NTAP.US (NTAP.US) Q1 conference call: AI drives demand for “structural improvements” rather than quick purchases, and the effects of price increases may appear more quickly
The Zhitong Finance App learned that NTAP.US (NTAP.US) announced the results for the first quarter of the 2027 fiscal year and held a results conference call. Q1 revenue was US$2.03 billion, up 30% year over year, far exceeding market expectations of US$1.84 billion; non-GAAP earnings per share were $2.58, up 66% year over year, higher than market expectations of $0.46; all-flash array revenue increased 47% year over year to US$1.31 billion; and operating margin expanded 610 basis points year over year to 31.9%. The company simultaneously raised its annual revenue guidance to US$79.75-8.225 million (median increase of 17% year over year) and its earnings per share guideline to US$9.73-10.03.
The company's first fiscal quarter results were impeccable on a digital level, but the market's questions about the quality of growth — structural improvements vs. early procurement, sustainability of pricing dividends, and whether the AI-driven modernization wave can continue — as well as concerns about a natural slowdown in growth in the second half of the year, together formed the deep logic of stock prices being pressured. The company repeatedly emphasized “structural improvements” and “broad demand” during the Q&A session to try to convey confidence in sustainable growth to the market, but investors clearly need more quarterly data to verify this narrative.
Focus 1: Sustainability of growth — structural improvements or early procurement?
Regarding the details of the financial report, J.P. Morgan analyst Joseph Cardoso was the first to ask: What factors are driving faster purchasing decisions and pricing advantages? How many of these needs are sustainable? CEO George Kurian responded that demand was “widely distributed” this quarter, covering various customers, regions and industry vertices. In particular, he emphasized that unlike previous cycles of sharp increases in silicon wafers and commodity costs, “we saw the opposite” this quarter — all types of customers showed strong momentum far exceeding expectations. He characterized this as “a significant structural improvement in the potential demand environment”.
Evercore ISI analyst Amit Daryanani asked: The growth rate slowed from 26% in Q1 (excluding an additional week) to 9%-10% in the second half of the year. What caused this slowdown? Kurian responded that the company “drastically raised its full-year performance expectations”, which itself reflects confidence in the strong momentum of the second half of the year. CFO Wissam Jabre added that after excluding the additional week, the revenue share for the second half of the year and the first half of the year was roughly five or five, in line with typical seasonal patterns.
Morgan Stanley analyst Erik Woodring further asked: Since demand is so qualitative, why not raise expectations by 10% or 20%? Jabre responded that the company saw “very strong structural improvements”, mainly driven by AI workloads and modernization. But he stressed that the company has only completed one quarter and “we will provide more information as our performance progresses during the year”.
Focus 2: Pricing Power and Gross Margin - How long can the dividends of price increases last?
Product gross margin is another central point of contention. The product's gross profit margin for the quarter was 54.6%, down 150 basis points from month to month. It was mainly affected by rising component costs, partly offset by better pricing. Citibank analyst Michael Cadiz asked how much pricing revenue has been achieved and whether demand elasticity has changed. Kurian notes that customers' data infrastructure budget priorities have “increased significantly”, and even higher prices will prioritize certain use cases. Jabre added that the impact of the price adjustment measures “will be felt faster than before” — it used to take two to three quarters to see results, but now it can be felt much earlier.
TD Cowen analyst Krish Sankar asked whether rising inventories were linked to specific customer orders and backlogs. Jabre responded that the increase in inventory was a “strategic purchase” to ensure sufficient supply to continue to drive business growth. Regarding the future trend of product gross margin, Jabre made it clear that the company's annual product gross margin expectations were “slightly improved” compared to 90 days ago, indicating “greater confidence in its ability to recover the new costs”.
Focus 3: AI-driven structural transformation — 350 transactions are just the tip of the iceberg
Approximately 350 AI and data lake modernization projects were completed this quarter, a “significant increase” over the same period last year, and the scale of the project continued to expand as customers transitioned from the proof-of-concept stage to the production stage. Kurian emphasized that although 350 transactions are unique to the AI stack, “the overall performance of the business reflects the impact of AI on the modernization of the entire data infrastructure” — artificial intelligence is driving the “complete modernization and platform restructuring” of the data infrastructure stack.
UBS analyst David Vogt asked about the sustainability of all-flash demand and the impact of early procurement. Kurian responded that the number of customers who can flexibly adjust the size of expenses is “very small”, limited to a few large private companies. He admits that this quarter did see some transactions that were originally expected to take several quarters to be completed in one quarter, but “this part of the business accounts for a very small proportion and is not an important part of the overall business.”
Regarding new customer development, Fox Advisors analyst Steven Fox asked about key promotion directions and successful vertices. Kurian said that the three aspects of new customer expansion, new business volume growth for existing customers, and technology upgrades “far exceeded internal expectations”. Regarding the AFX platform, he revealed that the program “is being certified by many customers” and is progressing smoothly. In terms of public cloud business, the 19% growth rate is still impressive even after excluding the additional week. Kurian said that more AI solutions will be showcased at the Insight conference in September.
Conference content
presenter
Dear guests, welcome to the US NetApp (NetApp) financial conference call for the first quarter of fiscal year 2027. [Operating Instructions] Please note that this meeting is being recorded.
I will now entrust the meeting to Mr. Chris Newton, VP of Investor Relations. Please get started.
Chris Newton, Vice President of Corporate Communications and Investor Relations
Hello everyone. Thank you for attending our first quarter FY2027 earnings conference call. I'm in attendance today with our CEO George Kurian and Chief Financial Officer Wissam Jabre. The conference call will be webcast and the replay can be viewed on our website netapp.com.
In today's conference call, we'll be making forward-looking statements and predictions about our financial outlook and future prospects, including but not limited to our performance guidance for the second quarter and full year of FY2027, expectations for future revenue, profitability, and shareholder returns, anticipated benefits from acquisitions and partnerships, and other growth plans and strategies. These statements are subject to a variety of risks and uncertainties that may cause our actual results to differ materially from expectations. For more information, please refer to the documents we file with the US Securities and Exchange Commission (SEC) from time to time and the documents on our website, including our most recent Form 10-K and Form 10-Q. We are under no obligation to update forward-looking statements and forecasts.
Unless otherwise specified, all financial measures presented in this conference call are non-GAAP (non-GAAP) measures. A reconciliation table between GAAP and non-GAAP measures is available on our website.
Now I'm going to hand over the phone to George.
George Curian, CEO and Director
Thanks, Chris. Good afternoon everyone. Thank you all for attending our meeting today. We had an excellent start to the year. All indicators for the first quarter surpassed expectations and reached record highs. Revenue increased 30% year over year to $2.03 billion. Even in an environment where component costs are being challenged, we turned strong revenue growth into significant profitability with a steady strategy. Gross profit increased 29% to a record US$1.43 billion, operating margin reached 31.9%, and earnings per share increased 66% over the same period last year. Even considering the extra week in the first quarter, our results are still among the best in the company's history.
This quarter's results not only reflect strong execution, but also highlight NetApp's growing leadership in a rapidly changing market environment. Our wide-ranging success spans every industry and region, including signing multi-year agreements, expanding new workloads, and deepening partnerships with customers, which are strong leading indicators for our sustainable growth.
While we've seen some procurement decisions accelerate and prices have benefited, we've also seen significant structural improvements in the potential demand environment, all of which contributed to strong results in the first quarter and fueled our growth momentum. This excellent quarter not only proved the effectiveness of our execution, but also clearly indicates that more opportunities will emerge in the future.
In light of our strong start and success in all aspects of our business, we have substantially raised our performance expectations for this year.
Artificial intelligence is no longer a vision for the future, but an inevitable requirement for enterprise development. As companies put artificial intelligence into practical applications, the challenge is not only computing power, but also data preparation. NetApp is a key partner in helping enterprises achieve this transformation, simplifying complexity and accelerating large-scale value realization. The NetApp platform enables customers to deploy all of their data locally, empowers them to apply artificial intelligence, provides unified storage, strong security, and a single control plane in a hybrid multicloud environment, and its capabilities have redefined industry standards.
By eliminating the need for data movement, we help enterprises accelerate artificial intelligence and analytics while maintaining governance and control so they can confidently transition from AI experiments to production.
The strength of our platform is driving us to connect more closely with our existing customers and attract more new ones. Recently, a major US utility company stood out from a competitive evaluation and ultimately chose NetApp over traditional and flash competitors, replaced the original vendor, and adopted our unified, AI-enabled data infrastructure as the standard. Customers entrust their most demanding workloads to NetApp, and success stories like these not only herald our growing position in the market, but also lay the foundation for our long-term growth.
Our first-quarter results reached a record high, mainly due to strong growth in the public cloud, all-flash and Keystone businesses, reflecting the positive momentum of our business and validating our strategy to deliver tangible results to our customers. Driven by strong customer demand for our own storage services and market-based storage services, public cloud revenue grew to $206 million in the first quarter, up 28% year over year, or 19% when counting the additional week. Customers choose NetApp because of our secure, scalable cloud-native storage service that helps them move their workloads to the cloud. VMware workloads, in particular, are increasingly becoming one of the targets of cloud migration, providing NetApp with huge growth opportunities. In the first quarter, an American hotel company adopted NetApp technology for the first time to support its large-scale VMware migration to AWS through Amazon FSx for NetApp ONTAP.
FSxN provides superior performance, lower cost, and diverse workload support. Similarly, a US public sector agency chose Azure NetApp Files as part of its data modernization plan. ANF overcame technical barriers in other cloud services and achieved significant cost savings. These success stories highlight how NetApp's differentiated cloud storage solutions facilitate seamless and efficient VMware migrations and reinforce our ability to drive enterprises to accelerate cloud adoption and achieve continued growth. All-flash array revenue for the first quarter reached $1.31 billion, up 47% year over year. Customers are using NetApp as a standardized solution for their mission-critical workloads, including GPU-intensive AI pipelines that require high performance, low latency, and built-in network resiliency. Our innovation and marketing strategies will continue to drive our share growth in this market segment.
The breadth and flexibility of the NetApp platform is a strategic advantage in today's challenging cost environment. We help our customers optimize performance, capacity, and budget requirements without sacrificing network security and ease of operation. This value proposition is driving strong customer demand across our entire product line. Notably, we're seeing a rapid growth in market interest in hybrid flash solutions.
Let me share some recent examples of how our rich product portfolio has helped us beat our competitors and win new customers. A European pension IT service provider first partnered with NetApp and chose our unified storage solution to meet the stringent security and resiliency requirements of its critical infrastructure. Our flexible architecture not only guarantees the availability and integrity of today's highly sensitive data, but also provides a secure, efficient, and sustainable foundation for tomorrow's AI workloads. NetApp also recently helped a leading transportation agency beat its rivals. Our solution combines all-flash arrays to handle massive video files with high performance, and uses hybrid flash arrays for reliable and cost-effective long-term data storage. Our ability to provide the scalability, reliability, and performance required for advanced analysis and ongoing infrastructure maintenance was key to winning this partnership.
Artificial intelligence is driving NetApp to usher in a new round of growth, and this momentum continues to grow and accelerate. In the first quarter, we won around 350 artificial intelligence and data lake modernization projects, a significant increase over the same period last year. More importantly, as customers move from the proof-of-concept phase to production, the scale of the project continues to expand. Projects won early in previous years are gradually being expanded to production-level workloads, reflecting customer confidence in NetApp's ability to support large-scale AI environments. Our solutions help customers activate legacy data to support artificial intelligence, accelerate insights, and achieve real business results, making NetApp the core of their AI transformation journey.
Here are a few examples from the first quarter. We have signed an important agreement with Samsung Electronics to support its EDA environment and artificial intelligence center of excellence. A public sector agency has awarded NetApp a strategic agreement to modernize and expand its intelligent capabilities and provide real-time analytics using NetApp AFX integrated with NVIDIA SuperPods. AFX's decoupled architecture provides the flexibility and performance required for advanced artificial intelligence workloads, and builds a future-proof infrastructure that provides the power and scalability needed to meet changing needs as data requirements grow.
NetApp successfully secured an important order with a new Asian cloud service provider to provide a highly available, secure, and scalable storage solution for its new AI services to customers. Our strong multi-tenant capabilities and deep expertise in large-scale Kubernetes and OpenStack environments set us apart, helping this service provider modernize infrastructure and support demanding AI inference workloads. This order replaces other vendors and lays a solid foundation for NetApp in one of the service provider's most important AI strategy projects.
We are consolidating our leading position through strategic acquisitions that not only expand the capabilities of the NetApp platform, but also broaden our target markets. These investments allow us to stay ahead of the curve as customer needs continue to change and deepen our differentiation in cloud computing and artificial intelligence.
In the first quarter, we acquired DataPelago, a well-known innovator in AI data infrastructure. Their Nucleus software engine enables high-performance in-place data processing, eliminating costly data migrations and streamlining the AI deployment process. We believe that with this technology, we can extract more value from the massive amounts of unstructured data already managed on the platform, providing new opportunities for customers to accelerate AI projects and maximize the potential of existing data assets. This makes NetApp a company that truly enables zero-copy activation of enterprise data to support artificial intelligence, helping customers advance AI projects, improve efficiency, and unlock more value from data.
At the beginning of the second quarter, we acquired JetStream, a leader in cloud-native disaster recovery for VMware environments. JetStream continuously protects and recovers VMware workloads across multiple storage environments and seamlessly replicates to NetApp cloud products such as Azure NetApp Files. This acquisition will enable us to provide a simpler, more flexible path to cloud modernization and position NetApp as the preferred recovery destination for VMware deployments, even when production data originates from competitors' infrastructure.
NetApp's strong first-quarter results underscore our leadership in a transformative era shaped by the accelerated adoption of artificial intelligence and cloud computing. The power and flexibility of the NetApp platform enables us to support a diverse and growing customer base. By winning new business, deepening partnerships, and investing in innovation, we're laying a solid foundation for continued leadership and long-term growth. With rigorous execution and foresight, we reinforce our leadership position and create lasting value for our customers and shareholders. We're excited to host our annual customer conference, NetApp Insight, in September. At that time, we will fully showcase the innovations of the NetApp platform, bring new value to artificial intelligence, and meet the unique needs of high-growth markets such as new clouds and sovereign clouds. We'll also host an investor conference to detail our strategies and solutions, and look forward to your participation.
Finally, I would like to thank all the staff for their dedication and dedication. Our excellent results at the start of the year are a testament to our team's commitment to our customers and our determination to drive NetApp's continued success.
Now I'm handing over the microphone to Wissam.
Wissam Jabre, Executive Vice President and Chief Financial Officer
Thanks George and good afternoon everyone. We had excellent results in the first fiscal quarter, exceeding all expectations. Revenue for the quarter was US$2.03 billion, up 30% year over year and 4% month on month. Non-GAAP earnings per share were $2.58, up 66% year over year. Revenue growth was driven by the overall growth momentum of the business, which highlighted the strength of our product portfolio. This quarter's results reflect an improvement in the market demand environment. Customers have increased their investment in artificial intelligence and modernization, while some customers have also accelerated their procurement growth and enjoyed preferential prices. It's important to note that the first quarter included an extra week. Excluding the impact of the additional week, revenue increased 26% year over year. The additional week contributed approximately $65 million in revenue, mainly from support services and public cloud businesses.
By business segment, hybrid cloud revenue was $1.82 billion, up 30% year over year, and 27% when an additional week's revenue was included. Product revenue was $987 million, up 51% year over year. Support services revenue was $7.2 billion, up 11% year over year, and 4% if the additional week's revenue (approximately $50 million) is not included. Professional services revenue was $112 million, up 15% year over year, mainly due to the continued strong growth of our Storage-as-a-Service (Storage-as-a-Service) product Keystone. Public cloud revenue for the first quarter was $206 million, up 28% year over year, and 19% when an additional week's revenue was included, reflecting strong market demand for first-party and market storage services. The additional week's revenue contributed approximately $15 million to the public cloud. At the end of the first quarter, our deferred revenue was $4.85 billion, up 7% year over year. Remaining performance obligations were $5.65 billion, up 14% year over year.
Next, let's look at the rest of the income statement. Please note, unless otherwise stated, my reviews are based on non-GAAP performance. The gross margin for the first quarter was 70.6%, higher than the upper limit of our previous expectations, but it was down 50 basis points year over year, mainly due to the increase in product revenue compared to the same period last year. Product revenue accounted for 49% of total revenue this quarter, compared to 42% in the same period last year. The negative impact on revenue structure was partially offset by year-over-year growth in product, support, professional services, and public cloud business gross margins. Gross profit was US$1.43 billion, up 29% from the first quarter of 2026. The gross margin of the hybrid cloud business was 68.8%, down 20 basis points from month to month, mainly reflecting a decline in product gross margin, which was partially offset by an improvement in the gross margin of the support and professional services business.
Product gross margin was 54.6%, down 150 basis points from month to month, mainly affected by rising component costs, partly offset by better pricing. Our recurring support business continues to be highly profitable, with a gross margin of 93.2%. The gross margin of professional services was 36.6%, up 4.5 percentage points from month to month. Public cloud gross margin was 86.4%, up 70 basis points from month to month, up more than 6 percentage points year over year, slightly benefiting from an additional week of operation. Over the past three quarters, the operating efficiency of the public cloud business has been above the upper limit of the long-term target range of 80% to 85%. Operating expenses were US$784 million, up 11% year over year and 5% month-on-month, mainly affected by variable pay and an additional week of operation (approximately US$22 million). Revenue was US$645 million, up 61% from the first quarter of 2026, and operating margin was 31.9%, up 6.1 percentage points year over year.
Earnings per share exceeded the upper limit of the expected range of $2.58, up 66% year over year, more than double the revenue growth rate, highlighting operating leverage and our ability to turn it into profitability.
In the first quarter, cash flow from operating activities was US$503 million and free cash flow was US$401 million. In the first quarter, we returned $302 million of capital to shareholders, of which $200 million was used for share repurchases and $102 million was used to pay dividends of $0.52 per share. The total number of diluted shares in the first quarter was 200 million, a year-on-year decrease of 3 million shares, or 1.5%.
Our balance sheet remains very healthy. At the end of the quarter, we held $3.6 billion in cash and short-term investments, with a total outstanding debt of $2.5 billion and a net cash position of $1.1 billion. Inventory grew both year over year and month as we managed supply and inventory levels to support growing demand. The inventory turnover ratio was 6, down from month to month.
Overall, the first quarter had a good start to the fiscal year, with strong revenue growth driven by surging demand for artificial intelligence and cloud storage solutions. Thanks to our rigorous execution, revenue growth significantly increased operating margins and earnings per share, and brought strong cash flow.
Now let's look at non-GAAP performance guidelines, starting with the second quarter. We expect revenue of $2.1 billion, fluctuating up and down by $75 million. Taking the median value, this represents a 23% year-over-year increase. We expect gross margin to be between 67% and 68%, a month-on-month decline, mainly due to an increase in product revenue as a share of total revenue. We expect operating margins to be between 30.9% and 31.9%. We expect earnings per share between $2.54 and $2.64, with a median of $2.59.
We now look ahead to the full 2027 fiscal year. We remain confident in the strength of our product portfolio and ability to perform in the current environment. Strong demand and continued business growth have boosted our confidence and supported our raised annual performance expectations. We have raised our revenue and earnings per share expectations for the 2027 fiscal year. Currently, we expect revenue for the 2027 fiscal year to be between $7.975 billion and $8.225 billion. The value was 8.1 billion US dollars, up 17% year on year, and an increase of 650 million US dollars from the previous forecast. We expect gross margins to be between 68.1% and 69.1%. This adjustment mainly reflects a higher share of product revenue than previously anticipated. At the same time, our product gross margin expectations for fiscal year 2027 increased slightly, while gross margin expectations for other businesses remained largely unchanged. We raised our operating margin forecast to 30.3% to 31.3%. We raised our earnings per share forecast to between $9.73 and $10.03. At the midpoint of $9.88, this would represent a 22% year-over-year increase.
Finally, looking ahead to the rest of the 2027 fiscal year, we remain confident in our strategy and rigorous execution. We will continue to focus on achieving strong revenue growth and profitability, enhancing free cash flow, and creating long-term value for our customers and shareholders.
Next, I'll hand over the phone to Chris for a question and answer session.
Chris Newton, Vice President of Corporate Communications and Investor Relations
Thanks, Wissam. Operator, let's start the question and answer session.
Q & A session
presenter
[Moderator's note] Your first question comes from J.P. Morgan's Joseph Cardoso line.
Joseph Cardoso, J.P. Morgan Chase Research Division
If I can, I'd like to ask a question first. George, you mentioned the advantages of accelerated purchasing decisions and pricing, as well as structural improvements and potential demand. Can you explain to us in detail what key factors contributed to these dynamic differences? What confidence do you have about the more enduring demand part of it? Especially in the context of looking ahead to the outlook for the second half of the fiscal year? I have one more follow-up question.
George Curian, CEO and Director
Thanks for the question. This year started off very well. Market demand is widely distributed, and all types of customers, regardless of size (small to medium public sector), are showing strong demand. This strong momentum spans the globe and spans every industry vertical, including workload solutions, on-premise deployment, Keystone, and cloud services. As a result, the overall performance of our product portfolio is very strong. I think if we differentiate these three categories, we'll find that the situation this quarter is quite the opposite of what usually happens when the cost of silicon chips and commodities rises sharply. Normally, customers tend to upgrade technology, but we see maintenance and non-renewal requirements. What we saw was just the opposite. Customers of all types showed strong momentum that far exceeded expectations.
Among our largest customer base, we've seen some customers buy faster. But for lower priority workloads and use cases, we've also seen their procurement practices be more cautious, which is in line with convention. Furthermore, as commodity prices rose, we adjusted our pricing strategy, as can be seen from the fact that our product gross margin exceeded expectations, which is reflected in our ability to obtain higher pricing power.
Joseph Cardoso, J.P. Morgan Chase Research Division
Understood. George, I appreciate the colors you provided. Regarding your previous comment, I'd like to quickly add one more point. I'd like to know what you think. I remember you guys saying that product gross margins will bottom out in the first quarter. What's the situation now? More specifically, have you fully felt the benefits of the pricing strategy, and were those benefits already apparent in the second quarter? Or should we expect these benefits to continue into the third quarter or a quarter beyond?
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes, good question. As George mentioned, our product gross margin in the first quarter really exceeded expectations. This is due to our favorable product portfolio for different customer types and geographical markets, which has played a role in improving our performance.
Looking ahead to the second quarter and the rest of the year, our expectations for product margins improved slightly from those announced 90 days ago. This is a positive sign that we are more confident in our ability to recover the new costs. Although it may not reach the level of the first quarter, I emphasize that we expect profit margins for the rest of the year to be better than what was expected 90 days ago.
presenter
Your next question comes from Mehdi Hosseini and Susquehanna Financial Group.
Mehdi Hosseini, Susquehanna Financial Group Research Division
Yes. I also have a two part question. George, please help me understand how would you divide customer investments and separate the modernization of existing storage devices from incremental capacity increased due to artificial intelligence reasoning?
My second question is for Wissam. I'm a bit confused about the trend in product gross margin. I had anticipated that gross margin — that is, product gross margin — would bottom out at around 50% and then begin to pick up. But your second-quarter results guidance seems to suggest we might see a month-on-month decline. If you could explain it would be much appreciated.
George Curian, CEO and Director
Regarding your first question, Mehdi, our product portfolio and products such as all-flash arrays, Keystone, and cloud storage have all experienced strong growth. It far surpassed expectations in almost every way. Moreover, this strong momentum is expected to continue for many quarters, so after the first quarter of this year, we have drastically raised our full-year performance expectations, including the second half of the year, right? As a result, the business is developing very strongly.
As far as we have observed, there are currently some architectures specific to artificial intelligence, such as GPUs as a service cloud, GPU environments within enterprises, and data lakes and modern data lake environments under construction. These environments are particularly suitable for GPU applications and artificial intelligence analysis. However, as others (including hyperscale data center operators) have pointed out, various related workloads and infrastructure are also undergoing extensive modernization, right? So when you use artificial intelligence, you also need to modernize and prepare your database and unstructured data environment. We've seen this happen in almost every industry and every customer group. As a result, the momentum is very strong. We are very confident about this year, our position in the market and our alignment with our clients' spending priorities.
Wissam Jabre, Executive Vice President and Chief Financial Officer
Regarding the second part of the question, Mehdi. Look, we did make predictions — maybe I can explain that we predicted the product gross margin trend for the whole year 90 days ago. We said there will be a trough in the first quarter, and we expect a slight improvement, or gradual improvement, for the rest of the year.
Fast forward to today, and our product gross margin for the first quarter was very well controlled. I think we did a fantastic job in execution and exceeded our expectations for the first quarter. So that's my first point.
Second, if we compare the second and fourth quarters of the rest of the year to what was expected 90 days ago, we now expect things to be slightly better. So, if you remember that the previous forecast was that the product gross margin was around 50% — although we won't give a specific numerical forecast, this does mean what is expected — then, according to the updated forecast, the product gross margin for the rest of the year will be slightly higher than this forecast. Hope this answers your questions.
presenter
Your next question comes from Evercore's Amit Daryanani.
Amit Daryanani, Evercore ISI Institutional Equity Research Division
I'd like to ask two questions. I think one of the most important questions investors want to figure out is whether the growth you and others are seeing is sustainable. If I take a look at your fiscal year results guidance, you expect 26% growth in the first quarter, and 23% growth in the second quarter after an additional week. The growth rate in the second half of the year appears to be only 9% or 10%. Can you explain what is causing this slowdown in growth? Is the 9% or 10% growth rate in the second half of the year in line with the company's long-term growth expectations?
George, you just mentioned that you've seen significant structural improvements in the potential demand environment. Can you help us understand what metrics you're watching or tracking to convince you that this is a structural shift and not an early buy due to price increases?
George Curian, CEO and Director
First, I think we're just starting the first quarter of this fiscal year, and our practice has always been to provide performance guidance we are confident in. We raised our full-year performance expectations sharply to reflect our strong market position, and raised our performance expectations for the second half of the year at the beginning of the year, right? So I don't think we're cautious about our full year results. We are confident in our results. As I mentioned before, our confidence comes from the fact that all of our product lines, customer groups of all sizes, all types of commercial vehicles we use, multi-year agreements, warehousing as a service, traditional capital expenditure transactions, and all of our market channels performed significantly better than expected, and we are very optimistic about the outlook for the whole year. As a result, we are very satisfied with the following aspects: how well we match customer expenses, the overall communication we are having with customers, and the growing opportunities we are seeing in the various customer groups.
presenter
Your next question comes from Krish Sankar's conversation with TD Cowen.
Sreekrishnan Sankarnarayanan, TD Cowen Research Division
Congratulations on this great achievement. My first question, George, is that you completed around 350 AI and data lake deals this quarter. Last quarter there were about 500. I've learned that deals are getting bigger. Can you quantify the deal size and revenue for July and April, respectively? From a broader perspective, how much of your revenue comes from artificial intelligence? Afterwards, I asked Wisam a follow-up question.
George Curian, CEO and Director
I think it's difficult to quantify the share of revenue driven by artificial intelligence for two reasons. First, there's a customer-specific artificial intelligence environment, right? This is the case with the 350 deals we mentioned. These deals are usually related to GPU-related artificial intelligence technology stacks.
Having said that, as we and others have pointed out, artificial intelligence is driving the complete modernization and platform restructuring of the data infrastructure stack to meet the needs of high-performance inference use cases and be able to build cross-application data infrastructure, which is reflected in the strong performance of our business. While 350 use cases are unique to the AI stack, the overall performance of the business reflects the impact of artificial intelligence on the modernization of the entire data infrastructure. We signalled many years ago that this momentum is accelerating. We saw this in the fourth quarter. We had an excellent start to the first quarter. We're very optimistic about the outlook for this year, and we're seeing good momentum across our product portfolio.
Sreekrishnan Sankarnarayanan, TD Cowen Research Division
Understood. Wissam, I have another question. Your parts costs are rising, and so are your inventory levels. What I want to ask is, when analyzing the product, you just mentioned the product gross profit margin. What is your calculation formula? Will gross margins be increased by optimizing the product portfolio or by using a pricing strategy? Where are inventory funds mainly spent?
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes. Krish, we did have slightly higher inventory at the end of the first quarter, but this is clearly because we continue to manage and secure supply to ensure we can meet the increase in demand we are currently seeing. Our main focus is on the company's total gross profit. We not only control the gross profit margin, but also the total gross profit. As you can see, as revenue grows, gross profit grows almost at the same rate. This is because gross profit is what really drives a company's profitability. I think this becomes even more obvious when you refine the data to operating profit margins. As you can see, basically every time we increase our gross profit and gross margin, we often get a considerable increase in operating margin. So, I'm not sure if that answered your question.
George Curian, CEO and Director
I think we've been working hard to provide customers with solutions suited to their application scenarios. One important step is the revitalization of hybrid flash in our product portfolio, and we expect hybrid flash to make a more significant contribution. As Wissam said, we are working to solve as many customer issues as possible through a reasonable product portfolio and manage the overall business to achieve gross profit growth.
presenter
Your next question comes from Citigroup's Asiya Merchant frontline.
Michael Cadiz, Citigroup Research Division
I'm Mike Cadiz from Citibank Asia Chamber of Commerce. My first question is about pricing. As pricing measures are gradually implemented during the quarter, how much do you think the expected pricing benefits have been achieved? Have you observed any changes in the elasticity of demand in the early stages?
George Curian, CEO and Director
I think -- I'll answer the demand side question; Wissam can talk about pricing. Regarding demand, we have always believed, and still believe, that the customer's budget is in dollars. What we're seeing from the market is a significant increase in customers' overall budget priorities for data infrastructure and storage. For example, for some specific use cases, customers will prioritize those use cases even if the price is higher. But for the same customer, they might defer lower priority use cases to the next quarter. We've already observed this in our customer base.
Some customers have also decided to move from flash-based solutions to hybrid flash solutions for lower value use cases, right? Therefore, I think the most important thing we have seen is that unlike previous cycles of sharp price increases, we have actually seen extensive infrastructure spending, which we think is closely related to artificial intelligence and the modernization needs of artificial intelligence.
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes. As for the delay between the price adjustment measures being implemented and we began to see results, we have taken steps to adapt to the current market environment. As a result, the impact of price increases should be felt more quickly than before. For example, it used to take two to three quarters to start seeing results, but now we can feel it much earlier.
Host, your next question comes from Morgan Stanley's Eric Woodlin.
Morgan Stanley Research Erik Woodring
George, I'd like to ask more about Amit's previous question. I know it's only past the first quarter, and it's still too early, but usually your earnings in the second half of the year will increase by a single digit compared to the first half of the year. And you lowered your expectations. So I understand that you want to stay conservative and set a realistic goal. But given your qualitative analysis of demand, why haven't you surpassed expectations by 10% or 20%? I'm just trying to confirm if we're missing something, such as how we usually take into account seasonal factors from the first half to the second half of the year, and if there are any factors that might offset this effect — how do we usually view normal seasonal changes? Lastly, please add one more question.
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes. Eric, I'm Wissam. Taking into account seasonal factors, if we adjust for the extra week of the first quarter, we now roughly see — probably five or five, maybe a slight difference — rounded up to slightly more than 50% in the second half of the year and slightly below 50% in the first half of the year. I mean, you can do the math yourself. But that's basically just based on our current judgement. However, as George mentioned in his prepared statement, we have seen a very strong structural improvement in demand. This improvement is widespread, mostly driven by AI workloads and modernization, and we expect it to be the main driver of revenue for the rest of the year.
George Curian, CEO and Director
Eric, we've finished a quarter. We feel very good about the company's business. We raised our second-quarter earnings expectations and raised our full-year earnings expectations. We will provide more information as our results progress during the year. We are very confident in our position in the market and will provide more information as our performance progresses during the year.
Morgan Stanley Research Erik Woodring
That's fantastic. Thank you, George. I can hear your tone. So, I appreciate it. Also, Wissam, I have one more question I need to clarify. Did you mention product gross margin and your potential slight increase in the first quarter is entirely dependent on pricing, pricing confidence, and confidence that demand elasticity is low? I just wanted to confirm that you may have slightly increased your product gross margin because of price factors rather than other factors, such as an increase in bill of materials costs.
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes. Look, I mean, my review is based on everything we've seen. As we observe, anticipate, and forecast the business, we incorporate all the information we know into the data. And that's the point of my review. It's about pricing, it's about product mix, it's about multiple factors — and of course, cost, which ultimately affects product margins.
presenter
Your next question comes from Param Singh's partnership with Oppenheimer Inc.
Paramveer Singh, Oppenheimer & Co. Inc. Research Division
So you've recently made a few acquisitions — all in a few segments. What I want to know is, what are your current gaps in your technology mix? In what situations is an acquisition more appropriate than independent research and development? Then I asked another follow-up question.
George Curian, CEO and Director
I think we have taken a strict approach when it comes to acquisitions. The two companies we've mentioned before are related to cloud computing and artificial intelligence. They will provide us with differentiated products and services, thereby accelerating our position in these application areas.
For DataPelago, its real focus is on AI-driven analysis and inference, and we can accelerate application processing next to storage to provide customers with better top-down inference solutions.
Regarding our acquisition of JetStream in early Q2, it really solidified our strong position in the VMware cloud migration space. We have excellent solutions for customers who want to migrate to NetApp. And for customers not deployed locally by NetApp, our cloud-based disaster recovery solution is an ideal starting point. Therefore, artificial intelligence and cloud are our two main areas of focus. We are confident in our existing technology portfolio and are continuously integrating to enhance the value of the overall solution to our customers.
Paramveer Singh, Oppenheimer & Co. Inc. Research Division
Got it, George. The next thing I want to ask is that according to your forecast, operating expenses as a percentage of revenue in the second half of the year will increase compared to the second quarter. So I want to know why the investment will increase in the second half of the year? What exactly will these funds be used for, R&D or sales and marketing? It would be great if you could elaborate on your investment plans for the rest of the year.
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes, Param, I'm Wissam. The growth is mainly due to two aspects. First, since our performance exceeded expectations, we received a slightly higher variable compensation package. Second, we continue to invest more in artificial intelligence solutions. However, if you look at overall operating expenses for the whole year, combined with performance guidelines, although operating expenses increased year-on-year throughout the year, the increase was still far less than half of the expected increase in revenue. As a result, we have always maintained a high level of prudence in our investment and operating expenses. Of course, this is because operating leverage and improving operating margins are key elements of our business model.
presenter
Your next question comes from Wamsi Mohan's partnership with Bank of America.
Wamsi Mohan, Bank of America Securities Research
I have a few questions to clarify. I think if you look back at the situation throughout the year, do you think the hybrid and all-flash casting expectations are similar to your previous expectations? Given the current supply situation, which do you think your projected upside will be driven more by? Also, I have a follow-up question.
George Curian, CEO and Director
Listen, I think if you look at the overall business, All-Flash had an unusually strong performance in the first quarter, right? That's a 47% year-over-year increase. So, throughout the year, all-flash performance still far exceeded our previous expectations. When it comes to hybrid flash, we're careful about customer spending on non-mission critical workloads when developing our annual plans. They usually do that, right? When prices increase, customers reduce capital equipment expenses, but we are seeing an overall acceleration in capital expenditure growth. This is a sign of the AI supercycle. But at the same time, we're also seeing customers buying more hybrid flash. I'd say if you compare the two, you'll find that all-flash has performed very well and will continue to be the main driver of our business's accelerated growth.
Wamsi Mohan, Bank of America Securities Research
OK. My follow-up question is, can you give us an overview of the scale of these accelerated purchases? Coming back to Eric's question about seasonality, you guys are clearly very confident about the outlook. But can you help us analyze -- mathematically speaking -- how big of an accelerated purchase is, or how much it contributed, and should we factor this into the impact of early purchases? Or is this just an acceleration in demand that doesn't necessarily come from the second half of the year?
George Curian, CEO and Director
First off, I don't think we're going to discuss this in detail, right? What I want to tell you, Wamsi, is that the number of customers who can flexibly adjust the size of their expenses and their share of our customer base is very small, right? These are usually very large private companies. Even public sector agencies don't have this flexibility to speed up procurement. So the percentage of this customer base is far smaller than you might think, right? A very small percentage.
In our first quarter results report, we found that some of the deals that were originally expected to take several quarters were completed within one quarter. But that doesn't mean these customers haven't put off other projects to work with them, right? So, what I want to say is that this part of the business accounts for a very small share. We didn't see it in the fourth quarter, but we saw it in the first quarter, and we think it's necessary to explain this. But that's not an important part of the overall business. As we mentioned before, some customers are building multiple data centers. They hope to complete construction as soon as possible. They said we plan to complete two of the four data centers within this year and come back later with the remaining two. We had anticipated that the construction of these data centers would be more gradual. This situation isn't common among all customers.
presenter
Your next question comes from Steven Fox of Fox Advisors.
Steven Fox, Fox Advisors LLC
I'd like to ask you to talk more about the expansion of new customers. As you mentioned, new customer development was also one of the contributors to this quarter's growth. I'd like to know what are your main areas of focus right now? For example, what are your main products to promote? And have you had success in some vertical areas that deserve our attention?
George Curian, CEO and Director
Thanks for the question. As described in our prepared statement, we have achieved strong performance that exceeds expectations in terms of new customer expansion, growth in new business volume from existing customers, and business technology updates. For new customers, we usually approach from two different perspectives. On the one hand, we provide cloud-based solutions or customized modular optimization solutions for enterprise and mid-market customers; on the other hand, we provide enterprise customers with a unified platform solution aimed at simplifying and integrating your infrastructure onto a unified platform. We are very satisfied with the current situation. Whether it is the number of new customers, new customer revenue, or the growth of existing customers' business, it has far exceeded our internal expectations.
presenter
Your next question comes from Kathryn Murphy at Goldman Sachs.
Kathryn Murphy, Goldman Sachs Group Research Division
Can you elaborate on the success of the AFX platform on how to acquire new customers through new workloads and new product categories? I know you've focused on public sector customer expansion this quarter, but can you share the growth momentum in this area and how it will impact the full-year performance outlook?
George Curian, CEO and Director
AFX is built for high performance and highly scalable environments. As a result, although the number of transactions is small, the size of a single transaction is quite impressive. We are focused on the AI GPU-as-a-service sector and have made significant progress. We discussed new clouds, as well as government agencies that are building private AI clouds. It's progressing very well. The program is being certified by many customers, and we are excited to continue improving the solution.
presenter
Your next question comes from Barclays Bank's Tim Long.
Timothy Long, Barclays Research Division
Yes, it might be possible to launch a follow-up report and then a second one. As far as the public cloud business is concerned, even after deducting the additional week, the 19% growth rate is still very impressive. Over the past year and a half or so, the growth we've seen has remained around this level. So I'd like to ask, are there any projects currently in the pipeline, new solutions, customer base, or anything else that could accelerate this growth?
Second, with regard to Keystone, I'd like to talk about the growth and strong momentum you mentioned. Let's take a look at the professional service line. If we push the time forward by a week, the growth doesn't seem to be significant. Also, due to the rise in NAND flash prices, we've seen or heard that more “as-a-service” procurement models are emerging in this field rather than purchasing more expensive hardware solutions. So please talk about what you've observed with these “as-a-service” solutions. I'm surprised we haven't seen more growth in this area.
George Curian, CEO and Director
In my opinion, as far as the public cloud business is concerned, the growth rate has remained above 10% as the scale of the business expands. Therefore, I am encouraged by the continued growth momentum of this business. Obviously, the performance of the cloud storage business far surpassed this. So we continue to see strong momentum in first-party (1P) and market storage services.
For our upcoming products, please visit the INSIGHT conference. We've partnered with hyperscale cloud service providers to launch more artificial intelligence solutions. We have more use cases that combine local data with hyperscale clouds, and have introduced block storage and lower pricing plans on multiple cloud platforms including Google and Amazon. As a result, our product portfolio in the cloud sector has made significant progress.
Regarding the Keystone business, I can't provide specific numbers, but I can say with certainty that the Keystone business grew more or less the same as the previous few quarters and our overall flash business, which is a very strong figure. So we're excited about how this business is progressing. We're seeing more and more new customers using Keystone services, and we're adding more features to this part of the product portfolio.
Wissam Jabre, Executive Vice President and Chief Financial Officer
Tim, let me add George's thoughts on Keystone. Keep in mind that Keystone didn't benefit much from the extra week; the benefits were very, very limited.
presenter
Your next question comes from Victor Chiu's collaboration series with Raymond James.
W. Chiu, Raymond James & Associates, Inc., Research Division
As a result, inventory almost doubled month-on-month. I was wondering if this was to ensure the supply of NAND flash memory and other components in response to anticipated demand? And how much of your increased inventory will be used to meet specific customer orders and backlogs? Also, will the increase in inventory give you a better idea of the rest of the year and next year's sales?
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes. I didn't understand the second part of the question. But with regard to the first part of the question, most of our inventory is built this way, including some strategic purchases. Basically, we manage inventory to ship to customers according to the strength and weakness of market demand. So, in my opinion, that's not a bad thing. We're really making sure there's enough supply to keep growing the business. Sorry can you revisit the second part of the question? I didn't understand...
W. Chiu, Raymond James & Associates Research Division
Yes. Does inventory accumulation give you a better understanding of supply and costs this year and even next?
Wissam Jabre, Executive Vice President and Chief Financial Officer
Yes, this is usually the case.
W. Chiu, Raymond James & Associates, Inc. Research Division
I think prices will play less and less of a role in the growth process.
Wissam Jabre, Executive Vice President and Chief Financial Officer
You're right, that's usually true.
presenter
Today's last question comes from UBS Group's David Vogt.
David Vogt, UBS Investment Banking Research
OK. George, I'll just keep it short. You've answered so many questions. Regarding demand for the next few quarters, I also have a question: was there any seasonal fluctuation in demand across industry verticals in the most recent quarter, particularly as we move into the next few quarters? I know that by the October quarter, some customers had a different fiscal year end date. Did you observe a slight difference in demand patterns during the quarter, or some seasonal changes? As I remember Wisam mentioned, there has been some backflow in demand. I'm just trying to understand how should we look at normal seasonal fluctuations? Maybe the current situation isn't normal, but as the second half of this year approaches, how should we view seasonal fluctuations in demand?
George Curian, CEO and Director
Listen, I think our performance outlook for the second quarter is roughly in line with typical seasonal patterns if we take into account the extra week of the first quarter. As Witham mentioned, the results for the second half and first half of the year are also very close to our typical seasonal pattern, right? David, I think the scope of our business is very broad. Therefore, no single customer change will affect our overall business. I think the only exception is typical seasonal fluctuations in the US public sector, right? You know that too. So we are very confident about the current momentum of business development.
As we said, the year started very well, with strong results in almost all of our business segments, regardless of customer type, on-premise or cloud deployment, and geographical coverage. As a result, we raised our full-year earnings forecast and raised our second-quarter earnings forecast. We're very optimistic about the current business momentum, and we'll share more information as time goes on. We're incredibly excited about this.
Chris Newton, Vice President of Corporate Communications and Investor Relations
Thank you, David. Next, I'll leave the right to speak to George and ask him to make a concluding statement.
George Curian, CEO and Director
Thanks Kris. With strong overall development momentum, we had an excellent start to the 2027 fiscal year, exceeding expectations on all indicators, which strengthened our confidence in the sustainability of market demand and strengthened our expectations for a significant increase in full-year results. The NetApp platform can meet the diverse needs of customers, help them operationalize AI workflows, accelerate cloud transformation, and win new customers and deepen existing partnerships. Our continuous innovation continues to enhance the value of the NetApp platform, and at the upcoming INSIGHT conference, we'll be showcasing new solutions that can unlock value for AI and high-growth markets. We're building a solid foundation for long-term success and creating lasting value for our customers and shareholders.
presenter
That concludes today's conference call. Thank you all for participating. You can hang up the phone now.