Nutanix Inc (NTNX) 2018 Q2 法說會逐字稿

Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Nutanix Q2 2018 Earnings Conference call. (Operator Instructions)

Tonya Chin, you may begin the conference.

Thank you. Good afternoon, and welcome to today's conference call to discuss the results of our second quarter of fiscal 2018. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of the Nutanix website. Joining me today are Dheeraj Pandey, Nutanix's CEO; and Duston Williams, Nutanix's CFO.

After the market closed today, Nutanix issued a press release announcing the financial results for its second quarter of fiscal 2018. If you'd like a copy of the release, you can find it in the Press Releases section of the company's website.

We would like to remind you that during today's call, management will be making forward-looking statements within the meaning of the safe harbor provision of federal securities laws regarding the company's anticipated future revenue, billings, gross margin, operating expenses, net loss, loss per share, free cash flow, business plans and objectives, product sales, plans and timing for, and the impact of our transition to focus more on software-only sales, expectations regarding product features, technology that is under development, competitive and industry dynamics, new strategic partnerships and acquisitions, changes in sales productivity, expectations regarding increasing software sales, future pricing of certain components of our solutions, our plans regarding how we will report the software content of our business, potential market opportunities, and other financial and business-related information.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially and adversely from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call.

For a more detailed description of these risks and uncertainties, please refer to our quarterly report on Form 10-Q for the first quarter of fiscal 2018 filed with the SEC on December 13, 2017, as well as our earnings release posted a few minutes ago on our website. Copies of these documents may be obtained with -- from the SEC or by visiting the Investor Relations section of our website.

Also, please note that unless otherwise specifically referenced, all financial measures we use on this call today are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the Investor Relations section of our website and in our earnings press release. As a reminder, all results today included in the call and the press release, are using the newly adopted revenue standard ASC 606.

Finally, Nutanix is hosting its inaugural Investor Day in New York City on the afternoon of March 12. Interested sell-side analysts and institutional investors should contact Tonya Chin if they're interested in attending. We hope to see as many of you as possible as we have a great day planned.

Now I'll turn the call over to Dheeraj. Dheeraj?

Thank you, Tonya. Hi, everyone. Thank you for joining. Q2 was yet another strong quarter for Nutanix, with billings, revenue, gross margin and EPS all better than our guidance and consensus. Q2 also saw us add a record number of new customers, bringing our total number to 8,870.

Last quarter, you heard a lot from us about our software emphasis, including eliminating the sale of pass-through hardware over time, to align our go-to-market with the software-defined nature of our business and to dramatically grow the surface area of our operating system.

I'm proud of how our sales leadership has stepped up to help us execute so well on this business model shift. In Q2, our revenues were up 44% year-over-year, even with the elimination of $14 million in pass-through hardware revenues. Our software and support business is also growing at a significant pace. That business has now reached over $1 billion in annualized run rate for billings in its own right. Very few public software companies have achieved this milestone, and we are pleased to be one among them.

This move towards a software-defined business model has helped us to accelerate our large deal momentum. In Q2 alone, we secured 57 deals worth more than $1 million, up 104% year-over-year. Also in Q2, we had 19 software and support deals worth more than $1 million. In fact, 5 were worth more than $3 million and 3 were worth more than $5 million. And all 3 of these were deals with Global 2,000 customers. We now have 57 customers with over $5 million in lifetime bookings, 18 customers with over $10 million in lifetime bookings, and 10 customers with more than $15 million in lifetime bookings, up significantly from the previous quarter.

Before we talk about Q2 numbers, I'd like to share a significant milestone that we believe is a watershed moment in the company's history. In early February, Gartner published its Magic Quadrant for Hyperconverged Infrastructure, representing the first time the analyst firm has emphasized the presence of operating system software companies in the Leaders quadrant. Our position, which was furthest to the right on the completeness of vision access and highest in the ability to execute access, is a testament to our product quality, customer service and end-user delight.

Software-defined infrastructure is gaining immense ground in the enterprise, and this state-of-the-art report from Gartner marks the inflection point of the journey of hyperconvergence of disparate data center tiers on a common operating system in the private cloud. In the next few years, we intend to make a similar case for hyperconverging disparate cloud data centers using a common software platform that we call the Enterprise Cloud OS. In the world of multi-cloud silos, enterprises have already started thinking hard about choice and application mobility.

In addition to our solid results and Gartner's reporting of our customer success, I'm also excited to share that we have signed a definitive agreement to acquire a company called Minjar. Minjar is the maker of Botmetric, an elegant service built for the AWS marketplace, providing customers with unified cost control and enhanced operational insights into their workloads running in public clouds. We expect Botmetric will enable our customers to embrace multi-cloud architectures, giving cloud operators the freedom to choose the best environment for their business applications and data.

In addition to Botmetric, Minjar also offers SmartAssist Assurance for customers through their public cloud services in a hassle-free manner and Minjar Managed Cloud service, which significantly offloads customers from public cloud management and operational minutiae. We leverage the technology and people expertise Minjar brings from the public cloud space to build and operate our own cloud services, Xi, spelled X-I.

Minjar bolstered our automation and life cycle management offering, Calm and Xi Cloud. In the coming months, we'll provide more details on how we'll specifically integrate the company and its technology into our fabric.

Last quarter, we also released our product version 5.5. This update was the biggest software release in the company's history, shouldering the burden of a seamless software transformation of the business. Noteworthy features include single-node clusters, software-based encryption, graphics and NUMA virtualization for our native AHV Hypervisor, real-time replication, stealth service portal and Calm for DevOps, antivirus support in software-defined file services AFS, and cross hypervisor migration.

As we've mentioned before, Calm brings an application-centric approach to multi-cloud orchestration, migration and life cycle management. Calm is also melding the worlds of virtualization and Kubernetes-based Linux Docker containers. In the coming years, this product offering will play a very crucial role in our DevOps go-to-market within the enterprise.

We are delighted by the interest from our customers since the product became generally available in our 5.5 release. In Q2, we saw 7 customer deals involving Calm, including one of the top deals in the quarter with a Global 2000 customer, which operates one of the largest clinical laboratory networks in the world.

Q2 2018 was a fantastic quarter for our business overall, increased our number of Global 2000 or G2K customers by 34 in the quarter, ending with 642. And as we increase our penetration into our G2K customer base, we're seeing a consistent pattern of account expansion over time. In Q2, we had 32 G2K customers spending more than $1 million and 5 spending more than $5 million with us. Moreover, 12 of our top 15 deals in Q2 were with our G2K customer base. It goes without saying that coverage and penetration of the Global 2000 remains a critical part of our growth strategy going forward.

Speaking about land and expand, across our deals with customers that spend more than $1 million in the quarter, nearly 50% were with customers that have also purchased from us in Q1 2018. One of our largest deals this quarter was with the previously mentioned Global 2000 customer that operates one of the largest clinical laboratory networks in the world. This customer has spent more than $10 million in lifetime bookings, and has transitioned in this quarter towards purchasing our software as it continues to expand the use of our solution within its private cloud.

Our largest deal of the quarter, which was over $10 million, was also with a G2K customer that is a major integrated beverages company. This $10-million-plus deal was one of the first for Nutanix with a brand-new customer, and also marked our largest AFS deal in the quarter. A critical success factor for this deal was the richness of our software-defined storage services. As the brand is growing, so is the confidence of first-time customers to do large deals with us. The Gartner MQ will be instrumental in further establishing their trust with enterprise prospects.

In Q2, we also had a $3-million-plus deal with a G2K customer that is an American natural gas utilities holding company. The company's engagement with us includes their operations management software, Prism Pro, making it one of the largest Prism Pro deals in our history.

Yet another notable win was with an American telecommunications company that provides wireless services and is an Internet service provider that runs its Nutanix deployment on Cisco UCS servers. This customer has made repeat purchases in every quarter since its initial low 6-figure purchase in Q3 of 2017. These deals have increased in value each quarter, reaching 7 figures in the last 2.

Our team in India signed a great deal with the Multi Commodity Exchange of India Ltd., or MCX, India's first listed exchange. MCX is a state-of-the-art commodity derivative exchange that facilitates online trading and clearing and settlement of commodity futures and options transactions, thereby providing a platform for risk management. The exchange has selected our platform to run its Cloudera, DevOps, and production workloads, with disaster recovery on our own Hypervisor AHV.

Finally, I want to take a moment to talk about one of the most important factors in building our business, our people. We were granted our 50th U.S. patent on building a distributed metadata system running on our cluster of commodity servers, invented by the engineering trio of Karan Gupta, Pavan Konka and Alex Kaufmann. We also bolstered our leadership team with the addition of Ben Gibson as Chief Marketing Officer and Aaron Bean as Chief Human Resources Officer. Ricardo Jenez also joined the management team of our engineering organization as Senior Vice President of Development. Chris Kozup joined as Senior Vice President of Global Marketing; and Rodney Foreman have joined as our new Vice President, Global Channel Sales.

In conclusion, I'd say that our software is increasingly becoming ubiquitous in terms of the number of hardware platforms it now runs on. Customers have come to appreciate the flexibility and portability of licensing. Our goal is to keep the customer experience as good as it has been in the last 6 years, and that'll require a tremendous focus in retaining our Net Promoter Score through this transition.

Like some of the best consumer brands, we are paranoid about NPS. And we promise that we'll keep our experience just as delightful as we give more choice to main street. With automation, machine learning and one-click design, we believe we can deliver software-defined infrastructure as true software running on commodity servers. That has been the DNA of this company and will continue to remain the biggest competitive advantage as we grow to become a larger company.

We've started on a strong footing with our new business model, and to talk more about some of the business insights, I'll turn it over to Duston. Duston?

Thank you, Dheeraj. I'm very pleased that our Q2 results came in much better than expected for virtually every significant metric. We had record performances in bookings, OEM bookings, billings, revenue, backlog, free cash flow, new customer adds, number of large deals, software-only bookings and Global 2000 bookings.

Revenue for the fourth quarter was $287 million, growing 44% from a year ago and up 4% from the previous quarter despite eliminating $14 million in pass-through hardware revenue during the quarter.

We billed $356 million in the quarter, representing a 57% increase from a year ago and a 13% increase from Q1. Although we don't specifically guide to billings, this billings performance far exceeded The Street consensus estimates. This outperformance was due in part to a general overachievement and a higher support renewals as well as receiving a prepayment in Q2 in excess of $10 million for a transaction that will ship in Q3.

The bill-to-revenue ratio moved up to 1.24 versus our previous estimate of about 1.15. In addition to the items stated above, we are also experiencing slightly higher revenue deferrals within our software-only deals, which has the impact of lowering our current quarter revenue, along with increasing our deferred revenue balance, and ultimately, adding additional predictability going forward via the recognition of more ratably recognized high-margin revenue in future periods. Our deferred revenue in Q2 increased by $69 million, growing 57% from a year ago and up 17% from the previous quarter.

Gross profit for the quarter was $182 million, growing 45% from a year ago and up 7% from the previous quarter. Our gross margin for the quarter was 63.5%, which was at the high end of our guidance and compares to 63.2% in the year-ago quarter and 61.9% in the prior quarter. As you may recall, last quarter, we targeted to eliminate up to $12 million of our pass-through hardware revenue. I'm pleased to say that we exceeded our plan with strong execution and eliminated $14 million of pass-through hardware revenue during the quarter. On a billings basis, our product mix for Q2 was 77% software and support, and 23% pass-through hardware. On a product mix on a revenue basis, was 73% software and support and 27% pass-through hardware. New customer bookings represented 34% of total bookings.

Our operating expenses were $202 million, below our guidance by $8 million, primarily due to the timing of new hires. We have a full court press on hiring in the second half of the fiscal year to try to make up this headcount shortfall. Our non-GAAP net loss was $23 million or a loss of $0.14 per basic share.

Performance across all of our geographic regions were outstanding, with all 3 regions recording record performances. EMEA and APAC were especially strong. EMEA's results exceeded its previous best quarter by well over 50%, while APAC exceeded its previous best quarter by over 35%. Both of these regions also experienced record sales productivity in the quarter.

Bookings from our international regions were 49% of total bookings in Q2 '18 versus 48% in Q2 '17. Both Dell and Lenovo contributed nicely in Q2. Dell matched its best historical performance, and Lenovo recorded its best performance, increasing almost 80% sequentially. Dell bookings came in slightly less than 10% of total bookings and included deal sizes net to Nutanix of $3.5 million and 2 deals at $2.6 million each. Lenovo included 4 deals greater than $1 million. IBM is still in its early stages of our relationship and progressing within our expectations. We booked our first 2 initial IBM-related deals within the quarter. And lastly, our Cisco UCS-related bookings increased over 40% sequentially, included deals of $2.5 million and $1.5 million.

Looking forward, our software business will continue to grow significantly. Our software is completely portable among many different server platforms. For instance, a customer could [procure] 75 nodes of software licenses from Nutanix and deploy 25 of these nodes on Dell servers, another 25 nodes on HP servers, and the remaining 25 nodes on Cisco servers, without our immediate knowledge regarding the exact deployment details. And a matter of fact, we have one Global 2000 that has completed over $6 million in ELA bookings directly with Dell, with licenses to be deployed on some mix of Dell and HP servers. In Q2, this exact same customer also did $2 million in ELA bookings directly with Nutanix, with the licenses to be deployed on Dell, HP and potentially other servers.

Going forward, due to the ubiquitous nature of the software, we will no longer be reporting or commenting on specific details surrounding the Dell, Lenovo and IBM OEM business or any other specific vendor such as Cisco or HP. Instead, we will combine and comment on all software sales deployed via our OEM transactions and on other various servers as well as our own edition software into a single grouping called software-only sales.

A few minutes on the balance sheet. We closed the quarter with cash and cash equivalents of $918 million. This is up from $366 million in Q1. The Q2 cash balance includes approximately $509 million in net proceeds raised during the quarter through a 5-year convertible senior note. As a reminder, this transaction was done at 0 interest rate, with an effective conversion premium of 100%, and at an effective pretax interest rate on the proceeds, including the cost of the call spread, of approximately $2 million -- 2%.

DSOs, based on a straight average, were 58 days compared to 57 last quarter. Weighted average DSO was 30 days versus -- 30 days in Q2. We generated $46 million in cash flow from operations in Q2, which was positively impacted by $12 million of ESPP funding. And we generated $32 million in free cash flow during the quarter. This was also positively impacted by the $12 million of ESPP funding. And AHV nodes as a percent of total Nutanix nodes based on a rolling 4-quarter average, was 30%.

Now looking at our guidance for the third quarter, the guidance, again, on a non-GAAP basis, is as follows: revenue between $275 million and $280 million; gross margin between 67% and 68%; operating expenses of approximately $218 million to $220 million; and a per-share loss of $0.19 to $0.21 using weighted average shares outstanding of approximately 167 million.

In Q3, we're assuming a bill-to-revenue ratio of approximately 1.2. The revenue guidance above assumes a 35% growth rate from the year-ago period. And even more importantly, the assumed gross profit guidance yields a 50% growth rate from the year-ago period. And as a reminder, we believe the best metric to measure our progress during this transition period to a software-centric model is gross profit dollars and growth in gross profit dollars and not revenue or revenue growth as revenue and even gross margins could be somewhat fluid during this transition.

Furthermore, we also believe that anyone who casts a negative opinion on the company founded on slowing revenue growth during this period of transition is simply being disingenuous based on our strong gross profit growth.

Lastly, this guidance assumes that we will eliminate approximately $45 million of our pass-through hardware revenue during the quarter.

And with that, operator, if you could call -- open the call up for questions, that would be great. Thank you.

(Operator Instructions) Your first question comes from Jayson Noland with Baird.

Okay, great. Congrats on the quarter. And just to clarify, Duston, what's Q3 expectation for hardware pass-through elimination as a percent of revenue?

Yes. It's going to be somewhere in that range that we had provided before, plus or minus 1% maybe. It's a complicated -- we've got a bunch of moving parts and variable inputs and outputs here. But I don't think it's going to be too different. We had said 22% this quarter and it came in around 23%. And the only reason, really, it came in at 23% is we shipped some more, having a good quarter. And we previously said 16%, I believe, for this quarter. And we'll be within that range, I think, let's say plus or minus, but we're making -- on that front, we're making good progress. North America is pretty much all now being transacted without the hardware attached. So those processes seem to be up and running and going pretty nicely. And we said all along that the real heavy-lifting is in the international regions. So we still have, obviously, significant work to do there, which we're undertaking as we speak. And we'll start to transact some of those orders without the hardware here shortly. We've done, actually, one transaction already, kind of a one-off in EMEA. It happened to be a -- just on the big deal theme, about a $9 million all-in order that we've already closed in the quarter. That was treat -- transacted without the hardware. So we're doing some pretty good stuff. Got a lot of work to do, but so far, so good.

Okay. And then a follow-up on Salesforce. I think you guys went software-only on quota, February 1. Maybe if you could give an early perspective on how that's taken with the sales force in the field. We've heard of the elimination of channel conflict on the hardware side, but curious to hear your thoughts.

Yes. This is Dheeraj. Thanks for the question. I would say that there is clarity for the Salesforce because, in the past, as we're thinking about how to fulfill and how that actually would relate to their quota-expiration and commissions and things of that nature. So now we have single currency and this normalizes everything into one. So by and large, I think what we've heard is that this clarity is a good thing. We have a very good leadership that's actually adept at change management. And we're going through that process, but there's nothing to say that this thing actually needs more work. I think we are in pretty good shape as of this quarter.

Your next question comes from Simon Leopold with Raymond James.

This is Victor Chiu in for Simon Leopold. Can you just speak about the acquisition that you guys made? Maybe just a little color around what your logic was behind that and what the strategy is there for that particular deal?

Yes, absolutely. So if you think about the orchestration layer that we have built with Calm, and that's about orchestration across multiple clouds, it's closer to developers and DevOps as the end user. Now, sitting next to it, Minjar actually sits right next to it and complements the multi-cloud layer with its costing, budgeting, governance and compliance feature sets. And now we believe that in the next 3 to 5 years, as we talk about -- this is in my earnings script as well, that as the world goes more and more towards multi-cloud, we'll talk about hyperconvergence of all these clouds and hyperconvergence of these clouds will require a control plane that includes Calm, Minjar and many future different pieces that need to fit together in the puzzle itself. So that's what Minjar really is. They have a couple of other things, one of which is a managed service that they've actually done to improve a migration of an on-prem customer to an off-prem customer, and we'll be using that for Xi Cloud as well.

I'm sorry. Did you guys disclose the terms of that transaction? Or could you?

We did not. It's not material to the balance sheet. So we won't be disclosing that.

Your next question comes from Matt Hedberg with RBC Capital Markets.

In your prepared remarks, Dheeraj, you talked about Xi Cloud, and I think it's still supposed to launch midyear. Tell us this model is clearly moving to software. But I'm curious, should we think about a second inflection coming? And I guess, what I'm referring to is an even more aggressive move towards ratable subscription revenue in the future?

Yes. I think there is definitely -- when -- as you think about us as a software company, we have been collecting 3-year support because of our appliance heritage. We used to collect 3-year support for that. So there's a lot of billings that is ratable today, and Duston threw some more color on that as well. But as we communicate with you going forward in the future quarters, we'll talk about subscription as an important pillar of our overall businesses as well. I don't know, Duston, if you want to add some more to it?

No. I think that's right. I think we've got to get a little bit more of Xi under our belt first, and then I think we can have a better opinion on that.

Okay, great. And then, Duston, a follow-up for you. I know you're guiding to Q3 today, and I assume we'll get, maybe, more of a long-term look at your Analyst Day. But I'm wondering if you can help us what a good gross margin exit rate might look like this year. I don't know if you'd willing to comment on an exit rate for fiscal '19 at all as well. But maybe exiting this year would certainly be helpful.

Yes. I mean, we don't go out more than a quarter, so I'm not going to specifically talk about our July quarter in this call. But I think, looking longer term, you should expect pretty healthy software-like margins once we're down to the 5%, which we've talked about as a billings target. That's probably 8%, maybe 9% on a revenue basis. But it would be similar to other software companies, 75%, 80%. At that point in time, you'd be at 60-plus-percent software, 100% margin, and then, probably 30-something or 30%-ish of support at a pretty decent margin. You can do that math, and then, the remaining hardware with whatever's left over would be at 0. So you can come up just with that calculation and with a pretty good healthy margin profile once we get down to some minimal appliance pass-through hardware stuff.

Your next question comes from Rod Hall with Goldman Sachs.

This is Matt Cabral on behalf of Rod. Dheeraj, just on the software transition. So I know it's still early days, but just wondering if you could talk a little bit about what the customer response has been so far. And just if you've seen any impact on sales cycle as a result of the change?

Yes. Thanks for the question. I think the big thing that we're seeing is that, as people decouple software and hardware consumption, we are also seeing deals becoming bigger. And obviously, as a company, we've never really tried to go big right away because the whole idea of hyperconvergence is more like cloud consumption, where you start small and you pay as you grow, and you grow over time. But if there's a customer that's been around for about a year or more, now they try talking about consumption that's actually bigger. They are looking at larger deals because, for them, software appreciates over time and hardware depreciates over time. So why would we have to buy a lot of hardware upfront? Because based on Moore's Law, you know that, over the next 12 to 18 months, things will actually become faster and cheaper. So I think we are seeing this resonate with our customer base today. And including our partners, we're talking to a lot of our channel partners, and they see value where they can go make money by selling software and we can share some of the margins with them as well. So I think all in all, main street is quite happy. I think -- again, it's early days, as a company, we are paranoid about things. And every quarter, we'll come and talk about some of these things as well. But I think we've got to a pretty good start.

Got it. And then, for Duston, just on the convert. So Q2 was a pretty strong cash generation quarter. I think you already had a pretty solid cash balance on hand, even excluding the proceeds. Just wondering if you could help us understand a little bit more the motivation behind the issuance and how you're thinking about using the proceeds over time.

Yes. The motivation was simply the markets where we're in an outstanding period of time to raise some good-quality capital at a remarkably effective rate and cost. And we clearly took the opportunity to do that. And I gave some statistics around that. There's no dilution to any shareholder until the stock appreciates 100% from when we did the deal. And even after that, we look forward to the day that happens. And then even after that, it's minimal dilution from there. So it's just -- it was a great time to go do the transaction. And then, the uses of the trends -- of the cash, it's really put us in a place that -- from an optionality perspective, to do what we need to do to grow the company and make our company the most successful possible. And with this cash -- from an M&A perspective, you should not expect any big, large deals. That's not -- it wouldn't work for us, necessarily, anyway. You should expect more smaller deals, just like the one we announced today, from that perspective. But it just gives us, again, the optionality good times and bad times, and good economies and bad economies, to take advantage of situations in having that cash on hand. I don't know, Dheeraj, do you want to...

Yes. I think I just want to reiterate what you just said, that the DNA of this company will not absorb a very large acquisition. I think it's just now what we're built for. And we'll look at smart teams, smart technologies, smaller teams that can really come and bolster this company's overall business in the next 3 to 5 years. There's no instant gratification of an M&A for us. Calm was an acquisition that was done in July/August of 2016 and we said we've got to do the right thing for the product and the end customer. So the G only came out in January. So a lot of these things that we're doing is looking at 3 to 5 years out as opposed to saying we need something for the next 12 to 18 months to bolster our revenue.

Your next question comes from Aaron Rakers with Wells Fargo.

I wanted to ask a little bit about the current quarter guidance, and just to make sure that I'm thinking about the math correctly. So if you look at the breakdown of your revenue stream, you've got about $10 million of product deferred that kind of flows into this April quarter. I guess, what I'm getting at is, based on the hardware burn-off, are you assuming that you can kind of grow software-only revenue as much as the 50-plus-percent range? And if that's true, how sustainable are you guys thinking about growth for software-only being in that 40-plus-percent year-over-year range over the next couple of quarters? And I have a follow-up.

Yes. So I'm not getting -- necessarily getting into the pieces of growth, Aaron, but maybe we'll just talk about some generalities, I guess. As far as how we feel comfortable going forward with the growth rates, I mean, I think we'll give a little bit of insight at our Investor Day on March 12 here coming up shortly. So we'll clearly give some insights there. And then, just in growth rates in general, we talked about, on a gross profit basis, we're growing, based on the guidance year-over-year, Q3 to Q3, at 50% year-over-year. If you just took the top line and you added back the $45 million that we're eliminating, that year-over-year growth rate would be close to, I believe, 60% year-over-year, so all healthy from a growth rate perspective and things like that. It's big market. We're a leader in that market, so we should have some pretty good, healthy growth rates going forward for a while.

Yes, I can't overemphasize the fact that we're still scratching the surface of this market. I mean, while this might have started as a box like oh, it's an MQ, but this MQ is going to be all-consuming. And if we haven't done that, then we're not a successful company, honestly. I think this is about computing. It's not about hyperconvergence. I mean, over time, as I said, we've got to make this about converging clouds, and there's a massive opportunity to build an operating system for that.

Great, that's helpful. And then, as a follow-up real quickly on the model as well. I think, last quarter, you talked about the support gross margin being kind of in that mid-50% range. It looks like you did well above that, 63.5% this quarter. So what's the right gross margin there? And then, you also talked about operating expenses kind of growing $10 million per quarter. Obviously, you underspent this quarter, but is that $10 million a quarter the right level to be thinking about going forward?

Yes. I think, plus or minus, it's a general -- generally, directionally correct. We've got a bunch of makeup we're trying do, obviously, this quarter coming up from the $202 million to the $218 million to the $220 million. But I think going forward, somewhere in that range, which we've stated before. So I think clearly, we've got a lot of projects to go spend on. The first part was...

The services gross margin, support gross margin.

Oh, yes. Yes. Yes. I mean it gets to be a bit of an involved answer there. That target margin includes some residual internal COGS, if you will, that stays once all the hardware's gone. So it has to flow somewhere. So that's kind of in a steady-state model is probably once we get to the 5% or 8% billings and revenue on the pass-through hardware piece, probably ultimately the right number to attach to that over time.

So just to be clear, you're sticking with the mid-50% that you gave last quarter?

Yes. I think when you look at it in its entirety, at a steady-state with very little hardware, all-encompassing, it has to go somewhere, and we've bumped it into that support piece.

Your next question comes from Katy Huberty with Morgan Stanley.

In the U.S. market, where you're pushing hardest in terms of the software transition, what's the mix now of new node shipments on the non-supermicro hardware? So software shipments on top of Dell, HP, Cisco, Lenovo, when you add that up, how has that mix changed over the last 6 months? And where do you think you might be in a year or 2 when you come out of this transition? And then, just connected to that, given all the success stories that you've walked through and use cases around customers deploying your software across a diverse number of servers, are you seeing that sort of awake the management teams of those other OEMs and realize that there's potentially an opportunity to work in a more aligned manner to participate in these deployments?

Yes. They're great questions, Katy. On the first one, lifetime, if you think about lifetime deployments, about 1/3 was non-supermicro. I would say about 35% was in the last 5, 6 years of selling. I would imagine, and this is, again, waging a guess, this would probably get to 50-50 in the next 18 months or so. And obviously, every 6 months, we'll be absorbing some of this as well. But I think that'd be a good one now. What are the market forces, because the market forces also are strong. We can't just do it on our own accord. Because people love the NX support, which is direct to us. And I think many of them, they just want to come to one-stop shop for support for both hardware and software. So while we might eliminate the hardware top line, the fact that they actually trust our support will be one of the forces that we have to continue to look at because we don't want to throw the baby out of the bathwater as we actually go through this transition. So I think I would wager something like 50-50 in the next 18, 24 months. And on the second question, I think it's happening. The grassroots is where the rebellion happens. The grassroots is the customers, the partners, they're the ones who've been basically saying, "Look, I love Nutanix, and I would like for you to really run it on your servers." And I think that's what we've been really trying to do for the last 12, 18 months, which is how -- one of the examples I gave about Cisco, another one then Duston gave about HP, is all about the power of the customer. They're extremely powerful, especially the Global 2000 is very powerful in the way it actually dictates what server vendors actually go and work on it or not.

Your next question comes from Alex Kurtz with KeyBanc Capital.

This is Steve Enders on for Alex. I was wondering if you could talk a little bit about what you're seeing in Europe right now. It seems like it's going really -- going well. And I guess executing well there. I was wondering these are the changes you guys have made over the past year or so, or what's really driving this development?

Yes. I think part of it was some restructuring of people and our VP of EMEA has done a pretty good job of looking at the kind of people needed for different roles. Part of it is also large deals. We've done some really good business last quarter, based on large deals from -- and many of them from existing customers, which has been one of our pillars of these business, large deals from existing customers. And then, lastly, there's something going on with Brexit as well. I think when customers and there are a lot of the market are thinking about where to go from Britain and whether to land in Germany and other such places, I think it's causing a lot of data center transformation projects to come alive because when they're moving operations, they're also moving their infrastructure as well.

And just on the EMEA large deal comment, I believe EMEA quarter-over-quarter large deals, by our definition, was about 3x the Q2's -- or the Q1 performance, so some really good, good, large deals happening in EMEA. And the exciting thing about that, again, as Dheeraj says, is the repeat purchase capability of most of these customers. So...

And the other thing that's also popping up is the system integrators in Europe are taking note now. And I think because there's a tipping point at which the XC start to take note. And you're starting to see some movement in that direction, especially.

Your next question comes from Wamsi Mohan with Bank of America Merrill Lynch.

So the pace of your incremental new customer add was very strong. I was wondering if you could comment on what drove that strength. And can you talk about the profile of the new buyer? It seems like the billings per new customer also increased materially. Are you seeing any shift in the profile of the buyers? And I have a follow-up.

Yes. I think on the first one, which is about -- sorry. I skipped the question.

The customer adds.

Customer adds. Yes, I think the channel is definitely kicking in, especially in the mid-market, we're seeing the channel -- I mean it took us a while to actually get to where we are. We have intense focus on how we really go and lead with the channel, look at them as a customer, not just as a partner. And I think that has been a huge contribution to our overall mid-market customer acquisition. And I think, on the second question, it is getting elevated. With Gartner MQ, the buyers' profile is changing because the C-level people, the CIOs, the VPs of infrastructure, they were waiting for this to come together as a mainstream thing. For the last 5, 6 years, we're carrying the burden of really creating a market, and I think we're seeing that change actually come together. So over the coming 18, 24 months, we'll see many more of these senior people now taking stock of the situation and especially as they see the big bills coming from the public clouds. I think they've got to figure out a way to really contain that and figure out there is better cloud architectures on-prem as well, to really go and box the budget and the spend.

And if I could just follow up. There's a lot of noise around what can happen at Dell VMware, including mergers and reverse mergers. And sounds from your commentary, you're really not seeing any change in behavior as it pertains to your relationship. But if there were any deal on that side happen, how would you handicap the probability of somewhat of a sharp deemphasis of Nutanix at Dell?

Yes. I mean, we are waiting and watching. Obviously, it's difficult to speculate. But what I will say is that I respect Michael Dell as a leader. And if he gets closer to VMware on one hand, I mean, he also has massive roots in server business. And one of his goals, and Jeff Clarke, who is the President of the company for the last 30 years, they have actually built this business on the strength of the server. And they would not want to lose that by not being close to us as well. I mean, there's only 2 operating systems that are really emerging in this market: one is VMware; one is Nutanix. And I mean, given what I know of this leadership there, which is one of the things that we've continued to see over the last 3, 4 years. I mean, this cloud over how EMC and Dell are coming together; what will happen to XC; what's going to happen to the Nutanix relationship, we have been fielding this question for the last 24 months. And I think they're just smart as business people, just like consumer companies who actually know that they can compete with partners and still have a marketplace, an App Store and all that stuff. I think that's what Dell is all about. I think they're getting closer to VMware. They've gotten closer to VMware. They probably might be one company. But I think for them to get close to another operating system would be a smart strategy.

Your next question comes from Jack Andrews with Needham & Company.

I was wondering if you could drill down a little bit more on the 5 $3 million deals you signed. Are there any just common themes, whether it's specific catalysts or use cases that were involved there? And if there are any applicable lessons learned from signing those types of deals that you could take with you moving forwards?

Yes. I think a big focus for us has been around customer success, which means that we start with this phrase called data center modernization. And then, we talk about upselling with the same workload. And then, we go and talk about, well, we've gained this trust over the last, I would say, 12 months with a customer and they liked the operational efficiency, they liked the pay-as-you-grow model, there's a simplicity in the elegance of the product, and the application folks start to really say, "I want to do more with this stuff as well." And that's when we talk about replatforming everything or at least a large chunk of their stuff. So as their existing capital actually comes to refresh, they are really looking at Nutanix as a platform play. And that's the big shift that we have seen over the last, I would say, 12 months. And I would imagine that the Gartner MQ is only going to help us with that because the trust actually comes with all the reporting that Gartner has actually done. So all in all, I would say that most of them are existing customers. We've played a pretty keen role in looking at the utilization, the Net Promoter Score, and as the trust is built, they have gone and tried to replatform their entire data center with Nutanix.

As a quick follow-up, could you touch on what are your hiring priorities, I guess, over the next couple of quarters?

Yes. I think you probably could even take a look at our website. It's pretty evident that we are big on hiring. There's a massive market ahead of us. And because of the repeat business that we've seen that we have even reported in our investor deck, you can imagine that once we actually get $1 from the customer, we'll get, on an average, $4.50 more from the entire population, close to $9, $9.50 from our Global 2000, and close to $20 -- or more than $20 from our top 25. So given all that, there's a formula that actually says we need to just go for coverage. Our Chief Revenue Officer, Lou Attanasio, he says that the places where I lose is where I don't have a seat on the table -- seat at the table. So I think there's a big push to increase the awareness of the company and actually get more account coverage, which is basically the focus for the business. And obviously, they're doing a lot of R&D work as well. But it's going to be within the guardrails. I mean, even though we actually go out and acquire some of these smart, smaller teams, I think the focus is to keep it within the guardrails of the last 3 or 4 quarters, which is close to 18%, 19% of revenue itself.

Your next question comes from James Fish with Piper Jaffray.

I'm on for Andy. Maybe just a follow-up to a prior question a bit ago. Are you seeing a reduction in channel friction following the change to the software-only model?

I think it is early, but probably in the next 6 months, we can come and report some more on how it's coming together. The thesis that it should reduce because now, they can be the matchmakers of the hardware vendors and our software, which can only be good because now it's not an either/or. It's you can take Nutanix software and put it on their other partner, as hardware and then go and sell it as a solution. And plus, they get to see some professional services on top of it. And as we sell more software ELAs, we expect and hope that the way we actually go and pay the channel more is based on utilization and consumption because we'll have a bunch of shelfware lying on the customers' shelves. And we want the partners to go and make money after the fact, based on consumption itself. So there is good business for them, and they can actually play the matchmaker that they've always played in the past 20, 30 years of IT history.

Got it. And just a follow-up, quickly. You talked a bit about being behind on hiring this quarter. And yet, you put up very solid billings growth. Do you actually need to hire as much as you expected before, really? In other words, how sustainable do you think that the productivity you saw this quarter is over the next year or so?

Yes. I think there's a bell curve here. You think about the international expansion, one of the things that we did well, 4 years ago, 5 years ago, we said we want to seed a lot of the international territories, because over time, half the business will come from outside the U.S. So we've done a pretty good job of not being laggards in that. And then, there are markets like Japan and Germany and ASEAN and places like that where we've seen good success, even the U.K. So I think we look at some of those, we look at federal, where honestly, we could do a whole lot more. I mean, federal was one of the pillars of this company's success 2, 3 years ago in a much bigger way. So I think we can go and double down in some of these success stories. Health care has been a massive vertical for us, but they're also referential. There's a lot of referential selling that happens in the health care space itself. So there's a few verticals, where we can actually put these specialist sales force that will come to help us with the Global 2000 in the coming 3, 4 years. And, Duston, you want to add...

Your next question comes from Nehal Chokshi with Maxim Group.

Gross profit in the billings will be higher than reported gross profit, is that correct?

I'm not sure I understand your question. Say that again, Nehal.

The gross profit that's held in the billings number will be higher than the reported gross profit. Correct?

Yes.

Yes, okay. So my question is then, is the gross profit billings growth, is that even higher than your reported gross profit growth? And would you be able to tease that out for us, actually?

I don't have that exactly at hand here, Nehal. We can get a little bit for you, but I don't -- yes, that's likely the case, but I don't have the exact numbers.

Okay, all right. And you did have a nice uptick in your Acropolis Hypervisor adoption. Was there any new factor at play that drove that slight acceleration there?

Well, last time we talked about was this whole journey of the customer starting from talking about data center modernization, going away from 3 tier to -- oh we can upsell in the same workload but then, finally, the one around replatforming because then, they're trying to look at the whole stack, not just hyperconvergence and compute and storage coming together, but what about the rest of the stack itself, which is where AHVs come into play, especially for existing customers. Citrix has been a good partner in that vein as well, so I think that workload has helped AHV, too and i.e., there are a few features that we were behind on that we've caught up with. And one of the big ones that's coming, and that's been cooking for the last 2 years, was micro segmentation around network virtualization. So I hope to see that whole stack comes together with network and security. And the partners that have actually written their stack, so we have opened up our network and security APIs to a lot of our partners, so you see a lot of virtual firewalls, virtual load balancers, network companies that are actually integrating with our APIs, is really making AHV into a true blue platform.

Your next question comes from Mark Murphy with JP Morgan.

This is Pinjalim sitting in for Mark. Dheeraj, congratulations on being featured as a leader in Gartner's Magic Quadrant. I think the report also states that by 2020, 20% of business critical workloads currently deployed on 3-tier architectures will transition to HCI. What is your opinion? Do you think that's an aggressive or conservative view? And could an acceleration in workload migration in the public -- to the public cloud derail that thesis?

Yes. I think we've been talking about this for the last 3 years now, and the pendulum had swung too far in the other direction about everything is going to be rented. And I think, as you know, that owning and renting will come to balance itself. So we -- personally, I mean, I look at this as a journey of hyperconverging public and private owned and rented, blurring the lines between on-prem and off-prem. That's where the real money will be, because over the next 3 to 5 years, the cloud will be a thing. It won't be an experience. And when something becomes a thing, there's money to be made on top of it, which is what we are actually banking on in doing our -- a lot of our innovation over the next 3 to 5 years is going to make that thing into an experience. Similar to what we did with on-prem. There was a lot of hardware boxes that we said, "Look, just need to make them into pure software." And that job only gets -- I mean, that goalpost of converging on-prem and off-prem is an even harder problem with respect to networking and security and identity and bursting into renting in seasonal quarters of a business and so on. So there are a lot of good problems in computer science and in design to go and solve for that I don't look at this as a zero-sum game. It's actually -- if you had a growth mindset, you can say there's a lot of money to be made when you look at cloud as a silo and how you can bring the silos together. On this Gartner thing, on the 20%, again, 4 years ago, it was 0. So now it's 20%. And I think if we were to succeed as a company and this Magic Quadrant were to become something bigger than what it is today, then it's just a computing TAM. I mean virtualization in 2005 was probably, "Okay, fine, we'll give you 20%." And then, every year, VMware was working on new workloads, better capabilities and features, reducing the virtualization tax and new regions, new geographies, new certifications and all that stuff. That's the right of passage of any new architecture. So we're in the very early days of this. And every year, we'll come and talk about it. And Gartner is going to revise its numbers based on how the market makers will really behave with respect to product and customer service and looking at legacy and holding the hands of the customer.

Got it. Now when you're thinking about that blurring the line between on-premise and off-premise, seems like networking is a big deal in there and VMware obviously, NSX and Nicira acquisition was a big deal for them, and that's sealing a lot of the holes that they had. Now for you, I think you're developing an in-house. How much of -- do you think there's a gap between NSX and your networking technology at this point in time? Or are you -- or would you say you are on par at this point?

Yes. I mean, look, I think we focus on 80% of the 60%. That's a formula that most good-product companies actually focus on. It's -- so if you think of 60% is the real stuff and the other 40% is just stuff that's bundled. But I would say that today we're already 80% of the 60%. And for us, it's not a $5 million, $10 million deal because network virtualization is not a thing that you need to buy for $5 million, $10 million and expect $12 million -- 12 months of rollout and professional services. I mean, look at the public cloud. They don't even talk about network virtualization because any developer can go and actually consume security groups and virtual private clouds in one click. So I think our goal is to really make it one click and one node at a time, and not have to really talk about it being a $10 million ELA because it's a thing, because network virtualization is not a thing, really. It's really a part of an entire operating system experience.

Understood. And if I can sneak in one more, in terms of all the changes that you're currently going through, especially with the sales comp changes coming in February 1 and could you update us on -- from a sales perspective, what -- or where are we with the changes? Are we already done with all the changes in territories, quote to cash process, everything else?

Yes, I mean, this is something that Duston and Mark have been talking about as well, about how we need to actually have Mark come to our Investor Day conference because there's a lot to really exchange notes on with JP Morgan, and we'd love to actually have you folks come in. But look, I think we have -- just like our software operating system is actually making a lot of improvements and innovation, I think there is a go-to-market operating system that's innovating upon at every quarter and every -- so I think it's early days, but the quarter -- every quarter's results will tell you more about how this change is coming together. We'd love to have you come together to the Investor Day conference itself, including Mark as well.

And at this time, this concludes the Q&A session for today's conference. I will now turn it back to the presenters.

Okay. Well, thank you so much, everybody, for joining us. I know it was a tough day because of VMware and Splunk and Pure and us going all in the same day. For all of you who actually showed us here -- showed your presence here, it means a lot to us, your time is precious and look forward to seeing you at the Investor Day Conference. Thank you.

This concludes today's conference call. You may now disconnect.