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Edited Transcript of CLDR.N earnings conference call or presentation 4-Sep-19 9:00pm GMT

Q2 2019 Cloudera Inc Earnings Call

PALO ALTO Sep 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Cloudera Inc earnings conference call or presentation Wednesday, September 4, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James W. Frankola

Cloudera, Inc. - CFO

* Kevin D. Cook

Cloudera, Inc. - VP of Corporate Development & IR

* Martin I. Cole

Cloudera, Inc. - Interim CEO, Chairman & Lead Director

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Conference Call Participants

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* Chad Michael Bennett

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Daniel Harlan Ives

Wedbush Securities Inc., Research Division - MD of Equity Research

* Jon Philip Andrews

Needham & Company, LLC, Research Division - Senior Analyst

* Matthew James Coss

JP Morgan Chase & Co, Research Division - Analyst

* Patrick D. Walravens

JMP Securities LLC, Research Division - MD, Director of Technology Research and Senior Research Analyst

* Robert S. Majek

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Sanjit Kumar Singh

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Good afternoon. My name is Elaine, and I will be your conference operator today. Welcome to the Cloudera Second Quarter Fiscal 2020 Quarterly Results Conference Call. (Operator Instructions) Please note, this conference is being recorded.

Your host is Kevin Cook, Vice President, Corporate Development and Investor Relations. Kevin, you may begin your conference.

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Kevin D. Cook, Cloudera, Inc. - VP of Corporate Development & IR [2]

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Thank you, Elaine. Good afternoon, and welcome to Cloudera's Second Quarter Fiscal 2020 Conference Call. We will be discussing the results announced in our press release issued after market close today. From Cloudera with me are Marty Cole, Chairman and Interim Chief Executive Officer; and Jim Frankola, Chief Financial Officer.

During the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the company, including those as merged with Hortonworks. Generally, these statements are identified by the use of words such as expect, believe, anticipate, intend and other words that denote future events. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release and on this conference call. These risk factors are described in our press release and are more fully detailed under the caption Risk Factors in our annual report on Form 10-K, our quarterly report on Form 10-Q and our other filings with the SEC.

During this call, we will present both GAAP and non-GAAP financial measures. Non-GAAP financial measures exclude stock-based compensation expense and amortization of acquired intangible assets. In addition, we provide a non-GAAP weighted average share count for fiscal 2020. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results, and we encourage you to consider all measures when analyzing Cloudera's performance. All numbers reported for prior periods are presented for Cloudera on a stand-alone basis since the merger with Hortonworks closed on January 3, 2019. And as such, there is no comparative year-over-year financial information for the combined company. For complete information regarding our non-GAAP financial information, the most directly comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today's press release regarding our second quarter results. The press release has also been furnished to the SEC as part of a Form 8-K.

In addition, please note that the date of this conference call is September 4, 2019, and any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events.

Now Marty Cole, Chairman and interim CEO.

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [3]

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Thank you, Kevin. Hello, everyone, and thank you for joining us to discuss our second quarter fiscal 2020 financial results.

It has been an exciting month since I became interim CEO on August 1. I am pleased to report that we executed well in Q2. I want to thank my team for its continued focus on our customers and people during this period. Among our recent accomplishments, we delivered as promised an initial release of our cloud native data management and analytics offering, Cloudera Data Platform. We also entered into an agreement to acquire certain assets of Arcadia Data, including technology that accelerates time-to-insight for data analytics. And we welcome 2 new Board members as a result of the large stake that Icahn Capital accumulated in Cloudera stock. During this call, we'll cover these topics as well as important changes in our licensing and distribution strategies.

Beginning with Q2 financial performance, total revenue in the second quarter was $197 million. Subscription revenue was $164 million, and operating cash flow was negative $33 million. Although the year-over-year comparisons on these numbers are not meaningful as a consequence of the merger with Hortonworks, each of these results exceeded expectations.

Annualized recurring revenue was $682 million at the conclusion of the quarter, representing 16% year-over-year organic growth, again ahead of expectations. Finally, we had a good quarter in terms of adding new customers. We now have 953 customers who exceed $100,000 of ARR, a net increase of 24 for the quarter.

With that quick overview of our results, let me spend a moment on my priorities as interim CEO. First, I am focused on improving execution, in particular the execution of our enterprise data cloud strategy. This strategy begins with the phased rollout of our new Cloudera Data Platform. We met the first milestone in the current quarter as last week we delivered initial releases of our CDP public cloud services. I am also very focused on the execution of our financial plans. We are deliberately balancing our investments in continued growth and disciplined expense management to improve cash flow.

Second, I am focused on retaining and growing as many of our customers as possible. Cloudera's base of large ARR customers is stable and has continued to expand each quarter, including in Q2. I have gotten increasingly active with our customer base as was my practice at Accenture, and all of my interactions have been positive. Customers are enthusiastic about CDP and the enterprise data cloud.

Third, I am focused on our employees and our culture. We have a very talented group of people at Cloudera distributed across the globe who are driving real innovation for the benefit of our customers. I'm working with the leadership team to create a more disciplined and action-oriented culture and to make Cloudera a great place for current and future employees to advance their careers while solving some of the world's biggest challenges through data.

And last, but not least, I'm focused on delivering greater value for our shareholders. As we get the first 3 right and succeed in producing hybrid and multi-cloud solutions, delighting customers and inspiring employees, we truly believe that our shareholders will benefit. The Board and I are committed to enhancing shareholder value.

Let me turn to some of the highlights for the second quarter and in recent weeks. Since it was a feature of last quarter's conference call, I'd like to follow up on customer buying behavior and industry trends. Our internal metrics and pipeline generation had materially improved from Q1 levels. Together with solid execution in our second quarter, we are on plan for achieving our objectives for this fiscal year. For example, basic renewal activity rebounded in Q2. We executed better, resulting in fewer slip renewals than in Q1. We believe the improvement in renewals was helped in part by more clarity regarding the new Cloudera technology road map and greater certainty as to the composition and functionality of CDP. We demonstrated these capabilities to our customers publicly in mid-June. In particular, our class of $1 million-plus ARR customers and its associated revenue remained stable. In spite of already being at revenue scale, this group continues to expand on a net basis.

As far as competition, in the second quarter, our metrics improved across the board, and we saw an increase in our win rates against the cloud service providers as compared to Q1. As CDP gets established, we expect to gain further across this competitive dynamic. That said, the hyperscale cloud providers remain our primary competitors. This is all reflected in continued pipeline growth. As discussed in connection with Q1 results, in Q1, we experienced a booking shortfall due to weaker-than-expected pipeline entering the quarter and the impact of the merger integration. The improvement we saw in pipeline generation at the conclusion of Q1 has persisted, and we believe that we are building pipeline at a rate that supports our financial plans.

Overall, I'm pleased with our execution in Q2, but we've got more work to do to restore higher top line growth. In addition to better execution, we are focused on meeting customers' demands for hybrid and multi-cloud solutions that support use cases from the Edge to AI. That is the promise of the enterprise data cloud and CDP. I am very grateful to our team for its tremendous effort in releasing our initial CDP cloud data services. We already have a select group of customers evaluating our CDP Data Hub, Data Warehouse and Machine Learning services. These are the first in a regular cadence of cloud services we expect to roll out over the next year.

We plan to launch CDP at the Strata Data Conference in New York later this month. It is a groundbreaking set of offerings that lay the foundation for the enterprise data cloud, spanning multiple public and private clouds as well as data centers. We believe CDP's consistent data security, governance and metadata management across all of these environments is a significant competitive advantage. CDP offers broad functionality including Edge, IoT, Data Warehouse, Machine Learning and AI and makes it easy for diverse sets of business users to apply them across shared data. CDP will enable enterprise IT to say yes to business use cases that were simply not possible before. CDP will enable enterprise IT to say yes to getting control over shortsighted and costly shadow IT projects that put the business at risk. And yes, CDP will be the industry's first enterprise data cloud.

The other major development in Q2 was the announcement of changes in our licensing and distribution model. We've aligned our model with the industry standard set by Red Hat. Red Hat's practices are well understood and have been broadly accepted by enterprise customers in the open source community. As a result of these changes, all Cloudera software will be licensed under an OSI-validated open source license. We expect that proprietary Cloudera software offerings will be provided under an open source license beginning early next year. Applied to former proprietary products and new product innovation, the terms of this license will serve to protect our intellectual property investments from encroachment by public cloud providers.

Secondly, the distribution of our compiled software, the binaries, will be limited. Specifically, access to these binaries as well as support services and technical expertise will be available only with the current subscription agreement. The binaries contain Cloudera-specific intellectual property, the testing, securing and integration of various open source projects into an enterprise-grade system that meets the requirements of our customers. Consistent with the Red Hat model, our binaries will no longer be freely available to nonpaying customers. These changes to licensing and distribution will affect all subsequent versions of our current products as well as new products, ensuring that future development by Cloudera and the community is better protected. The net of our new licensing model is that we'll be more open with respect to the customer and developer use of the software and more restrictive concerning nonpaying customers and efforts by others to take our innovation for their own commercial purposes. We believe that this licensing and distribution framework will have a material benefit on Cloudera's business over time.

With that update on product and licensing, let me quickly touch on a couple of other important strategic matters. Some of you will recall that we expanded our partnership with IBM in Q2. We are very excited to be working much more strategically with IBM. We had our best customer bookings quarter ever with IBM in Q2 and believe that the launch of CDP will further the momentum of the partnership. CDP and the enterprise data cloud is a natural complement to IBM's and Red Hat's enterprise cloud initiatives.

Today, we also issued a press release on our agreement to acquire certain assets, customers and intellectual property of Arcadia Data. Arcadia was a partner and we had many joint customers. Its technology will greatly improve productivity and time-to-insight for business users when utilizing CDP with cloud object stores such as S3, ADLS and with Apache Kafka. Arcadia's ArcEngine software uses machine learning to anticipate and precompute common queries and reports for self-service access to data and accelerated analytic response times. We expect Arcadia's technology to enhance the usability of our platforms and the experience for business users through higher performance and dramatic increases in user concurrency on large data volumes. In addition, I'm pleased to welcome the entire Arcadia engineering organization to Cloudera.

Finally, as you likely know, Icahn Capital, built a large position in our stock. We work constructively with Carl Icahn and his associates to develop a stencil agreement with a number of important terms. Consistent with that agreement, we're pleased to welcome Nick Graziano and Jesse Lynn to our Board of Directors. We look forward to working with Nick and Jesse to enhance value for all of our shareholders.

Let's now turn to Jim for the detailed financial discussion before I return for some concluding remarks. Jim, over to you.

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James W. Frankola, Cloudera, Inc. - CFO [4]

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Thanks, Marty. Hello, everyone.

As Marty indicated, Q2 was better than planned and positions us well for the remainder of the year. Total revenue for the second quarter was $197 million, and subscription revenue was $164 million. Operating cash flow for the quarter was negative $33 million. Because of the merger, comparative year-over-year information on these items is not meaningful. As always, details concerning definitions and trends can be found in the supplemental materials on Cloudera's Investor Relations website.

Annual recurring revenue for fiscal Q2 was $682 million, up 16% year-over-year. ARR growth is driven primarily by existing customers renewing and expanding agreements. It is encouraging that every ARR size cohort expanded in Q2 as compared with the second quarter of last year. Revenue and ARR benefited from stronger operational execution and improved field level functioning. In Q2, we had fewer slipped renewals and converted some of Q1 slipped renewals. Dollar-based churn was in line with Q1 as forecasted. With improved execution and the launch of CDP, we expect churn to decline to a 12% to 13% annualized rate in the second half of the year.

We concluded Q2 with 953 customers who started at or have grown to more than $100,000 of ARR. This was a net increase of 24 over the prior quarter. As Marty highlighted, our greatest customers remain -- our largest customers remain stable and continue to expand consumption of our offering with more than 140 customer spending in excess of $1 million of ARR.

As I review the remainder of the income statement, note unless otherwise stated, all references to expenses and operating results are on a non-GAAP basis. Historical non-GAAP results are reconciled to GAAP results in the press release issued earlier today. Our adjustments from GAAP to non-GAAP are limited to stock-based compensation and amortization of M&A-related intangibles.

Total gross margin for Q2 was 77% driven by subscription gross margin of 86%. Operating expenses were $158 million for the second quarter or 80% of revenue, an improvement of -- from 84% of revenue in Q2 of fiscal 2019. Included in operating expenses are $13 million of merger-related spending. Excluding these amounts, operating expenses were 74% of revenue in Q2. These results reflect the rapid achievement of our planned cost synergies and increased operating leverage since the merger. In particular, sales and marketing expense declined from 45% of revenue in the year-ago period to 41% of revenue in Q2, and R&D fell from 28% of revenue to 24%. The $13 million of merger-related expenses includes severance and retention costs as well as third-party fees associated with integrating the systems and processes of the combined company. Overall, operating loss was $7 million in Q2, representing an operating margin of negative 4%, burdened by 7 percentage points of merger-related expenses. Excluding these expenses, operating margin would have been positive 3% for the second quarter, a substantial improvement from Q2 19's operating margin of negative 7%.

Loss per share was $0.02 in the second quarter based on 277 million weighted average shares outstanding compared to a loss of $0.05 in the second quarter of fiscal '19.

Now turning to the balance sheet and cash flow. We exited Q2 with $509 million in cash, cash equivalents, marketable securities and restricted cash, down from $547 million at the conclusion of Q1. Operating cash flow for the second quarter was negative $33 million, which includes $13 million of merger-related payments. Cash flow performance was better-than-expected due to strong execution on merger synergies in both headcount and nonheadcount-related spending. As you may recall, we had planned to reach $125 million of annualized cost savings by the end of this fiscal year. We are ahead of schedule and have already achieved this annualized target in Q2. Capital expenditures were $2 million in the quarter. Total contract liabilities, which comprise deferred revenue and other contract liabilities, were $464 million at the end of the second quarter. RPO was $707 million.

I will conclude by providing initial guidance for fiscal Q3 and updated guidance for fiscal 2020. We expect Q3 total revenue to be between $187 million and $190 million and subscription revenue in the range of $162 million to $164 million. Net loss per share is projected to be $0.08 to $0.06 based on 283 million weighted average shares outstanding. For fiscal year 2020, we expect total revenue to be between $765 million and $775 million and subscription revenue in the range of $645 million to $655 million. Since we are ahead of plan in capturing merger cost synergies, we now expect operating cash flow for fiscal year 2020 to be negative $80 million to negative $65 million and net loss per share to be $0.28 to $0.24 based on 280 million weighted average shares outstanding. Projected operating cash flow for fiscal year 2020 includes approximately $60 million of merger-related payments. Adjusting for these nonrecurring merger-related expenses, the business is expected to be nearly OCF breakeven for the fiscal year.

As discussed last quarter, soft Q1 bookings and pipeline will weigh on revenue and ARR growth rates in the second half. We believe that we have turned the corner from Q1 and will continue to consistently build pipeline in Q3 and Q4. Given our typical sales cycle, we believe that the pipeline growth that we saw in Q2 will yield bookings in Q4 and Q1 of fiscal '21. As such, we are raising our subscription revenue and ARR guidance in the second half. Specifically, we anticipate Q3 ARR to be in the range of $685 million to $695 million and Q4 ARR to be in the range of $685 million to $720 million.

With respect to components of revenue, we expect a continued mix shift in the second half of fiscal 2020 in favor of subscription revenue. Services revenue should decline as a percentage of total revenue as subscription revenue outperforms and as some of our services personnel are deployed to assist with a smooth CDP rollout. As a reminder, our fiscal '20 financial plans do not depend on CDP customer adoption. We believe the value of CDP in fiscal 2020 is the assurance that it provides to customers and prospective customers an exact composition, functionality and performance of the next-generation platform. We expect our financial plans to be achieved through the purchase and expansion of our existing offerings through the balance of this fiscal year. The revenue impact of CDP from specifically CDP sales will occur primarily in fiscal 2021.

I will now return the call to Marty.

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [5]

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Thanks, Jim. We are pleased to provide a straightforward, clean report for the second quarter and to offer an improving outlook for the year. We are executing according to our plans and exceeded expectations in Q2. I've been on the ground over the past few months and have been pleased that our employees are responding well to the call to action. Our team is focused on delivery and execution.

We completed a major milestone in August with the delivery of the first release of the CDP public cloud service, and we're encouraged by the early reception of CDP by customers. And apart from customer adoption, the launch of CDP has instilled confidence in our buyers as they now know that they can invest toward an enterprise data cloud. While recognizing the challenges ahead, I am optimistic that we are in better footing today than when we entered the fiscal year.

Anticipating the question, I have no news to share regarding a permanent CEO. As discussed previously, the Board has formed a search committee, and that committee is actively evaluating candidates. These placements take time, and we're focused on finding the right individual for the job. Until that process concludes, I am on the ground acting as interim CEO and keeping the team focused on executing our plans.

So let's pause here and take some questions. Operator, please begin the Q&A portion of the call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) You have a question from Jack Andrews from Needham.

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Jon Philip Andrews, Needham & Company, LLC, Research Division - Senior Analyst [2]

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I was wondering if you could shed some light on the messaging to customers around CDP. It seems like clearly a superior product to what you have currently been offering. So is this considered an upgrade to their existing solution and may therefore command a higher price? Or are you aiming to perhaps hold pricing steady through a different consumption-based pricing model? Is there any sort of thoughts you can share about this dynamic?

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [3]

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Yes. Thank you. The -- we're going to certainly describe a lot more at Strata later this month, particularly with respect to pricing and how that's going to be positioned, but let me just take a moment and talk about why we're excited about the offering and the capabilities. As we talked about, this will be the only -- the first and only enterprise cloud in the market -- enterprise data cloud in the marketplace. We're creating capabilities that support both hybrid and multi-cloud needs. We're going to address the multifunction analytics from the Edge to the AI. And also, using our Shared Data Experience, SDX, we're going to have a consistent security and governance, all of that on an open source environment. So I think our view is it's unique. It's what our customers are looking for, and we're delivering it.

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Jon Philip Andrews, Needham & Company, LLC, Research Division - Senior Analyst [4]

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Great. Look forward to some more details, I guess, in a couple of weeks. Just as a quick follow-up, you talked about the internal metrics and pipeline generation have improved markedly from 1Q. Could you drill into that a little bit more? I mean outside of the clarity on the technology road map, is there something else that's driving that improvement, whether it's a different approach you've taken on the sales front? Or is it just you've got everybody as the merger integration is more complete and everyone is just executing better overall?

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [5]

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Yes. Our view is that certainly, in Q2, we've seen an increasing pipeline. We believe our execution is better than it had been coming out of the early days of the merger. And just as important, we have clarity regarding the road map. We've been able to demonstrate CDP to customers. We did that in mid-June, which gave them more confidence as to the direction and capabilities we were delivering. So it's -- and I would summarize it, it's around delivery and execution is leading to better results.

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Operator [6]

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Your next question comes from Chad Bennett from Craig-Hallum.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [7]

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So Marty, I just want to drill down into something you talked about in the new licensing and pricing model, but I think it's pretty important just the whole binary functionality. And I'm not sure how many people understand how important that is, but can you give us a sense for just how much of the base, especially with your larger ARR base, how important that binary functionality is and maybe even how important that binary functionality is broadly to the open source community?

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [8]

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Yes. So -- and Chad, thanks for asking the question because this is an important area around licensing. And to sort of give you the context, as the 2 companies came together, we needed to make a decision, and one of the decisions we made in this quarter was that we were going to go and adopt the Red Hat model. We believe that was industry best practice, and so we've done that. And what happens in the binaries is this is where the proprietary capabilities, sort of the stickiness, the security, the governance, all comes together. And as we've spent time with customers even in the quarter, we've had some who have said, "Okay, this is important. We want that capability. We want your support. We want your services."

And so we believe that does create an element of stickiness that was beyond what was previously available. And in particular, it also -- it recognizes that the public cloud providers can't just take the capability and commercialize it in an open source world without the capabilities that we're delivering. So we do believe this makes a difference, and we've had customers who have been appreciative of sort of the direction we're taking while being open source and yet move beyond that with the binaries behind the paywall.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [9]

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Great. No, that's perfect. And then maybe one follow-up for Jim. So Jim, it's good to see the guidance improvement incrementally for the year. And just thinking about the drivers of that, I mean you mentioned you're not really factoring in anything for CDP cloud. And then it sounds like the churn rate really didn't improve much at least in this quarter, and you're expecting some improvement in the second half, which I think you probably would expect on the prior guide. So I'm just wondering kind of what kind of was the main or a couple of main drivers of you guys upping the target a little bit.

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James W. Frankola, Cloudera, Inc. - CFO [10]

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Yes. Thanks, Chad. I'll echo Marty's point on execution. So solid execution in Q2 really helped us out financially. So in Q1, we were still operating through the fog of the merger. Many Q1 deals that were set to renew in Q1 slipped into Q2. We had forecasted that some of that fog would continue into Q2. And quite frankly, we're back to normal operations with respect to renewal cycles. So we were able to renew many of those slipped Q1 deals. Our Q2 renewal cycles were essentially on our historical averages. We executed to our internal plans, actually beat our internal plans on new and expansion bookings. So across the board, we basically executed to our objectives, and that is what drove the performance in the quarter and allowed us to raise the software numbers for the back part of the year. And an element of that is, as Marty said, our pipeline generation got back on track.

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Operator [11]

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And your next question comes from Dan Ives from Wedbush Securities.

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Daniel Harlan Ives, Wedbush Securities Inc., Research Division - MD of Equity Research [12]

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Solid quarter. So my question is in regards to the customers' sales force, what you're seeing, talk about maybe some of the changes in conversation that you're having today versus maybe even 3, 4 months ago. And does it feel like there's more clarity in terms of the product road map and just the type of conversations you're having with customers.

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [13]

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Yes, Dan, this is Marty. So as we talked about last quarter and some of the challenges coming out of the merger, we had less visibility to our product road map. It was less clear where we were going with the enterprise data cloud vision and capabilities. So we continue to have strength with our on-premise customers and what I would characterize as our current offerings. And now we're able to advance those conversations to talk about where we are going and what will come next. And so our ability to demonstrate it, to show what those capabilities are, to understand what the migration path will be, and we're in -- those are individual conversations with individual customers as to where do they go from their HDP or CDH capabilities products to where does that go with CDP.

And so I think that, that clarity, that availability of information is very powerful because we're no -- they're no longer speculating. They're no longer wondering whether our future will be as bright as we believe it to be. They can now see it. And then, in particular, getting it out there in -- for demonstrations and then releasing it as promised to some customers over the last couple of weeks has been a very powerful reinforcement.

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Daniel Harlan Ives, Wedbush Securities Inc., Research Division - MD of Equity Research [14]

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Just second question, what -- on a day-to-day basis, as you've gone through pipeline and just gone through integration process, what's maybe surprising you guys both on the positive and negative side? Will one be that you're -- if I just think about where we are today going back to maybe the last 3 months.

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [15]

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Yes. Surprises, we're pleasantly surprised feeling very good about customer adoption of our current products. As we said, certainly, our customers over $1 million remain very strong, well north of 140 customers. Our overall number of customers, we said, has gone up. So that's a very positive statement. And what I've been working to reinforce is the customers are extremely important. It's kind of a truism. Obviously, without it, there's not much in the business. One of the things we did in the quarter is we put in place a Chief Customer Officer to further emphasize the importance of customer success and to work around the adoption from here forward with CDP.

Probably the one area that maybe has surprised us a bit as well, and then probably I wouldn't say surprised because we saw this coming, is we continue to compete with the public cloud providers. And on the one hand, our customers say to us, "We don't want lock-in. So we appreciate where you guys are taking us." But yet there's still some adoption that's occurring there among large enterprises. And so we expect that there will be some normalization rationalization that occurs over time. As companies go to multi-cloud, they'll want that capability. They'll want to go hybrid. Some things will be on-prem. Some things will be private. Some things will be public. And we like that. So maybe at a point in time, that is viewed as less positive, but we're actually playing right into that position. That's where we're targeting our solution.

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Operator [16]

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And your next question comes from the line of Mark Murphy from JPMorgan.

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Matthew James Coss, JP Morgan Chase & Co, Research Division - Analyst [17]

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This is Matt Coss on behalf of Mark Murphy. Jim, guidance for Q3 revenue implies a sequential decline in Q3 total revenue, and I believe annual guidance would imply a single-digit sequential increase in Q4 total revenue. I know we're not sort of apples-to-apples comparing last year's seasonality, but it also sounds like you're a little bit more bullish coming out of Q2. And I'm wondering is this too conservative or is the level of conservatism you're baking into your guidance is similar to the levels that you shared with us in your guidance last quarter.

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James W. Frankola, Cloudera, Inc. - CFO [18]

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Yes. Matt, what I'll say is our forecasts are prudent and reflect our best view of what the world looks like. The level of conservatism hasn't changed much in terms of quarter-over-quarter. Our visibility to the business has improved, as you expect, another quarter post-merger, our systems and processes are more mature and we have greater visibility. What I'll say is in terms of all the metrics you mentioned, ARR is the single best metric to look at what is going on in the business year-over-year or quarter-over-quarter because it normalizes for purchase price adjustment, merger effects. One of the dynamics that's going on is our recurring software revenue is growing faster than the nonrecurring software revenue or professional services revenue. So you have all those dynamics in play that factor into the revenue numbers that are cleansed out of the ARR number.

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Matthew James Coss, JP Morgan Chase & Co, Research Division - Analyst [19]

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Got it. That's helpful. Maybe can you drill down a little bit into what you've seen in the way of contribution from IBM? I think this agreement might have flown under the radar a couple of months ago. But is there any comment or color you can give us on the lead generation, maybe what IBM customers are seeing in CDP versus some of your other partners?

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [20]

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Yes. This is Marty, Matt. So as I referenced earlier, we had a very strong quarter with IBM in Q2. It was our best quarter ever. And at the same time, we also -- our announcement, the significance of our announcement is the relationship has expanded significantly. Now all of our products, all of the Cloudera products, are available to the IBM sales force to take to market. So that is significant in that we went from a limited set of products to all products. And as well, as we work with IBM, we share a sort of common bias towards large enterprise customers, I mean we're working together there. So we now have the benefit of more of their feet on the street on a global basis. We also have the ability to take their products into the market. And so we'll be looking over time as to what's best for our customers: is it something that we have built, something that they traditionally built and are there ways to merge or integrate them together. But it's a very powerful relationship and, at this point, it's a unique relationship.

The other part that's very exciting to us, as you look at IBM's strategy particularly around the hybrid environment, clearly, their -- I'll say, in my words, clearly, their decision to move forward with Red Hat around the enterprise cloud is very complementary to what we're building with the enterprise data cloud. And thus, we're very excited by that.

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Operator [21]

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And your next question comes from the line of Paul Walravens (sic) [Pat Walravens] from JMP Securities.

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James W. Frankola, Cloudera, Inc. - CFO [22]

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Pat, are you on the line?

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Patrick D. Walravens, JMP Securities LLC, Research Division - MD, Director of Technology Research and Senior Research Analyst [23]

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Sorry. I was muted. So here's a big picture question for you. So if you look at MongoDB, they were an open source database company, right? Three years ago, they introduced a cloud-based product, Atlas. Now it's doing $150 million in revenue. It's 30% -- 37% total revenue, grew 255% this quarter. So how is your situation with the Cloudera Data Platform similar? And how is it different?

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [24]

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Well, in terms of -- let me start with the Cloudera Data Platform sort of just picture it for...

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Patrick D. Walravens, JMP Securities LLC, Research Division - MD, Director of Technology Research and Senior Research Analyst [25]

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And I hope that's fair, Marty, because I figured given your background, like you could take a shot at it.

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [26]

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Well, I'm not going to spend a lot of time -- I learned a long time ago, don't spend a lot of time talking about specific competitors, but I will tell you sort of what we're doing and maybe the areas where there are some differences. I think in terms of -- hopefully, we're making it clear in terms of where we're going with Cloudera Data Platform in terms of the enterprise data cloud. In terms of similarities, we think the opportunity is big. There's both -- for us, we have been in a very strong position on-prem as we delivered CDP and particularly the first set of releases is around the public cloud. We've now -- opening up that market to us as well, so that's significant for us.

In terms of timing, maybe they're a bit ahead of where we have been, but we believe that our ability to catch up is significant and sort of an adoption because of the unique capabilities we're offering, which is beyond just the database. We have the Data Hub, the Data Warehouse, Machine Learning, all of these capabilities are part of our CDP offering.

So -- and I think the other aspect is we're going to be a similar experience and ease-of-use whether you're on-prem, public cloud, eventually private cloud. So that's our unique aspects. And I think just as I sit -- and thank you for suggesting my experience is relevant. But just as I reflect on it and understanding big enterprise customers, they like that flexibility. They don't want to lock in. They want the ability to move across platforms. That's what we're focused on.

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Patrick D. Walravens, JMP Securities LLC, Research Division - MD, Director of Technology Research and Senior Research Analyst [27]

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Got it. Great. And then, Frankola, one for you. I mean just as you sort of sit back and look at all this, what part of the story do you think is most misunderstood by investors?

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James W. Frankola, Cloudera, Inc. - CFO [28]

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I think the thing that's most misunderstood is that a lot of folks think there's a binary outcome, that there would either be a winner in the cloud or on-prem. And the real answer is it's going to be both. There are some customers and workloads that naturally belong in the cloud. There are some that belong on-premises. There are some that belong in private clouds. And for our target market, the largest 2,000 enterprises in the world, we believe, based on what we hear from them, that they will have hybrid solutions in all places, and they'll value a vendor that brings that all together. So I think the fact that it's -- that a lot of people think it's binary, a win or lose, versus a much more nuanced how big is this market is the most misunderstood thing.

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Operator [29]

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And your next question comes from the line of Michael Turits from Raymond James.

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Robert S. Majek, Raymond James & Associates, Inc., Research Division - Senior Research Associate [30]

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This is actually Robert Majek calling in for Michael. You made it clear that the pipeline improved. How much of that benefit is due to the acquisition of MapR? Or alternatively, do you see an opportunity to win those customers down the line?

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [31]

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At this point, the HPE's acquisition of MapR we view as a positive, but it has not yet become a material impact in the pipeline. There are select customers that we're focusing on, as well focusing with our partners. So we're optimistic that, that will lead to improved results, certainly more wins for us, but it's not something that we have modeled as material at this time. We see it as upside.

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Robert S. Majek, Raymond James & Associates, Inc., Research Division - Senior Research Associate [32]

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That's great. And then just perhaps one more from me. You touched on it earlier, but can you give us some more color on some specific initial customer feedback you've received on CDP?

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [33]

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Yes. It's -- they're accessing it. They're working with it. They're starting to use use cases or deploy use cases. And it's -- I'd say the reaction is very positive. We're spending a lot of time and energy on the experience. I think the key part is that the fact that they can have a common security and governance using the -- what we refer to as SDX is really powerful, right? So they actually have the ability to do our capabilities they've historically done on-prem, now move those to the cloud, provision clusters much quicker. That is like really, really cool stuff to them, and they want more of it. And so directionally, it's been very exciting. Our engineering team has done a phenomenal job getting us to this point. Very positive.

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Operator [34]

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And your last question comes from Sanjit Singh from Morgan Stanley.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [35]

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And nice to see you back to sort of beating rate territory after a couple of quarters. I guess I have another similar basic question similar in the past, which is what does Cloudera want to be in the sense of who is going to be the target customer going forward. And related to that, what does that -- given the focus on whatever target segment of the market you're looking at, what should we expect in terms of profitability and cash flow? I mean coming out of this transition, should we expect Cloudera to be focused on a narrow set of customers with better profitability and cash flow? I'm just trying to get a sense of what the longer-term strategy here is in terms of how you want balancing profitability and cash flow versus the opportunity that you see in front of you.

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [36]

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Yes. So let me start now and have Jim add some thoughts as well. Let me begin with our strategy has not changed. We -- so even as I've moved into the post and been running the company for a period here, we remain with the same strategy, we're investing in growth. But at the same time, as I commented in my prepared remarks, we're also going to be more disciplined on the cost side. So we're going to determine where is the right place to make investments, and where is the right place to be more efficient or optimize our cost structure. We're focused on the Global 2000. That has been our target market, the largest global enterprise with complex multifunction use cases. We go from the Edge to AI. We have the capabilities in between in terms of Data Warehouse, Data Hub.

So the strategy remains the same, and our focus is on restoring the greater top line growth, at the same time, managing our cost in a diligent fashion. And as I think -- and Jim can certainly comment, hopefully, you will have seen in our Q2 results we've done a better job of that in Q2 and certainly improving on our operating cash flow. Jim, maybe you can add some -- just a little additional color.

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James W. Frankola, Cloudera, Inc. - CFO [37]

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Yes. So we believe that our target customer set, large customers, still represent a market opportunity measured in the tens of billions of dollars. So from a market opportunity standpoint, it's enormous. The segments that we play in are naturally growing 15%, 20%, 25% a year, depending on which analyst survey you look at, so with a large market, rapidly growing, which bodes well for us once we have CDP out in the market.

From a financial model standpoint, I'd be careful, it's still way premature to start giving guidance. But the way we think about the business model is, if our top line is growing at 15% or 20% or even slightly more than 20%, we believe that we now have the leverage and the scale to throw off 20% or so of cash flow margins. So once we get through the transition, once we get CDP out there and gaining traction, we think that the opportunity is to grow substantially and throw off very healthy margins.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [38]

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I guess one follow-up, Jim, on the cloud side. So on the scenario that CDP does get well received by market, you're starting to see demand build over multiple quarters, what's the implications for the model? Are you going to use CDP to grow within your target market, call it, the Global 2000? Or is that going to be as a linchpin to service other parts of the market? I guess that's part one of the question. But then what are also sort of the model implications in terms of if the cloud -- CDP becomes a larger portion of revenue, what does that do to the model in terms of your customer acquisition costs, your gross margin, So the longer-term impacts as we think about the potential for CDP over time?

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James W. Frankola, Cloudera, Inc. - CFO [39]

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Yes. So first of all, CDP encompasses several products. It encompasses a public cloud product. It encompassed products that work on-premises or whether it's bare metal or in a private cloud. So we're focused right now -- I'm talking about the public cloud. That is going to create new market opportunities for us. So we think that will stimulate growth over time. And to the extent it impacts our model, it will be generally additive.

Now with that said, as you'd expect in a public cloud environment, we think the form of purchase will be primarily in some form of prepaid credits that, by definition, have a contract duration or billings duration less than a typically subscription term. So we do expect our durations to gradually fall over time, but we think that's going to be very gradual because our billings duration is already roughly 13 months today. So we've moved from a multiyear prepaid model to an annual upfront model, so we don't think the billings model impacts will be negative. We think the economic benefits will be positive with increased growth. And then it's very hard to predict, but we believe that it will also help us in terms of gross margins. Our gross margins are close to 90% today. We see this helping us take a path toward 90%. And we think that over time, it will help us with our engineering and sales ratios as well.

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Martin I. Cole, Cloudera, Inc. - Interim CEO, Chairman & Lead Director [40]

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Well, I think that concludes our call today. I want to thank you all for joining us. Appreciate your questions. And we're on to Q3. See you all in our next call. Thank you.

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Operator [41]

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This does conclude today's conference call. You may now disconnect.