Sidney Ho — Deutsche Bank — Analyst

Yeah. Thank you.

Mike Berry — Executive Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question will come from Tim Long with Barclays. Please go ahead.

Tim Long — Barclays — Analyst

Thank you. Yeah, maybe two if I could. First on the all flash array front, still pretty good growth, but you mentioned your installed base is still not moving that much. So could you talk a little bit about what you think NetApp can do to further get that installed base over to all flash given the better economics all around for you.

And then, second, if I could just go back to the cloud ARR business. Could you talk a little bit about kind of better conversion of your installed base on-prem and what you’re seeing from the other large on-prem players, and if they are trying to enter into this piece of the market as well? Thank you.

George Kurian — Chief Executive Officer

First of all, the installed base that we are penetrating is a very, very large installed base, and there are several factors that they consider as they look at new purchases, right, IT budgets, a mix of different system types. We did see a higher mix of our hybrid flash portfolio, where we have the only model and operating system that supports hybrid flash technology.

In prior circumstances, when there was some uncertainty about budgets or economics, we would shift towards more of a value oriented system like a hybrid flash. So whether that’s true or not, it’s one data point, but we did see very strong hybrid flash unit shipments this quarter, which is why the total penetration into our installed base was relatively flat.

We continue to do the work to quantify more applications, more new workloads and drive our field to go after new logos, as well as drive our installed base conversion. There are incentives in place to sell new systems at a higher rate than renewals or refreshes, and those have been put in place for this year. And so I’m hopeful that, that will drive more conversion.

With regard to cloud ARR, I think the main questions are, listen, we feel good about the acquisition of net new customers into our cloud portfolio. I think when we started the cloud journey, there was a concern that cloud growth would literally be offset by on-prem decline. We’re not seeing that and it’s reflective of the strength of our portfolio on both fronts.

And so, yes, could we do more to convert our installed base to cloud, we have got incentives in place this year, where the sales reps cannot make their number without selling cloud, as a part of their overall kind of quota. And so there are discrete quotas set up for cloud, they have got a complete selling bag to be able to accomplish their total compensation objectives. And so, we’ve got work underway, we’re doing enablements, but I do feel good about the fact that we are able to acquire a lot of net new customers. Those are our competitors’ customers after all with our Cloud Storage portfolio.

Tim Long — Barclays — Analyst

Thank you very much.

Operator

Thank you. Our next question will come from David Vogt with UBS. Please go ahead.

David Vogt — UBS — Analyst

Great. Thanks for taking my questions, guys. Just a quick question on the acquisition strategy. So before you decided to hit pause, can you kind of discuss how the pipeline was shaping up and how sort of the opportunities might have looked for that particular strategy, given the repricing that we’ve seen in both the public and the private markets? And when you think about the opportunity cost of pursuing — not pursuing transactions, how do we think that affects the ramp of the longer-term target in that sector or in that segment, I should say? And then I have a quick follow-up.

George Kurian — Chief Executive Officer

Listen, I think we’ve had a disciplined acquisition strategy, right. We started with Cloud Storage, we enabled Cloud Storage to become multi-cloud across all the hyperscalers with both NetApp managed and native cloud services. We then added monitoring, which is Cloud Insights, organically taking one of our enterprise products and making it cloud ready and made that a multi-cloud monitoring service, so that customers could understand the performance of their applications. Then we brought in Spot, which gave us the complement for compute that we had with storage, right, our organic storage.

So now we’ve got a multi-cloud infrastructure services portfolio, that’s truly unique in the market, and we are adding applications deliberately, right. So we’re not trying to be in every application. We’ve got specific applications that leverage the full portfolio of our infrastructure services. Spot PC for virtual desktop uses Cloud Volumes and Spot’s compute optimization technology. We’ve got for Spot for Kubernetes, which uses the Spot Ocean technology, as part of its underlying infrastructure capability, and then most recently, Instaclustr. I feel really good about the portfolio.

Listen, we want to integrate these acquisitions, so that they get off to a fast start, and I think we feel really good about our portfolio. If you look at the numbers that we’re guiding to, I think if we hit — we finish FY ’23 strong, we’re in great shape to accomplish our $2 billion target. And you know, we just focused on, let’s get these right in the first half of the year and then we’ll take a look at the market.

David Vogt — UBS — Analyst

Great. Thanks, George. And then, Mike, maybe a follow-up for you on Public Cloud gross margin. What scale, maybe can you give us a sense of scale that you need to get to, to get to your longer-term targets? Because even if I look before this quarter, sort of the incremental gross margins have been running in the low 70%s, as you invest in the business, and obviously there is some cost absorption issues or maybe it’s helpful if you can give us sort of an order of magnitude of what that delta might look like from a margin perspective, so we could see the roadmap to that 75% plus Public Cloud gross margin that you sort of targeted out there. Thanks.

Mike Berry — Executive Vice President and Chief Financial Officer

Yeah. Hey, thanks, David. So I want to answer that by saying, hey, by the time we get to a $1 billion in ARR and I’m going to break it up for you a little bit. We would certainly expect to see us getting very close to at least the bottom of that range, and there is two major drivers to that brand. In CloudOps, the majority of those products are software and cloud-based, as those continue to grow, they are accretive to not only cloud, but certainly the total Company. And hey, the other big driver here is in Cloud Storage. We are continuing to invest a good bit for all the right reasons to drive growth in ANF and GCP.

As we’ve talked about, when it comes after a couple of years, as we start to modulate that capex investment, those are being depreciated over three years, that depreciation is going to start to cap out. It’s going to have a significant positive impact to gross margins because now we’re going to benefit from utilizing those assets longer than their accounting life because their useful life is quite a bit longer.

So of all the stuff we’ve talked about, I feel really good about getting to 75% at least at the bottom end because of all those items. And to your earlier question, acquisitions will focus around those software and cloud assets as well. So all of those things added together make me feel really good about that range.

George Kurian — Chief Executive Officer

I’ve got to just add one more…

David Vogt — UBS — Analyst

Great. That’s — yeah — that’s helpful.

George Kurian — Chief Executive Officer

Yeah. Hey, if I were to just add one more, FSx is a software only solution. So as that ramps, that’s also accretive.

Mike Berry — Executive Vice President and Chief Financial Officer

Great point. Thank you.

David Vogt — UBS — Analyst

The clarifications, very helpful. Thanks, guys.

Operator

Thank you. Our next question will come from Simon Leopold with Raymond James. Please go ahead.

Simon Leopold — Raymond James — Analyst

Thank you very much for taking the question. First, I just wanted to see if maybe we can clarify what happened to gross margin for the Public Cloud in the quarter with the step down, was there any new significant investments being made in terms of deployed footprint ahead of revenue, given that you’re not facing the same kind of input cost issues, that’s just a clarification.

And then, in terms of my longer term question, I’d like to see what you’re hearing in terms of the demand side that’s influencing your forecast for the Public Cloud services revenue outlook. I heard a lot about the execution and the internal aspects, but I want to get a better understanding of the demand side of that equation? Thank you.

Mike Berry — Executive Vice President and Chief Financial Officer

Sure. So, hey Simon, it’s Mike. I’ll do the gross margin, first. So a couple of things. It dipped down a little bit from, I believe 71% to 68% [Phonetic], there were two major drivers of that. Number one is, a little bit lower revenue, obviously there is some fixed costs in there. The other part is we continue to invest in the capacity specifically for ANF. Even though, we are largely for our capex number for fiscal ’22 right about where we guided, there was a mix shift, candidly we spent less in facilities because I’m going to bring up supply chain, again, we had a little issue there, that got pushed into ’23, and for all the good reasons, we actually deployed more capacity for ANF. Now that depreciation hits right away, and then the ARR builds. So that — those were the two major drivers.

As we go through fiscal ’23, our goal is to get back to that 70% [Phonetic]. Instaclustr will come in, I’d call it mid 60%s margin, and we expect that to fully get to about 70% [Phonetic] exiting the year. And then as we continue to build ARR and leverage the existing footprint, that’s why we feel good about getting back to 70% [Phonetic] by the end of the year. So those are the margin puts and takes.

George Kurian — Chief Executive Officer

On demand, we feel good. Listen, we had strong customer adds across the portfolio in the quarter. We continue to see good dollar based net retention rates of 159%. So we feel good. And we’re really focused on going and capturing the demand. Cloud continues to be a place, where we see customers prioritizing investment.

Simon Leopold — Raymond James — Analyst

Thank you.

Operator

Thank you. Our next question will come from Wamsi Mohan with Bank of America. Please go ahead.

Wamsi Mohan — Bank of America — Analyst

Yes. Thank you. On gross margins, you thought that 4Q would be the bottom in gross margins, I think you’re saying that again today. But you’re also saying first half will be roughly at the same level for this in the next quarter, is that the trajectory you had expected last quarter or did things change that was causing you to bump along the trough margins for a longer time, especially given that fiscal 2Q, you typically have a much richer mix from federal that should be helping your gross margins tick up higher. And I have a follow-up.

George Kurian — Chief Executive Officer

Listen, I think what we said is, the first half of this coming year will be relatively similar to what we had in Q4, which is substantially better than what we — that we realized a substantially better outcome than what we feared going into the quarter. I think what we said is, second half of the year is a modest tailwind to the first half of the year.

We see improvements in the supply chain through the course of the year. I think COVID-related freight should get better. I think the amount of open market purchases should hopefully get better over time. I think we’re being a little bit cautious about where we are in the course of the year. But overall, I think that’s the picture.

Wamsi Mohan — Bank of America — Analyst

Okay. Thanks, George. And just as a clarification, I know you made several comments around PCS tracking a bit weaker than expected, but as you’re mapping this on to longer-term targets, can you give your thoughts around hitting pause on CloudOps M&A, which is a big part of the overall long-term guide. I mean it’s a substantial part of how you were originally getting to your long-term guide, especially in light of the fact that valuation seem to have come down, you just did Instaclustr. Just wondering if hitting the pause is more some cautiousness about the rate and pace of trajectory or is it about the speed of integrating some of these assets that you have acquired, especially given the valuation compression that was seen in the market? Thank you.

George Kurian — Chief Executive Officer

Listen, we don’t expect the valuation compression to go away, right. I think we see that as the start of the journey, and so we see plenty of opportunity ahead to do in organic goals. I think the focus we’re trying to bring is, first of all, in our outlook, we feel really good about the outlook. We wouldn’t guide the year to a strong number if we didn’t feel that way.

We see continued strength in organic innovation, for example, Cloud Storage and Cloud Insights. We’ve done a substantial number of acquisitions in CloudOps, and we’re going to take a little bit of time to integrate them on the product side and integrate them on the go-to-market. I think it’s just, it’s prudent, it’s disciplined, and will be — we feel very, very good about our portfolio, not just in Cloud Storage, but in CloudOps as well.

Wamsi Mohan — Bank of America — Analyst

Okay. Thanks, George.

Operator

Thank you. Our next question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Aaron Rakers — Wells Fargo — Analyst

Yeah. Thanks for taking the question. I’ll try and slip in two real quick, if I can. I guess, the first one is, one of your competitors tonight talked about actually some customers pulling forward demand from the back half of the year into the first half of the year, there’s been a lot of discussion around the backlog. And so I’m curious, number one, if you’ve seen any of that and how would you characterize the duration of kind of the backlog you’re seeing and how maybe that’s changed over the last two quarters or three quarters?

George Kurian — Chief Executive Officer

We haven’t seen any evidence of pull forwards or phantom demand, I think we have a close relationship with our customers. Every one of them has been quite balanced in terms of being a good citizen around, hey, we’ll take some of our order and we’ll wait for others. So I think we’ve got a pretty balanced book of business. As we said, we’ve had supply gate demand for two successive quarters, Q3 and Q4 very clearly saw the same pattern and backlog is elevated.

Aaron Rakers — Wells Fargo — Analyst

Yeah. And just as a quick follow-up, simple question, how would you characterize the competitive landscape? I know, Dow, EMC saw growth for the first time in a while this last quarter. How would you characterize what you’re seeing competitively in the market?

George Kurian — Chief Executive Officer

I think it’s pretty much the same. Pure and NetApp taking share from Dell and HP and several other players. So I would characterize it as no fundamental change to be honest. Thank you.

Aaron Rakers — Wells Fargo — Analyst

Perfect. Thanks.

Operator

Thank you. Our next question will come from Nehal Chokshi with Northland Capital. Please go ahead.

Nehal Chokshi — Northland Capital — Analyst

Yeah. Thanks. I realize you guys are not economists here, but what do you think is the probability of the IT capex downcycle given tightening financial conditions? And then what are your thoughts on NetApp share gain trajectory being stunted or helped by a potential IT capex downcycle as well?

George Kurian — Chief Executive Officer

Mr. Nehal, I’ll just say I’m not an economist, right. We are in discussions with our customers. I would say in every IT portfolio, there’s probably projects that are strategic that will continue to be invested in regardless of supply chain constraints or economic environment or whatever it is, right. So I think those projects we see continuing, and we’re going to be a part of those as much as we can.

I think with regard to our competitive environment, listen, we are part of several mega trends that those will continue, right, cloud, data management, analytics, high performance computing environment. So long as we continue to innovate and stay focused, I think we’ve got a good opportunity ahead.

Nehal Chokshi — Northland Capital — Analyst

And so, just to be clear, you expect your share gain trajectory to be helped or stunted by a potential IT capex downcycle?

George Kurian — Chief Executive Officer

I think if there is an IT capex downcycle, what we generally see is, within the IT spending envelope, transformational projects that are critical to business need will get prioritized. And so long as we are part of those projects, it’s a share gain opportunity.

Nehal Chokshi — Northland Capital — Analyst

Great. Thank you.

George Kurian — Chief Executive Officer

Thank you.

Operator

Thank you. And today’s final question will come from Jason Ader with William Blair. Please go ahead.

Jason Ader — William Blair — Analyst

Great. Thank you. I guess, George, just to wrap up, what lessons has NetApp learned from these last couple of years, where you’ve been kind of on an acquisition binge in this cloud services space, you know, as you kind of reflect on what you could have done better and what you need to do better. Maybe just kind of summarize your thoughts there for us?

George Kurian — Chief Executive Officer

Listen, I feel like we’ve accomplished a lot, right. I think no one believed us when we said our Cloud Storage would be a native service in all of the three major hyperscale cloud providers, and we’ve delivered on that. We said we would cross $500 million in cloud ARR and we delivered on that. We said cloud gross margins would be at or better than Company average gross margins, we’ve delivered on that.

We said cloud would be a way for us to acquire a whole lot of net new customers, we’ve delivered on that. And over the course of the last two years, we’ve balanced organic innovation, and there has been a substantial amount with complementary deliberate acquisitions that allow us to serve a full customers’ need, right, around an application portfolio.

I think where we could do better is learn from the mistakes we made around integration, and we’re going to — everybody learns from that and we’re going to own that and we’re going to see, do the work that’s needed to integrate those acquisitions better in the first half of this year. But I don’t think any of that diminishes from the opportunity in front of us or the place that we are. We are in a strong position, and we’re going to capitalize on it with disciplined execution.

Jason Ader — William Blair — Analyst

Very good. Good luck. Thank you.

George Kurian — Chief Executive Officer

Thank you. Before we close, we delivered a solid Q4 rounding out a strong FY ’22 with record levels of gross margin dollars, operating income and earnings per share. Looking forward, we remain focused on capturing the substantial opportunity ahead, as we scale our Public Cloud services, while continuing to drive growth in our Hybrid Cloud solutions. I want to underscore my confidence in the long-term thesis we presented at our Investor Day of delivering value through sustained growth. Our alignment to customer priorities, strong balance sheet and prudent operational management puts NetApp in a position of strength. Thank you.

Operator

[Operator Closing Remarks]