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Edited Transcript of PSTG earnings conference call or presentation 21-Aug-19 9:00pm GMT

Q2 2020 Pure Storage Inc Earnings Call

Mountain View Sep 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Pure Storage Inc earnings conference call or presentation Wednesday, August 21, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Charles H. Giancarlo

Pure Storage, Inc. - Chairman & CEO

* David M. Hatfield

Pure Storage, Inc. - President

* Matt Kixmoeller

Pure Storage, Inc. - VP of Strategy

* Matthew Daniel Danziger

Pure Storage, Inc. - Head of IR

* Timothy Riitters

Pure Storage, Inc. - CFO

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Conference Call Participants

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* Aaron Christopher Rakers

Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst

* Alexander Kurtz

KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst

* Andrew Teutli-Vadheim

Wolfe Research, LLC - Research Analyst

* David Ryzhik

Susquehanna Financial Group, LLLP, Research Division - Associate

* Eric Martinuzzi

Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst

* George Michael Iwanyc

Oppenheimer & Co. Inc., Research Division - Associate

* Jason Noah Ader

William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications

* Karl Fredrick Ackerman

Cowen and Company, LLC, Research Division - Director & Senior Research Analyst

* Kathryn Lynn Huberty

Morgan Stanley, Research Division - MD and Research Analyst

* Matthew Normand Cabral

Crédit Suisse AG, Research Division - Research Analyst

* Nehal Sushil Chokshi

Maxim Group LLC, Research Division - MD

* Pinjalim Bora

JP Morgan Chase & Co, Research Division - Analyst

* Roderick B. Hall

Goldman Sachs Group Inc., Research Division - MD

* Steven Bryant Fox

Cross Research LLC - MD

* Timothy Patrick Long

Barclays Bank PLC, Research Division - MD

* W. Chiu

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

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Presentation

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Operator [1]

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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 2020 Earnings Conference Call. (Operator Instructions)

I will now turn the call over to Matthew Danziger, Vice President of Investor Relations. You may begin your conference.

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Matthew Daniel Danziger, Pure Storage, Inc. - Head of IR [2]

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Thank you, and good afternoon. Welcome to the Pure Storage Second Quarter Fiscal 2020 Earnings Conference Call. Joining me today are our CEO, Charlie Giancarlo; our CFO, Tim Riitters; our President, David Hatfield; and our VP of Strategy, 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 various 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 our earnings press release and slides.

This 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 available 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.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [3]

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Thank you, Matt, and good afternoon, everyone. Thank you for joining us on today's earnings call. I will begin by sharing our high-level results from the quarter, Hat will provide a go-to-market update and Tim will offer detailed review of our financials.

We had a strong quarter and the fundamentals of our business remain solid. For Q2, revenue was $396 million, growing 28% year-over-year, which was above the midpoint of our guidance. Our industry-leading gross margin grew to 69.4% and operating margin was a negative 0.8%, beating our guidance range.

In less than 10 years, we disrupted the storage industry by creating solutions that are intelligent, automated and modern and delivered 10x improvements in the performance, the cost of operations and usability. We are now setting a bold new path for Pure for our second decade, which will deliver the next set of 10x breakthroughs. Our goal is to take the fragmented and antiquated data storage environment and recreate it into a unified, automated and multi-cloud data experience.

Pure delivers a modern data experience to our customers. Unlike legacy infrastructure vendors, Pure enables customers to utilize more of their data while reducing the complexity and expense of managing the infrastructure behind it. We provide a data experience that creates a common operating environment across multiple data centers and clouds, easing operations via APIs and intelligent AI-driven automation. We now offer our customers integrated, hybrid cloud and on-prem solutions consumable as a flexible subscription to deliver that modern data experience.

Looking at the market as a whole, Pure is clearly out-executing our traditional competitors, some of whom have expressed concerns around the macro economy. We do not believe the macro environment has affected us this past quarter. What we do see is a significant transitory NAND supply/demand imbalance, which impacted component prices and the storage industry as a whole. We expect this situation to continue to affect us for the balance of the year given the natural lag between component costs and storage market pricing. However, we are already seeing NAND pricing rise in the spot market and suppliers are delaying additional fab capacity. We believe these signals point to an improving market next year.

As compared to others, Pure's continued exceptional growth and margin leadership highlight our differentiation, which is consistently validated by our growing happy customer base. Our results underscore that our strategy is working. We also know that it is in challenging market environments when our superior value proposition enables us to gain even more market share. In today's world where data is at the core of digital transformation, legacy vendors have inexplicably decreased their investment in innovation and instead are relying on commodity hardware and software. They attempt to convince customers that all systems are the same and that price is all that matters. Customers, however, understand that an investment in innovation is an investment in their future. Our continued investment in successful innovation is one of several reasons we are growing faster than public market competitors. At our Accelerate conference next month, we will announce groundbreaking portfolio additions and future innovations as part of our strategy for the next decade.

Pure's focus on priorities important to CIOs today: building a hybrid cloud; transitioning to fast, consolidated data architectures; deriving business value from AI and analytics; and enabling customers to rapidly recover from IT failures mean that more customers than ever are choosing Pure. We are the essential company driving change in the data industry providing an unparalleled experience which delivers business outcomes and ensures customer delight.

Now I would like to share some more personal news. As you may have read in our press release, our CFO, Tim Riitters, will be leaving Pure for personal reasons. An executive search is already underway for our next CFO. Tim will participate in that process and will help in the transition.

When he first joined Pure, we were less than $200 million in revenue, a private company. We had 600 employees and just one product. Five years later, we disrupted an entire industry. We've grown almost 10x, consistently delivering double-digit annual revenue growth. We achieved profitability, acquired 2 companies and dramatically expanded our portfolio. He's been an invaluable asset and has had an incredible impact on our company. I want to personally thank Tim for his years of excellent service, his consistent energy and care and for his friendship and partnership over my tenure.

With that, I'll turn it over to Hat.

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David M. Hatfield, Pure Storage, Inc. - President [4]

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Thanks, Charlie, and let me add my thanks to Tim for all he's done over the past 5 years. We hope you can enjoy some much deserved time with family and friends.

Pure is positioned to help enterprises tackle their most strategic IT initiatives, is gaining market share and enabling our customers to achieve outcomes that were not previously possible. Our industry-leading customer satisfaction, our Evergreen ownership model and our expanding suite of solutions position us not only as the most innovative but also the safest choice for our customers. In contrast, Pure is growing approximately 10x faster than any competitor and their rate of spending on innovation is on average 2x less than Pure's R&D investment. Customers are challenged with navigating competitor product line consolidation and disruptive upgrades while Pure's customers reap the benefit of our Evergreen experience with its continuous expansion of new capabilities and services.

We believe that data is strategic to our customers' digital transformation journey. Data requires innovation and investment, especially as new application architectures are driving unprecedented levels of performance, parallelism and multi-cloud data workflows. Customers are selecting Pure because we enable them to simultaneously modernize their existing applications and accelerate their adoption of hybrid cloud, containers, dev ops, AI and real-time analytics at scale. Unlike our competitors who are simply shipping commodity storage arrays, Pure's modern data experience is cloud-managed, AI-driven, constantly improving and consumable via flexible subscription model that can be deployed in a hybrid IT environment. This is not your grandparents' data storage environment.

Our focus on the largest consumers of storage across cloud, enterprise, commercial and public sector markets is working. Customers are realizing Pure's differentiation and our win rates continue to hold nicely. We finished the quarter with more than 6,600 total customers, adding approximately 7 net new each business day, equating to more than 450 new customers in Q2, the highest number in any Q2 of our history.

During last earnings, we discussed the increase in new sellers and the transition we encountered in Q1. In Q2, we were pleased with the level of sales execution and the quality and ramp of new sellers. This quarter, we closed a number of large transactions, including a 50% increase in million-dollar deals from Q1. We were particularly pleased with the progress in our enterprise and public sector segments as both outpaced the growth of our overall business.

Turning to our technology and strategic partnerships. We saw continued progress across our ecosystem in the fastest-growing segments of the market. Alliances include Splunk and Elastic in next-generation analytics, NVIDIA for AI and machine learning, Cisco for mission-critical converged infrastructure and a broad range of data protection partners to deliver the next generation of rapid restore and data protection. We were thrilled with the continued FlashBlade momentum, specifically in the rapid restore and data analytics use cases as well as the excitement for our Cloud Data Services, including Cloud Block Store on AWS. We will share more on this with them at Accelerate next month.

To highlight some of this momentum, in Q2, a large U.S. government agency chose FlashBlade and Splunk SmartStore to meet policy objectives for regulatory compliance and to manage a large-scale implementation. As a result, the agency eliminated multiple copies of data, reduced their physical footprint by 8:1 and avoided thousands of dollars in potential penalties for power and space consumption achieving a highly compelling TCO.

Another notable customer success in the quarter, a large global asset management firm chose Pure for ease of management, cloud native automation and orchestration in their hybrid cloud environment. By freeing up time, resources and money, this firm can now focus on their own innovation instead of day-to-day operations.

And finally, the interest in our unique, unified subscription model across hybrid IT with our Cloud Data Services and Evergreen Storage Service is growing. This quarter, a midsized hospital in Illinois invested more than $2 million in our ES2 offering. This customer moved their existing infrastructure to 100% subscription model with Pure, which enabled easy capacity and performance planning and will allow them to shift to Cloud Block Store on AWS under their ES2 contract. Customers like this have realized that ES2 empowers them to utilize our technology on-premises today while also preserving future flexibility for where and how they will architect their data strategy going forward. We are as excited as ever to execute on our long-term vision and provide freedom for organizations to build for today and tomorrow.

Pure's Q2 performance and rapid market share gains against the competition demonstrate our differentiation from our traditional peers. We truly are just getting started.

See you at Accelerate next month. And with that, I will now turn it over to Tim. Tim?

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Timothy Riitters, Pure Storage, Inc. - CFO [5]

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Thanks, Hat. Q2 was a strong quarter for Pure as we continue to demonstrate industry-leading growth, gross margins and continued innovation across our product portfolio in an evolving environment.

Before I dive into the 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. Reconciliations of these non-GAAP metrics to their GAAP comparables as well as our full Q2 results and presentation are available on our website at investor.purestorage.com.

For the quarter, total revenue grew 28% year-on-year to $396.3 million. Product revenue grew 24% year-on-year to $300.1 million and support and subscription revenue grew 42% year-on-year to $96.2 million.

Geographically, 74% of our sales came from the United States and 26% came from our international markets for the quarter.

Our gross margins continue to be industry-leading with product margins well above our competitors and aggregate gross margins reaching an all-time high in the quarter of 69.4%, up 1.3 points sequentially. Total gross margins reflect the significant differentiation and innovation we deliver to our customers. Product gross margins in the quarter were 70%, up 1.3 points due largely to benefits we are seeing in component cost declines. Support gross margins were 67.4%, up 1.1 points sequentially. The sequential increase in margins were due both to operating ongoing efficiency improvements along with an approximately 0.5 point impact from onetime benefits in this line of business.

Moving to operating margin. In Q2 operating profit was negative $3.2 million or negative 0.8% of revenue and compares to an operating profit of $0.9 million or 0.3% in the year ago quarter. Operating profit was better than expected due primarily to overperformance on gross margins for the quarter.

Q2 net income for the quarter was positive $2.5 million or positive $0.01 per share. This compares to the year ago period of positive $2.4 million or positive $0.01 per share. The weighted average shares used for the per share calculations are 271 million shares in Q2 and 263 million shares in the year ago period.

Moving to the balance sheet and cash flow. We finished the quarter with cash and investments of $1.18 billion, an increase of $16 million from the previous quarter. Our quarter-on-quarter increase in cash was driven primarily by strong free cash flow in Q2, which is a typically low quarter for us. Free cash flow in Q2 was positive $19.9 million, which includes $5.7 million of impact related to our employee stock purchase plan. Adjusting for the normal impact of our employee stock purchase plan, free cash flow was positive $14.2 million in the quarter.

We delivered strong deferred revenue growth in the quarter. Deferred revenue at the end of the quarter was $607.3 million, an increase of 47% over the same period a year ago. The strong deferred revenue performance was driven by 3 ongoing key trends: meaningful year-on-year renewals growth, longer initial subscription agreement purchases and the early traction of our ES2 product. In addition, you will note from today's press release, Pure's Board of Directors has authorized an up to $150 million stock repurchase program. This program demonstrates the confidence in our company's strategy and our long-term growth potential. Our top priority continues to be investing in our business for growth. At the same time, this program gives us one more capital allocation tool to return value to shareholders in periods where we can repurchase shares at reasonable levels and will help reduce the net amount of employee stock award dilution going forward.

Now I will turn to our guidance. As it relates to revenue, first and most importantly, as Charlie mentioned, we are in an inflection phase with respect to the NAND pricing environment with price declines falling faster in Q2 than we had originally anticipated. While we were able to show strong top line growth in Q2 in spite of these circumstances, we want to be mindful of this dynamic as we think about the rest of the year in developing our guide. We believe a more balanced revenue and NAND market environment will emerge as the quarters progress and return to the consistent long-term NAND market trend line.

Second, while we did not see any specific indications that macro impacted our business in the quarter, we nevertheless want to be mindful of the environment given the recent headlines and cautionary tone of other infrastructure vendors. We remain confident in our ability to drive growth in the quarters ahead.

With this as context, for the third quarter of fiscal 2020, we expect revenues in the range of between $434 million and $446 million or $440 million at the midpoint. Non-GAAP gross margins in the range of between 66% and 69% and non-GAAP operating margin in the range of between 3% and 7% or 5% at the midpoint. For the full year of fiscal 2020, we now expect revenues in the range of between $1.645 billion and $1.715 billion or $1.68 billion at the midpoint. Non-GAAP gross margins in the range of between 67% and 69% and non-GAAP operating margin in the range of between 2.25% and 4.75% or 3.5% at the midpoint. You will notice that our operating profit guidance remains unchanged. This speaks to our focus on thoughtfully and carefully investing given the current environment and adjusting our spend plan to maintain our profit goals despite the reduction in our top line expectations.

As I wrap up, I'd like to offer some final thoughts on why we continue to be excited about the road ahead here at Pure. Number one, our Q2 results highlight Pure's momentum with us growing roughly 10x faster than any of our public competitors. Number two, the fundamentals in our business remain strong. Number three, we are on the cusp of a significant and exciting product cycle. And finally, we remain focused on driving a smart and profitable business.

In closing, as Charlie mentioned, I have made the personal decision to leave Pure. My last day will be later in the year. And in the interim, I'll participate with the selection of and transition to our new CFO. And I will be at Accelerate next month and look forward to meeting many of you at our Investor Day. It has really been an honor to serve as Pure's CFO. The company is positioned well for the future, and I am excited to see what Pure does in its next decade.

With that, I'll turn it back to the operator for question.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Alex Kurtz from KeyBanc.

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Alexander Kurtz, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [2]

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Before I get into questions, I just want to say, Tim, it's been a real pleasure working with you and maybe we'll see you on the mountain one day.

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Timothy Riitters, Pure Storage, Inc. - CFO [3]

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I appreciate, Alex. Thank you.

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Alexander Kurtz, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [4]

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Yes. Best of luck on what's next. So as I try to understand your pricing dynamic points you made in the prepared remarks, can I just give a quick example and you can tell me how far I'm off here. So at the beginning of the year, customers were expecting maybe $2 to $3 per effective gig when they came into a deal. Now with this oversupply in the NAND market, maybe they're looking for $1 to $3. And so your reps are hitting their numbers, but now they'd have to ship extra bits to get to the original guidance. Is that the right framework?

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [5]

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Yes. We're just shipping more terabytes per sale, right? And when prices drop more rapidly than you expect, it takes a while for customers to adjust to the idea of 2 things. One is buying more terabytes for workloads that they've already planned but now looking at new workloads at new tiers, and that takes a little more time and planning on the customer side. So as I've said many times in the past, Alex, that in a steady -- we live in an environment with steadily decreasing component and commodity prices, right? That's the entire tech market. And as long as it's slow and steady, the market equilibrates on that. But you do have quarters where it's faster than you expect and it takes a while for the customers to catch up with that, so that is what we saw.

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Alexander Kurtz, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [6]

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And just to be clear, cohorts as far as their yield rates have been trending correctly. Any context there, Tim?

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Timothy Riitters, Pure Storage, Inc. - CFO [7]

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Yes. You mean sales cohorts or customer cohorts?

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Alexander Kurtz, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [8]

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Yes, the sales cohorts.

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Timothy Riitters, Pure Storage, Inc. - CFO [9]

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Sales cohorts performing nicely. As you know, we had a big class come in this year and early signs are positive.

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Operator [10]

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Your next question comes from Matt Cabral from Crédit Suisse.

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Matthew Normand Cabral, Crédit Suisse AG, Research Division - Research Analyst [11]

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Also wanted to ask about the lower guidance. Just wondering if you could parse a little bit between just the push you're making on the larger enterprise deals versus the more run rate commercial business and just help us understand the incremental caution that you're putting into the guidance and just how that compares to where you were looking about it 90 days ago?

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [12]

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Yes. I'll let Hat answer that first piece. But really, those 2 things are quite separate for us. The balance, let's say, between enterprise and commercial did not affect or calculate into our guide at all. But I'll let Hat answer the complexion between those 2.

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David M. Hatfield, Pure Storage, Inc. - President [13]

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Yes. Really good progress in enterprise. In our prepared remarks, we talked about enterprise and the public sector both outpacing the growth of the company. That's a highlight. Quarter-on-quarter, more million-dollar deals closed, including a couple of the larger ones we talked about in Q1 for 7 and 8 figures. So we feel great about the momentum in the business overall.

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Matthew Normand Cabral, Crédit Suisse AG, Research Division - Research Analyst [14]

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And then on gross margins obviously came in meaningfully above your range for the quarter. Just wondering if you could talk a little bit about how you're balancing growth versus profitability and just if you think there's an opportunity to get a little more aggressive against what seems to be a little bit more of a difficult environment out there.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [15]

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Yes. I've said this before. We don't win on price. We don't lose on price. And generally, we're not losing on price. So I think the upward margin reflects the fact that we do get to take advantage of lower component pricing before the rest of the competition so that adds a little bit to it. I think if we thought that we could win a deal, especially with a new customer by discounting, we do it. So that's not holding us back. So generally, those are not the things that -- pricing is not the thing that is holding us back.

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Operator [16]

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Your next question comes from Pinjalim Bora from JPMorgan.

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Pinjalim Bora, JP Morgan Chase & Co, Research Division - Analyst [17]

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Congrats on the strong Q2. I also wanted to dig deep on the revenue guidance. Is there a way to basically parse the 300 points or so of cut? I mean, well, how much is macro concerns? How much is the pricing environment? And then I know the narrative in the market is -- across your peers is pretty bleak, but are you seeing any signs of macro softness in the pipeline or maybe more scrutiny or maybe Brexit-related weakness or any kind of signal which is calling you to be more prudent with the guidance?

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Timothy Riitters, Pure Storage, Inc. - CFO [18]

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Yes. So this is Tim. The first part of your question, we're not specifically stating a specific number, but the majority of it is really the pricing environment that Charlie talked about. As it relates to macro, certainly, we want to put some sort of prudence in there as well, and that's the second or the reason for the guidance. But to your question about the signals we are seeing, one of the big measures I look at is pushed deals. And our pushed deal number was down quarter-on-quarter, right? Which if you're into a macro situation that you'd expect that number to go up. So we're just really not seeing those signals. When we're driving the leadership and the differentiation we are, it's obviously a good thing, but we just didn't see those signals.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [19]

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And let me just add to that. When you're an innovator and a share taker, I think the macro tends to affect you less. So it may be out there and we may just be a little less sensitive to it, but we're a share taker right now. And so that's not what -- as Tim said, it's mostly the pricing environment that has created the caution.

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Pinjalim Bora, JP Morgan Chase & Co, Research Division - Analyst [20]

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Understood. Well said. I just wanted to ask a follow-up on DR strength. Obviously, it kind of jumps out of the page. And I think part of the reason you said is longer initial subscription agreements. Has there been a meaningful change in the duration for these agreements and is that the main driver for the growth here because I think ES2 is probably pretty small.

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Timothy Riitters, Pure Storage, Inc. - CFO [21]

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Yes. So on deferred revenue, a couple of things. Number one, the main reason for deferred revenue growing the way it is, is our renewal business or our subscription business, subscription renewal business. That Evergreen model is indeed working and we're starting to see big tranches renew, very nice renewal rates. So that's really what's happening and the main reason.

On elongation of the overall initial rate, that's happening but it's more of a second-order effect than the primary reason which is renewal.

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Operator [22]

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Your next question comes from Katy Huberty from Morgan Stanley.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [23]

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Just looking at your guidance versus consensus coming into today, you lowered October but not so much the January quarter. Is there something you see in terms of large deal pipeline or product cycle that give you more confidence around the January versus the October quarter?

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Timothy Riitters, Pure Storage, Inc. - CFO [24]

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Katy, this is Tim. Really, it's a question of more sort of challenging and easier comps last year. So if you look at last year given some of the things we had in Q4, it's a relatively easier comp. And so by definition, it's less of the adjustment that we made versus the harder comp that's in Q3.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [25]

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Okay. That makes sense. And Tim, DSOs have run higher the last 3 quarters. Is there a changing dynamic in terms of timing of deals or collections as you move towards subscription or something else going on that's impacting DSOs?

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Timothy Riitters, Pure Storage, Inc. - CFO [26]

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Yes. Something slightly different, Katy. We've talked a lot about our upmarket focus and getting into larger and larger enterprise customers. Those enterprise customers tend to be more forceful in wanting longer extended terms and it's a great use of our balance sheet. We'll do that any day if we can get into big accounts. So they'll typically take a little bit longer term. And that's what you're seeing more than anything else in AR.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [27]

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Okay. And then just lastly, sales and marketing as a percentage of revenue continues to grow despite pretty significant scale and market-leading growth rate. Do you have a view as to when we can start seeing sustainable leverage on the sales resources that you've put in place?

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [28]

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I'll take that, Katy. As we said at the beginning of this year, this was going to be a major investment year for us as we expanded into enterprise and really believe that with the addition of new products that are coming out this year and early next that we were really going to be able to take just larger share in the enterprise. But of course, it's the at-bats that matter. So I would expect that this will be the last year where you see that and you'll start to see it come down in future years.

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Operator [29]

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Your next question comes from Simon Leopold from Raymond James.

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W. Chiu, Raymond James & Associates, Inc., Research Division - Senior Research Associate [30]

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This is Victor Chiu in for Simon Leopold. Can you provide some color around the linearity in the July quarter, specifically, whether you saw business slow during the month of July and a reduced pipeline as you go into the October quarter?

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David M. Hatfield, Pure Storage, Inc. - President [31]

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Yes. This is Hat. I'd say that we actually saw a really strong July and we had solid linearity throughout the quarter but kind of different from what some of our peers were seeing. We actually see things really had great momentum toward the end and continued momentum in the beginning of Q3.

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W. Chiu, Raymond James & Associates, Inc., Research Division - Senior Research Associate [32]

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Okay. And I guess do you have any metrics, I guess, to give us an update on the progress of new sales hires and ramping up to speed and how that's impacting the progress towards, pivoting towards larger deals?

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David M. Hatfield, Pure Storage, Inc. - President [33]

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Yes. We're super diligent on looking at all the cohort classes. We have 27 cohort classes that we've had since I've been here and we look at it month to month. And what we measure is their ramp to productivity relative to their peer group. And so we've seen the largest classes we've had over the last couple of quarters come in and deliver in line with expectations and in line with previous cohorts. So it's early days. We're spending a lot of time and energy driving enablement, et cetera, but really nice early signs.

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Operator [34]

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Your next question comes from Steven Fox from Cross Research.

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Steven Bryant Fox, Cross Research LLC - MD [35]

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First, I was wondering if you can give a little more color on the public sector. You mentioned one large win. How broad was the growth that exceeded overall growth beyond that one win? And then I had a follow-up.

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David M. Hatfield, Pure Storage, Inc. - President [36]

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Yes. Public sector has been an area that we've been investing in for the last couple of years. We wanted to get into a more meaningful run rate. And I think the last 2 quarters that we've seen, 3 quarters that we've seen real consistent growth quarter-on-quarter. It's across the large central agencies in the federal government in the U.S. as well as state and local governments coming in and contributing. So it's nice breadth. We feel positive that, that will continue especially into the September quarter where they end the fiscal year. And so we feel like we're kind of starting to hit our stride in the public sector business in the U.S. in particular but also globally.

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Steven Bryant Fox, Cross Research LLC - MD [37]

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And then just as a follow-up, when we think about the transition to NVMe which you guys have moved forward pretty rapidly, I mean, what's the impact then on financials from just that technology transition?

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [38]

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Yes. Thanks for that question. So as you may recall, while we innovated in both cases, both at the back end and the front end, we were the first to incorporate NVMe on the back end and of course, that helped both margin and pricing and made us competitive in the market, helped overall performance of the systems versus the competitors. And then just a couple of quarters ago, we introduced it on the front end with the NVMe over Fabric. We are seeing a very nice interest level by the most advanced customers. As you may recall, NVMe over Fabric requires a change in overall rack architecture. We're seeing a nice pickup there but it's early days. Kix, you want to add?

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Matt Kixmoeller, Pure Storage, Inc. - VP of Strategy [39]

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No. I think that was great. I mean, the only thing, I think, I would add is that, as we talk with industry analysts, I think, in the last quarter, we mentioned that we're at this point kind of a majority of our businesses ship with NVMe. And the comments from the analysts lead us to believe that we're far, far ahead of any competitor in that regard.

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Operator [40]

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Your next question comes from Aaron Rakers from Wells Fargo.

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Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [41]

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And also, Tim, it's been great working with you and wish you the best of luck. I want to go back to kind of the sales leverage question. Can you, first of all, talk about maybe any updated metrics around the success that you've seen as far as bundling across the product portfolio given kind of the expansion that you've seen? And then also in this last quarter, I know a couple of quarters ago you had a large GSI, a systems integrator alignment. Have you started to recognize revenue from that relationship or is that still that $100 million-plus opportunity still in front of us?

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David M. Hatfield, Pure Storage, Inc. - President [42]

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Aaron, this is Hat. Yes. So first of all, the portfolio motion is really working well. It's a key contributor to why we're thrilled with the FlashBlade performance, but we also saw really nice uptick in our FlashStack business. And as we introduce new products, the ability to have our core reps attach that to their deals or find other opportunities, do that portfolio motion, it's super encouraging. So we haven't provided any specific metrics on that, but we're seeing a nice uptick on the percentage of our core sellers selling multiple products, which is really the key pull-through metric that we look at.

And on the GSI win that we mentioned a couple of quarters ago, yes, we did see some incremental contribution from that in the quarter and seeing great pipeline build in the number of product announcements with their organization specifically. And then broadly across the rest of the GSI sector, we're seeing nice momentum. So that route to market, as we talked about, was going to be critical for us, and it's nice to see it starting to contribute net revenue in the quarter.

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Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [43]

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Okay. Perfect. And then a real quick follow-up, as flash pricing kind of normalize here as we look forward, can you help us just understand why we should expect gross margin to fall possibly below 68% again in the product gross margin line or do you think that we've hit kind of a new level of sustainability on product gross margin?

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Timothy Riitters, Pure Storage, Inc. - CFO [44]

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Aaron, this is Tim. What I would point to is the guide that we offered for the year. I mean, again, we raised it for the full year, which speaks to the environment we're in. As it relates to a longer-term gross margin number, we don't typically talk about a longer-term number in an earnings call so we'll probably leave it at that.

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Operator [45]

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Your next question comes from Tim Long from Barclays.

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Timothy Patrick Long, Barclays Bank PLC, Research Division - MD [46]

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Just 2 quick ones, if I could. Just back to the large enterprise and OpEx, can you just talk a little bit about where we are with the investment needed to better penetrate that? It sounds like you are seeing good traction with the large deals. So if you can just talk about the investment and where we are. And then secondly, you mentioned ES2 traction and maybe if you can talk about Cloud Data Services as well. How does the trajectory look there over the next few quarters for those businesses?

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David M. Hatfield, Pure Storage, Inc. - President [47]

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Yes, Tim. This is Hat. I'll take maybe the first part of that. The investments really are across a number of areas. One is sales capacity. And so we've obviously made a significant investment in Q4 and Q1 of that. Two is routes to market. And so one of the reasons why we've been highlighting the GSI win and the managed service provider wins with Rackspace and others, those are critical routes to market to be able to go get access to the enterprise customers. They take some time to build, but we see really nice trajectory on that as well as continued growth of the mix of the pipeline of larger deals. And I think as we look at those metrics, all very encouraging signs.

As Charlie mentioned, we do expect to get some leverage as that capacity comes online through next year and the year beyond that. And those are opportunities where the TAM is higher. So we do get and will expect to get more revenue per quota-bearing head that are catering to those enterprise customers.

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Matt Kixmoeller, Pure Storage, Inc. - VP of Strategy [48]

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I'll answer the question about the Cloud Data Services. So I'd say, overall, we're still in the beta phase with our Cloud Block Store, but it's already turning to be a success for our product line as a whole. Talking about the platform motion that Hat mentioned earlier, having a cloud dimension to our platform has materially changed the kinds of conversations we're in and how people look at not only the platform today but where it can take them in the future. And the flexibility we provide around ES2 to be able to deploy on-prem and extend that to the cloud in the future, again, has really materially changed the discussion.

In terms of the beta, going really well, great results from that so far. And come to Accelerate next month, you'll hear more from both us and Amazon at Accelerate.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [49]

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And customers that are using it on Amazon.

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Operator [50]

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Your next question comes from Andrew Vadheim from Wolfe Research.

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Andrew Teutli-Vadheim, Wolfe Research, LLC - Research Analyst [51]

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Yes. I had a follow-up on the DSO question. So if we look to the other side of the balance sheet, you saw days payable go down meaningfully as compared to the prior year. So it seems like it's taking longer to collect, but also it seems like customers aren't allowing you as long to pay. And together, those kind of seem like tepid indicators. So is there anything else to read macro-wise from this?

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Timothy Riitters, Pure Storage, Inc. - CFO [52]

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No, not at all. On the asset side, we talked about the reason AR does sort of rise a little bit. On the AP side, it's just timing. There's not really anything we're seeing in any of our vendors which would sort of change terms or whatnot. So that I wouldn't read into that.

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Andrew Teutli-Vadheim, Wolfe Research, LLC - Research Analyst [53]

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Okay. And then maybe just a follow-up on the public sector commentary. So strength in the quarter, but any indication there might be pull forward that occurred and might potentially dilute what we'll see in the October quarter?

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David M. Hatfield, Pure Storage, Inc. - President [54]

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No. I don't think so. It's still a reasonable, a smaller contributor to our overall top line. And the deals that we're getting are new wins that they build on. So there's not a lot of pull forward in this quarter or the quarter before and we're optimistic about what we'll see in the fiscal year-end.

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Operator [55]

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Your next question comes from Jason Ader from William Blair.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [56]

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First question is for Charlie. Can you give us an update on ObjectEngine and then also just Cloud Block Store? Can you talk about some use cases where the customers that you've seen traction with are applying the technology?

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [57]

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Sure. Well, the rapid restore has proven to be a really strong product introduction for us. This is based on FlashBlade. ObjectEngine helps on that depending on the circumstances. But rapid restore, a lot of customers never realize that they can get back up and running in less than an hour, and it's proven to be a major mover of that overall FlashBlade product line.

As Kix mentioned on Cloud Block Store, because it's in beta, of course, there's no revenue to speak of yet. We do have customers that are, look, I feel fairly confident we'll see the first revenue in Q3. But as you know, it's a subscription revenue so it will be recognized ratably over the life of the contract. But we have many dozens of beta customers, and some of whom are talking about standardizing their application development as they go into the cloud on Cloud Block Store. So very promising but very early days.

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Matt Kixmoeller, Pure Storage, Inc. - VP of Strategy [58]

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And I'll just add, you asked about use cases. I think one of the things we've been pleased about is really the diversity of the use cases where we see people wanting to do application migration but actually in both directions. So people interested in doing, say, dev test on-prem, deploy in the cloud or the other way around. People are interested in DR as a use case between on-prem and the cloud and then, of course, just application mobility. So still early days but we're encouraged by what we're seeing.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [59]

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Okay. And then second question for Tim. Tim, have you made any different assumptions on conversion rates in your guide relative to your normal guidance methodology?

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Timothy Riitters, Pure Storage, Inc. - CFO [60]

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Well, I think, Jason, it's a function of acknowledging pricing as well as sort of ensuring, so we think about macro as well. I mean implicit in that is to think about different sort of ways of measuring conversion. So I think the short answer is yes.

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Operator [61]

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Your next question comes from Karl Ackerman from Cowen and Company.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [62]

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Two questions, please. The first question, I was hoping you could address how you think philosophically about utilizing more of the channel as well as changing your pricing structure with the channel. I ask that because a cynic would say, you don't have an innovation or technology challenge, you have a variable cost challenge. So perhaps that changes with the new CFO, but any color on the company's plans to rein in discretionary and some variable spending amidst this soft end-demand background would be very helpful. And I have a follow-up, please.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [63]

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Karl, that's an interesting question. We changed our pricing structure about a year ago in order to accommodate the channel, where we went to standard discount across all of the product lines and made the pricing more transparent, more easily -- and gave them much, much clearer discretionary paths, if you will, in terms of how to price the product without Pure being involved. It took us some time to get all the tools out. That is all the electronic tools and so forth, but that's been largely done now. And I'm not quite sure where the question is ending up, but we have provided now very standard pricing into the channel. Of course, when prices drop more rapidly, we follow up with list price changes so that they can follow the same swim lanes, if you will, which we've done and do continuously. So you want to handle the rest of the channel question, Hat?

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David M. Hatfield, Pure Storage, Inc. - President [64]

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Yes. So philosophically, the channel has been incredibly a productive asset for us from the very beginning and we anticipate it continuing to do so. And the majority of our net new customers are identified by our channel partners, getting the right routes to market to map to the customers that we're segmenting in, our GSIs are getting us access to large-scale enterprises that was very difficult for us to get access to on our own. And we're driving toward independents so we can actually lower our costs by leveraging the channel over time to be able to quote and configure and sell independent of Pure. And so as I look at the channel or the partner ecosystem, those are all accelerators and routes to market. But to the extent they don't deliver that value to us, we'll look at it very practically and making sure we're getting the right ROI for every dollar we put into it.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [65]

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That's helpful. If I may move back to the outlook question. One of the investor questions I've received is, how much visibility do you have at attaining your new revenue outlook for 2019 which has been curtailed again. The core fundamentals from several peers would suggest the overall IT spending environment perhaps might get worse before it gets better and midrange competition may be accelerating. You mentioned earlier on this call how NAND pricing and not the macro is the larger factor. But I guess, are there any steps that you may provide or that you have taken that would enable you to have perhaps better visibility over a multi-quarter time horizon and how we should think about that as investors?

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [66]

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Every time, we have a learning process as we had over the last couple of quarters with respect to, in particular, this pricing challenge, we bring that into our planning model going forward. But I'll tell you that it's certainly the case that when you have a commodity market that is less steady, less linear, it does make it a little more challenging to predict going forward. With that, we've tried to incorporate everything that we are aware of at this time, including the signals that we're seeing from the commodity market, which as I said that, overall, the commodity prices are firming up.

Now we also believe that our strategy overall is working. I mean, we are growing. I mean, despite, let's say, a modification of our forecast, I mean, we're growing, in some cases, 40% or more faster than our competition. That means we're actually gaining more share. I do believe that in tough times, that is the time when leaders take more share. We are putting out a boatload of new products this year and early next. And I think that's going to allow us to continue to win in the future, but short term swings are more difficult to predict.

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Operator [67]

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Your next question comes from Rod Hall from Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [68]

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I guess I wanted to go back to the dynamics around NAND and just ask kind of a question about what you're assuming in terms of contract pricing lead time or lag time, I should say, to the spot market. So we know that it lags, but are you then assuming -- because the spot market has been recovering, are you assuming that then positively impacts your revenues in that fiscal Q4 implied guidance?

And then can you also talk us through sort of the margin puts and takes around this because we understand that lower NAND pricing is leading to lower revenues and then that's partially offset by higher gross margins, but then we expect the impact on gross profit there to be neutral, unless you pass through 100% of the component cost reductions, but then gross profit guidance is coming down. So I know that's kind of a long-winded one, but just the dynamic of those margins relative to what you've commented on the component pricing changes and the revenues would be helpful.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [69]

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Well, Rod, you've, I think, perfectly identified the fact that it creates a complex environment because the one thing that I think that you alluded to but didn't explicitly mention is also the elasticity of the market. That as pricing goes down, you can now compete for more workloads. Workloads that would go to hybrid or to disk because of the pricing of semiconductor flash now is more competitive. So when you roll that all together, what occurs is that in Day 1 your pricing is lower, you're going to sell more terabytes to do it. Customers may not yet be ready for those more terabytes. But as they do, as they understand the lower pricing, start looking at other workloads, they can bulk up on it. It's the ability of our sales force to convince the customer that they should, while prices are low, that they should buy more terabytes. It's all those things that go into making the quarter at the end of the day.

With respect to margins, because we do believe that we are able to take advantage of the costs before our competitors, it generally is a good news for margins for Pure. So we think of it affecting our margins less than it does the most immediate quarter. And as to timing, yes, we see it as we see the spot market as well as indications that new fab capacity is being delayed by NAND suppliers as positive for the pricing environment, but whether that hits our market in Q3, Q4 or Q1, that's more difficult to predict.

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Operator [70]

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Your next question comes from Nehal Chokshi from Maxim Group.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [71]

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So that was actually a really strong deferred revenue add especially relative to our model. You did give the 3 reasons of strong renewals, longer initial subscriptions and ES2 traction. I guess, first of all, the longer initial subs, is that on ES2 or is that the other cloud-based products?

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Timothy Riitters, Pure Storage, Inc. - CFO [72]

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Our traditional mainline business, Nehal.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [73]

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Okay. Got you. And so could you parse those 3 drivers in terms of what were the biggest drivers or percentage of the strong deferred revenue add?

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Timothy Riitters, Pure Storage, Inc. - CFO [74]

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In terms of order of operations is the biggest to smallest. So again, renewals first, elongation of contracts second and then ES2. And we're not talking about what they are in a percentage basis, but it gives you at least a sense of magnitude of how they stack up.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [75]

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Okay. So this is your second reduction in full year guidance. Have you guys actually reduced the sales quota along with this reduction in your guidance or are the salespeople still marching the same objectives that was initially laid out for their own plans?

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David M. Hatfield, Pure Storage, Inc. - President [76]

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Yes. We don't comment, Nehal -- this is Hat -- on the quota piece, but they're marching toward the productive goal that we put out for them. And those are all data-driven and opportunity-based inside of their territories. And so that's where we're focused and we're driving toward participation of those folks hitting their goal.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [77]

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Okay. And then finally, definitely appreciate the million-dollar deals increased 50% Q-over-Q, but can you give color on how that did on a year-over-year basis?

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David M. Hatfield, Pure Storage, Inc. - President [78]

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Yes. Nice progress, up year-on-year as well, so continued momentum there.

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Operator [79]

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Your next question comes from Mehdi Hosseini from Susquehanna Financial.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [80]

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This is David Ryzhik for Mehdi. Charlie, you talked about some meaningful additions to the portfolio to be announced at Accelerate. Would those be commercialized by Q4 and does your implied Q4 guide include some impact from those new products? Then I had a follow-up.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [81]

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Yes. Yes. We've got some very exciting new products, some of which will be GA and some of which we will announce a beta, but there will be new GA products at Accelerate.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [82]

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Got it. And can you maybe provide an update on your international strategy, maybe give us what percentage of business is international and maybe what steps you're taking to diversify the revenue base?

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David M. Hatfield, Pure Storage, Inc. - President [83]

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Yes. We continue to see great progress internationally at 24% of our revenue, I believe, on the quarter. Had a particularly strong quarter in APJ, which was great and nice to have that business come online. And obviously, you want to be looking at the biggest business, which is the Americas business in the context of that international growth. And we've had 3 consecutive quarters of improved performance in our Americas business. And so that's a great indicator of the health. We think that's driven by the enterprise and public sector that we talked about, the portfolio motion that's there and the routes to market really kicking in. So of course, that leaves EMEA. And EMEA was a little softer than what we would have expected. But any given quarter, you're going to have some segments perform higher and some perform lower, but we feel great about the pipeline in the second half for EMEA as well. So really nice contribution and in line with expectations.

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Operator [84]

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Your next question comes from George Iwanyc from Oppenheimer.

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George Michael Iwanyc, Oppenheimer & Co. Inc., Research Division - Associate [85]

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With the strong new customer adds, can you maybe give us a little bit more color? Is there anything changing with the size of the lands or the makeup of the customers you're adding?

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David M. Hatfield, Pure Storage, Inc. - President [86]

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We've been very clear on saying volume isn't the focus, the quality is. And so we saw a really nice mix across our focus segments of cloud, enterprise, public sector and commercial on a global basis. So continuing to focus on that G2K, native cloud 1,000 and nonpublic kind of central government organizations. So we saw progress across all of those theaters. We like the 450 number. In our situation, we have to go take share from somebody, so 450 or 7 net new customers per day, business day. Everybody else is trying to protect their base and we're having to go out and win net new. So we keep a real focus on the quality and the execution there, and we think that's a really nice indicator.

Relative to size, we don't talk about ASP specifically, but we're seeing nice lands in each of those segments. They vary by segment as you'd appreciate. But we're seeing nice lands, and we're also seeing a continued progress on our repeat purchases. So when you look at the fundamentals, we got to go win and take share from somebody. We're doing that better than anybody else. We're doing so at a nice ASP and repeat purchase rate. So the temporal nature of this pricing dynamic I think is what it is that we'll drive through it and gain our share in Q3 and Q4. We feel great about next year.

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George Michael Iwanyc, Oppenheimer & Co. Inc., Research Division - Associate [87]

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All right. And expanding on that from a competitive standpoint, is our win rates ticking up a little bit in the current environment and is that helping drive those lands or are they primarily just a larger channel presence that's giving you a chance to land across more customers at the same time?

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David M. Hatfield, Pure Storage, Inc. - President [88]

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Yes. We saw a nice quarter-on-quarter uptick on win rates. Year-on-year, they're stable and kind of across the board. So you're going to see little nuances on a quarter by quarter basis by competitor. But broadly speaking, we saw a nice pickup quarter-on-quarter. So I think that's the majority of the contribution. Our biggest competition remains not being in the fight in the first place, which are at bats. And so as we continue to invest in our channel and continue to make them more independent, it's getting in more and more fights on the front end. We've always said we'd take lower win rates in exchange for more at-bats and I maintain that. But we feel great. We're clearly differentiating ourselves especially in a market like this with the competition. And we feel like it's the time for us to really dig in and grind and pop out the other side of this with a lot more market share.

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Operator [89]

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Your next question comes from Eric Martinuzzi from Lake Street.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [90]

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My question has to do with the use of cash. You've got a tremendous amount of cash on the balance sheet. Typically, people put that to work either M&A or investing in the business. And you guys are obviously pulling a lever with the repurchase program. But I guess, are we inferring from the actions that you're taking that there's not really a front burner M&A opportunity and that you're not interested in kind of taking a deeper dive into maybe a midyear course correction on sales hiring to continue to press and take share versus competitors?

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [91]

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Yes. No. Our M&A strategy remains the same which is build, partner, buy. And we have the assets to be able to do that with cash or if appropriate, stock as well. We do see a very well-priced asset right now. It's called Pure Storage. And so our Board has enabled us to take advantage of that.

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Operator [92]

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There are no further questions at this time. I'll turn the call back over to Charlie Giancarlo for closing remarks.

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Charles H. Giancarlo, Pure Storage, Inc. - Chairman & CEO [93]

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Thank you. As you can see, Pure is clearly outpacing and out-innovating the legacy vendors. By creating a modern data experience, we're offering a dynamic solution that solves our customers' problems today and in the future.

I want to thank Tim for his partnership over the last 2 years, Tim. He's had an impressive impact on Pure, and he will be missed. We wish him the very best on his new adventure.

And then all of us here look forward to seeing many of you at Accelerate next month, and I want to thank you for your time today.

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Operator [94]

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