Nutanix Inc

NASDAQ:NTNX

Earnings Call Transcript 2019-Q2

[Operator]

Good afternoon. My name is Amy and I will be your conference operator today. At this time, I would like to welcome everyone to the Nutanix Second Quarter Fiscal Year 2019 Earnings Conference 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. Tonya Chin, VP of Investor Relations and Corporate Communications, you may begin your conference.

[Tonya Chin]

Good afternoon and welcome to today’s conference call to discuss the results of our second quarter of fiscal 2019. This call is also being broadcast over the web and can be accessed in the Investor Relations section of the Nutanix website.

Joining me today are Dheeraj Pandey, Nutanix’s CEO and Duston Williams, Nutanix’s CFO. After the market close today, Nutanix issued a press release announcing the financial results for its second quarter of fiscal 2019. If you would like a copy of the release, you can find it in the Press Releases section of the company’s website.

We would like to remind you that during today’s call management will make forward-looking statements within the meaning of the Safe Harbor provision of federal securities laws, regarding the company’s anticipated future revenue, billings, gross margin, operating expenses, net loss, net loss per share, free cash flow, our business plans and objectives, demand for and customer adoption of our products and services, plans for and timing for the impact of our transition to a subscription-based and recurring revenue business model; our continued investment in technology, talent and sales and marketing efforts and any expected impacts from these investments; the benefits and capabilities of our platform; competitive and industry dynamics; market size and 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 Form 10-Q for the first quarter of fiscal 2019 filed with the SEC on December 10, 2018 as well as our earnings release posted a few minutes ago in our website. Copies of these documents maybe obtained from the SEC or by visiting the IR section of our website. Also please note that unless otherwise specifically referenced, all financial measures we use on this call today are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the Investor Relations section of our website and in our earnings press release.

Lastly, Nutanix will be hosting its Investor Day 2019 in New York City on Wednesday, March 20. The event will be webcast on our Investor Relations website. Institutional investors and sell side analysts interested in attending in person should please contact IR for registration information.

With that, I will turn it over to Dheeraj. Dheeraj?

[Dheeraj Pandey, Chief Executive Officer]

Thank you, Tonya. Good afternoon everyone. Q2 was a good quarter for us as we continue to transform to a subscription business, with a meaningful extended product portfolio. Our continued shift to a recurring revenue model resulted in 57% of our billings coming from subscription, up from 38% in the year ago period and our subscription revenue is up 112% year-over-year to $157 million. Continued execution in product, customer support and enterprise selling resulted in a number of new large deals, strong continued penetration into our existing customers and record AHV penetration.

Our differentiated product offering helps us drive continued standardization within customer accounts. In Q2, we again saw strength in large deals, closing 57 deals worth more than $1 million and 6 deals worth more than $5 million in the quarter, 3 of which were from customers who also spent more than $5 million just a quarter ago. We now have 17 customers with a lifetime spend of more than $15 million and nearly 800 customers with a lifetime spend of more than $1 million. Global 2000 customers continue to recognize the value of our platform and the simplicity it brings to their infrastructure. We now count more than 760 as customers, including 2 of the Forbes Global 5, 6 of the Global 10 and 40 of the Global 50. And even as we add to our diverse customer base, we remain committed to providing an outstanding customer experience which continues to be a strong differentiating factor between us and our competitors. The market we address remains very strong and our win rates and pipeline conversion have remained consistent. We feel there is a very large opportunity to continue to sell our industry recognized Nutanix core offering to customers who are looking to modernize their IT environments with the greatest choice. And increasingly, we see demand from both new and existing customers to solutions outside our core offering.

As we look forward to and plan for the continued growth of our business, we are constantly examining every aspect of our business execution. In that vein, I would like to take you through three key areas of our business where we are making adjustments to maximize our strong market opportunity. First, we recently identified some imbalances in our lead generation spending that were beginning to impact our sales pipeline. We recognized these imbalances in Q2 and have adjusted our lead generation spend accordingly. Despite these, these actions will take some time to take effect and therefore our Q3 guidance reflects the short-term impact of these imbalances. The changes we implemented are already showing early positive signs at the top of the funnel and we expect to see increasing traction in our sales pipeline over the coming quarters. Duston will provide more details on these imbalances and our actions taken later in the call.

Second, over the past few quarters, we have not kept pace with our bullish sales hiring goals. This plays a role in our sales pipeline development. Hiring at this scale is a norm and there is an ebb and flow to the process. We have been putting more focus on this aspect of our execution as we don’t foresee any macro weakness in the horizon. Finally, we are in the process of addressing a few opportunities to improve our sales execution in the Americas region. To address this, we have promoted Chris Kaddaras, our current Head of EMEA sales to lead both the Americas and EMEA sales organizations. Chris has led our EMEA sales engine to tremendous growth over the past 2.5 years turning around the business that was initially challenged and we expect that he will bring the same execution excellence to North America. He is in the process of moving back to the U.S. and he leads both the Americas and EMEA regions, which are effectively 80% to 85% of our business. He has the wisdom and a healthy paranoia for operations that are key to success for a high growth company such as ours. We are in excellent hands with him leading these two important geographies as we try to build an iconic company at such high velocity.

As we make these operational adjustments to our business, our sales force continues to have the benefit of selling our best-in-class software. Just this quarter, our database service offering, Era, was named 2018 Product of the Year by CRM. And for the second year in a row, Gartner has recognized our platform as the leader in the market in its Magic Quadrant for HCI systems. In fact, our software has been ranked as the top HCI solution by Gartner for the past 6 years across two different magic quadrant reports. These achievements are based not just on the excellence of our engineering organization, but also our commitment to providing our customers with unparalleled choice of platform, Hypervisor and deployment model and our industry leading customer support organization. Our commitment to excellence in both our product and our customers’ success organization has clearly paid off and we are proud of the continued recognition of the industry. Additionally, we have seen several large new customers coming to us in the past couple of quarters after trying good enough competitive solutions.

I would like to highlight a few key wins from the quarter. We saw continued adoption of our products globally and across many verticals in the quarter, including a deal worth more than $5 million within the U.S. Department of Defense. This customer has a lifetime spend of more than $15 million and continues to expand its investments in our software. This customer has gone all-in on AHV, our Hypervisor contributing to the record 40% adoption for Hypervisor this quarter. Another deal this quarter was more than $5 million was with our Global 50 American multinational retailer. Three large teams within this customer’s organization have now standardized on our platform. This customer already has a lifetime spend of more than $10 million in just two quarters with many more projects in scope.

Our largest deal worth more than $5 million was with an American for-profit operator for healthcare facilities. This competitive win against traditional 3-tier expands on an existing customer deployment to bring a new workload, Splunk, on to the Nutanix platform. This particular deal is a great example of our ability to win trust in large accounts, one workload at a time. They first purchased our software through a fee facility more than 2 years ago. The field operation was looking to streamline its IT infrastructure for production workloads and chose our software amid an extremely competitive process. Over time, our software now runs across its facilities and this customer has a lifetime spend of more than $20 million.

We have seen this type of lifecycle progression with another of our large deals this quarter worth more than $5 million. With this customer, a Global 500 French multinational investment bank and financial services company, we converted a small private cloud deployment 4 years ago into a lifetime spend of more than $15 million, more than 30,000 virtual machines running on our software globally and expansion into new workloads like VDI. As this customer expands its workload mix, it has also begun evaluating solutions beyond our core offering and to the Essentials and Enterprise segments which include Era, Calm, Beam and Xi IoT.

We are increasingly seeing customers looking not only to modernize their infrastructure with our core HCI offering, but also to take advantage of our new solutions that deliver a true hybrid cloud experience. Within our own customer base, IT leaders are thoroughly evaluating and often purchasing our solutions that expand the reach of Nutanix Core, delivering new solutions including our database as a service offering, our cloud cost control and governance platform, our DevOps platform and our Edge Computing IoT service.

A great example of this is a deal worth more than $1 million with one of the largest insurance companies in the world based in Italy. This Global 500 company is continuing to expand its adoption of our core HCI platform. But perhaps most notably, this customer is also taking advantage of one of our Essentials offerings, Files, to collapse the traditional file server silo into a pure software offering running as an app on the commodity server grid. Another example is one of our Global 500 customers, an American multinational financial services corporation that has a lifetime spend of more than $5 million. This customer is relying on our software that modernizes its datacenter infrastructure, using it to run server virtualization, desktops and database workloads.

It is also exploring services in addition to our Nutanix Core and as part of its $1 million purchase in Q2 made a significant investment in Files, which was the largest Files purchase since the solution became generally available. This shift beyond core HCI is notable in the public sector as well. One of our largest deals of the quarter and the first with this customer worth more than $5 million was with the service component command during the U.S. Army. Using Flow, our micro-segmentation product within Nutanix Essentials, the customer is able to run a large scale farm on AHV and maintaining strict isolation for workloads and networks ensuring that strict data classification requirements are followed and users can access information even in an un-trusted network. This is our largest Flow deal, since we introduced the service in Q4 of fiscal 2018.

And we also had a great win with a British multinational contract food service company in the Global 1000 that purchased our Xi IoT solution to power an innovative machine-learning driven computer vision project within its facilities. In this deal worth $2 million, the customer will use Xi IoT, a product within our Enterprise segment to build a solution that will allow a customer in a restaurant to proceed through checkout without any human interaction. Xi IoT is just one of our Xi cloud services offerings that shows a promising start. Xi Leap, our DR service, which became generally available just 3 months ago, has already been adopted by several customers.

In conclusion, this September we will be 10 years old. In these last 9 plus years, we have sold more than $4 billion worth of product and services, built a proven product portfolio, assembled a hungry and a humble employee base, captured the imagination of a trusting customer base and yet we are only a good company. To go from good to great is a decade-long journey and that decade is about to begin.

With that, I will turn it over to Duston to provide more details in the quarter and guidance. Duston?

[Duston Williams, Chief Financial Officer]

Thanks, Dheeraj. Before we get into the other specific deals around our Q2 performance, let me first provide an overview on two items that we were particularly pleased with in Q2, our recurring subscription business and large deals. We made great progress in Q2 with our recurring subscription business. Subscription billings accounted for 57% of total billings, up from 51% in Q1. And additionally, subscription revenues now account for 47% of total revenue. In Q2, $57 million in bookings were based on our new term based subscription licensing methodology, up from $20 million in Q1 and almost 50% of the $57 million came from existing customers who had previously purchased non-portable licenses. In the quarter, we saw over 500 customers purchased term based licenses and approximately 40% came from large enterprises.

We remain on track to have our recurring subscription business represent 70% to 75% of total billings in three to five quarters. We also executed well in closing large deals in Q2. Specifically, we had a record number of deals greater than $500,000 and a record number of deals greater than $5 million. Large deals greater than $500,000 averaged 1.2 million, up from 1 million in Q2 2018. About one-third of our total Q2 bookings came from customers booking deals greater than $1 million and almost 20% of our total large deals came from new customers. We had a record number of G2K customers transacting deals greater than $500,000 and almost 50% of our total G2K customer base transacted business with us in Q2 showing continued standardization on our enterprise OS platform. Excluding our federal business, G2K customers accounted for over 40% of total bookings, with large G2K deals averaging approximately $1.6 million in the quarter.

Now move on to some other Q2 financial highlights, revenue for the second quarter was $335 million, up 17% from a year ago and up 7% from the previous quarter and at the top end of our guidance of $325 million to $335 million. Software and support revenue was $297 million in Q2, up 42% from the year ago quarter and up 6% from the prior quarter. Total billings were $414 million in the quarter, representing a 16% increase from the year ago quarter and up 8% from Q1. Software and support billings were $375 million, up 37% from the year ago quarter and up 7% from the prior quarter and the bill-to-revenue ratio in Q2 was 1.23, slightly higher than the 1.22 last quarter. We continue to defer a large percentage of our revenue and our Q2 deferred revenue increased by $78 million from Q1, an increase of 63% from a year ago and up 11% from the previous quarter ending the quarter at $780 million. New customer bookings represented 25% of total bookings in the quarter, down from 35% in Q2 2018, which included one $12 million deal.

In Q2, our software and support bookings from our international regions were 49% of total software and support bookings, up from 46% in Q2 ‘18. Our strong international performance was driven by EMEA. In fact, a strong EMEA performance drove that region to a record 28% of total bookings. Our EMEA region also had a record number of large deals greater than $1 million. And we are pleased that the EMEA ramped rep productivity has increased 70% over the past 6 quarters from a low point in Q1 ‘18. Our non-GAAP to GAAP gross margin in Q2 was 76.8% versus 63.5% in the year ago quarter and 78.6% in the prior quarter, reflecting a slightly higher than expected hardware mix in Q2. And while the hardware billings were within the 5% to 10% we guided, it was at the higher end of this range and above what we have planned for in Q2. Other cost of goods sold, were also slightly higher than planned. Operating expenses were $297 million, slightly lower than our guidance range of $300 million to $305 million and fewer headcount additions accounted for most of the shortfall. Our non-GAAP net loss was $40 million for the quarter or a loss of $0.23 per share.

Now, a few balance sheet highlights, we closed the quarter with cash and short-term investments of $966 million that was up $1 million from Q1. DSOs based on a straight average were 68 days, an improvement of 1 day from the last quarter. The weighted average DSO at 26 days in Q2 and we generated $38 million cash from operations in Q2, which was positively impacted by $17 million of ESPP inflow. Free cash flow in the quarter was negative $4 million. The performance was also positively impacted by the $17 million of ESPP inflow in the quarter. And important to note that both operating and free cash flow were negatively impacted by an $18 million tax payment related to moving our non-U.S. intellectual property back to the U.S. nearly all of this $18 million will be refunded within a four-year period.

Now turning to the guidance for the third quarter and before getting into the line item detail, let me step back a bit and provide some additional context for our Q2 performance and our third quarter guidance. In Q2, while we were pleased with our progress with moving toward recurring subscription business as well as with our large deals in EMEA performance, we were disappointed to miss our pipeline targets. Generally speaking, our Q2 was a quarter that should afford us to build backlog and that did not happen this year.

As Dheeraj discussed at the beginning of the call, we recently identified some imbalances in our lead generation spending that were beginning to impact our sales pipeline. Lead generation spending is a key component to building pipeline, which ultimately significantly impacts bookings, billings and revenue. In fiscal 2018 I’m sorry, in fiscal 2017 we had increased lead generation spend by 75% over the prior year. This increase drove strong pipeline generation of fiscal 2017 and fiscal 2018, as well as improved efficiencies within the lead generation spend during fiscal 2018. Encouraged by our overall company performance, in fiscal 2018, we reallocated some of our lead generation spending to other priorities. As a result, there was a fourth quarter period from Q4 2017 to Q3 2018 that we basically kept lead generation spend flat, all while the company continued to perform quite well.

Based on the lead generation spend efficiencies we experienced in FY 2018, we assumed further efficiencies would take place in FY 2019 and we again reallocated capital away from lead generation spend during our planning process. In Q2, we noticed a pattern that some of our lead generation efficiencies that we had planned for were not being realized. We began taking actions to reallocate capital back to lead generation spending, while at the same time, dialing back on non-sales hiring. We have continued these actions into Q3. Our quota-carrying sales reps also contributed to pipeline build and our pipeline targets were further impacted by a shortage of sales reps in the first half of the fiscal year, resulting in an under-spend by several million dollars. It’s important to note that all this shifting of spend back to lead generation is not an insignificant amount. The magnitude of the shift is in a few tens of millions.

Although we started making this adjustment in Q2, we expect it to take a couple of quarters to show meaningful results. In the meantime, we will double down on driving further business from within our large existing enterprise customer base, while the augmented lead generation spending works its way into the pipeline. This brings us to our guidance for Q3, where we expect significant impact from imbalance and lead generation spending earlier in the year, and slower-than-expected sales hiring. Expect the following, billings between $360 million and $370 million, revenue between $290 million and $300 million, gross margins between 75% and 76%, operating expenses between $330 million and $340 million, and a per-share loss of approximately $0.60, using weighted average shares outstanding of 183 million.

I’ll finish off with a quick comment on our $3 billion FY 2021 software and support billings target, as well as the Rule of 40. We have further analysis to perform. However, based on the plan to increase in lead generation spending, combined with the incremental growth that we expect from license refreshes and new essentials and enterprise products, we remain encouraged by our growth potential into FY 2020 and 2021. And we’ll provide additional detail and thoughts around our $3 billion billings target at our upcoming Investor Day on March 20. And regarding the Rule of 40, we will dip below our target score of 40 over the next couple of quarters with the objective to return to 40, as soon as practical.

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

[Operator]

[Operator Instructions] Your first question comes from the line of Rod Hall with Goldman Sachs. Rod, your line is open.

[Rod Hall, Goldman Sachs]

Yes, hi guys. Thanks for the question. I guess I wanted to go back to this lead generation issue, as I’m sure you expected to get a few questions on it. I’d just ask, if you could give us a little bit more color on why that efficiency deteriorated so much in this past quarter and maybe a little bit of an example of where these leads are coming from and have you changed the source of leads, anything like that? Then I have a follow-up to that.

[Duston Williams, Chief Financial Officer]

Yes, why don’t I start, Rod and then I’m sure Dheeraj will want to pitch in here also. Let me just again kind of reiterate a few things that I had said in the script, and maybe a few more things, but if you back up again back to FY 2017, where we increased spending 75% year-over-year, effectively allowed us to build some pretty good backlog, pretty good pipeline in FY 2017 and into FY 2018. And then in 2018, we started to see some pretty good efficiencies within that spend. We talked about efficiencies as how much pipeline we build and ultimately how much bookings we get out of a demand dollar spent. And we saw some pretty good efficiencies there in 2018.

Now, looking back at it, we probably over rotated a bit to the existing customer base and large customers there, where those efficiency dollars are easier to get and probably underspent a little bit on new customers, which those efficiencies are little tougher to get on new customers. But the company was doing fine in FY 2018 and then we go into FY 2019 and we have a lot of spending demands and a lot of pressure on spending and a lot of people looking for leverage, and we made a decision at that point that we figured those efficiencies would not only continue, but increase in FY 2019 and we reallocated spending away from demand gen to a certain degree into headcount.

[Dheeraj Pandey, Chief Executive Officer]

I think one other thing I’d also add to this is that, it’s like building this business is like building a software. There is who’d would market it like an operating system and things emerge, like in the last three months, we saw the aspect of the business around how we needed to have actually spent on demand gen in 2018 to have made these new customers as existing customers of 2019. And as you know from the last 2 years of a lot of our go-to-market has been around, making our existing customers even more successful, and it camouflaged some of the things that we needed to do, in terms of adding to the cohort of existing every year, so that next year you can go, reap that customer base itself.

[Duston Williams, Chief Financial Officer]

So, we took some action in December and we reallocated dollars in December. We did the same thing in January, and we’re doing the same thing now in Q3 and we’ll repeat that in Q4, reallocating more dollars to demand gen and some away from non-sales hiring.

[Rod Hall, Goldman Sachs]

Okay, okay. And then, my follow-up to that thanks for that and I wanted to, I guess, follow-up and see NetApp called out this weakness in January. And I’m wondering if you if there is any possibility in your mind that this lead generation deficiency as you perceive it, might be due to external factors like competition or maybe demand disruption as a result of the trading the other issues, the government shutdown etcetera, do you think that there’s any external forces that might be affecting what you’re seeing?

[Dheeraj Pandey, Chief Executive Officer]

Yes, I mean obviously, the things that we don’t know that we don’t know, but based on everything that we analyze in this business. We first look internally and it’s about inputs and outputs, and we ended up focusing too much on outputs in 2018, based on what we are getting from our existing customers. So, we went back and did some first principles thinking to say, hey, why was 2017 like that, because in 2016 we had slowed down quite a bit in demand spending too, because of those three quarters of macro issues with China and oil crisis and Brexit and everything. So, 2016 with a slow year for us and then we woke up in 2017 and said, we got to do this thing around demand as well, and that really helped us in 2017 and 2018.

So right now, we’re really thinking about this is an internal issue. I mean we’ve looked at our win rates closely and if anything, they’ve actually had a steady a little bit of an uptick. Our pipeline conversion rates have actually stayed pretty steady. We look at our Global 2000 customer base and they continue to buy, this is a record quarter for us in terms of number of $1 million deals, number of $5 million deals, number of more than $0.5 million deals. So, many of those things actually point in the direction of internal stuff as opposed to external. And you know, competition, I mean, I’ve talked about this forever on this call and to pretty much anybody who’s willing to hear. There are few things in competitive stuff that have that change every year. I mean and so there is a give and take that goes on competitively speaking, right. If you think about our competitive landscape, obviously, there is the public cloud, there is a need to think about the hybrid cloud, there is OpEx versus CapEx stuff that everybody is thinking about. And those are new things in the last 2 years. But then there are things that we also got along the way, like our product is 10x better than 3 years ago. We used to run on one or two workloads four years ago. Now we run pretty much every workload. We used to run on one server four years ago. Now, we run on a multitude of servers and we have all these different software-only form factors and subscription form factors. We have a much bigger customer base than three, four years ago. Repeat business is way better than three, four years ago. The brand is bigger. The Gartner Magic Quadrant has been new in the last couple of years. We used to have Vblock and FlexPod two, three years ago, and that’s been totally dismantled. Our portfolio of the product is much bigger. And so, when you look at all these things, you are like well, you get some and you give some. And competitively so I think the waxing and waning of a few things one way or the other goes on all the time actually.

[Duston Williams, Chief Financial Officer]

I think ultimately, Rod, we squeeze too hard on lead generation spend and we shouldn’t have done that, and we’ve corrected that.

[Rod Hall, Goldman Sachs]

Great. Okay, guys. Thank you.

[Operator]

Your next question comes from the line of Matt Hedberg with RBC Capital Markets. Matt, your line is open.

[Matt Hedberg, RBC Capital Markets]

Great, thanks. I want to dig in a little bit more on the sort of the questions that were just asked. I’m curious what areas did you reallocate capital to versus lead-gen? And is the plan sort of beyond this Q3 to increase the overall level of spending or is it just reallocating back? And then maybe secondarily, is this primarily a U.S. issue, given your comments on EMEA, and the sales commentary as well, the sales head commentary?

[Dheeraj Pandey, Chief Executive Officer]

So, I’ll actually take the latter question and Duston, you can take the first one. So EMEA is obviously probably 12 months behind the U.S., and it reaped the existing customer base really well and will continue to do so in this next six to 9 months. But they will start to see the effects as well probably in the next 12 months. America is 12 months ahead. They reaped the benefits of existing customers over the course of the last year as well. But obviously, there was execution stuff that EMEA did well as well. Under Chris’ leadership, and that’s why we’re giving him both Americas and EMEA as well. But all-in-all, I think I would say that the spend issue was a global issue for us across the board between EMEA, APAC and U.S. itself.

[Duston Williams, Chief Financial Officer]

On the expenses, we reallocate clearly to headcount, a lot went to engineering, some new products and things like that. And if you look at the expenses quarter-over-quarter now, it did $297 million in Q2. We’ve guided to $330 million, $340 million in Q3 here. Almost 75% of the expense increase quarter-over-quarter projected is in the run rate, effectively. And there’s not a whole lot that we can do about that. We expect the top line to be bigger it would have absorbed that spending easily. And then the only real we’ve added a little headcount in the current quarter here, and we’ve upped lead generation spend in the quarter. But I think if you fast forward to Q4, obviously we’re just guiding a quarter a time at this point, but you won’t see a similar increase in expenses from three to four, as you did from two to or we projecting from two to three.

[Matt Hedberg, RBC Capital Markets]

That’s helpful. And then in and I assume we might get into this more at Analyst Day, but I’m curious looking I guess a little longer-term here, when you think about this move from non-portable to subscription revenue, I’m curious, it seems like you are having some success there. Can you help us with sort of the puts and takes for a customer as well as yourself, sort of the unit economics of that decision, because it seems like that’s critical to this subscription mix that you sort of reiterated 70%, 75%?

[Dheeraj Pandey, Chief Executive Officer]

Yes, I think on the customer front, it’s all about flexibility and choice, because imagine in the next 12 months, 18 months, if there is a recession, if there is macro issues to deal with, we can at least go and start with a one-year subscription, a one-year term with these folks that we could not have done without having the one-year entitlement itself. So, getting a foot in the door when the purse strings are tight, I think it’s a great way to get there. At some point Xi Leap, for example, can do monthly subscription and quarterly subscription and all those things are now up for grabs, which is basically the sort of what cloud is all about if like factual consumption down to the last month if possible.

I think in the spectrum, on-premise still people are buying 100,000 at a time, so it looks like one-year terms are good enough. But over time I think as things actually get tougher because of a bad macro, I think will open us up for getting foot in the door with many customers. Many of the people are actually obviously looking at OpEx versus CapEx. It gives us flexibility on OpEx versus CapEx like federal in the last couple of years, especially, because of these continuing resolutions, the CRs, many of the budgets are only flowing because of TNOD, I mean, sorry, the O&M spend which is operation and maintenance stuff, so subscription helps there as well. So, it just gives us a lot of flexibility in many which ways and then customers can – we can go back to the customers when it’s time to refresh and actually have a better discussion that gives us better predictability and forecasting as well.

[Matt Hedberg, RBC Capital Markets]

Thanks guys.

[Operator]

Your next question comes from the line of Alex Kurtz with KeyBanc Capital Markets. Alex, your line is open.

[Alex Kurtz, KeyBanc Capital Markets]

Yes, thanks guys. A quick comment than a question, I would say, given Chris’ strong reputation in the industry, his time at EMC, I think investors could really benefit from hearing from him at the Analyst Event, and if not, maybe on the next earnings call. I think he has a lot of perspective in the industry and I think it would be helpful to kind of have him weigh in on sort of these changes that we’re seeing in the marketplace and internally within the sales organization. My question Duston is, I think historically we’ve talked about rep productivity and so the historical hires and sort of the upside opportunity from reps getting to fuller productivity. I didn’t really hear you talk about that today, that’s always been a kind of repetitive view and narrative from the team. So, could you comment on what that looks like and how that sort of played into this change in bookings growth?

[Duston Williams, Chief Financial Officer]

Yes. So again we – because we’ve got stronger and weaker quarters 1 and 3 and 2 and 4, we will always look at rep productivity on a rolling 6-month basis. So, on a rolling 6-month basis ending Q2 here, productivity and we always look at on a ramped rep basis obviously. EMEA ramped rep productivity went up in the quarter. APAC’s – APAC ramped rep productivity went up a little bit in the quarter, and North America, ex-Fed came down in the quarter.

[Dheeraj Pandey, Chief Executive Officer]

Yes, by the way, one thing I would like also like to add is that, productivity is still a derived variable, Alex. It’s not the real input. The inputs are salespeople and pipeline spend, the demand gen spend that we talked about a little while ago.

[Alex Kurtz, KeyBanc Capital Markets]

Yes. Thank you.

[Operator]

Your next question comes from the line of Jason Ader with William Blair. Jason, your line is open.

[Jason Ader, William Blair]

Yes, thank you. Guys, I wanted to – I know that lead-gen is going to dominate the conversation here. But, I wanted to understand a little bit more about whether you think number 1, you may have over rotated a little bit much to the – too much to the large enterprise, and also whether you think it took too much on in terms of new products in 2018, which may have affected the demand gen just from the standpoint of maybe the sales force in the channel being a little bit confused with all of these new products?

[Dheeraj Pandey, Chief Executive Officer]

Yes, I think on the – thanks, Jason for the questions. On the first one, it does camouflage stuff and the fact that we had large deals and large customers, it does come in the way of thinking. So now it’s looking back. We are running at high velocity. I wish we didn’t have to think about this as an afterthought, but it does come up. And I think how we go and really segment Commercial Select and look at the top 12,000 customers of America not just the top 3,000, 5,000, I think those things have been things that we have looked at in the last 3 months to 6 months. But before I get to the product, people also probably will realize that in the last 18 months, this company has gone through two big transformations and our sales force has gone through the transformation that has been – the people that have really gone through this, which is software-only and then subscription now. So, in the last 18 months, they have had a big payload of transformation and it probably does count towards simple things like hiring and stuff like that. They are like man, it’s a big change. So, I think how we do a better job of absorbing all this stuff while we become a software company, while we become a subscription company, while we become a cloud company, I think does come up.

On the product portfolio, yes, I mean, obviously, I’m a big fan of Andy Grove and the way he wrote two chapters in the book, Let Chaos Reign and then Rein in Chaos. So, we let chaos reign in the first half of ‘18 with product portfolio in terms of lack of crisp messaging and then obviously when we realized that we had to do a better job of messaging and classification and things of that nature. I think the Core, Essentials, Enterprise has been a great sort of storytelling methodology for everybody and people need to realize that they can’t just sell things because Beam is a thing and IoT is a thing and Calm is a thing, but they have to really think about the customer journey. And really empathize on behalf of the customer to say look, start with Core, then Essentials, then Enterprise. So, I think it’s helped a lot in the last 4 months, 5 months. But yes, it comes up. We are a high velocity company and sometimes we let chaos reign and then we go and rein in the chaos. But I think the most important sort of – at least in my head is how our sales force has actually gone through two big transformations in the last 18 months, 24 months.

[Jason Ader, William Blair]

Okay. And one quick follow-up, do you get a sense at all, Dheeraj, whether the Amazon Outposts announcement and just the hybrid cloud story overall has impacted demand generation just as customers sort of maybe pause and think about what they’re going do and look at the options etcetera whereas that didn’t really exist a year ago?

[Dheeraj Pandey, Chief Executive Officer]

Yes, I mean it’s too far-fetched for us to look at our data in terms of our opportunities created. Right now, we’re doing first principle thinking, which is input-output. What was the input to the system and what are the intermediate outputs and what’s the final output, and in that sense, I think we are still blaming ourselves more than looking at things that could be three, four orders out. Honestly again, and maybe because I have a cognitive bias towards this stuff, I feel like it’s great for Amazon to say cloud is everywhere. Outposts needs to come on-prem, because then we don’t have to have people saying, but cloud is all about renting and it only is off-prem and things like that. I think the market is going to become bigger once Outposts is there, and then it’s going to be about multi-cloud and flexibility and choice and running on multiple servers and all sorts of things and Amazon will also have to realize that miniaturizing and atomizing a cloud is actually harder than anything else and Intel realized this with ARM and low-power processors and things of that nature. So, I think this market is not given on a platter to them. I think we’ll – we’ll actually – we would love for cloud to be dispersed and distributed in many, many more regions of the world than just 100 datacenters actually.

[Jason Ader, William Blair]

Thank you.

[Operator]

Your next question comes from the line of Katy Huberty with Morgan Stanley. Katy, your line is open.

[Katy Huberty, Morgan Stanley]

Thank you. Duston, can you give us some clarity as to how much backlog was down year-on-year exiting the second quarter and which quarter do you think you can get backlog back to growth? And then I have a follow-up?

[Duston Williams, Chief Financial Officer]

Yes, I don’t want to give the specific details. Again, usually we build backlog in Q2, we took a little down in the quarter. And it’s a reflection of not having enough pipeline generated in the quarter. I would hope obviously that the Q3 guidance affords us the ability to start that path in Q3.

[Katy Huberty, Morgan Stanley]

Okay. And Dheeraj, 21% of customers are buying software beyond the Core. How long do you think it takes to get that to 50% or something more significant that would message that Nutanix isn’t an HCI company anymore, it’s a true cloud software company?

[Dheeraj Pandey, Chief Executive Officer]

Yes, thanks for the question, Katy. I mean, if you look at AHV, which we introduced almost 4 years ago, so it took 4 years to get to 40%. And one good thing, we have a good track record for introducing products and then doubling down on them and doing a good job and I think that what we did with AHV, what we are doing with Files, what we are doing with all these different products, they’ve probably gone through their first year in the next 2 years to 3 years and especially talking about 2021, we definitely feel like getting to 40%, 50% would not be unachievable. Now, the important thing is, how we don’t just share shift from Core to Essentials and Enterprise, because it’s relatively easy to just share shift and say look, we can account this as Essentials and account that as Enterprise. But how do we go create new earth is a hard problem and most companies, who are still growing need to find them to be growth engines rather than shifting it from the left pocket to the right pocket actually. So, that’s the challenge that we have upon us and we have to really go and do a good job of creating new earth.

[Katy Huberty, Morgan Stanley]

Thank you. That’s helpful.

[Operator]

Your next question comes from the line of Aaron Rakers with Wells Fargo. Aaron, your line is open.

[Aaron Rakers, Wells Fargo]

Yes, thanks for taking the question. Obviously on the lead-generation side, I want to go back to – if you were to look at your breakdown between existing and new customers, how would you characterize the challenges that you’ve had in lead-generation over this period of kind of a reset? Is it more gaining the new customer momentum or is it – have you seen it show up also in your kind of repeat business at existing customers? And really what I’m trying to get at is, how Duston, has your kind of assumptions around the 3 billion billings number changed relative to what you provided at the Analyst Day back in last March?

[Duston Williams, Chief Financial Officer]

Yes, I mean, just the – and we’ll show you actually, Aaron, the assumptions that we made relative to the 3 billion back a year ago now, as far as repeat purchases, average ASP for new customers, the cohorts and stuff like that. So, I mean, we’ll go back in a few weeks here show you what we had suggested that might look like and a year later after another year of history go compare what we told you. And there’s nothing there that’s off. We got puts and takes, but there’s nothing real different from that perspective. And relative to the 3 billion, I made some comments there, but effectively, we probably pushed things a quarter or two. And I think the good news is, we’ve got a big refresh piece – we really haven’t talked too much about that there’s a lot of that entitlement, if you will, in FY21. So, we’ll show you what that looks like. We haven’t talked much about the potential of Essentials and Enterprise growth there. We will show you some potentials there. But yes, I mean, we will be pretty open as far as what we think there, and ultimately, we’re probably off a quarter or 2 maybe.

[Aaron Rakers, Wells Fargo]

Okay. And then as a quick follow-up just kind of curious on the headcount investment side, as – first of all, how short do you think you’ve been in terms of headcount hiring, and just remind us again, how long it takes to see those investments once they come in and turn to or what’s your views on getting to the right productivity levels on those new hires?

[Duston Williams, Chief Financial Officer]

Yes, on the new hires, again, depending on what type of hire it is, it varies anywhere from 4 quarters or – in Enterprise or GAM from 6 to potentially 8 quarters depending on the scale of the customer they’re going after there. So, that’s kind of the range, so that hasn’t changed much from that perspective.

[Dheeraj Pandey, Chief Executive Officer]

The volume of the hires are still Commercial Select and –

[Duston Williams, Chief Financial Officer]

Correct.

[Dheeraj Pandey, Chief Executive Officer]

Territory guys. Enterprise and GAMs are obviously not that many. And I think in terms of – as I was mentioning before as well that, our sales force has gone through a lot in the last 2 years and there is a little bit of sales prioritization issue, but also to do it in a way that is empathetic to them about subscription, software-only, segmentation, all these things, there are some indirect consequences of the lower marketing spend on how they actually perceive new heads versus existing heads. And also, there were some calendar year-end hiring seasonality as well that we have not taken into consideration, many salespeople actually wait till January. So, I think we probably will have a back-end loaded hiring schedule.

[Aaron Rakers, Wells Fargo]

Okay. Thank you.

[Operator]

Your next question comes from the line of Wamsi Mohan with Bank of America Merrill Lynch. Wamsi, your line is open.

[Wamsi Mohan, Bank of America Merrill Lynch]

Hi, thank you. Duston, your commentary suggests you might have about 6 quarters of under-spending in this lead-generation element. Can you talk about the cumulative amount of under-spend, it sounded like tens of millions, but can you be a little more specific, and how fast can you normalize that spend and does revenue reacceleration just take as long as the time when you redeployed into this? And I have a follow-up.

[Duston Williams, Chief Financial Officer]

Certainly not four quarters, no, I mean, we made a decision back then based on again, efficiencies and how the company was doing in general, that ultimately we kept it flat there. But I mean, the spending going forward, we said in a couple – few tens of millions, so we’ve allocated call it 20-ish plus or minus there million dollars back to lead-gen and we’ll continue to monitor that to make sure that’s enough. But that will – I mean, there is massive focus as you might expect throughout the company on this. As Dheeraj mentioned, we are seeing some early signs there, it takes a while to flush through the funnel. And, but we would expect to see some pretty good progress going into Q4 and then hopefully setting us up into FY20 to have a pretty good year. The cumulative amount, I don’t know exactly what you mean there. We underspent, but we don’t need to obviously increase the spend by history of what we’ve under-spent. It’s not that kind of spend profile.

[Wamsi Mohan, Bank of America Merrill Lynch]

Yes. Okay, thanks, Duston. And correct me if I’m misstating this, but when you say that some shift went from lead-gen to headcount, does this mean that your longer-term OpEx structure is just structurally higher? And can you also comment perhaps about the customer acquisition cost, should that be higher than what we have calibrated to over the past couple of years? Thank you.

[Duston Williams, Chief Financial Officer]

I think the lead-generation spend that we’re talking about in the scheme of things for a company that just spent $300 million a quarter isn’t a massive amount. That’s another thing that we hope to show you at Investor Day is effectively lifetime value of customer, the cost of acquisition of a customer and I think we looked pretty good from that perspective. So maybe in the short-term, we got a little blip here. But again, depending on the growth profile in the past regarding what we’re going to spend, but I don’t think anything has been meaningfully shifted one way or another.

[Wamsi Mohan, Bank of America Merrill Lynch]

Okay. Thank you.

[Operator]

Your next question comes from the line of Jack Andrews with Needham. Jack, your line is open.

[Jack Andrews, Needham]

Good afternoon. Thanks for taking my question. I was wondering if you could drill down a little bit more on the specific tactical marketing spending that you’re talking about. Examples of what exactly do you mean by spending on lead-generation, because you mentioned that the product is 10X better than it was a few years ago, you obviously have a much higher customer base. So, I’m just wondering, are you essentially going to be rolling out a similar playbook that was working a few years ago or do you need to change what is actually happening from a tactical perspective around this initiative?

[Dheeraj Pandey, Chief Executive Officer]

Yes, I think you know it starts with – as I said, two simple inputs, it’s time and money and time is what sales force actually puts in, and money is what we give them to go and do all sorts of events and how do you set up meetings. So, we start looking at these different tiers of the funnel starting from marketing qualified leads to meeting setup to opportunities created to things below that in the funnel itself. And in that sense, I don’t think the methodology has changed. It’s just that the input which is the most basic input is dollars and that has to be the certain formula to that how those dollars convert to leads and to meetings and to opportunities and things of that nature. So, I think we are dispersing a lot of this stuff across the world in like 17 different regions of the world and it’s very similar to what we did almost 18 months ago.

[Jack Andrews, Needham]

Got it. Thanks for your perspective.

[Operator]

Your next question comes from the line of John DiFucci with Jefferies. John, your line is open.

[Julia Karl, Jefferies]

Hi. This is Julia Karl on for John DiFucci. I was just wondering, you had been touching on retention rate previously, but you didn’t touch on it here today. Has anything significant happened with retention rates?

[Duston Williams, Chief Financial Officer]

Yes, it’s a great question. We probably should’ve mentioned that. After we put that in the investor deck last quarter, I think we did ourselves a disservice. We showed a retention rate of roughly 90%. But we did that on a cumulative basis and we should have been doing it on an annual basis like everybody else was doing it. So again, we’ll roll that out at Investor Day, it’s much better than the 90%. So – but we’ll just – we’ll show you that in a few weeks.

[Julia Karl, Jefferies]

Okay, thank you.

[Operator]

Your next question comes from the line of Mark Murphy with JPMorgan. Mark, your line is open.

[Adam Bergere, JPMorgan]

Hi, this is Adam Bergere on behalf of Mark Murphy. Aside from the huge deal with the Department of Defense, did you guys see any material impact due to the long government shutdown this past quarter? Thank you.

[Dheeraj Pandey, Chief Executive Officer]

Yes. I think DoD was still funded and Intel is funded – was funded. It was Civilian and obviously, Civilian, a lot of the stuff was up for grabs and I think the thing actually – the government shutdown was kind of completed a couple of days or a few days before the quarter closed. But apart from one $5 million deal, I don’t think we actually saw an effect from Civilian.

[Duston Williams, Chief Financial Officer]

If the Civilian was funded, we probably could have done a little better, but not meaningful.

[Adam Bergere, JPMorgan]

Awesome. Cool. Thank you.

[Operator]

Our final question for today comes from the line of Simon Leopold with Raymond James. Simon, your line is open.

[Victor Chiu, Raymond James]

Hi guys. This is Victor Chiu in for Simon. Could we isolate the impact to results exclusively to lead-generation meaning if you hadn’t reduced the lead-generation allocation, how confident are you that, that you could have driven results and you had a consensus expectation of like 20%-ish year-over-year growth?

[Dheeraj Pandey, Chief Executive Officer]

I think both sales hiring and lead-generation were the two inputs that we were shy of, and most of it – in an 80-20 kind of argument, I think 80% of it can be contributed to these two actually. 20% is obviously related to better sales execution with the same inputs could drive better outputs. I think Americas could have done better there as well.

[Victor Chiu, Raymond James]

Have you seen any changes in the competitive landscape or secular demand? I know Dell reported results and I haven’t had a chance to weigh in on there yet, but I know ACI is an area that they continue to focus on, so, is there any changes in the competitive landscape?

[Dheeraj Pandey, Chief Executive Officer]

Not really, I mean you know, obviously in the last 18 months, our relationship with them has also evolved. Now we meet in the channel and our products look really, really good. I mean, I can tell you that the few things that we feel proud about is being competitive now. Obviously, they are also going and cannibalizing their existing storage business, which comes in the way of things like gross margin and such for them. But the more they actually go ship VxRail, the better it is for us, because we need like a lot more marketing dollars to be spent on market enablement and education than we can do just on our own.

[Victor Chiu, Raymond James]

Okay, great. Thank you.

[Operator]

This concludes today’s conference call. On behalf of Nutanix, we would like to thank you for your participation. You may now disconnect.