NetApp's Q1 2026 Earnings Call: Contradictions Emerge on Gross Margins, AI Growth, and Public Sector Exposure

The above is the analysis of the conflicting points in this earnings call

Date of Call: August 27, 2025

Financials Results

• Revenue: $1.56B, up 1% YOY; up 3% YOY excluding Spot; FX favored growth by ~1 pt
• EPS: $1.55 per diluted share
• Gross Margin: 71.1%, up 160 bps sequentially
• Operating Margin: 25.7%

Guidance:

• Q2 revenue expected at $1.69B ± $75M (~+2% YOY; +3% ex-Spot).
• Q2 consolidated gross margin 71% ± 0.5%; operating margin 28%–29%.
• Q2 diluted EPS $1.84–$1.94 (midpoint $1.89).
• FY26 revenue $6.625–$6.875B (midpoint $6.75B, ~+3% YOY; +4% ex-Spot).
• FY26 diluted EPS $7.60–$7.90 (midpoint $7.75).
• Raised long-term Public Cloud gross margin target to 80%–85% (from 75%–80%).
• Expect product gross margin to improve and operate mid–high 50% for rest of FY26.

Business Commentary:

* Revenue Growth and Product Mix: - NetApp reported revenue of $1.56 billion for Q1 2026, above the midpoint of its guidance range, with a major contributor being strong demand for all-flash offerings. - Exiting Q1, 45% of systems in their installed base under active support contracts were all-flash, with a 6% year-over-year increase in all-flash array revenue to $893 million, equating to an annualized run rate of $3.6 billion. - The growth in all-flash systems was driven by healthy customer engagement and interest in NetApp’s unified and block-optimized all-flash storage portfolio.

• AI and Cloud Services Expansion:
• NetApp's first-party and marketplace cloud storage services grew by 33% year-over-year in Q1 2026, with approximately 125 AI infrastructure and data lake modernization deals secured across various geographies and industries.

• This expansion is attributed to the demand for data infrastructure modernization, driven by the emerging enterprise AI market, and strong customer interest in hybrid and multi-cloud transformations.

• Operational Performance and Margins:

• NetApp's consolidated gross margin improved by 1.6 percentage points sequentially to 71.1%, with public cloud gross margin reaching 80.1%, up 80 basis points sequentially.

• The improvement in margins was due to favorable product mix, particularly in the highly profitable Support revenue, and a decrease in costs from previous quarters.

• Regional Performance and Market Dynamics:

• Revenue growth was driven by the Americas enterprise segment, offsetting declines in the U.S. public sector and EMEA.
• The U.S. public sector experienced softness due to delays in budget allocations, while EMEA faced challenges in specific regions like the UK and Germany.
• Despite the regional challenges, strong execution and demand patterns were observed in the Americas and parts of Asia Pacific.

Sentiment Analysis:

• Delivered a strong quarter, exceeding the midpoint of our revenue and EPS guidance ranges. Total revenue $1.56B, up 1% YOY; all‑flash revenue up 6% YOY. Achieved Q1 records for cash flow from operations ($673M) and free cash flow ($620M). Reiterating full‑year FY26 guidance (revenue $6.625–$6.875B; EPS $7.60–$7.90) and guiding Q2 to YOY growth. Public Cloud gross margin reached 80.1% and long‑term target raised to 80%–85%. Management noted USPS and some EMEA softness and macro caution but emphasized strong Americas enterprise demand and disciplined execution.

Q&A:

• Question from Krish Sankar (TD Cowen): Why did all‑flash growth decelerate and product gross margin decline—pricing vs demand—and what’s the outlook? Also, how are AI architectures driving storage/capacity/software needs?
  Response: All‑flash growth slowed due to USPS/EMEA softness; product GM was pressured mainly by higher flash costs and mix; margins should improve and operate in the mid–high 50% range going forward.

• Question from Mehdi Hosseini (Susquehanna Financial Group): Does availability of 128TB QLC NAND affect AI search solutions, and how should we think about January quarter seasonality?
  Response: Not gated by NAND—NetApp offers broad drive options matched to workloads; confident on FY but will guide quarter‑by‑quarter given macro uncertainty.

• Question from Erik Woodring (Morgan Stanley): Will strength in Americas commercial and weakness in U.S. public sector/EMEA persist, and any end‑market inflection ahead?
  Response: Americas ex‑public was strong across enterprise/mid‑market; USPS was very weak but Q2 is seasonally stronger; EMEA softness localized (UKI, some German large enterprise); APAC largely solid.

• Question from Erik Woodring (Morgan Stanley): Why raise the Public Cloud gross margin target to 80%–85%?
  Response: Sustained margin gains from depreciation roll‑off of initial hardware and higher software mix; expect continued gradual improvement, supporting the higher 80%–85% target.

• Question from Samik Chatterjee (JPMorgan): What’s the size/mix of AI deals and should the win rate accelerate through FY26?
  Response: AI deals span small POCs to very large RAG/training and AIaaS; wins more than doubled YoY; expect steady growth through the year.

• Question from Samik Chatterjee (JPMorgan): Visibility into back‑half acceleration needed for FY guide; role of large data‑center modernization deals?
  Response: Working multiple large deals and DC modernizations; feel good about the year but will update the trajectory after Q2; USPS headwind lessens in H2.

• Question from Wamsi Mohan (BofA Securities): How can Q2 gross margin be down sequentially if product and Public Cloud GMs improve; and outlook for operating leverage?
  Response: Consolidated GM is essentially flat; higher product mix in Q2 creates a small headwind; expect operating leverage to continue in the back half.

• Question from Timothy Patrick Long (Barclays): Plans to convert remaining installed base to all‑flash and implications; and Keystone outlook?
  Response: High refresh win rates due to consistent software/ops; HDD still used for cold/backup; Keystone is growing as a flexible as‑a‑service model and aids competitive transitions.

• Question from Simon Matthew Leopold (Raymond James): Readiness and direction of AI product strategy and moving up the value chain?
  Response: Priorities are high‑performance storage, cloud‑equivalent capabilities, richer data management (search, governance, vectorization), and deeper NVIDIA/hyperscaler ecosystems; more coming at Insight.

• Question from Ari Nareg Terjanian (Cleveland Research): Update on all‑flash competitive landscape and pricing actions?
  Response: Competitive intensity unchanged; USPS exposure weighed more than competitors; no tariff‑driven pricing; product GM pressure mostly cost‑related with compares improving later in the year.

• Question from David Vogt (UBS): High‑performance vs capacity flash mix and regional dynamics; component prebuys/supply chain status?
  Response: Mix differed from plan but high‑performance flash outgrew capacity; product GM should improve; supply chain healthy with some volumes under locked pricing.

• Question from Ananda Prosad Baruah (Loop Capital Markets): AIaaS/sovereign AI implications for TAM; and effect of reasoning agents on RAG pipeline?
  Response: Entering AIaaS via NVIDIA certifications and sovereign opportunities; core storage TAM remains enterprise inference; adding tools to prepare/optimize unstructured data for RAG and reasoning.

• Question from Asiya Merchant (Citi): Hypervisor strategy amid VMware changes and Nutanix/HCI landscape?
  Response: Support a broad set of on‑prem and cloud hypervisors based on customer choice and will continue expanding support.