Pure Storage Inc

NYSE:PSTG

Earnings Call Transcript 2019-Q2

[Operator]

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Pure Storage Second Quarter Fiscal 2019 Earnings Conference Call. 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].

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

[Matt Danziger, Vice President of Investor Relations]

Thank you, and good afternoon. Welcome to the Pure Storage Q2 Fiscal 2019 Earnings Conference Call. Joining me today are our CEO, Charlie Giancarlo; our CFO, Tim Riitters; our President, David Hatfield; and our VP of Product, Matt Kixmoeller.

Before we begin, I would like to remind you that during this call management will make forward-looking statements which are subject to various risks and uncertainties. These include statements regarding competitive, industry and technology trends, our strategy, positioning and opportunity, our current and future products, business and operations, including our operating model, growth prospects and revenue and margin guidance for future periods.

Any forward-looking statements that we make are based on assumptions as of today and we undertake no obligation to update them. Our actual results may differ materially from the results predicted and reported results should not be considered as an indication of future performance. A discussion of risks and uncertainties relating to our business is contained in our filings with the SEC and we refer you to these public filings.

During this call, we will discuss non-GAAP measures in talking about the Company’s performance and reconciliations to the most directly comparable GAAP measures are provided in our earnings press release and slides. This call is being broadcast live on the Pure Storage Investor Relations Web site and is being recorded for playback purposes. An archive of the webcast will be archived on the IR Web site for at least 45 days and is the property of Pure Storage.

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

[Charlie Giancarlo, Chief Executive Officer]

Thank you, Matt. Good afternoon everyone. Thanks for joining us on today’s earnings call. I will begin the call with a summary of our Q2 results and highlights. Hat will then provide a go-to-market update and finally, Tim will give a detailed review of our financials and our updated outlook.

Q2 was an exceptional quarter for Pure. Our Q2 performance was very strong and the team executed well. We saw great momentum in the business and achieved profitability in our seasonal Q2, reflecting the inherent advantage of our technology and the strength and leverage in our business model. Revenue for the quarter was $309 million, up 37% compared with the same period a year ago. Gross margins were particularly strong at 68%, up 1.7% sequentially and operating margins were positive 0.3%. All three measures exceeded the upper end of our guided ranges. We expect to strengthen gross margin to continue for the remainder of the year and we are raising our outlook as Tim will share in more detail later.

Pure’s continued focus on customers and innovation has positioned us repeatedly as the technology leader in the data storage market. For the fifth consecutive year, Gartner has recognized Pure as a leader in their Magic Quadrant. And in the most recent report, Pure was positioned farthest to the right and highest on both the execution and innovation axis. Our focus on software, next generation applications and bringing NVMe to the mainstream, positioned us above all other competitors as we continue to democratize flash for an increasing number of use cases. This strategy of democratizing flash for the mainstream was on display at our Accelerate Conference in May. At the event, we highlighted our customers’ journey to a data centric architecture, replacing old styled scale-out direct-attach storage designs. The optimization of SaaS converged networks, compute and storage led by Pure, has enabled enterprises of all sizes to build modern data centric architectures with shared accelerated storage.

In Q2, we delivered on that vision. As you recall last year, we announced FlashArray//X, the first all NVMe all-flash array. At Accelerate this May, we launched the full X family, which enables NVMe across the entire product line. And in Q2, more than 50% of shipments were all NVMe. In contrast, our competitors are just beginning to bring their NVMe offerings to market and only in their highest priced products. The speed of adoption of our X family of products has been impressive and we continue to expect that by the end of the year the vast majority of our revenue will be NVMe. In short, our democratization of NVMe is working.

It was also a strong quarter for FlashBlade as we saw expansion in our major use cases such as AI and rapid restore, as well as our largest customers expanding their purchases with a material number of new customers acquiring FlashBlade for the first time. During the quarter, we saw very promising momentum with our AI deployments of AIRI. We also recently completed the acquisition of StorReduce, Pure’s first M&A transaction as a public company. StorReduce is a unique cloud optimized de-duplication engine for object storage, which enables both hybrid and cloud native architectures for managing large-scale unstructured data. StorReduce’s technology is 100% software and was designed to be cloud first, and we are excited about the natural integration plans with both our current on-premise product portfolio and also its contribution to Pure’s cloud integration and cloud services capability. We welcome StorReduce customers and partners and most importantly the StorReduce team to the Pure family.

When I spoke to you a year ago, we outlined three operating priorities, including focus on our customers, operational excellence and innovation everywhere. With an NPS score that continues to rise, industry-leading and increasing gross margins, a healthy, profitable business model and a product portfolio that continues to lead the competition, we will continue to achieve milestones and look forward to increasing our leadership.

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

[David Hatfield, President]

Thanks, Charlie. Q2 was indeed a stellar quarter for Pure as our momentum continues to build. Pure’s strategy to deliver unparalleled technology innovation, a differentiated business model and a relentless focus on customer success, has underpinned our consistent operating results. We are in a fantastic innovation cycle across our FlashArray, FlashBlade, FlashStack, AIRI and Pure1 platforms. This innovation, together with the evergreen architecture and business model that we pioneered, enables our customers to take advantage of these unique capabilities earlier and with no business disruption when compared with any of our competitors.

Our differentiated innovation and execution is not only validated in the Magic Quadrant, but Pure also scored the highest of all vendors in Gartner's critical capability report. Being recognized as number one in virtualization, database and OLTP, NDI use cases three of the largest revenue segment in the AFA market. Thousands of global enterprises turn to Gartner's for guidance in identifying best-in-class companies to partner with, and we are proud of this recognition for the fifth consecutive year.

We are also pleased to share that the fourth year in a row, Pure has an increase to certified net promoter score 86.6, up from 83.7 last year retaining our spot in the top 1% of all B2B companies. Critics have noted that as companies scale it’s common to see net promoter scores decline over time. However, it’s rewarding to us with our relentless customer-first focus to defy this conventional wisdom. Our channel centric go-to-market strategy to take these unique capabilities to market is working, especially when we see our largest competitors taking more business direct. The new partner program that we unveiled at our Accelerate Conference last quarter has been well received and is showing quick results, particularly within our largest national partners.

Our sales teams performed extremely well in the quarter and are benefiting from the differentiation in our current product cycle. We added nearly 400 new customers for a total of more than 5,150 and we are pleased with the mix across our focus markets. Win rates remain very strong across the Board. And along with our industry-leading gross margins, it showcases that our sales teams and partners are consistently able to quantify our unique value. FlashArray win rates increased sequentially and year-over-year, driven largely by our new all-NVMe FlashArray//X product line and the adoption of active cluster. Quite simply, we don't think anyone should find ASA in 2018 without NVMe at its core, and only Pure can deliver this fully parallel architecture cost effectively to the market.

We also had a very strong quarter with our FlashBlade offering. Our rapid restore use case continues to enjoy strong momentum and the Q1 launch of our AI ready infrastructure solution, AIRI together within Nvidia, expanded in Q2 with AIRI Mini and it delivered strong retraction as well. Importantly, we’re finding that the simplicity of AIRI Mini to kick-start AI deployments and then easily expand is a value proposition that competitive solutions just can’t match. While still in the early innings, AI is proving to be a technology that cuts across many industries in all geographies. We now have multiple AI customers in finance, government, social media, technology, healthcare, automotive and AI services with a balance of customers from early-stage startups to decade old market leaders.

Our data centric architecture and consolidation message is resonating across all industries as well with a number of million dollar wins in Q2, the highest in our history. We were particularly pleased with our progress selling into the cloud, healthcare and financial services segments in Q2. Our cloud segment continues to represent approximately 30% of our overall business and enjoys the highest win and repeat purchase rates across our customers. Across the enterprise segment, we saw continued progress in our customers, consolidating business applications and next generation analytics into a shared accelerated storage platform, including both FlashArray and FlashBlade. In the quarter, we had wins across some of the leading healthcare and financial services organizations, including University of Texas, MD Anderson Cancer Center, the New York Genome Center, Desjardin Group and the Royal Bank of Canada.

Finally, as Charlie noted, we are thrilled about the acquisition of StorReduce. StorReduce has already forged strong partnerships with key public cloud providers, and their technology enables multiple cloud and on-prem use cases, including multi-cloud data tiering, migration and protection. We look forward to sharing more on our plans for StorReduce integration and our overall cloud strategy in the months to come. The momentum in our business is fantastic. We’re in a great innovation cycle. We’re investing in the cloud. And customers and fellow Puretans are enthusiastic about the second half and the years ahead. It truly feels like we’re just getting started.

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

[Tim Riitters, Chief Financial Officer]

Thanks, Hat. Q2 was a great quarter for Pure as we exceeded our guidance ranges on all three of our guided measures; revenue, gross margin and operating margin. Before I dive into specifics, I'll make my usual note that the gross margin, operating margin, OpEx, net income and free cash flow numbers I will use are non-GAAP unless otherwise noted. A reconciliation of these non-GAAP metrics to their GAAP comparables, as well as our full Q2 results and presentation are available on our investor relations Web site at investor.purestorage.com.

Total revenue for the quarter was $308.9 million or 37% growth year-over-year and exceeded the upper end of our guided range. Product revenues were $241.1 million or growth of 34% year-over-year. Support subscription revenues were $67.8 million or growth of 51% year-over-year. Revenue performance was driven by solid business fundamentals and strong execution by our go-to-market teams. Geographically, 74% of revenues came from the United States and 26% came from international markets.

Total gross margin in Q2 was 68%, up 1.7 points from the previous quarter. This represents the highest gross margin performance we have seen in the Company's history. These results illustrate the value we deliver to our customers and validate the significant differentiation between our software centric products and our competitors’ retrofit architectures. Product gross margin increased 1.6 points to 67.9%, driven by continued strength across all of our products, component cost savings and the early adopter margin benefits associated with the launch of our FlashArray//X product line. Support subscription gross margins increased 2.1 points to 68.4%, driven by a continued increase in amortization of ongoing support subscription contracts as a result of our growing install base, continued solid execution in our support organizations and timing of certain renewal bookings during the quarter.

Turning to operating margin. We delivered another quarter of profitability with Q2 operating margins at positive 0.3%, representing an 11 point improvement over the same period a year ago and a 5 point improvement over the midpoint of our guidance. The outperformance in the quarter was driven by a strong revenue growth and gross margin above our Q2 guided ranges. Net income in the quarter was positive $2.4 million or positive $0.01 per share based on a weighted average share count of 263 million shares. This compares to a net loss of negative $20.7 million or negative $0.10 per share based on a weighted average shares outstanding of 209 million shares in Q2 of the last year. Total headcount at the end of the period was more than 2,450 employees, which represents an increase of approximately 150 employees during the quarter.

Turning to the balance sheet and our cash flows. We ended Q2 with cash and investments of $1.1 billion, which was up slightly from last quarter. Free cash flow was negative $18.9 million in the quarter, including $7 million from our employee stock purchase plan. This compares to free cash flows of negative $22.5 million during the year ago quarter, which included $5 million from our employee stock purchase plan. As a reminder Q2 tends to be the lowest point of cash flow generation throughout our fiscal year.

With that, we’ll now turn to our guidance. For our third quarter, we expect revenues in the range of between $361 million and $369 million, or $365 million at the midpoint. We expect gross margins to be in the range of between 64.5% and 67.5% or 66% at the midpoint. We expect operating margins in the range of between positive 4% and positive 8% or positive 6% at the midpoint. For the full year, we expect revenues in the range of between $1.35 billion and $1.38 billion, a midpoint of $1.365 billion, which represent an increase of $20 million from our previously guided midpoint. We are raising our gross margin range to between 65.5% and 67.5%, or 66.5% at the midpoint. We are also raising our operating margin range from between 2.5% to 4.5%, or 3.5% at the midpoint. The raising of our full year guidance is an indication of the strong momentum we are seeing in our business, a validation our strategy is working and a statement on the excitement we have for the second half of the year.

With that, we’ll now open the call for questions. Operator?

[Operator]

[Operator Instructions] Your first question comes from Aaron Rakers from Wells Fargo.

[Aaron Rakers, Wells Fargo]

I was wondering if you could just dig a little bit deeper into the gross margin drivers here and in particular, I'm curious if what you're seeing from a NAND pricing dynamic, whether or not you're able to abstract or that is the driver to any of the gross margin. And I guess just given on a forward-looking basis, it sounds like you feel like some of these dynamics will continue. How much confidence do you have in that as we start to see NAND flash pricing decline and whether or not you would pass that through to your end-users?

[Charlie Giancarlo, Chief Executive Officer]

I would break down the gross margin benefit that we had this quarter and what we see going forward on three different things. The first is, frankly, we’re able to sell value and we’re able to -- I think coming out with the X series and just our increasing awareness of our evergreen program is having the intended effect on our customer base. They understand the value that we bring and clearly we get a premium now for our products and that’s expanding. Two is that yes, we definitely -- the X series did bring more value to the customer and also because it actually gets enhanced performance out of the flash, that gives us a benefit. And then third is as we’ve mentioned in the past, we believe that we’re able to take advantage of lower cost NAND faster than anyone else in the industry.

And as we’ve been predicting for almost a year now, we thought we’d start to see NAND prices start to decrease or that we’d be able to get the benefit of decreasing NAND prices starting this quarter -- starting this past quarter and that's exactly what we saw. We saw the beginnings of that last quarter and we feel pretty good. We know what those NAND prices are going to be for us for the next quarter or two, so we feel pretty good about that.

[Aaron Rakers, Wells Fargo]

And as a quick follow-up as we think about the growth and just in general the storage market, your closest peer NetApp grew 50% year-over-year in terms all-flash business, you guys grew 37%. I am just curious when you look at the overall market and what seems to be a pretty good demand backdrop. How do you think about traditional enterprise storage versus what you're seeing as far as the contribution from next generation workloads, if you will, AI, rapid restore within your product revenue stream?

[Charlie Giancarlo, Chief Executive Officer]

Well, let me just take flat out that we’re competing for the entire storage market. And when we look at that, we grew 37% year-over-year and the rest of our competitors at best were high single digits. So let there be no mistake. There you can't compare replacing some magnetic install base with putting in some new flash disks and identify that as being the same growth rate as what we’re seeing. We’re growing 37% as a company. Hat, do you want to add some color on that?

[David Hatfield, President]

The only thing I would add is we’re thrilled with our net new customer acquisition, nearly 400 that’s six net new customers per day. And I think the other folks have stopped talking about that, because they really are relying on converting their install base. The win rates I think in gross margin were two areas that are the headline here. Our win rates against NetApp and everybody else grew sequentially and grew quarter-on-quarter and year-on-year, while we’re expanding margin. So we think that pretty much on that.

[Charlie Giancarlo, Chief Executive Officer]

And the last thing that’ll mention if I can add in here is that. As we do see pricing decline with NAND over time, elasticity is real. We will be getting more and more of what our traditionally tier 2 use cases, and that’s market expansion opportunity for us.

[Operator]

Your next question comes from Mark Murphy from J.P. Morgan.

[Mark Murphy, J.P. Morgan]

Thank you very much, and I will add my congrats on healthy results. What to ask you whether your confidence in 30% multiyear revenue growth increase is coming off a quarter where the growth rates are higher than they were a year ago. You mentioned your net promoter scores rose even higher as well. So does the confidence increase and what factors do you think are essential to achieve sustainable growth at that scale, which is very rare in the technology markets?

[Charlie Giancarlo, Chief Executive Officer]

We’re very confident of the growth rates that we set out before. We’re on track for $2 billion in a couple years time and hopefully, hitting that on a run rate basis next fiscal year. I would say that our confidence stems not so much from any one quarter's performance, but much more from the NPS scores that you identified that is love of our customers. And just as importantly, the pipeline of products that we have coming out the door, we just released X series but we have a whole pipeline of new capabilities that we’ll be talking about over the next year. And we feel very good about the innovation engine that we have behind us.

[Mark Murphy, J.P. Morgan]

As a follow-up on your cloud mix or cloud adoption, I believe you recently had a SaaS company make a seven-figure initial purchase. Could you update us on the traction and maybe the types of discussions that you're having with the cloud and SaaS providers? And maybe what you think this going to bring here in the second half of the year?

[David Hatfield, President]

So as I mentioned, the cloud business continues to be a really strong for us, multimillion dollar wins initially, the highest repeat purchase rates and highest close rates; so that continues to be a key area of focus for our selling teams in the cloud 1,000 and candidly the top cloud providers overall. So we'll keep investing there. We are pleased with the up market by emphasis that we had at the beginning this year. And I think that's reflected in having the highest number million dollars wins in the quarter as well. So cloud business is a key growth driver for us but we saw great traction across enterprise and our commercial businesses front.

[Operator]

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

[Wamsi Mohan, Bank of America Merrill Lynch]

If you look at the competitive landscape, there has been lot of talk about product SKU consolidation at EMCs and significant introduction of different channel strategies by others. But you guys delivered the best gross margin quarter in your history. Are you leaving some revenue growth on the table with these margins?

[Charlie Giancarlo, Chief Executive Officer]

Thank you for the message. We don't think so, we certainly -- I would say from a standpoint, we’re focused on growth as a company. Now we’re not going to leave money on the table and certainly we take our premium as we can get it. But I’ve said this in the past, we certainly don't win on price but we’re not going to lose price either. So for every opportunity that we are -- that our product is the best solution for, we’re going to win that deal.

[David Hatfield, President]

Wamsi, I’ll just add, there is no doubt this product cycle is benefiting the sales team. But I’ve been doing this for almost 30 years and I think we have the best sales team in this segment by far. I think that in conjunction with our channel centric go-to-market is really paying dividends. I think we’re growing international partners, we’re growing with the larger partners and that's a back drop where the competitors are taking more deals direct. So I just think we have a really nice competitive landscape to operate in with really great sales team and breaking capabilities to differentiate.

[Wamsi Mohan, Bank of America Merrill Lynch]

And as a quick follow-up, you mentioned elasticity of demand as NAND price declines. The NAND price declines have been fairly significant. What do you think that does to overall industry growth rates? I mean can we talk about 10 point faster potentially growth for the industry or how do you guys think about sizing that opportunity in terms of elasticity or demand?

[David Hatfield, President]

That’s a difficult question frankly to answer. We know that elasticity is real, but it’s hard to project exactly what -- we of course see NAND pricing declines. But translating that into AFA market declines is a complex formula that’s controlled largely by large players more than us. And so it’s difficult to -- as we mentioned in the past, we think they will not be able to take advantage of low NAND prices as quickly as we do. And therefore that may be longer incoming, so a little bit difficult to predict. But what we do know for sure is as NAND declines more of the magnetic market will come up for AFA replacement.

[Tim Riitters, Chief Financial Officer]

That elasticity is something that we’ve tracked a lot since we’ve been a company. And that elasticity has proven itself out in all of these scenarios of NAND going up NAND going down, so it’s a trend that we feel very confident in.

[Operator]

Your next question comes from Sherri Scribner from Deutsche Bank.

[Sherri Scribner, Deutsche Bank]

You guys have had very strong margins over the past couple of quarters to some extent helped by the changes in NAND pricing. And if you look at the guidance, it suggests margins come down a bit but still in the higher end of the range. I guess what are some of the puts and takes on your business and the gross margins doing better as we move through, not just this year but longer term, it’s been your long term target. And what are some of the risks to the margins as you move into ’19 with NAND prices may be stabilizing?

[Charlie Giancarlo, Chief Executive Officer]

Let me take the front end of that and then I’ll pass it to Tim on the other side of it, which is that the first thing that I think is very important is that NAND pricing is part of our improvement in margins. But frankly, the new X series and the value that we have been -- the greater recognition of the value that we bring with evergreen and therefore our ability to maintain a premium for our product is I think probably the more the greater advantage. So the advantage in our overall solution, the model, the software that we bring, the capabilities that we bring with that software and the premium we’re able to get for it, I would say, is probably the larger contribution to that but certainly NAND pricing helps. And I’ll let Tim take that.

[Tim Riitters, Chief Financial Officer]

Yes, I would just echo Charlie on all of those dimensions. I think I’d really focus on the software innovation. We’ve been talking about this for a long time about how we were software designed at its core, which has allowed us to optimize on whatever flash maybe out there and whatever flash maybe advantageous for us. And you’ve seen that in times of declining NAND, you’ve seen that in times of increasing NAND. So there's a reason why we are at the top of the industry and product gross margin and we expect that to continue.

[Sherri Scribner, Deutsche Bank]

I guess just following up on that, I think you got your long-term target. You’re clearly at the high end of that. And the product mix, the value that you guys are providing, all seem to be big drivers of that, and those don’t seem to potentially be going away. So how should we think about those long term targets? Are they maybe at the low end it’s probably too conservative and we should really be thinking about you being at the higher end long term?

[Charlie Giancarlo, Chief Executive Officer]

Well, what we’ve guided to is the rest of the year, so we’re feeling fairly confident there. We’re not ready to change our long-term guidance on this it’s a bit too early. You alluded to mix. What you see in any new product line, such as FlashBlade is that with you get better margins as sales increase. So I wouldn't put too strong a focus on mix going forward. As FlashBlade increases in sales we’ll get better gross -- it is a lower gross margin product today, to be clear but the margins are improving. And I expect that -- that’s a normal course of events for new products.

[David Hatfield, President]

And you saw that certainly over the medium-term, Sherry in terms of the guidance that we offered, obviously are raising 0.5 for gross margin for the full year give the statement in terms of the position we are in right now where we have this significant lead in NVMe, the innovation cycle is working very well. So we really like what we see in the medium-term.

[Operator]

Your next question comes from Katy Huberty from Morgan Stanley.

[Katy Huberty, Morgan Stanley]

You spend a lot of discussion about product margins that you’ve seen and even more impressive growth in support margins over the last couple of quarters. So would love your thoughts as to why that won’t continue as revenue scales, or is there some reason that we’re approaching a growth on support subscription margins…

[Charlie Giancarlo, Chief Executive Officer]

There is a lot of interference Katy on your line. I think you’re asking about op margin performance and why we might not expect that to continue going forward. Again, I'll start off with an answer and then let Tim conclude. So as we’ve talked about in the past, our target was to get to mid single digits profitability and then really pour on the gas in terms of growth rate overall for the company that as long as our -- as long as we are profitable and that we could maintain growth in the 30 to 40 or higher percent range that our real focus as a company was going to be on maintaining growth, that is our aim. We do have the foot on the gas in terms of growth. And each quarter has the vagaries of hiring and expense and so forth but that’s our target is to really focus on growth.

[Tim Riitters, Chief Financial Officer]

And Katy our apologies as there was little bit of noise in static here. I think you're also asking a question about support margins, and you're absolutely right. Support margins if you look over the last several quarters, they've been climbing very, very nicely. I think it's really a combination of great efficiency and effectiveness by our wonderful world class support organizations they’re doing a fantastic job. But also just as that business scales, there is inherent leverage in the business. And then finally the evergreen model is starting to kick in. We’re seeing great renewal rates now at scale and really that’s providing that nice lift on the support gross margin side as well. So a lot of things to be excited about both pieces of gross margin if you will.

[Operator]

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

[Alex Kurtz, KeyBanc Capital Markets]

So just another clarification on the X series. Tim is there -- also that’s out anyone, because you’re delivering a significant difference in price per IOP than your traditional products with the X series. Is there a segment of the high-end of your install base that are seeing real value there and maybe your product margins could just structurally be higher going forward, because you're providing so much more value at the really tier 0, tier 1 workloads. So maybe there is just a reset on the top end of your install base? And then I have a follow-up on the cloud.

[Tim Riitters, Chief Financial Officer]

So Alex on gross margins, we’ve always thought about our gross margins as a pool in a portfolio in the business. And so we sell as you heard Charlie say earlier value. And so part of what you saw this quarter is those early adopters really putting X to the test and X to use and we’re delighted with what we’re seeing. And so we’re going to manage that pool. I wouldn’t draw the next conclusion that gross margins keep going and going and going. But we’ve always managed the pool and with the X series, it’s no different.

[Charlie Giancarlo, Chief Executive Officer]

I think in general, we just have never believed in the high end niche performance segment back to the earliest days of Pure, we believe in democratization and that's exactly what we’ve tried to drive with X, bringing NVMe to the masses. And so if you look at achieving 50% of our product line on NVMe now, we think the high -- the far bigger opportunity is to drive consolidation with the product line.

[Alex Kurtz, KeyBanc Capital Markets]

Just on the cloud, when you look at the year, what’s the cadence of the growth rates there relative to the rest of the business?

[David Hatfield, President]

Continued progress on the 30%, we think that’s reflective of where we’re going to continue to have it march. Our up market buys focuses on three key segments the cloud 1,000 is obviously at the top of the list, the Fortune 500, which is north of 35% now and the [G2K] and in the largest nonpublic healthcare government agencies, and we saw nice progress across all three of those.

[Operator]

Your next question comes from Andrew Nowinski - Piper Jaffray.

[Andrew Nowinski, Piper Jaffray]

So first I want to ask about ELAs, one of your competitors started offering ELAs to larger strategic customers. Does Pure Storage offer these yet? And if not, are you willing to begin offering these to the larger global customers?

[Tim Riitters, Chief Financial Officer]

No ELAs at this point in time, as the business scales and we think about software that might be something we take a look at. But again remember all of our products, how we’ve gone to market in the past is everything is included. And so that’s one of the other reasons you’re not seeing ELAs in our business right now.

[Andrew Nowinski, Piper Jaffray]

And then last I just want to ask about your hybrid cloud strategy. I saw your ES2 announcement at Accelerate. But I guess how do you compete against NetApp if the client wants a storage platform that enables on the run the same operating system in Amazon as they do on premise?

[Matt Kixmoeller, Vice President of Product]

I think we absolute believe in the hybrid model of IT, and we’ve made a number of announcements and development initiatives around supporting that. So at Accelerate we announced our CloudSnap offering, which allows us to integrate our arrays on-prem and be able to send data to the cloud natively. And then if you look at the acquisition we announced today, we’re excited about a lot of the hybrid use cases that that acquisition unlocks to be able to federate data across both on-prem and hybrid cloud.

[Operator]

Your next question comes from Ittai Kidron from Oppenheimer.

[Ittai Kidron, Oppenheimer]

Couple of questions for me first for you, Charlie. Last call you’ve talked about how you're working hard to scale the business, one of the main reason you came to this company is to make a lot of changes in the go to market and the enterprise approach. Help me think about some of the things that you've done. In what way are they already showing and in what way are they still not showing, and they’re still very much ahead of us to look forward to?

[Charlie Giancarlo, Chief Executive Officer]

I wouldn’t say that I came to make a lot of changes but I certainly would say that I came to help the company to continue to scale going forward. Some of the changes that we made, which I think the company to a large extent was already embarked on was this upscale bias and what that meant in terms of channel programs, in terms of product to product structures, in terms of marketing programs and how we address enterprise and cloud level opportunities, we’ve certainly done that. And as you know, we reorganized the company's business for greater focus around business units and that certainly give us a greater focus for this year.

And other things that are perhaps less apparent to the outside was just making sure that we had really good alignment around the main area that was going to make a difference for us going forward, such as what we do for enterprise customers, such as how we align all the way from supply chain to engineering, to marketing, to sales. So I would say it was really just innovating around the edge or aligning what was already all the good practices at that the company and refocusing around the ones that were going to make a bigger difference for us in the future.

[Ittai Kidron, Oppenheimer]

Then you for you Kix, NetApp and NVIDIA also announced this relationship I guess around AI. How do I compare and contrast what you do with them versus what NetApp is doing with them?

[Matt Kixmoeller, Vice President of Product]

The same attention is just from a flattery and I think it was certainly the case in those announcements. I’ll just point to a couple of things. Number one, we’re seeing real growth in our app business and we continue to see wins with NVIDIA and feel good about it. You can look at the public references we put out, and I’m sure any of competitors have put out any public AI references as an example. And secondly I would say is that one of the things that really is an advantage to flash plate is it scale from small to big. And mostly our initiatives don't start huge they start small, but then they grow quickly as people get steam with them. And one of the real advantages to our product line is you don’t have to buy in our largest array on day one. You can start with a small flash plate and grow seamlessly as you add initiative grows.

[Operator]

Your next question comes from Jason Ader from William Blair.

[Jason Ader, William Blair]

I have one for Tim and one for Charlie. For Tim, can you confirm that the X series has a better gross margin than the M series because that’s what’s it seems to imply from the margins this quarter?

[Tim Riitters, Chief Financial Officer]

The short answer, Jason, at this point, yes X margins are better for us for the reasons I think we talked earlier on the call in terms of value our customer are seeing and the value that we can capture from it, so yes.

[Jason Ader, William Blair]

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

[Tim Riitters, Chief Financial Officer]

There is some benefit there because as Charlie alluded early in the call, we’re starting to see the benefits of NAND. I mean we’ve seen a tight NAND market for the last year, we always thought that right around this time we start seeing some relaxing on that bill material components and that’s indeed happening.

[David Hatfield, President]

The other thing I would add is just with our direct flash architecture, we can now program directly to run in. And so with X we’re buying run-in instead of buying finished SSDs and that of course gives us an advantage to it.

[Jason Ader, William Blair]

And then for Charlie. Maybe following up a little bit on Ittai’s thread, obviously the business looks really strong. But where do you think the company can be doing a better job, maybe a vertical or a geo, I guess it's -- maybe it’s as much perhaps you're too just in terms of the sales and go-to-market side?

[Charlie Giancarlo, Chief Executive Officer]

Coming into any company, I would view it as an antique car. You’re driving down the road, having a wonderful time but you’re only miles away from the alternator going or a break pad or something like that. And every company always requires this constant tuning. So in any particular quarter, there are things we can do better and we want to make sure that we’re well aware of those. And so having a company that is very transparent as to where its challenges are so that you can address them rapidly is very important, and that’s what we try to instrument here. I don’t know that it’s useful to go into specific areas. But there are - to be clear, we started our journey focusing more up market. There's still a lot more work to do there to be very clear.

We’re excited about our technical team and technology and the acquisition that we’re announcing today. There is more that we can do there and we plan on bringing out more. And we continue to fill out a number of areas, both features and capabilities of our product line, which as we’ve said in the past we still have more to go there, as well as our cloud story, we continue to build there. So lots of room for improvement but we’re proud of where we are and very optimistic about how these -- as we continue to focus on these areas, how that will improve the business going forward.

[Operator]

Your next question comes from Erik Suppiger from JMP Securities.

[Erik Suppiger, JMP Securities]

A couple of times you’ve referenced some of your competitors taking business direct. I assume that’s EMC. Can you talk a little bit about what type of business you see that taking place and what actually has happened with some of your channel partners as that's opened up some opportunities?

[David Hatfield, President]

I wouldn’t isolate it into one specific vendor I think it's a trend that we’re seeing across multiple. I think we’ve got order 10 to 15 points of gross margin advantage and a differentiated product line that we just extended our lead even further, it’s hard to compete with that. And so I think they're trying to do whatever they can do to win. And our success in competing with them is measured in terms of the expansion of the gross margin and the win rates. And so, Dell, I think has changed the culture of it, of EMC, we see a lot of those folks leaving many of them are leaving to partners of ours. So they’ve got deep domain knowledge and they’ve been deep biased quite a bit.

So they will go over with the receptive embrace and we also see them coming here. And it seems to me that the trend is they’re more focused on top line and they can get there with servers, they get there with servers versus focusing so much on storage. So I think it’s a general competitive landscape that benefits our uniqueness and we’re very confident in the second half of the year.

[Erik Suppiger, JMP Securities]

Then last question. Do you think you might start breaking out FlashBlade in the some -- foreseeable future, maybe in fiscal ’20?

[Charlie Giancarlo, Chief Executive Officer]

We really, as I've said in the past, breaking out individual line items on a reported basis for individual products, especially new products that tend to be lumpy and tend to go through learning curves, is I think can distract from our -- from the way that were followed. FlashBlade did have a good strong quarter this quarter, so we’re pleased about that. But I don’t see breaking it out anytime in the near future.

[David Hatfield, President]

Eric just one thing to follow-up you mentioned on the partner as well. And so the new partner programs that we rolled out have been really well received. And the national partners -- we’re rewarding those partners that invest in us. And so there's reciprocal relationship that they’re investing in practices and they’re driving more leads to us, they benefit financially from that. So that’s an area we’re going to continue to invest. And I think it’s that dynamic while the others are pulling away a little bit from the channel at least as appears to me and to us is benefiting us from the largest national players.

[Operator]

Your next question comes from Simon Leopold from Raymond James.

[Victor Chiu, Raymond James]

This is Victor Chiu in for Simon. I was hoping you can help us dig a little deeper into the longer-term opportunities and the role of flash specifically in newer applications like Big Data and AI. Because when we look back historically at how flash storage evolved, there was a time when it was considered an extravagance because of the performance was so far ahead of the rest of the parts of the data center, it is hard to make the case for it economically. Obviously, that’s shifted as compute hardware has advanced to the point where legacy disk is obviously the bottleneck in a lot of situations and flash is more standard. So I guess my question is, should we think about the progression and advancements of GPUs and other specialized silicons as being analogous in this respect? And are the current flash platforms sufficient enough to meet the current needs, given that we’re still in the early stages here? And at what point ever do they become bottlenecks versus more specialized solutions like FlashBlade?

[Matt Kixmoeller, Vice President of Product]

I think we’re excited about expansion on both sides of the spectrum. So as you noted with GPUs and AI and a renaissance on the top end of the performance that’s creating demand that only flash conserve and so that helping us sell NVMe and some of the higher performance offerings. And then as you look at the forward motion of NAND cost price declines, we think we can go after even more so by data center that would have only been in the layer of disk before. And then the final thing ultimately the StorReduce acquisition from us is about going after terabytes that might even landed on disk or tape and modernizing those as well , leveraging cost storage is the cheaper storage option as opposed to on prem. And so we think it’s high time to modernize everything and we’re seeing good opportunities in both directions.

[Operator]

Your next question comes from Mehdi Hosseini from SIG.

[Mehdi Hosseini, SIG]

Thanks for taking my question. Most of the good questions have been already asked, I have couple of follow-ups. Looking at your acquisition announced tonight is very intriguing and very interesting, especially the dedupe feature of this acquisition, and two follow-ups. Do you see this acquisition running independent for a few years before becoming embedded into your flash products? Or is it going to be embedded into the FlashBlade as you try to scale your object oriented products? And I have a follow up.

[Charlie Giancarlo, Chief Executive Officer]

So by independent I think you mean what we sell at software running on a standard hardware. And the answer to that is yes. We do plan -- so to be clear though, for the immediate next several months our plan is to maintain -- to continue to maintain and support their customers but not to add new customers. While we -- you might call it purify the software that is make it compatible with our management, make sure that it has the reliability that our large customers are going to expect, the availability in that environment. And we'll talk more about this towards the latter half of the year.

We’ll be able to describe exactly how this folds-into our overall product line and the exact program of what the new product announcements are on that. As Tim might have mentioned, we -- both the expenses as well as the revenue are incorporated in our current guidance. So we don't see it being a major…

[Tim Riitters, Chief Financial Officer]

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

[Mehdi Hosseini, SIG]

And one follow-up on NVMe. When do you expect NVMe over fabric solution to be supported by fiber channel?

[David Hatfield, President]

So I think as you’re aware, when we look at the NVMe opportunity, we saw -- the biggest opportunity to be implemented within our systems that’s where most of the latency in a storage transaction occurs, so that’s where we focused on first. We promised that we would be bringing out NVMe over fabric by the end of this year. And as we’ve stated publicly, our first goal is to actually start on the IP side and then follow that on the fiber channel side. And so we are absolutely on track with our deployment of the IP side this year and we expect fiber channel next year.

[Operator]

Your next question comes from Rod Hall from Goldman Sachs.

[Unidentified Analyst]

I have couple of questions, on FlashArray, you said that win rates have increased quarter-on-quarter. Just wondering is it solely driven by NVMe FlashArray, or anything else that’s helping in there? And then I’ve got a follow-up.

[David Hatfield, President]

The product cycle overall I think is contributing to that. There’s no doubt that the FlashArray//X really extended our mote in differentiation is having a big effect on our biggest business.

[Unidentified Analyst]

Any particular geography or against any competitor that you’re seeing better win rates?

[David Hatfield, President]

We’ve seen them consistently across the board for years and that hasn't changed. So I think we’ll continue to focus on driving our success in the largest markets internationally and the largest segments that we’ve got. So we did see a particularly strong quarter in the Americas in Q2, which we were thrilled with and obviously it being our largest business when that grows, it really helps the overall top line as well.

[Unidentified Analyst]

One last question, what kind of trends are you seeing in FlashBlade business? You mentioned that you’re seeing larger deals more frequently. Any further color on that would be helpful. Thanks.

[David Hatfield, President]

I would just say -- I'll hit the first part and Kix maybe follow-up underneath it. We’re seeing great traction in three real use cases, one is the rapid restore use case and other one is in backup [and data] replacements and the third one is in the next generation analytics and AI. And so all three of those are very repeatable and we’re seeing great traction and success across segments. We talked about the New York Genome Center, it’s one of the largest competitive installs that we’re aware of in this area. We also talked about RBC and this is a great win for us with one of the largest banks globally. And so there’s a whole bunch of other successes that we had across healthcare, large SaaS companies and public sector. So we’re seeing great adoption across those three use cases across segments.

[Operator]

Your next question comes from Eric Martinuzzi from Lake Street.

[Eric Martinuzzi, Lake Street]

A question regarding StorReduce, just wondering if this is -- did you find that you were maybe lacking something in the product portfolio, so not having this capability cost you maybe and some competitive bids? Or is this really more about broadening your current offering to the install base so that you’re there with them when they want to have a hybrid capability?

[David Hatfield, President]

Look, I’d say a couple of things. First off, we don’t have dedupe today in flash plates and this is a natural fit in that sense. But in the broader equation here, often times when we go out and meet customers around Big Data, they have hundreds of petabytes of data. And bringing hundreds of petabytes to flash stick probably isn’t realistic. And so we often get to discussion with them about how we can move tens of their petabyte to flash, but we need some lower tier for the rest of the data. And so we think the rest of the data should be in the cloud. And so if you look at a previous workflow from a decade ago customers might have used three flavors of disk and tape, we think the future is flash and low cost public cloud storage.

[Eric Martinuzzi, Lake Street]

And as far as the partner education, I understand you got to do some integration on the technology side. But what about the timeline for getting the partner smart on this capability?

[David Hatfield, President]

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

[Charlie Giancarlo, Chief Executive Officer]

And we feel like we’ve got the time to be able to do that. So we feel confident about the timelines we have in place for that.

[David Hatfield, President]

And perhaps it’s also useful to mention that this product also brings strength in new partnership areas. StorReduce was successful and created a number of cloud partnerships as well and we intend to embrace and extend those partnerships.

[Operator]

Our last question comes from Stephen Fox from Cross Research.

[Stephen Fox, Cross Research]

Just on the channel centric focus and also the ramp-up in the larger scale wins. It seems to be creating some operating expense leverage, as well as gross margin leverage. Can you just talk about whether your expectations for further OpEx leverage have changed going forward given the success you’re having? And then I had a very quick follow up.

[Tim Riitters, Chief Financial Officer]

No, I think you’re right in suggesting that there is leverage there to be had. But I would just point to the guidance that we issued here today, raising our full year profit up. So there is inherent leverage in the business to build, the business is performing well and very healthy. But I don’t think it’s changed our long-term view of the dynamics and go-to-market and the success we've been having.

[Charlie Giancarlo, Chief Executive Officer]

And I’d just add, a lot of the investments that we make upfront take some time to come through. And so we’re seeing the benefits of some of that and candidly we’re doubling down. I think our competitors in the market are going to feel us in the second half as we invest in our channel partnerships, invest in market awareness and invest in additional capacity. So we're really excited and motivated about the second half. And Kevin this one's for you, EFT.

[Stephen Fox, Cross Research]

And Tim just real quick on the cash flows for the full year guidance now. What is that say about not necessarily cash flow from operations, you’ve been specific about that, but free cash flow now as we think about your investments for the full year. Where do you think you come out for the year roughly on the free cash flow line?

[Tim Riitters, Chief Financial Officer]

Steve, we’ve never really guided free cash flow, it just can be noisy. I mean, it has to do with cash collections standing in individual quarter boundary or anything like that. I think all we've done is qualitatively said last year we were positive free cash flow for the year a small amount. We definitely anticipate being a stronger FCF generation year this year but really point people on our progress to the operating margin, which is a much more stable book stable and predictable number than any given quarter of FCF.

[Operator]

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

[Charlie Giancarlo, Chief Executive Officer]

Thank you, Mike. Everyone, we’re proud of our progress this quarter and we’re proud of empowering our customers to succeed. I really want to thank the entire Pure team and our global partners for their tireless efforts and their dedication. And lastly on behalf of all Puretans globally, I’d like to welcome again the StorReduce team along with their customers and partners to the Pure Storage family. We believe that the StorReduce team has built an incredibly exciting technology that has the opportunity to make a major impact on the next generation of cloud storage architectures. And once again, I want to thank you all for joining us on this call today. It’s been a pleasure talking to you and I look forward to chatting with you in the days and weeks to come.

[Operator]

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