Pure Storage Inc (PSTG) 2019 Q2 法說會逐字稿

Good afternoon.

My name is Mike, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Pure Storage Second Quarter Fiscal 2019 Earnings Conference Call.

(Operator Instructions)

I will now turn the call over to Matt Danziger, Vice President of Investor Relations.

You may begin your conference.

Thank you, and good afternoon.

Welcome to the Pure Storage Q2 Fiscal 2019 Earnings Conference Call.

Joining me today are our CEO, Charlie Giancarlo; our CFO, Tim Riitters; our President, David Hatfield; and our VP of Products, Matt Kixmoeller.

Before we begin, I would like to remind you that during this call, management will make forward-looking statements, which are subject to various risks and uncertainties.

These include statements regarding: competitive, industry and technology trends; our strategy, positioning and opportunity; our current and future products; business and operations, including our operating model; growth prospects; and revenue and margin guidance for future periods.

Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update them.

Our actual results may differ materially from the results predicted, and reported results should not be considered as an indication of future performance.

A discussion of risks and uncertainties relating to our business is contained in our filings with the SEC, and we refer you to these public filings.

During this call, we will discuss non-GAAP measures in talking about the company's performance, and reconciliations to the most directly comparable GAAP measures are provided in the earnings material, press release and slides.

The call is being broadcast live on the Pure Storage Investor Relations website and is being recorded for playback purposes.

An archive of the webcast will be archived on the IR website for at least 45 days and is the property of Pure Storage.

With that, I'll turn the call over to our CEO, Charlie Giancarlo.

Thank you, Matt, and good afternoon, everyone.

Thanks for joining us on today's earnings call.

I will begin the call with a summary of our Q2 results and highlights.

Hat will then provide a go-to-market update.

And finally, Tim will give a detailed review of our financials and our updated outlook.

Q2 was an exceptional quarter for Pure.

Our Q2 performance was very strong and the team executed well.

We saw a great momentum in the business and achieved profitability in our seasonal Q2, reflecting the inherent advantage of our technology and the strength and leverage in our business model.

Revenue for the quarter was $309 million, up 37% compared with the same period a year ago.

Gross margins were particularly strong at 68%, up 1.7% sequentially, and operating margins were a positive 0.3%.

All 3 measures exceeded the upper end of our guided ranges.

We expect the strength in gross margin to continue for the remainder of the year, and we are raising our outlook as Tim will share in more detail later.

Pure's continued focus on customers and innovation has positioned us repeatedly as a technology leader in the data storage market.

For the fifth consecutive year, Gartner has recognized Pure as a leader in their Magic Quadrant.

And in the most recent report, Pure was positioned farthest to the right and highest on both the execution and innovation axes.

Our focus on software, next-generation applications and bringing NVMe to the mainstream positioned us above all other competitors as we continue to democratize flash for an increasing number of use cases.

This strategy of democratizing flash for the mainstream was on display at our Accelerate conference in May.

At the event, we highlighted our customers' journey to a data-centric architecture replacing old style scale-out direct-attached storage designs.

The optimization of fast converged networks, compute and storage led by Pure has enabled enterprises of all sizes to build modern data-centric architectures with shared accelerated storage.

In Q2, we delivered on that vision.

As you recall, last year, we announced FlashArray//X, the first all NVMe, all FlashArray.

At Accelerate this May, we've launched the full //X family, which enables NVMe across the entire product line.

And in Q2, more than 50% of shipments were all NVMe.

In contrast, our competitors are just beginning to bring their NVMe offerings to market and only in their highest-priced products.

The speed of adoption of our //X family of products has been impressive.

And we continue to expect that by the end of the year, the vast majority of our revenue will be NVMe.

In short, our democratization of NVMe is working.

It was also a strong quarter for FlashBlade, as we saw expansion in our major use cases, such as AI and Rapid Restore as well as our largest customers expanding their purchases with a material number of new customers acquiring FlashBlade for the first time.

During the quarter, we saw a very promising momentum with our AI deployments of AIRI.

We also recently completed the acquisition of StorReduce, Pure's first M&A transaction as a public company.

StorReduce is a unique, cloud-optimized, deduplication engine for object storage, which enables both hybrid and cloud-native architectures for managing large scale, unstructured data.

StorReduce's technology is 100% software and was designed to be cloud first, and we are excited about the natural integration points with both our current on-premise product portfolio, and also its contribution to Pure's cloud integration and cloud services capability.

We welcome StorReduce customers and partners and, most importantly, the StorReduce team to the Pure family.

When I spoke to you a year ago, we outlined 3 operating priorities including: focus on our customers, operational excellence and innovation everywhere.

With an NPS score that continues to rise, industry-leading and increasing gross margins, a healthy profitable business model and a product portfolio that continues to lead the competition, we will continue to achieve new milestones and look forward to increasing our leadership.

With that, I'll turn the call over to Hat.

Thanks, Charlie.

Q2 was indeed a stellar quarter for Pure as our momentum continues to build.

Pure's strategy to deliver unparalleled technology innovation, a differentiated business model and a relentless focus on customer success has underpinned our consistent operating results.

We are in a fantastic innovation cycle across our FlashArray, FlashBlade, FlashStack, AIRI and Tier 1 platforms.

This innovation, together with the evergreen architecture and business model that we pioneered enables our customers to take advantage of these unique capabilities earlier and with no business disruption when compared with any of our competitors.

Our differentiated innovation and execution is not only validated in the Magic Quadrant, but Pure also scored the highest of all vendors in Gartner's Critical Capabilities report, being recognized as #1 in virtualization, database and OLTP, NVIDIA use cases, 3 of the largest revenue segments in the AFA market.

Thousands of global enterprises turn to Gartner for guidance in identifying best-in-class companies to partner with, and we are proud of this recognition for the fifth consecutive year.

We are also pleased to share that for the fourth year in a row, Pure has increased its certified Net Promoter Score to an 86.6, up from 83.7 last year, retaining our spot in the top 1% of all B2B companies.

Critics have noted that as companies scale, it's common to see Net Promoter Scores decline over time.

However, it's rewarding to us with our relentless customer-first focus to defy this conventional wisdom.

Our channel-centric go-to-market strategy to take these unique capabilities to market is working, especially when we see our largest competitors taking more business direct.

The new partner program that we unveiled at our Accelerate conference last quarter has been well received and is showing quick results, particularly within our largest national partners.

Our sales teams performed extremely well in the quarter and are benefiting from the differentiation in our current product cycle.

We added nearly 400 new customers for a total of more than 5,150, and we are pleased with the mix across our focused markets.

Win rates remain very strong across the board, and along with our industry-leading gross margins, it showcases that our sales teams and partners are consistently able to quantify our unique value.

FlashArray win rates increased sequentially and year-over-year, driven largely by our new all NVMe FlashArray//X product line and the adoption of active cluster.

Quite simply, we don't think anyone should buy an AFA in 2018 without NVMe at its core.

And only Pure can deliver this fully paralleled architecture cost effectively to the market.

We also had a very strong quarter with our FlashBlade offering.

Our Rapid Restore use case continues to enjoy strong momentum, and the Q1 launch of our AI-ready infrastructure solution, AIRI, together with NVIDIA, expanded in Q2 with AIRI Mini and has delivered strong retraction as well.

Importantly, we're finding that the simplicity of AIRI Mini to kickstart AI deployments and then easily expand is a value proposition that competitive solutions just can't match.

While still in the early innings, AI is proving to be a technology that cuts across many industries and all geographies.

We now have multiple AI customers in finance, government, social media, technology, health care, automotive and AI services with a balance of customers from early-stage start-ups to decades old market leaders.

Our data-centric architecture and consolidation message is resonating across all industries as well with a number of million dollar wins in Q2, the highest in our history.

We were particularly pleased with our progress selling into the cloud, health care and financial services segments in Q2.

Our cloud segment continues to represent approximately 30% of our overall business and enjoys the highest win and repeat purchase rates across our customers.

Across the enterprise segment, we saw continued progress in our customers, consolidating business applications and next-generation analytics into a shared accelerated storage platform, including both FlashArray and FlashBlade.

In the quarter, we had wins across some of the leading health care and financial services organizations, including The University of Texas MD Anderson Cancer Center, the New York Genome Center, Desjardins Group and The Royal Bank of Canada.

Finally, as Charlie noted, we are thrilled about the acquisition of StorReduce.

StorReduce has already forged strong partnerships with key public cloud providers, and their technology enables multiple cloud and on-prem use cases, including multi-cloud data tiering, migration and protection.

We look forward to sharing more on our plans for StorReduce integration and our overall cloud strategy in the months to come.

The momentum in our business is fantastic.

We're in a great innovation cycle, we're investing in the cloud and customers and fellow Puretans are enthusiastic about the second half and the years ahead.

It truly feels like we're just getting started.

With that, I'll now turn the call over to Tim.

Thanks, Hat.

Q2 was a great quarter for Pure, as we exceeded our guidance ranges on all 3 of our guided measures: revenue, gross margin and operating margin.

Before I dive into specifics, I'll make my usual note that the gross margin, operating margin, OpEx, net income and free cash flow numbers I will use are non-GAAP unless otherwise noted.

A reconciliation of these non-GAAP metrics to their GAAP comparables as well as our full Q2 results and presentation are available on our Investor Relations website at investor.purestorage.com.

Total revenue for the quarter was $308.9 million or 37% growth year-over-year and exceeded the upper end of our guided range.

Product revenues were $241.1 million or growth of 34% year-over-year.

Support subscription revenues were $67.8 million or growth of 51% year-over-year.

Revenue performance was driven by solid business fundamentals and strong execution by our go-to-market teams.

Geographically, 74% of revenues came from the United States and 26% came from international markets.

Total gross margin in Q2 was 68%, up 1.7 points from the previous quarter.

This represents the highest gross margin performance we have seen in the company's history.

These results illustrate the value we deliver to our customers and validate the significant differentiation between our software-centric products and our competitors' retrofit architectures.

Product gross margin increased 1.6 points to 67.9%, driven by continued strength across all of our products, component cost savings and the early adopter margin benefits associated with the launch of our FlashArray//X product line.

Support subscription gross margins increased 2.1 points to 68.4%, driven by a continued increase in amortization of ongoing support subscription contracts as a result of our growing install base, continued solid execution in our support organizations and timing of certain renewal bookings during the quarter.

Turning to operating margin, we delivered another quarter of profitability with Q2 operating margins at positive 0.3%, representing an 11-point improvement over the same period a year ago and a 5-point improvement over the midpoint of our guidance.

The outperformance in the quarter was driven by a strong revenue growth and gross margins above our Q2 guided ranges.

Net income in the quarter was positive $2.4 million or positive $0.01 per share based on a weighted average share count of 263 million shares.

This compares to a net loss of negative $20.7 million or negative $0.10 per share based on a weighted average shares outstanding of 209 million shares in Q2 of the last year.

Total headcount at the end of the period was more than 2,450 employees, which represents an increase of approximately 150 employees during the quarter.

Turning to the balance sheet and our cash flows.

We ended Q2 with cash and investments of $1.1 billion, which was up slightly from last quarter.

Free cash flow was negative $18.9 million in the quarter, including $7 million from our employee stock purchase plan.

This compares to free cash flows of negative $22.5 million during the year-ago quarter, which included $5 million from our employee stock purchase plan.

As a reminder, Q2 tends to be the lowest point of cash flow generation through our fiscal year.

With that, we'll now turn to our guidance.

For our third quarter, we expect revenues in the range of between $361 million and $369 million or $365 million at the midpoint.

We expect gross margins to be in the range of between 64.5% and 67.5% or 66% at the midpoint.

We expect operating margins in the range of between positive 4% and positive 8% or positive 6% at the midpoint.

For the full year, we expect revenues in the range of between $1.35 billion and $1.38 billion, a midpoint of $1.365 billion, which represents an increase of $20 million from our previously guided midpoint.

We are raising our gross margin range to between 65.5% and 67.5% or 66.5% at the midpoint.

We are also raising our operating margin range from between 2.5% to 4.5% or 3.5% at the midpoint.

The raising of our full year guidance is an indication of the strong momentum we are seeing in our business, a validation that our strategy is working and a statement on the excitement we have for the second half of the year.

With that, we'll now open the call for questions.

Operator?

(Operator Instructions) Your first question comes from Aaron Rakers from Wells Fargo.

I was wondering if you could you just dig a little bit deeper into the gross margin drivers here.

And in particular, I'm curious of what you're seeing from a NAND pricing dynamic.

Whether or not you're able to kind of abstract or is that is a driver to any of the gross margin?

And I guess, just given on a forward-looking basis, it sounds like -- you feel like some of these dynamics will continue, how much confidence do you have in that as we start to see NAND flash pricing decline and whether or not you would pass that through to your end-users?

Yes.

Hi, Aaron, Charlie here.

Thanks very much for the question.

I would break down the gross margin benefit that we had this quarter and what we see going forward on 3 different things: the first is frankly, we're able to sell value and we're able to, I think, the -- coming out with the //X series and just our increasing awareness of our Evergreen program is having the intended effect on our customer base.

They understand the value that we bring.

And clearly, we get a premium now for our products, and that's expanding.

Two is that, yes, we definitely -- the //X series did bring more value to the customer.

And also because of that -- because it actually gets enhanced performance out of the flash, that gives us a benefit.

And then third is as we've mentioned in the past, we believe that we're able to take advantage of lower cost NAND faster than anyone else in the industry.

And we've -- as we've been predicting for almost a year now, we thought we'd start to see NAND prices start to decrease or that we'd be able to get the benefit of decreasing NAND prices starting this quarter -- starting this past quarter and that's exactly what we saw.

We saw the beginnings of that last quarter and we feel pretty good.

We know what those NAND prices are going to be for us for the next quarter or 2. So we feel pretty good about that.

Okay.

And as a quick follow-up as we think about the growth and just in general the storage market, your closest peer NetApp grew what 50% year-over-year in terms of the all-flash business, you guys grew 37%.

I'm just curious when you look at the overall market and what seems to be a pretty good demand backdrop, how do you think about traditional enterprise storage versus what you're seeing as far as a contribution from next-generation workloads, if you will, AI, Rapid Restore within your product revenue stream?

Right.

Well, let me just state flat out that we're competing for the entire storage market, okay.

And when we look at that, we grew 37% year-over-year and the rest of our competitors, at best, were high single digits.

So let there be no mistake.

There -- you can't compare replacing some magnetic install base with putting in some new flash discs and say -- and identify that as being the same kind of growth rate as what we're seeing.

We're growing 37% as a company.

Hat, you want to add some color on that?

Yes, the only thing I would add is we're thrilled with our net new customer acquisition, nearly 400.

That's 6 net new customers per day.

And I think the other folks have stopped talking about that because they really are relying on converting their install base.

The win rates, I think, and gross margin are the 2 areas that are the headline here.

Our win rates against NetApp and everybody else grew sequentially and grew quarter-on-quarter and year-on-year, while we're expanding margin.

So we think that pretty much nails it.

And the last thing that I'll mention, if I can add in here, is that as we do see pricing decline with NAND over time, elasticity is real.

We will be getting more and more of the, whatever traditionally, Tier 2 use cases and that's a market expansion opportunity for us.

Your next question comes from Mark Murphy from JPMorgan.

Want to ask you whether your confidence in 30% multiyear revenue growth increase is coming off a quarter like this where the growth rates are higher than they were a year ago.

You mentioned your Net Promoter Scores rose even higher as well.

So does the confidence increase?

And what factors do you think are essential to achieve kind of sustainable growth at that scale, which is very rare in the technology markets?

Yes.

We're very confident of the growth rates that we set out before.

We're on track for $2 billion in a couple of years time, and hopefully, hitting that on a run rate basis next fiscal year.

I would say that our confidence stems not so much from any one quarter's performance, but much more from the NPS scores that you identify that is a love of our customers and, just as importantly, the pipeline of products that we have coming out the door.

We just released the //X series, but we have a whole pipeline of new capabilities that we'll be talking about over the next year, and we feel very good about the innovation engine that we have behind us.

As a follow-up on your cloud mix -- or cloud adoption.

I believe you recently had a SaaS company make a 7-figure initial purchase.

Could you update us on the traction and maybe the types of discussions that you're having with the cloud and SaaS providers and maybe what you think this is going to bring to you in the second half of the year?

Yes.

So as I mentioned, the cloud business continues to be really strong for us, multimillion dollar wins initially, the highest repeat purchase rates and highest close rates.

So that continues to be a key area of focus for our selling teams in the Cloud 1000 and candidly the top cloud providers overall.

So we're going to keep investing there.

We're pleased with the upmarket bias emphasis that we had at the beginning of this year, and I think that's reflected in having the highest number of million dollar wins in the quarter as well.

So the cloud business is a key growth driver for us, but we saw a great traction across enterprise and our commercial businesses as well.

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

If you look at the competitive landscape, there's been a lot of talk about product SKU consolidation at EMC, some significant introduction of different channel strategies by others, but you guys delivered the best gross margin quarter in your history.

Are you leaving some revenue growth on the table with these margins?

Yes.

No, Wamsi, thank you for the message.

We don't think so.

We certainly -- I would say, from a focus standpoint, we're focused on growth as a company.

No, we're not going to leave money on the table, and certainly, we'll take our premium as we can get it, but I've said this in the past, we certainly don't win on price, but we won't -- we're not going to lose on price either.

So for every opportunity that we -- that our product is the best solution for, we're going to win that deal.

Yes, Wamsi, I will just add, there is no doubt that this product cycle is benefiting the sales team, but -- and I've been doing this for almost 30 years.

And I think we have the best sales team in this segment by far.

I think that in conjunction with our channel-centric go-to-market is really paying dividends.

I think we're growing international partners, we're growing with the larger partners and that's (inaudible) a backdrop where the competitors are taking more deals direct.

So I just think we have a really nice competitive landscape to operate in with really great sales team and great capabilities to differentiate.

Okay.

And as a quick follow-up, you mentioned elasticity of demand as NAND price declines.

As the NAND price declines have been fairly significant, what do you think that does to overall industry growth rates?

I mean can we talk about a 10-point faster potentially growth for the industry?

Or how do you guys think about sizing that opportunity in terms of elasticity of demand?

That's -- Wamsi, that's a difficult question, frankly, to answer.

We know that elasticity is real, but it's hard to project exactly what -- we, of course, see NAND pricing declines.

But translating that into AFA market declines is a complex formula that's controlled largely by the large players more than us.

And so it's difficult to -- as we mentioned in the past, we think they will not be able to take advantage of low NAND prices as quickly as we do, and therefore, that may be longer in coming.

So a little bit difficult to predict, but what we do know for sure is as NAND declines, more of the magnetic market will come up for AFA replacement.

And Wamsi, this is Tim.

That elasticity is something that we've tracked a lot since we've been a company and that elasticity has proven itself out in all of these sort of scenarios with NAND, NAND going up, NAND going down.

So it's a trend that we feel very confident in.

Your next question comes from Sherri Scribner from Deutsche Bank.

You guys have had very strong margins over the past couple of quarters to some extent helped by the changes in the NAND pricing.

And if you look at the guidance, it suggests margins come down a bit, but still kind of in the higher end of the range.

I guess, what are some of the puts and takes on your business and the gross margins doing better as we move through not just this year, but longer term than your long-term target?

And what are some of the risks to the margins as you move into '19 with NAND prices maybe stabilizing?

Sherri, this is Charlie.

Let me take the front-end of that and I'll pass it to Tim on the other side of it.

Which is that the first thing that I think is very important is that NAND pricing our part is part of our improvement in margins, but frankly, the new //X series and the value that we've been -- the greater recognition of the value that we bring with Evergreen and therefore, our ability to maintain a premium for our product is, I think, probably the more the greater advantage.

So the advantage in our overall solution -- the model, the software that we bring, the capabilities that we bring with that software and the premium we were able get for, I would say, is probably the larger contribution to that.

But certainly, NAND pricing helps.

I'll let Tim take that.

Yes.

I would just echo Charlie and all of those dimensions.

I think I'd really, sort of, focus on the software innovation.

We have been talking about this for a long time about how we were software designed at its core, which has allowed us to optimize on whatever flash may be out there and whatever flash may be most advantageous for us.

And you've seen that in times of declining NAND, you've seen that in times of increasing NAND.

So if there's a reason why we are at the top of the industry in product gross margins and we [can] expect that to continue.

Okay.

I guess, just following up on that thinking about your long-term target.

You're clearly at the high-end of that and the product mix, the value that you guys are providing, all seem to be big drivers of that and those don't seem to be potentially be going away.

So how should we think about those long-term targets?

Are they maybe the low end is probably too conservative and we should really be thinking about you being at the higher end long-term?

What we've guided to is the rest of the year.

So we're feeling fairly confident there.

We are not ready to change our long-term guidance on this.

It's a bit too early.

You alluded to mix.

What you see in any new product lines such as FlashBlade is that with you get better margins as you -- as sales increase.

So I wouldn't put too strong a focus on mix going forward.

As FlashBlade increases in sales, we will get better gross.

It is a lower gross margin product today, to be clear, but the margins are improving and I expect that -- that's a normal course of events for new products.

And you saw that certainly over the sort of medium term Sherri, in terms of the guidance that we offered up, obviously raising 1.5% for gross margin for the full year gives a statement in terms of the position we are in right now, where we have this significant lead in NVMe.

The innovation cycle is working very well.

So we really like what we see in the medium term.

Your next question comes from Katy Huberty from Morgan Stanley.

A lot of discussion about product margins, but you've seen an even more impressive (inaudible) in support margins over the last couple of quarters.

So would love your thoughts as to why that won't continue to expand as revenues scales.

So is there some reason that you're approaching a (inaudible) on the support subscription margin?

Okay.

Thank you, Katy.

Operator, can you put the -- Thank you.

Katy, there is a lot of interference, Katy, on your line.

I think you're asking about op margin performance and why we might not expect to continue going forward.

Also, again, I will start off with an answer and then let Tim conclude.

So as we've talked about in the past, our target was to get to mid-single digits profitability and then really pour on the gas in terms of growth rate overall for the company that as long as our -- as long as we were profitable and that we could maintain growth in the 30% to 40% or higher percent range, then our real focus as a company was going to be on maintaining growth.

That is our aim.

We do have a foot on the gas in terms of growth and each quarter has the vagaries of hiring and expense, and so forth, but that's -- our target is to really focus on growth.

Katy, our apologies there was a little bit of noise and static here.

I think you were also asking a question about support margins and you're absolutely right.

Support margins if you look over the last several quarters, they've been climbing very, very nicely.

I think it's really a combination of great efficiency and effectiveness by our wonderful world-class support organizations.

They're doing a fantastic job.

But also just as that business scales there's inherent leverage in the business.

And then finally, the Evergreen model is starting to kick in.

We're seeing great renewal rates now at scale and really that's providing that nice lift on the support gross margin side as well.

So a lot of things to be excited about on both pieces of gross margin, if you will.

Your next question comes from Alex Kurtz from KeyBanc Capital Markets.

So just another clarification on the //X series.

Tim, is there -- I'll throw this out to anyone.

Because you're delivering a significant difference in price per IOPS than your traditional products with the //X series, is there a segment of the high-end of your installed base that are seeing real value there?

And maybe your product margins just could structurally be higher going forward, because you're providing so much more value at the really high Tier 0, Tier 1 workloads?

Maybe there's just kind of like a reset on the top end of your install base and then I have a follow-up on the cloud.

Alex, on gross margins, we've always thought about our gross margins as a pool in our portfolio on the business.

And so we sell as you heard Charlie say earlier, value, and so part of what you saw this quarter is those early adopters really putting //X to the test and //X to use.

And they're delighted with what we're seeing.

And so we're going to manage that pool.

I wouldn't, sort of, draw the next conclusion that gross margins keeps going and going and going but we've always managed the pool and with the //X series it's no different.

I guess, I was...

I think in general, we just have never believed in the high-end niche performance segment.

Back to the earliest days of Pure, we believed in democratization, and that's exactly what we tried to drive with //X bringing NVMe to the masses.

And so if you look at achieving 50% of our product line on NVMe now, we think the far bigger opportunity is to drive consolidation of the product line.

We can follow-up on that call back on that but just on the cloud, when you look at the year, what's the cadence of the growth rates there relative to the rest of the business?

Hi, Alex, it's Hat continued progress on the 30%.

We think that's reflective of where we're going to continue to have it march, our upmarket buys focuses on 3 key segments.

Cloud 1000 is obviously at the top of the list.

Fortune 500, which is north of 35% now, and the G2K, and the largest nonpublic kind of healthcare government agencies and we saw nice progress across all 3 of those.

Your next question comes from Andrew Nowinski from Piper Jaffray.

So first I want to ask about ELAs.

One of your competitors started offering ELAs to larger strategic customers.

Does Pure Storage offer these yet?

And if not, are you going to begin offering these to the larger global customers?

Andrew, this is Tim.

No ELAs at this point in time.

As the business scales and we think about the software that may be something we take a look at.

But again, remember all of our products how we've gone to market in the past is everything is included, and so that's one of the other reasons you're not seeing ELAs in our business right now.

Okay, understood.

And then last I just want to ask about your hybrid cloud strategy.

And I saw your ES2 announcement at Accelerate, but I guess, how do compete against NetApp if a client wants a storage platform that enables them to run the same operating system on Amazon as they do on-premise?

Yes.

This is Kix I'll take that one.

Look, I think we absolutely believe in the hybrid model of IT, and we've made a number of announcements and development initiatives around supporting that.

So Accelerate, we announced our CloudSnap offering which allows us to integrate our arrays on-prem and be able to send data to the cloud natively.

And then if you look at the acquisition we announced today, we're excited about a lot of the hybrid use cases that, that acquisition unlocks to be able to [federate] data across both on-prem and hybrid cloud.

Your next question comes from Ittai Kidron of Oppenheimer.

Couple of questions from me.

First for you Charlie.

Last call you've talked about how we're working hard to scale the business.

One of the main reasons you came to this company is to make a lot of changes in the go-to-market and the enterprise approach.

Help me think about some of the things that you've done.

In what way are the already showing and in what way are they still not showing and there is still very much ahead of us to look forward to?

Ittai, thank you.

I wouldn't say that I came to make a lot of changes.

I certainly would say that I came to help the company to continue to scale going forward.

Some of the changes that we made, which I think the company, to a large extent, was already embarked on was this upscale bias and what that meant in terms of channel programs and in terms of product structures, in terms of marketing programs and how we address enterprise and cloud level opportunities.

We've certainly done that.

As you know, we reorganized the company's business for greater focus around business units.

And that's certainly given us a greater focus for this year.

And other things that are perhaps less apparent to the outside was just making sure that we had really good alignment around our -- the main areas that was going to make a difference for us going forward, such as what we do for enterprise customers, such as how we align all the way from supply chain to engineering to marketing to sales.

So I would say, it's really -- it was really just innovating around the edge or aligning what was already the good practices at the company and refocusing around the ones that are going to make a bigger difference for us in the future.

Got it.

For you, Kix, NetApp and NVIDIA also announced this relationship, I guess, around AI.

How do I compare and contrast what you do with them versus what NetApp is doing with them?

They say imitation is the deepest form of flattery and I think that was certainly the case in those announcements.

Look, I would just point to a couple of things.

Number one, we're seeing real growth in our AI business and we continue to win [draws] with NVIDIA and feel good about it.

You can look at the public references we put out and I'm not sure any of our competitors have put out any public AI references, as an example.

The second thing I would say is that one of the things that really is an advantage of FlashBlade is it scales from small to big.

And most AI initiatives don't start huge, they start small, but then they grew quickly as people [get steam] with them and one of the real advantages to our product line is you don't have to buy into our largest array on day one.

You can start with a small FlashBlade and grow seamlessly as your AI initiative grows.

Your next question comes from Jason Ader from William Blair.

I have one for Tim and one for Charlie.

For Tim, can you confirm that the //X series has a better gross margin than the //M Series because that's what it seems to imply from the margins this quarter?

The short answer, Jason, at this point is, yes.

//X margins are better for the reasons, I think, we talked earlier on the call in terms of the value our customers are seeing and the value that we can capture from it.

So yes.

Okay.

And from a cost of goods standpoint, is it roughly the same for you?

There is some benefits there because as Charlie alluded to earlier in the call, we're starting to see the benefits of NAND.

I mean, we've seen a tight NAND market for the last year, we always thought that right around this time we would start seeing some relaxing on that [bill of] material components, and that's indeed happening.

The other thing I would add is with our direct flash architecture, we can now program directly to raw NAND.

So with //X, we're buying raw NAND instead of buying finished SSDs and that of course gives us an advantage as well.

Okay, great.

And then for Charlie, maybe following up a little bit on Ittai's thread.

Just you know obviously, the business looks really strong, but where do you think the company can be doing a better job?

Maybe a vertical or a [GO,] I guess it's maybe as much for Hat here, too, just in terms of the sales and go-to-market side?

Coming in to any company, I always view it as an antique car.

You're driving down the road, having a wonderful time, but you're only miles away from the alternator going or a brake pad or something like that and every company, always requires just constant tuning.

So in any particular quarter, there were things we could do better and we are -- we want to make sure that we're well aware of those and so having a company that is very transparent as to where its challenges are so that you can address them rapidly is very important and that's what we tried to instrument here.

I don't know that it's useful to go into specific areas, but there are -- to be clear, we started our journey and going focusing more upmarket.

And there is still a lot more work to do there, to be very clear.

We have -- we are excited about our technical team and technology and the acquisition that we're announcing today.

There is more that we can do there and we plan on bringing out more.

And we continue to fill out a number of areas, both the features and capabilities of our product line which as we've said in the past, that we still have more to go there as well as our cloud story.

We continue to build there.

So lots of room for improvement, but we're proud of where we are and very optimistic about how these as we continue to focus on these areas, how that will improve the business going forward.

Your next question comes from Erik Suppiger from JMP Securities.

A couple of times you referenced some of your competitors taking business direct.

I assume that's EMC.

Can you talk a little bit about what type of business you see that taking place and what actually has happened with some of your channel partners as that's opened up some opportunities?

Yes, Erik, this is Hat.

I wouldn't isolate it into one specific vendor.

I that it's a trend we're seeing across multiple.

So I think when we've got order of 10 to 15 points of gross margin advantage in a differentiated product line that we just extended our lead even further, it's hard to compete with that.

And so I think they're trying to do whatever they can do to win and our success in competing with them is measured in terms of the expansion in gross margin and the win rates.

And so Dell, I think, has changed the culture a bit, of EMC.

We see a lot of those folks leaving.

Many of them are leaving to partners of ours so they've got deep domain knowledge and they've been beat by us quite a bit.

So they will go over it with a receptive embrace.

And we also see them coming here.

And it seems to me that the trend is they are more focused on top line and if they can get there with servers, they get there with servers versus focusing so much on storage.

So I think it's a general competitive landscape that benefits our uniqueness and we're very confident in the second half of the year.

Okay.

Then last question.

Do you think you might start breaking out FlashBlade in the semi -- foreseeable future, maybe in fiscal '20?

Yes.

This is Charlie.

As I've said in the past, breaking out individual line items on a reporting basis for individual products, especially new products that tend to be lumpy and tend to go through learning curves is, I think can distract from our -- from the way that we're followed.

FlashBlade did have a good strong quarter this year, so we're pleased about that.

But I don't see breaking it out any time in the near future.

Erik, there is one thing to follow-up as you mentioned on the partner as well.

So the new partner programs that we rolled out have been really well-received.

The national partners, we're rewarding those partners that invest in us.

And so there is a reciprocal relationship that as they're investing in practices and they are driving more leads to us, they benefit financially from that.

So that's [near] , we're going to continue to invest, and I think that dynamic, while the others are pulling a little away from the channel, at least as it appears to me and to us, is benefiting from us from the largest national players.

Your next question comes from Simon Leopold from Raymond James.

This is Victor Chiu in for Simon.

I was hoping you can help us dig a little deeper into the longer term opportunities and the role of flash specifically in newer applications like Big Data and AI because when we look back historically at how flash storage evolved, there was a time when it was considered an extravagance because the performance was so far ahead of the rest of the parts of the data center it is hard to make the case for it economically.

Obviously, that's shifted as compute hardware has advanced to point where legacy disk is obviously the bottleneck in a lot of situations and flash is more standard.

So I guess, my question is should we think about the progression and advancements of GPUs and other specialized silicones as being analogous in this respect and are the current flash platforms sufficient enough to meet the current needs given we're still in the early stages here and at what point if ever do they become bottlenecks versus more specialized solutions like FlashBlade?

It's Kix.

I will take this one.

I think we're excited about expansion on kind of both sides of the spectrum.

So as you noted, with GPUs and AI and kind of a renaissance on the top of the end of performance that's pretty in demand that frankly, only flash can serve, and so that's helping us sell NVMe in some of the higher performance offerings.

And then as you look at the forward motion of kind of NAND and cost price declines, we think we can go after even more terabytes within the data center that would have been only in the layer of disk before.

And then, the final thing, ultimately, the StorReduce acquisition for us is about going after terabytes that might even have landed on disk or tape and modernizing those as well, leveraging cloud storage as the cheaper storage option as opposed to on-prem.

And so we think it's high time to kind of modernize everything, and we're seeing good opportunities in both directions.

Your next question comes from Mehdi Hosseini from SIG.

Most of the good questions have been already asked.

I have a couple of follow-ups.

Looking at your acquisition announced tonight, it's very intriguing and very interesting, especially the dedupe feature of this acquisition.

And 2 follow-ups.

Do you see this acquisition running independent for a few years before becoming embedded into your flash products?

Or is it going to be embedded into the FlashBlade as you try to scale your NAS or object-oriented products?

And I have a follow-up.

That was a very good question, Mehdi.

Thank you for that.

By independent, I think you mean will we sell it as software running on a standard center hardware?

And the answer to that is yes.

We do plan on -- to be clear though, for the immediate next several months, our plan is to maintain -- to continue to maintain and support their customers, but not to add new customers, while we -- you might call it purify the software that is -- make it compatible with our management, make sure that it has the kind of reliability that our large customers are going to expect, the kind of availability in that environment.

And then we'll talk more about this towards the latter half of the year.

We'll be able to describe exactly how this folds into our overall product line and the exact program of what the new product announcements are on that.

As Tim might have mentioned, we both the expenses as well as the revenue are incorporated our current guidance.

So we don't see it being a major...

And to be clear on the revenue side, Mehdi, for the rest of this year we don't anticipate any dollars in the guide, nothing's baked into the guide for that acquisition.

Okay, got it.

And want to follow-up on NVMe.

When do you expect the NVMe-over-fabric solution to be supported by fiber channel?

So I think as you're aware when we look at the end to end NVMe opportunity, we saw the biggest opportunity to be implemented within our systems, that's where most of the latency in a storage transaction occurs.

So that's what we focused on first.

We promised that we would be bringing out NVMe-over-fabric by the end of this year.

And as we stated publicly, our first goal is to actually start on the IP side and then follow that on the fiber channel side.

So we are absolutely on track with our deployment of the IP side this year and we expect fiber channel next year.

Your next question comes Rod Hall from Goldman Sachs.

This is Balaji in for Rod.

I have a couple of questions.

On FlashArray, I noticed that win rates had increased quarter-on-quarter.

Just wondering, is this (inaudible) by NVMe, FlashArray or anything else that's helping in this?

And I then I got a follow-up.

This is Hat.

The product cycle overall I think is contributing to that.

There is no doubt that the FlashArray//X really extended our moat and differentiation is having a big effect on our biggest business.

Okay, that helps.

Any particular geography or I guess any [country] that you're seeing better win rates?

We've seen them consistently across the board for years and that hasn't changed.

So I think we will continue to focus on driving our success in the largest markets internationally and the largest segments that we've got.

So we did see a particularly strong quarter in the Americas in Q2, which we were thrilled with and obviously it being our largest business, when that grows, it really helps the overall top line as well.

Great.

One last question.

What kind of trends are you seeing with the FlashBlade business?

You mentioned that you are seeing larger deals more frequently?

Any further color around that will be helpful.

I would just say, I will hit the first part and Kix maybe you follow underneath it.

We're seeing great traction in 3 real use cases.

One is the rapid restore use case.

Another one is in backup -- and sort of -- pardon me, [exadata] replacements.

And the third one is in this next-generation analytics and AI.

So all 3 of these are very repeatable.

And we're seeing great traction and success across segments.

We talked about the New York Genome Center, it is one of the largest competitive installs that we're aware of in this area.

We also talked about RBC and this is a great win for us with one of the largest banks globally.

And so there is a whole bunch of other successes that we had across healthcare, large SAS companies and public sectors.

we're seeing great adoption across those 3 use cases, across segments.

Your next question comes from Eric Martinuzzi from Lake Street.

Question regarding StorReduce.

Just wondering if this is -- did you find that you were maybe lacking something in the product portfolio so not having this capability cost you in some competitive bids?

Or is this really more about broadening your current offering to the installed base so that you're there with them they want to have a hybrid capability?

Look, I'd say a couple of things.

First off, we don't have dedupe today in FlashBlade.

So this is a natural fit in that sense.

But in the broader equation here, oftentimes when we go out and meet customers around Big Data, they have hundreds of petabytes of data and bringing hundreds of petabytes to FlashBlade probably isn't realistic, and so we often get into discussion with them about how we can move tens of their petabytes to flash, but we need some lower tier for the rest of the data.

And so we think the rest of the data should be in the cloud.

And so if you look at a previous workflow from a decade ago, customers might have used [3 flavors of] disk and tape.

We think the future is flash and low cost public cloud storage.

Okay.

And as far as the partner education, I understand you have got to do some integration on the technology side, but what about the time line for getting the partners smart on this capability?

Yes.

I mean, once we kind of engineer and purify the product as we talked about, it will be a full tier product that we will launch as we do with any, train all of our partners, work to drive technology-partner integrations, all the normal stuff.

And we feel like we got the time to be able to do that.

So we feel confident about the timelines we have in place for that.

And for us it's also useful to mention that this product also brings strength in new partnership areas.

StorReduce was successful in creating a number of cloud partnerships as well and we intend to embrace and extend those partnerships.

Our last question comes from Steven Fox from Cross Research.

I will keep it quick.

Just on the channel centric focus and also the ramp-up in the larger scale wins.

It seems to be creating some operating expense leverage as well as gross margin leverage.

Can you just sort of talk about whether your expectations for further OpEx leverage have changed going forward given the success you're having and then I had a very quick follow-up.

This is Tim.

No, no.

I think you're right in suggesting that there is leverage there to be had.

But I would just sort of point to the guidance that we issued here today, raising our full year profit up.

So there is inherent leverage in the business.

The business is performing well and very healthy.

But I don't think it has changed our long-term view of the dynamics and go-to-market and the success we've been having.

I'll just add.

A lot of the investments that we make upfront take some time to come through, and so we're seeing the benefits of some of that.

And candidly, we're doubling down.

I think our competitors in the market are going to feel us in the second half as we invest in our channel partnerships, invest in market awareness and invest in additional capacity.

So we're really excited and motivated about the second half.

And Kevin, this one is for you, [EFT.]

And Tim, just real quick on the cash flows for the full year guidance now.

What does it sort of say about -- not necessarily cash flow from operations.

You've been specific about that.

But free cash flow now, as we think about your investments for the full year.

Where do you think you come out for the year, roughly, on the free cash flow line?

Yes, Steve, we've never really guided free cash flow.

It just can be noisy.

I mean, it has to do with cash collections spanning an individual quarter boundary or anything like that.

I think all we've done is qualitatively said last year we were positive free cash flow for the year, a small amount.

We definitely anticipate being a stronger FCF generation year this year.

But really point people on our progress to the operating margin, which is a much more stable and, sort of, predictable number than, sort of, any given quarter of FCF.

I will now turn the call over to Charlie Giancarlo for closing remarks.

Thank you, Mike.

Everyone, we're proud of our progress this quarter and we're proud of empowering our customers to succeed.

I really want to thank the entire Pure team and our global partners for their tireless efforts and their dedication.

And lastly, on behalf of all Puritans globally, I would like to again welcome the StorReduce team along with their customers and partners to the Pure Storage family.

We believe that the StorReduce team has built an incredibly exciting technology that has the opportunity to make a major impact on the next-generation of cloud storage architectures.

And once again, I want to thank you all for joining us on this call today.

It has been a pleasure talking to, and I look forward to chatting with you in the days and weeks to come.

This concludes today's conference call.

You may now disconnect.