Nutanix's (SQBG) CEO Dheeraj Pandey on Q2 2017 Results - Earnings Call Transcript

| About: Nutanix (NTNX)

Nutanix, Inc. (NASDAQ:NTNX)

Q2 2017 Earnings Conference Call

March 02, 2017 05:00 PM ET

Executives

Tonya Chin - SD, IR

Dheeraj Pandey - Founder, CEO and Chairman

Duston Williams - CFO

Howard Ting - CMO

Analysts

Jayson Noland - R.W. Baird

Nehal Chokshi - Maxim Group

John Lucia - JMP Securities

Andrew Nowinski - Piper Jaffray

Jason Ader - William Blair

David Ryzhik - Susquehanna

Simona Jankowski - Goldman Sachs

Richard Kugele - Needham & Company

Mark Murphy - J.P. Morgan

Katy Huberty - Morgan Stanley

Ittai Kidron - Oppenheimer

Alex Kurtz - Pacific Crest Securities

Matthew Hedberg - RBC Capital Market

Operator

Good afternoon. My name is Meriama and I will be your Conference Operator today. At this time I would like to welcome everyone to the Nutanix Q2 Fiscal 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. I would now like to turn the call over to Tonya Chin, Investor Relations. You may begin your conference.

Tonya Chin

Good afternoon everyone and welcome to today’s conference call to discuss the results of our second quarter of fiscal year 2017. This call is also being broadcast live over the web, and can be accessed in the Investor Relations section of the Nutanix website. Joining me today are Dheeraj Pandey, Nutanix’s Chairman and CEO; Duston Williams, CFO; and Howard Ting, Chief Marketing Officer.

After the market close today, Nutanix issued a press release announcing the financial results for its second quarter of fiscal 2017. If you’d like a copy of the release, you can access it in the Press Releases section of the company’s website.

We would like to remind you that during today’s call management may make forward-looking statements within the meaning of the Safe Harbor provisions of federal securities laws, regarding the company’s anticipated future revenue, gross margin, operating expenses, net loss, loss per share, free cash flow, business plans and objective, product features, technology and consumption models that are under development, competitive and industry dynamics, changes in sales productivity, expectations regarding increased software sale, future pricing of certain components of our solutions, our plans regarding and the impact of the adoption of new revenue recognition standards, potential market opportunities and other financial and business related information.

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

For a more detailed description of these risks and uncertainties, please refer to our quarterly report on Form 10-Q for the second quarter of fiscal 2017 filed with the SEC on December 08, 2016, as well as our earnings release posted a few minutes ago on our website. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website.

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

Now, I’ll turn it over to Dheeraj Pandey, CEO of Nutanix. Dheeraj?

Dheeraj Pandey

Thank you, Tonya. Hi everyone, thank you for dialing in. January 27, was a cherishable moment for Nutanix. November 11, through January 12, was our first full quarter of selling our earliest product. General availability of our 1.0 product happened exactly five years ago in January of ‘12. Most naysayers along the way thought we should sell the company, because it was going to be nearly impossible to build a new category and software infrastructure without the muscle and staying power of an incumbent.

Rather than sell the company we packaged and sold products, root force and built a market around hyper-convergence largely because of our share conviction for web scale engineering and consumer grade design. Today everyone is trying to copy us and yet most except VMware, are missing the point with this fundamental rearchitecture enterprise computing, there is so much more than a new form factory in hardware.

It’s all about a software defined infrastructure running on commodity servers powered by a cloud operating system and OS that works the whole body of compute, storage, virtualization, networking, systems and operations management, web scale automation and security.

It is meaningfully treated in the definition of this cloud OS at least twice in the last four years. So, once in late 2013, when we fundamentally laid the ground work for our own hypervisor that we now call AHV. And then in 2016 a few months before the IPO, when we acquired Calm.io to lay the foundation for app centric automation.

There is also a new convergence on the horizon, with VMware and AWS announcing intent to serve the enterprise customers with a new hybrid cloud stack that melts AWS’s hardware with VMware’s software. This could be a lost opportunity if it’s done arm’s length like the way converge infrastructure was done with re-blocks and flex spots. As we all know they are largely fading away mostly not refreshed the second time.

Hyper-converging the on-prem owned with a public rented infrastructure is as bigger challenge, if not bigger as converging things on x86 servers. It’s as much an operating system’s problem as it is user experience and design challenge. It took a clean camera’s approach like we have been taking for the last seven years; we stand to emerge as a pure play cloud company that uniquely merges the OpEx of the CapEx consumption models for our enterprise customers. Time will tell.

Our 5.0 release of the software began shipping in the quarter and reflects our ambition of this cloud operating system. AHV is the first enterprise with hypervisor build in the era of conversions for example, security, networking and orchestration are built in with a new architecture in mind. AFS and ABS manage file and block data in pure scale out software services rather in proprietary hardware.

Containers are an organic part for our APIs is 5.0. Certifications of Oracle, SAP and Citrix continue to push AHV deeper into the enterprise. There is an immense opportunity to make the infrastructure invisible with prism and self-service portal.

Shifting to go-to-market, we continue to expand our addressable market opportunity with our diverse packaging options that provide maximum flexibility to our customers on how they consume our software. Our Dell relationship remains the strong contributor to our total sales, and we added nine new Global 2000 logos with them in Q2.

Lenovo had their best quarter since they started selling Nutanix powered appliances about a year ago and we continue to identify new market opportunities to pursue together. Specifically around in SAP go-to-market where Lenovo's erstwhile IBM servers had a strong foothold traditionally.

In addition to OEMs we continue to sell our software directly to end-customers to run our enterprise cloud operating system on Cisco UCS and other prequalified hardware. In Q2 we closed deals with a large credit card processor and a large U.S.-based energy company both Global 2000 companies to deploy our software on Cisco UCS. While also expanding our relationship with important Cisco channel partners as a result of these transactions.

The software portion for our business is poised to exhibit strong growth in future quarters. On the competitive landscape we certainly see a rapidly evolving dynamic with new vendors such as NetApp, Cisco and HPE announcing their entry or renewed focus on the hyperconverged market.

In the era of public cloud, converging compute and storage alone is five years too late for the market. Simply changing the consumption model of storage is not enough for the enterprise where developers are demanding self-service for everything from compute, networking, storage, security and containers.

Now let me review the financial highlights of the quarter. Revenues of $182 million were above street consensus and our guided range growing 77% year-over-year. We saw several areas of strength in the quarter including international performance. Deals from new customers and very strong age read options. Billings for Q2 were $227 million, up 59% year-over-year. Favorable to whole gross margin of 60% even while facing very strong increases in component pricing. And finally we delivered a better than expected net loss per share beating consensus by $0.07.

Our win rates remain strong and consistent with prior quarters and we are pleased with our ability to demonstrate the value of our full stack operating system and competitive opportunities. With an annualized billing run-rate of nearly $1 billion it is increasingly important for us to cultivate and grow our pipeline and sales talent.

We added a record number of new customers in the quarter finishing up with over 900, up from 700 in the first quarter. The strong performance brings our total number of customers to over 5,300. We also continue to see strong growth in the Global 2000, increasing our total Global 2000 penetration to 473 up 68% from Q2 last year.

Our repeat multiple of Global 2000 customers increased to 7.4 times in the quarter. As we've said before Global 2000 customers represent a huge opportunity for us as they rearchitect their applications and infrastructure to focus on self-service and automation.

Our land and expand model continues to do well with the average customer greater than 18 months purchasing 3.8 times their initial purchase. Our net promoter score on customer support and our unique emphasis on product quality have been quite scale differentiators in this no easy era of hyperconvergence.

Quality at scale is an extremely difficult engineering challenge, going by what we are seeing our accounts where customers initially bought into the hike of this new form factor. We're extremely proud of our rapidly growing customer roaster, which include some of the world's largest and most respected companies that depend on our platform to run their mission critical applications.

Our solutions have been purchased by five of the top 10 and 56 of the top 100 companies in the Forbes Global 2000 list. Along with the number one ranked companies across at least 20 industry segments. Our vision of the full stack cloud operating system and the focused execution and quality and customer support continue to bear fruit in this segment. Large enterprises resist buying point products that do not scale or cannot be procured in software and have questionable quality and customer support.

In this quarter we close a large transaction with a new Global 2000 account a $10 billion manufacturer of hospital supplies and equipment. To re-platform it’s Oracle database environment from Solaris to x86, key factors in win were the value for full stack including AHV and the simplicity of Prism to manage the entire datacenter.

We expanded our relationship with JetBlue the sixth largest U.S. airline to power the Citrix platform that runs their mission critical applications. We’re also partnering with the airline to explore new workloads to increase both in-flight and terminal efficiency.

I highlighted our progress to Dell earlier with my remarks and we are pleased to close the number of fantastic wins with them in the quarter. For example, we’ve further our momentum in the Global 2000 with a key wind at a 60,000 person global professional services firm that specializes in risk management. Following a very competitive bid process, which included all the major infrastructure players in several large incumbents we were selected as the complete infrastructure replacement for six global data centers over an 18 months rollout running all virtual workloads.

We also expanded our relationship with one of the largest hospitality companies in world that operates in over 90 countries with over 4,000 hotels. We’ve completed the move of their core reservation system, which has been running non-virtualized in Solaris for nearly two decades to Nutanix powered all-flash Dell XE nodes as part of a major application refresh. A key driver for this win was AHV, which the customer was eager to adopt in order to reduce its virtualization costs.

We added Hearst Technology one of the world’s largest private companies to our customer portfolio. Hearst was looking for infrastructure with simplifies management to consolidate, compute and storage to help from the centralized IT group into true internal cloud provider.

This quarter we recorded our first win with one of world’s largest aerospace and defense companies in the world. After conducting an exhaustive evaluation of Nutanix alongside other HCI solutions, the customer ultimately selected Nutanix on the Dell XE platform due to the performance, security and scalability of our solution.

As we continue to expand our presence in Global 2000 accounts, we believe our hybrid cloud strategy is critical to our future success. We have seeing increased activity with our customers who under bring workloads back from the public cloud because of underperformance and cost overruns.

One of our notable wins this quarter is the largest privately held automotive dealership group in the U.S. which decided to bring back critical business applications that dealt with vehicle transactions and customer engagement. An absolute requirement of these customers has been the preservation of the cloud agility, self-service and one-click simplicity they have grown a custom too.

Whenever public cloud goes down, cloud huggers blame the application and its architecture. But most of the SaaS and consumer applications that went down last week or written in the last four five years by early adopter or West Coast developers. Imagine the stage of legacy apps and the late majority of developers around the world. A true lift and shift would only be possible for the cloud to sub soon this disaster recovery and business continuity capabilities within the operating system.

Having said that, we do realize the advantages of the public cloud for growing and shrinking consumption via an OpEx model. We continue to work on product and go-to-market capabilities to become a company that does not take sides on CapEx versus OpEx and own versus rent.

As we move towards our next billion dollars in business, we need to continue to fight complexity and waste, retail that maniacal focus with new product design and engineering on end-user delight, scale the customer service that revels in bringing repeat business and operate go-to-market machine that celebrates leverage.

With that I turn the call over to Duston for more detail review for Q2 results. Duston.

Duston Williams

Thank you, Dheeraj. We delivered record revenue in Q2 above the target range. This performance coupled with lower than expected expenses enabled up to deliver non-GAAP EPS that was significantly better than our expectations. Revenue for the second quarter was $182 million growing 77% from a year ago and up 9% from the previous quarter.

New business was up nicely in the quarter, with new customer bookings growing to 40% of the total bookings up from 35% in the prior quarter. We built $227 million for the quarter, representing a 59% increase from a year ago and a 5% decrease from the prior quarter.

This quarterly billings performance was somewhat impacted by fewer than expected large deals. We define the large deals as customers buying more than $500,000 in any given quarter. Over the last four quarters deals over $500,000 averaged about 45% of our total bookings.

In Q2 we performed somewhat below this level, primarily in North America. With the focus on long-term sustainable growth over the last quarter or so we started the segment the North American sales force with more focus around major accounts. The execution is ongoing, but in the process we may have underestimated the impact of productivity associated with this realignment, which included promoting some of our best performing sales reps into management roles. This realignment is a natural step in our evolution, as we prepare to deliver the next $1 billion in billings.

We expect the North American productivity to rebound over the next few quarters and you can certainly expect us to update you on our progress in this area next quarter. Our international bookings came in very strong. And I am happy to report that both EMEA and APAC have experienced record booking quarters in Q2 by a wide margin, with international bookings representing a record 48% of total bookings in the quarter.

We have invested and we continue to invest a significant amount of resource in these regions and although international mix of business varies each quarter, we see clear revenues that these investments are starting to take hold. The bill-to-revenue ratio came in about 1.25 and as we mentioned on last quarter’s earnings call, we expect this ratio to continue to range in the more normalized level of around 1.25 to 1.3 going forward.

Our gross margins for the quarter was 60%, this is versus 63% in the prior a year ago quarter and 61% in the prior quarter. Team did a nice job of managing margins during the quarter and we are able to overcome most DRAM and NAND cost increases. To put this in perspective, on average we typically reduce total product cost by 4% to 6% on a quarterly basis. In Q2 due to increases in memory prices, total product costs increased by 2% and despite this rapid shift in cost we were able to operate within our 60% gross margin target.

We do expect Q3 cost increases to be higher and again I will cover that in more detail, when I discuss the Q3 guidance. Our operating expenses were fairly flat quarter-over-quarter due to lower than expected headcount now at site services, leading us to a better than expected non-GAAP net loss of $40 million or $0.28 per share.

Next, let me review a few balance sheet stats along with a few other key performance metrics for you. We closed the quarter with cash and cash equivalents of $355 million, up from $347 million in the prior quarter. DSOs on a straight average was 76 days, 5 days better than the 81 days we recorded in the prior quarter. The weighted average DSOs reflecting the period of average receivables outstanding was 24 days in Q2 same as the prior quarter.

We generated $20 million of positive cash flow from operations, marking five consecutive quarters of positive operating cash flow. We should note that approximately $10 million of the cash flow from operations came from ESPP contributions that will reversed out in Q3. We also generated a positive $7 million of free cash flow during the quarter, although once again this benefited by approximately $10 million from ESPP contributions.

The continued strong adoption of AHV was evident, with AHV nodes as a percent of total nodes improving to 21% versus 17% in the prior quarter, using a rolling fourth quarter average. And software as a percent of total booking based on rolling fourth quarter average was 15% and this was consistent with Q1.

Turning to the guidance for Q3, Q3 guidance on a non-GAAP basis is as follows. Revenue to be between $180 million and $190 million, gross margins between 57% and 58% and a per share loss of $0.45 to $0.48 using weighted average shares outstanding of approximately 44 million.

Let me now give you some context to understand the trends impacting our guidance. In developing our guidance range as we go into Q3, we took into consideration the fact that Q3 is a seasonally slow quarter as well as the efforts we're putting in place to reaccelerate the North American sales productivity. In fact timing of this is a bit uncertain causing us to potentially reflect some conservatism in our guidance.

As I mentioned earlier, memory prices have also become more volatile. In Q3 we expect DRAM prices to increase 30% to 40%. In response to this increase we've raised our product list prices on February 1st. It's too early to understand how effective this will be and therefore we have reduced our gross margin guidance for Q3. If our price increase hold there is a chance for over performance on this guidance, however it's just too early to tell.

With these types of commodities history always repeats itself. And we know at some point in time there will be equally strong reversals in DRAM pricing. But at this point in time it’s just too early to predict when this will occur.

Next I'll touch a bit on the outlook for operating expenses, we did a nice job of controlling expenses in Q2. However as we have continued to invest in the business and given a more moderate Q3 outlook, our projected expenses as a percent of revenue look a bit more aggressive than we would like.

We've already taken actions to limit planned headcount additions to primarily the sales and marketing related. Of course any planned reductions and headcount adds will have a bigger impact to Q4 as oppose to Q3. It's obviously a delicate balance between overly controlling expenses and ensuring we are properly investing to position the company to continue its superior growth well into the future. And I believe our plans balance these two objectives well.

Before I open the call up to questions, I want to spend just a few minutes on the expected revenue recognition changes that will take place under the new revenue recognition standard known as ASC-606. We had previously communicated to you that we would be adopting the new standards starting in our fiscal Q1, 2019 or in August of 2018. We're now taking a serious look at early adopting this new standard effectively one year earlier starting in August of 2017 as oppose to August of 2018.

Although we still need to close out on a few items, we believe it is feasible to early adopt the new standard and early adoption is our preference. Our enterprise cloud platform can be monetized in many unique ways including via pure software in various forms. It is however becoming more obvious that as we stage the business for a higher percentage of software content, the current revenue standard will increasingly complicate the understanding of our financial statements and performance.

We believe the adoption of the new 606 revenue standard will give investors better inside into and appreciation of the true power and strength of the Nutanix business model. As an example and based on a tops-down estimate, in Q2 alone under the new 606 revenue standard gross margins could have been approximately 300 basis points higher than we reported under the current existing revenue standard. We'll give you a clear understanding of our timing to adopt the new revenue standard during our Q3 earnings call.

Operator if you could now open up for questions that would be great. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Jayson Noland with R. W. Baird.

Jayson Noland

Okay. Great, thank you. I wanted to ask about the promotions that impacted productivity. Are those productivity issues expected to continue into the back half of this year?

Dheeraj Pandey

I think we have done the right thing for the long-term, which is six months out. We definitely believe that these people need to have a larger blast radius than just individual contributors. But we are hopeful that the way they actually will become player coaches rather than just being players will actually help us out in the next half -- in this coming half as well.

Duston Williams

We have obviously Jayson replaced those individuals with other great performance some from the outside, some from the inside. So that process takes place and as that process takes place the productivity comes down a little bit, looks like it’s come down it has come down in North America specifically. And there is no reason why that shouldn’t work out overtime.

Jayson Noland

Okay. And then a follow-up Duston on the commodity constraints. Are you seeing any impact to lead times? And then is this -- is your expectation that this carries through the first half of this calendar year or at least your fiscal year?

Duston Williams

Yeah, I mean we don’t have perfect inside, but clearly next quarter doesn’t look a whole lot better. And from a lead time our ops guys have done a terrific job, we bought ahead a little bit in Q2. So that helped us out from a cost perspective. And yes SSDs have certainly been tight, we have been able to manage that around and change mix and a few things like that. And we’re going to other means as needed on DRAM and things like that. But so far the teams has done a really nice job.

Dheeraj Pandey

And we also looked at some dual sourcing, which goes to little bit of consumer grade flash kinds as well, which is not really consumer grade but have little bit more endurance cycle that we think we can actually absorb in their platform itself.

Dheeraj Pandey

Okay, I’ll leave it there. Thanks guys.

Operator

Your next question comes from Nehal Chokshi with Maxim Group. Your line is open.

Nehal Chokshi

Thank you. The promotion of this top producers into player cultures, does it introduced a new sales management layer or this has been the mode of operation in prior years as well?

Dheeraj Pandey

So this has been like Nehal, obviously in the last one year we’ve had an increased surge in sales hiring, which now requires a management hierarchy that is basically experienced in the story telling as well as in understanding what it means to conduct a lot of these enterprise conversations.

Nehal Chokshi

So, why do you think then that it impacted the typical play book this quarter as oppose to prior quarters then?

Dheeraj Pandey

The calendar 2016 was a year when we had two surges of sales force, which was not evident in 2015 itself.

Nehal Chokshi

Okay, thank you.

Operator

Your next question comes from John Lucia with JMP Securities. Your line is open.

John Lucia

Hey guys, thanks for taking my questions. I just wanted to ask, what kind of gives you the confidence that the sales that you saw in Q2 in regard to the productivity will improve over the next couple of quarters? I didn’t really heard a direct answer there, so do you have anything, any plan that you have to fix those issues or can you just walk us through that?

Duston Williams

Just I’ll let Dheeraj give you some specifics there, but just again the said context here. In Q2 the revenue was above guidance. So we were pleased from that perspective. Our internal plans didn’t quite meet up to expectations, but we did from a total perspective do okay there. And please don’t lose sight of what’s happened in EMEA and APAC, which has been -- had a great quarters, we got new leadership in EMEA that’s looking good, APAC was actually our best performing most productive region last quarter. So they had an outstanding quarter.

So, those two are bright spots there and by the way North America has performed pretty flawlessly over the last several years. So, there is absolutely no reason in the world why they shouldn’t get back to their record productivity that they’ve had in the past. I don’t know Dheeraj you want to add something.

Dheeraj Pandey

I think that’s well said, actually at the end of the day, North America has carried most of the rest of the world all the time in. But the good thing is that we have built a really good portfolio of regions around the world, EMEA and APAC and Federal and U.S. commercial. And I think we have managed a portfolio that’s been diverse just happen to be a quarter where EMEA and APAC carried the bulk of the portfolio doesn’t mean that Americas won’t come back.

John Lucia

Okay. And did I hear you right that you said you added nine Global 2000 customers?

Dheeraj Pandey

It’s Dell XE only, just with Dell XE.

John Lucia

Okay. What was the total?

Duston Williams

49 in total, I believe.

John Lucia

49. Okay. Alright, thank you.

Duston Williams

That was a good quarter Global 2000 wise.

John Lucia

Great.

Operator

Your next question comes from Andrew Nowinski with Piper Jaffray. Your line is open.

Andrew J. Nowinski

Alright, thanks. So, pure stores claims that hyperconverged structures only being used in smaller less data driven workloads and in branch offices and I know you said last quarter that the branch office is only about 8% to 9% of workloads and 75% is used for virtualization. So like can you just give us your view of where you see hyperconverged being used?

Dheeraj Pandey

Yes, I mean those numbers have been change at all. And we pretty much are in the same ballpark. I mean, if you think about $1 billion annual run rate, we cannot be selling remote office, branch office systems and making $1 billion in annualized run rate. Definitely about more than 50% of our workloads are with Tier 1enterprice workloads. VDI is about a little less than 30% for our workloads and a lot of the Tier 1 workloads include Microsoft, SAP, Oracle. And as we give examples in the prepared speech there is tone of really mission critical workloads that we are driving in Global 2000 as well.

Andrew J. Nowinski

Got it, thanks. And then just a question on the accelerated option of Acropolis. So when customers use Acropolis are they still using VMware or hypervisor in their rest of their data center for the workloads that don’t reside on the Nutanix ray well it’s actually ripping out VMware entirely? I’m just trying to understand the adoption curve of Acropolis and how easy it will be to sustain that accelerating rate?

Dheeraj Pandey

So Acropolis Hypervisor and it’s call AHV, basically goes with at least one workload in mind and as I give the example of one of our hotel customers and large hotel chain. They start testing on a single workload and from then on as the confidence grows they actually start to dialup the AHV consumption itself, and that's what we have seen. One of our largest retail customers today has thrown the count list to us saying I want to get VMware out of my entire account with AHV. So these things happen once the trust for the platform has actually grown.

Andrew J. Nowinski

Got it, thanks.

Operator

Your next question comes from Jason Ader with William Blair. Your line is open.

Jason Ader

Thank you. First, I just wanted to see if you could give us any detail on the percentage of bookings from Dell? And then second on top of that, if Dell favors their own technology in their new comp plan how does that impact to bookings over the next year?

Duston Williams

Jason, I’ll take the first part. As you know historically we haven’t broken out the OEM piece of the business, we’ve -- a little bit of a proxy maybe on the software content which we talked about early at 15% of bookings. I will say we did ship more OEM nodes this quarter fair amount, but more OEM nodes this quarter than we did last quarter.

Dheeraj Pandey

I think on the just the a prognoses of the relationship Jason, people have speculated about the demise of this relationship ever since to Dell-AMC merger was announced 18 months ago. And Dell has had EVO:RAIL and VxRail and vSAN ready nodes to sell for a long-time now. They say they lead with VxRail and VMware only environments.

So it’s our job then to convince the customer on why Nutanix is a better fit to support their multi hypervisor strategy. And with that there is only one product in town that works at scale. We should not expect Dell to build our AHV brand or demand. That's what our sellers do with their do and touch with the end-user. Now having said that we continue to develop our go-to-market with Lenovo and Cisco and it increasingly taking the software layer out for some of our largest customers.

We are also continuing to explore other win-win partnership opportunities with companies and channel partners. We’ll see the need to build alternative revenue streams for themselves beyond the VMware stack itself.

Jason Ader

Okay. So you basically at this point you do not think that even if the comp plan creates incentives for the Dell sales people to fit their own technology that it’s going to have a significant impact on your relationship with Dell is that what you're saying?

Dheeraj Pandey

Well there is a frontend comp plan, but this backend rebates and gross margins a lot of those things. I mean eventually it's the bottom-line that eventually matters. And a lot of those things will be combination of the frontend comp plans and the backend rebates and such.

Howard Ting

Jayson this is Howard let me just add one thing here. The other thing that I think we've been successful conveying to the Dell sellers is that this is a product that works in a boarder set of scenarios in used cases then their own VxRail product. And it's exhibited extremely strongly repeat purchase rates. So I think on those two basis also there is a tremendous amount of interest in their sales organization for this product.

Jason Ader

Okay, thanks guys.

Operator

Your next question comes from Simona Jankowski with Goldman Sachs. Your line is open.

Simona Jankowski

Hi thank you. Just as a follow up the previous question, I think Dell EMC VMware combined their go-to-market at the beginning of February in terms of their incentives. So just curious what kind of impact should you noticed in terms of the run rate of bookings or wins in the month since that change. And then more broadly on the competitive environments, any comments you can share following HP SimpliVity transaction would be helpful as well.

Dheeraj Pandey

Yes on the first one we have done as much activity in terms of training and enabling the Dell EMC CPSD team. This is a converged platform team that was the erstwhile we see team that's now has a portfolio that includes hyperconverged as well. And honestly Simona this is going to come down to the hassle on the street.

Because EMC owned VMware in the past as well I mean the sales manager, the RDs, the account managers and how they actually work with each other and figure out what's the fastest product to retire their quotas and what's going to leave them the least friction in terms of repeat business. Those things will actually matter more than just a strategy from the corporate itself. So we believe that Dell CPSD strategy includes Dell XC as a big part of their overall portfolio as well.

And SimpliVity front, if you take a step back, SimpliVity really were bringing that customer delight to its end users it wouldn't have ended up the way it did. And we have predicted this six-seven months ago because we were hearing all this from the market. There was a reason why Cisco passed on them, even though they were close partners.

HP picked up a relatively distressed asset, which will buy them nothing more than some short lived press. If the products don't work I think even the HP partner sellers don't care about back end rebates. They sell whatever retire their quotas the fastest and brings repeat business with least friction.

But we're absolutely not concerned about HP or Cisco or NetApp in terms of competition. They're not software companies with experience in building full stack operating systems that address compute and storage and networking and security and overall management.

Simona Jankowski

And just back on Dell for a second with their software bookings flat at about 15% does that imply that, assuming Lenovo continue to grow, that Dell was down on a sequential basis?

Duston Williams

Again we don't break it out. Just on the calc itself again we do a rolling four quarters just in this quarter on a rolling four quarters we happen to drop out a higher quarter and a lower quarter came in, which knocked it down a little bit it would have gone up a little bit. So that little bit insight there.

Simona Jankowski

I see. Thank you.

Operator

And your next question comes from Rich Kugele with Needham & Company. Your line is open.

Richard Kugele

Thank you good afternoon. Two quick questions. First, Duston is there a way of looking at AHV adoption on a customer basis versus node? And just to understand perhaps like you could have quite a few large customers who're just expanding their nodes on their AHV versus something about boarder adoption marketwise. And then I have a follow-up.

Dheeraj Pandey

Yes so Richard we have a very philosophical view on whether we want to really be part of an MQ for the hypervisor at all. Because like Amazon Zen hypervisor is not part of an MQ for the hypervisor itself. I think the hypervisor is now a means to an end, it’s not an end in itself and I think the way it was actually being sold for the last decade where virtualization was a strategy of the CIO is no more true.

So we don’t believe in going and trying to build an MQ and then say look we are the leaders at the visionary quadrant. I think it’s going to be stepping back five years into this whole thing. We have to bundle it, we have to sort of give it out for free and yet say look, you don’t need a virtualization budget, you don’t need a virtualization team to manage all those stuff, it’s part of the overall solution itself. Is that answer of your question?

Richard Kugele

Yes, thank you. And then from a Global 2000 perspective, you did actually add a pretty similar amount to what you had added in previous quarters. So I guess when you’re looking at your sales force this is strictly a very large customer, very large order issue in specifically North America. Correct?

Duston Williams

Yes larger, I wouldn’t say very large, but larger yes in North America.

Richard Kugele

Okay. And are you concerned that’s the price increases even if they are component related can delay that recovery?

Duston Williams

I don’t think so, I think they’re fairly modest, when you look at the memory cost -- memory pricing and then you look at the percentage of our COGS that memory is made up and then you look at the pricing and what we need to do to get somewhat even, it’s not a substantial list price increase.

Richard Kugele

Okay, understood. Thank you.

Operator

Your next question comes from Mark Murphy with JPMorgan. Your line is open.

Mark Murphy

Yes, thank you very much. So I believe you said that you consummated a price increase on February 1st, and it sounds like it’s not a large magnitude, but I am curious with a month under your belt. How do you think at this point the elasticity of that pricing change will net out if you had to take a guess?

Duston Williams

Just I think it’s just too early to tell quite honestly. We’re -- you are right, we’re in a month, but I think we need to let it play out a little bit to give you a solid answer.

Dheeraj Pandey

Especially because the codes that actually ended up as POs in February or given out in January and maybe late part of December itself.

Mark Murphy

Okay. And then what is your, I am sorry, go ahead.

Howard Ting

As there is some flushing to do here on the older stuff too.

Mark Murphy

Okay. And what is your expectation for how long the component price increase phenomenon continues in terms of DRAM and NAND, I think we can see that it will extend into next quarter. I am curious how much longer beyond that do you think it will continue?

Duston Williams

Yes at this point, I think the price increases again next quarter not as severe and these things they turn quick when they turn. But I think it’s probably somewhat and probably mitigated a little bit more in our Q1, but it probably extends into Q1. And then we need to see from there how it plays out.

Dheeraj Pandey

And I think in the meanwhile, we also have to work the whole body, when it comes what it means to deliver something in pure software for very large deals and so on. So those are things that we’ll also be exploring and becoming quarters.

Mark Murphy

So the last question I wanted to ask you the press release you mentioned that you’re evolving and refining your strategy including sales focus and alternate consumption models. And I am just curious if that’s a gradual evolution along the same trend line you have been on? And relating to the sales focus concepts that you had mentioned already today, are you contemplating maybe some more material changes going forward that we’re not aware as yet?

Dheeraj Pandey

Not at this point, I mean it’s an -- this new consumption model is a relatively young idea and most things because of the inertia of rest they take a while to actually get there. So as and when it becomes something material we’ll come back and talk more about it.

Mark Murphy

Thank you.

Operator

Your next question comes from Katy Huberty with Morgan Stanley. Your line is open.

Katy Huberty

Yes thanks, good afternoon. Duston, I wanted to ask you a couple of questions. First, one is, in the gross margin guidance for the next quarter are you assuming that none of the price increases stick and are pass through to customers is that what’s baked into guidance or is it something else? And then the second question is sales and marketing expense was up very slightly sequentially much less than normal, was that a slowdown of hirings that occurred in the January quarter, or is that had to do with commissions given that as you said the revenues came in below internal plan?

Duston Williams

Yes, so on the question there, sales will grow more this quarter. As you saw with our guidance there we brought sales expenses up and we have got some sales meetings that occurred this quarter, will occur this quarter. So we have got that going in the opposite direction and we have got headcount that we added towards the end of Q2, which gets fully baked into Q3. So there is a bunch of headcount there, there is so more marketing demand spend which we’ll spend certainly around larger account focused and things like that in Q3 also.

So, we hired a fair amount of folks, we hired over 200 people in Q2, we will bring that down a little bit, probably obviously for Q3, but there wasn’t a massive backing of hiring, there is some timing of expenses and sales meetings when they fall and stuff like that. I am sorry the first question again Katy.

Katy Huberty

The first question was what’s baked into gross margin for the April quarter, are you assuming that’s none of the price increases stick, or are you assuming that some of that is able to push through.

Duston Williams

Yes, I am pretty much assuming none of the very little if any of the price increases stick. And again we will see, hopefully that’s not the case, that’s not the plan. But, you can do that math too if you look at the cost increases in DRAM and memory as a percent of our total BOM and you can back into pretty much starting at the 60% you can get to the 57% to 58% just almost basically on the DRAM cost increases.

Katy Huberty

Okay, thanks. And then just quick question for Dheeraj, as it relates to AHV adoption increasing, what does that mean from a financial modeling standpoint, do those customers repurchase at a higher rate? Do they tend to pay for more software overtime? How should we read that from a financial modeling standpoint that the [indiscernible] penetration is increasing?

Dheeraj Pandey

Well I think the first thing there is stickiness and how it helps the company actually get a full stack in front for customers. And beyond the stickiness it’s also how does the story, the way we actually go and talk to the CIO especially in the Global 5000 go and compete with this idea for public cloud rented model versus owned. So owned versus rented, we couldn’t do this without really having a full-fledged cloud operating system itself.

I think that’s where it actually begins and we have been very consistent in saying that the way to monetize this is to actually look at the full stack as oppose to looking at a skew which is the hypervisor as a separate line item in an invoice itself. But I think without AHV we will never deliver things like paravirtualized storage IO pipeline, we could not deliver network virtualization in all this NSX goodness that you hear from VMware all that is only possible because we own AHV.

I mean we’re doing things with hybrid networking and things like that a lot of that stuff means that we had to own AHV as a strategic asset and the fact that we have been developing it for the last three plus years is now barring some fruit in lot of the core kernel of this infrastructure components beyond compute and storage.

Katy Huberty

Thank you.

Operator

Your next question comes from Ittai Kidron with Oppenheimer. Your line is open.

Ittai Kidron

Thanks. Couple from me, first on the billings comment that you mentioned that you had fewer larger deals over 500k, I just want to make sure that that directly maps to the changes of leadership and promotions you did in sales. Meaning it didn’t happen in areas where you did not make material changes to your sales organization?

Duston Williams

Correct, again EMEA was had a good quarter and APAC had a really good quarter.

Ittai Kidron

And is the pace of productivity improvement of new sales people I mean is that changing are you still thinking 9 to 12 months to get to full productivity.

Duston Williams

Well we've got a four quarter ramp, but as we bring on large account global type sales reps here naturally those are going to take longer to ramp because they’re bigger accounts and we need to give the reps time to go obviously get those comps up and running. So it won't be a large percentage of our sales force, but reasonable piece of it will have some elongated ramps just by the nature of the accounts that they're hunting.

Ittai Kidron

Okay. And then lastly on the gross margin Duston you talked about the impact where the typical cost declines you expect every quarter and that this quarter it was actually up 2%. Is it fair to say that your gross margin would have been more around 62%, 63% in the quarter if this would have been a normal DRAM price decline?

Duston Williams

All things being equal that's a fair calculation the only unknown there is what we would have done with that 2% and I'm pretty sure I know what I would have done with that 2% it would have been 60% and the billings would have been higher.

Ittai Kidron

Got it okay, very good. Alright, good luck guys.

Operator

Your next question comes from Mehdi Hosseini with Susquehanna. Your line is open.

David Ryzhik

Hi thanks this is Dave Ryzhik for Mehdi Hosseini. Duston going back to the FASB-606 [ph] for 2Q you mentioned it would have been 300 basis points higher. Just our base back it on roadmap suggested those that software only revenue would be around 20% of total product revenue. Is that about right? And I have a follow up.

Duston Williams

I haven't quite honestly done that direct calc there. But there is some other movement in there and some other calculations it may not be perfect. But you're probably not massively off.

David Ryzhik

And for your 3Q guide what would gross margins be under the new revenue recognition if you were to obviously have it for 3Q?

Duston Williams

Yes we haven't done that or calc. What we did is we went back and took at a tops-down look at the history and what it would look like the Q2, but we have not done that looking forward.

David Ryzhik

And just one quick one, you source all your hardware from third-parties and you mentioned that you built up, you strategically built up inventories. Just wanted to understand how that work since the third-parties I assume they would be the ones procuring the DRAM and the SSDs.

Duston Williams

Yes we don't -- we're obviously involved in that, but we don't carry inventory specifically ourselves.

David Ryzhik

Okay, got it. Thank you.

Operator

Your next question comes from Alex Kurtz with Pacific Crest. Your line is open.

Alex Kurtz

Hey guys just a couple of questions from me. And sorry if this question has already been asked, but late last year there was a view that rep productivity from a large chunk of the sales force hadn’t really accelerated and that was sort on the horizon as far as driving revenue acceleration. So again sorry if you already answered this, but what happened to that catalyst in the story from where we were late last year to now?

Dheeraj Pandey

Well I think as we spoke there was four or five really good account managers that we've promoted to become RDs. And then basically $0.5 million plus deals which happens to be 45% plus consistently or around 45% for the last four quarters dipped a little. So in the loss averages I think these two things by themselves would have made Q2 look way better.

Duston Williams

And then Alex also within that whole process, I mean promoting some of the top performance is one piece of it, but within that process we're also in some cases taking existing reps and refocusing for commercial to enterprise because of the opportunities there. Well naturally you get a little what we've experienced is some downturn in productivity with that and we're bringing in more folks to focus on that too.

So you've got a combination of things it’s just not -- wouldn't just focus on the promotions more of the realignment of the sales force again towards enterprise business, more towards enterprise business.

Alex Kurtz

And just my last question VxRail head-to-head...

Duston Williams

I'm sorry just to make sure you heard the statistics again, we've been pretty successful here. We've been running bookings roughly deals over $500,000 equaling about 45% of the total bookings that’s been reasonably consistent. So we’ve already been reasonably successful here that just turned down a little bit in the current quarter.

Alex Kurtz

I understand. And then just one VxRail was there a change in the comparative percentage against VxRail quarter-to-quarter with an increase/decrease?

Howard Ting

None of material changed, we are seeing more hyperconverged for all as the large incumbent system spenders are starting to lead more with hyperconverged as oppose to try and protect their traditional three tier. So overall we are seeing a higher share of hyperconverged in the deals that we are competing. But the win rate remains high and of the hyperconverged category VxRail is probably the number one product we’ve seen.

Alex Kurtz

Okay. Thanks, Howard.

Operator

Your next question comes from Matthew Hedberg with RBC Capital Market. Your line is open.

Matthew Hedberg

Hi, guys. Thanks for taking my questions. I had one other on the gross margin side, with the early adoption 606 and assuming that component prices rebound, it would seem logical to me that gross margin could be at this 63% to 65% long-term model maybe sooner than we expected. I guess looking our further, would there be up side do you think to that gross margin expectation longer term or do you think you could spend any upside there?

Duston Williams

Yes, I think, Mat, we’ve talk about this a lot. I think I would continue to focus on around 60% for the immediate future.

Matthew Hedberg

But is the assumption though that after post adoption I think you said it was a 300 basis points potential tailwind?

Duston Williams

Yes, I mean obviously we wouldn’t do anything extreme, but we’d take advantage of some of it maybe let some go through, but too early to make a call on that yet.

Matthew Hedberg

Okay. And then…

Duston Williams

First half to get through the DRAM mess that's going on in the marketplace now and we’ll let that clear out and then we’ll have a clear review on things going forward.

Matthew Hedberg

Got it. And then last for you guys, I believe it was .NEXT in Europe that you guys talked about to move to network visualization. Curious if you could give up an update there on sort of what you’re hearing from customers there?

Dheeraj Pandey

So, we did release network visualization as part of our 5.0 release, but we are also working on micro segmentation service, services chaining, service insertion so that you can really get the whole portfolio of what one can actually expect from an east west network and security, software defense security story itself.

So, things like how do you insert parallel to firewall are a 5 load balancer things like that. How do you do a one click micro segment that actually goes in protection application all happening from the self-service portal itself. Those are the kind of things that you should come to expect from us in the coming quarter or too.

Matthew Hedberg

Great, thanks guys.

Operator

There are no further questions at this time. I will now turn the call back over to Tonya Chin.

Tonya Chin

Thanks again to everybody for joining us today. We’re very excited about the opportunity in front of us and feel we hold this unique leadership positions in a rapidly growing market. Our enterprise cloud platform is the best in the industry and well positioned to capture increasing opportunities in the hybrid cloud market. With NTS of 90 plus for the last several years our superior value proposition to customers is clearly evident. We look forward to updating on our progress on our next earnings call. Okay just disconnect operator.

Operator

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

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