Pure Storage Inc

NYSE:PSTG

Earnings Call Transcript 2021-Q2

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Pure Storage Q2 Fiscal 2021 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to hand the conference over to your speaker today, Nicole Noutsios, Investor Relations. Thank you. Please go ahead.

[Nicole Noutsios, Investor Relations]

Thank you and good afternoon. Welcome to the Pure Storage second quarter fiscal 2021 earnings call. My name is Nicole Noutsios, Investor Relations at Pure. Joining me today are our CEO, Charlie Giancarlo; and our CFO, Kevan Krysler; and our VP of Strategy, Matt Kixmoeller.

Before we begin, I would like to remind you that during this call, management will make forward-looking statements which are subject to various risks and uncertainties. These include statements regarding the COVID-19 pandemic and related disruptions, our growth in sales prospects, competitive industry and technology trends, our strategy and its advantages, our current and future product offerings and business and operations. Any forward-looking statements that we make are based on facts and assumptions as of today and we undertake no obligation to update them.

Our actual results may differ materially from the results forecasted and reported results should not be considered as an indication of future performance. A discussion of some of the risks and uncertainties related to our business is contained in our filings with the SEC and we refer you to these public filings. During the call, we will discuss non-GAAP measures in talking about the company’s performance and reconciliations to the most directly comparable GAAP measures which are provided in our earnings press release and slides. This call is being broadcast live on the Pure Storage Investor Relations website is being recorded for playback purposes. An archive of the webcast will be available on the IR website and is the property of Pure Storage.

With that, I will turn the call over to our CEO, Charlie.

[Charlie Giancarlo, Chief Executive Officer]

Good afternoon, everyone. Thank you for joining us on today’s earnings call. Let me start by extending my sincere wishes that you, your family, friends and colleagues are all healthy and staying well. The current environment continues to challenge us all, but I am proud of how Pure has risen to the occasion. We are helping our customers navigate the crisis and accelerate their digital transformation during this difficult time. The ease, flexibility, and economic security of our Evergreen model has never been more necessary or appreciated by our customers.

Pure’s core differentiators of unmatched technology leadership, simplicity of operation, high performance, and ultimate reliability makes Pure the right decision, especially at this time. These core tenets are also the foundation of our vision of the modern data experience: data storage that is entirely automated, fully dynamic, and provides a cloud-like experience in an as-a-service model with flexible on-demand consumption responsive to the needs of the application. This modern vision is taking hold in the market. The most important characteristic of any cloud infrastructure is reliability and customers become even more acutely aware of this in times of crisis.

I am pleased to announce that in Q2, Pure’s FlashArray product surpassed the full seven nines of total availability across our installed base of tens of thousands of arrays, including during all upgrade cycles, which is unprecedented in our industry. To put this in perspective, seven nines is the equivalent of only 3 seconds of downtime per year. Across our product portfolio, we are delivering savings in power, cooling, and floor space driving ecological advantages and contributing to the lowest total cost of ownership at a time when economic and environmental efficiency are on the minds of our customers. And with our renowned simplicity and cloud-based Pure1 management and support, we dramatically reduced employee time managing storage, freeing them to innovate in a landscape with new demands.

I am pleased with our execution during this crisis and I continue to be very confident that we will exit this downturn in a position of strength supported by our innovative technology, subscription services and a long-term vision that is aligned with customer needs. In Q1, we saw a wave of customers, many of them critical and essential businesses, coming to us to expand their applications and replace their legacy infrastructure that just couldn’t keep up with the new demands brought on by the pandemic. It was a quarter that was dominated by urgent and immediate needs and our customers’ previously important plans were put on hold. In contrast, Q2 was a quarter of re-planning for many organizations. Companies paused to consider the future and reassess their technology direction aligning it to the new reality that their organizations face. Although the situation remains fluid, we believe the second half of the year will see businesses return to and even accelerate digital transformation.

The growth and strength we saw from our international business in the quarter provides an early, but positive indication of increased demands for our solutions when crisis levels created by COVID-19 decline. We continue to dramatically outpace our industry and innovation, and I am excited to share several technology announcements, expanded partnerships, and portfolio and subscription services momentum with you. Today, we announced the second generation of FlashArray//C, the industry’s first and still only all-QLC storage solution. This offering effectively renders hybrid storage obsolete by providing flash density, performance, and reliability at lower costs than legacy hybrid disk arrays. With FlashArray//C for capacity-oriented workloads, FlashArray//X for performance-centric workloads and Cloud Block Store in the cloud, all available under our unified subscription, customers are able to consolidate a broad set of workloads onto a single platform.

Late last quarter, we expanded our file portfolio with the introduction of File Services on FlashArray//C, which allows customers to further simplify and consolidate their general purpose file needs on the same platform. The combination of file support and FlashArray//C enables customers to cost effectively consolidate and run their block-based applications like VMs, databases, and VDI alongside their general-purpose file systems and user shares on a unified FlashArray platform. We continue to see strength in our FlashBlade product for addressing high performance file and object needs with a single platform. FlashBlade continues to redefine what is possible for cutting-edge analytics, real-time data, AI, and scientific workloads. The wide array of software features we delivered earlier this year and in particular file and object replication are rapidly expanding FlashBlade into additional mainstream enterprise use cases. FlashBlade is helping customers drive unparalleled consolidation across multiple workloads so that they can both modernize file and introduce high-performance object in a single platform.

For example, this quarter a large media and entertainment customer selected FlashBlade to consolidate their Splunk, ElasticSearch, and Rapid Restore environments onto a single unified fast file and object platform. This quarter, the National Center for Missing and Exploited Children selected FlashBlade for its high performance replicated file storage to expand and enhance their analysis and machine-learning applications used in the fight against online child exploitation. In these very trying times, it is gratifying to see the ways in which our technology is being used to help those most in need. FlashBlade’s adoption to power rapid recovery and protect against ransomware continues to grow.

Two weeks ago, we announced a partnership with Cohesity to introduce Pure FlashRecover. This is the first fully integrated all-flash rapid recovery solution on the market and we are excited to deliver it in Q3 with streamlined support delivered through Pure. Customer demand has been strong for an integrated solution that not only restores data rapidly in the event of an attack, but also reduces complexity, while scaling both performance and capacity to meet even petabyte-level recovery requirements.

Pure’s Subscription Services continue to yield great results. These services include our Evergreen program and our unified subscription, which delivers our on-prem solutions and Pure’s Cloud Block Store under a single consumption experience. Our unified subscription saw continued strong growth from both existing and new customers in both cloud and enterprise segments, including Telstra, Dizzion Managed Desktop as-a-Service, BidFX and Arrow Energy. These customers are choosing our unified subscription because it is a true enterprise class utility that delivers ultimate flexibility for storage consumption. It provides a cloud-like experience on-premise with the ability to move data to the cloud at any time and align spend with actual consumption.

Cloud Block Store, which is part of our unified subscription, solves one of the biggest challenges for enterprises today, how to cost effectively bridge private and public clouds for Tier 1 applications. The unified software and unified subscription of Pure as-a-Service offer both compelling cost efficiencies and high performance both on-prem and in the cloud. We have also seen strong customer adoption of our Pure Service Orchestrator software, which enables automated, stateful container storage, creating a modern container environment for developers to build cloud-native apps on-prem. Pure Service Orchestrator, combined with Cloud Block Store create a hybrid container strategy that truly unlocks the potential of Kubernetes. We believe our modern data experience vision, unique unified subscription services and hybrid cloud and container strategy, all driven by our FlashArray and FlashBlade platforms, will enable us to continue to grow and take even more market share in the coming quarters and years. Looking forward, I am confident in our opportunity, our long-term strategy, and our ability to reaccelerate growth upon exiting the global crisis, all while continuing to focus on operating discipline. We are the one company driving change in this $50 billion industry, providing an unrivaled experience that customers simply love.

In closing, I am truly thankful to our employees, customers, partners and the entire Pure community for their tenacity, due diligence and flexibility to adapt to and overcome the challenges of the current environment.

With that, I will turn it over to you, Kevan.

[Kevan Krysler, Chief Financial Officer]

Thank you, Charlie and good afternoon everyone. Our Q2 financial results reflect solid execution during the headwinds of the macro environment caused by COVID-19. We are also pleased with the continued strength of our subscription services and the growth of our international business following a challenging Q1.

Total revenue during Q2 grew 2% year-over-year to $403.7 million. Product revenue declined 9% year-over-year, while subscription services momentum continues as revenue grew 37% year-over-year and represented approximately 33% of total revenue, up from 24% of total revenue year-over-year. Subscription services revenue includes revenues from our Evergreen subscriptions and our unified subscription, which includes Pure as-a-Service and Cloud Block Store. We saw significant growth in our international business during Q2, while facing headwinds in the United States created by COVID-19. Total revenue in the United States during Q2 was $282 million, declining 4% year-over-year and total international revenue grew 20% year-over-year to $122 million during Q2. Given the ongoing macroeconomic uncertainty that persists I will continue to provide additional color around our sales performance. Total bookings, or sales, during the first 6 months of the year grew 8.3% year-over-year and during Q2, declined 3.3% year-over-year due to the headwinds we faced in the United States.

Global channel sourced sales continued to represent a growing and meaningful percentage of our total sales. We are very pleased with the close partnership of our global channel. New customers are continuing to choose Pure. Both average deal size for new customers and FlashBlade new customers grew year-over-year. Sales to new customers choosing Pure during Q2 represent over 20% of our total sales. Across our full solution portfolio, we acquired over 350 new customers compared to over 450 customers during Q2 of the prior year. Non-GAAP gross margins for product and subscription services during Q2, was 69.8% representing a slight year-over-year increase of 0.4 points. Non-GAAP product gross margin in Q2 was 70.1%, generally consistent year-over-year and non-GAAP subscription services margin increased 1.8 points year-over-year to 69.2%.

Total non-GAAP operating profit during Q2 was approximately $11 million compared to a non-GAAP operating loss of approximately $3 million during Q2 of the prior year. We continue to focus on strong operating discipline while investing thoughtfully. Non-GAAP net income during Q2 was $18 million and non-GAAP net income per share was $0.06. Non-GAAP net income in Q2 of the prior year was $3 million and non-GAAP net income per share was $0.01. Weighted average shares used for the non-GAAP net earnings per share calculation was 283 million shares in Q2 and 271 million shares in the prior year.

We generated positive operating cash flows of $51 million for Q2 compared to $49 million in the prior year and free cash flows of $26 million compared to $20 million in the prior year. Total cash and investments at the end of Q2 remain very healthy at $1.29 billion. Total deferred revenue for Q2 was $725 million compared to $706 million at the end of Q1 and $607 million at the end of Q2 of the prior year. Our remaining performance obligations, or RPO, which includes our committed and non-cancelable future revenue for Q2 is nearing $1 billion at $956 million. This compares to $912 million at the end of Q1 and $770 million at the end of Q2 of the prior year. During Q2, we returned $20 million to shareholders through share repurchases of 1.18 million shares. Approximately $45 million remains for our share repurchase authorization. Total headcount at the end of the quarter was approximately 3,700 employees compared to approximately 3,500 employees at the end of Q1 and 3,300 employees at the end of Q2 of the prior year.

Now moving to guidance, the growth we have achieved and our focus on operating discipline during the first half of the year is based on the core fundamentals of our business being strong despite the significant economic contraction caused by COVID-19. As we look to Q3, we expect recurring revenue and sales of our Evergreen and unified subscription services will continue to show strong growth though significant uncertainty due to COVID remains. Similar to last quarter, we believe it is still not prudent to provide formal guidance. We are pleased that our total pipeline opportunity for Q3 has increased meaningfully compared to the total pipeline opportunity we saw for Q2. However, a greater proportion of the opportunities in our Q3 pipeline are at earlier stages compared to Q2. And then although not considered formal guidance, our current internal view is that total revenues will be approximately flat sequentially.

Moving to investments, we continue to exercise solid operating discipline throughout the organization, which has enabled us to invest in innovation and increased sales capacity during the first half of the year. We expect net incremental resource additions will slow during the second half of the year and will be concentrated on continued innovation. With our current views of Q3 revenue, we estimate that operating margin will be slightly below breakeven, near negative 2%. To summarize, we are continuing to innovate and successfully navigate the business during an unprecedented economic contraction, including strong growth in our Evergreen and unified subscription services. Our broad customer base, strong partnership and commitment to our channel and our strong growth in recurring revenues, positions us for long-term growth.

With that, we will now open the call for questions.

[Operator]

[Operator Instructions] Your first question comes from Pinjalim Bora from JPMorgan.

[Pinjalim Bora, JPMorgan]

Hey, guys. Thanks for taking my question. Could you – can I double click on just the performance across the different segments? Could you maybe talk about in terms of the bookings growth, how did enterprise do, how did mid-market do, how did cloud and public sector?

[Charlie Giancarlo, Chief Executive Officer]

You bet. Hi, Pinjalim, it’s Charlie. Good to hear your voice. We had – as you heard in the prepared remarks really an excellent international quarter. And I think it reflects what happens when economies recover after a corona lockdown. So, that we felt very strong about that. And we also had very strong unified subscription and overall subscription revenues, very positive there. On a relative basis, cloud and enterprise were much stronger, but of course with the U.S. being down generally, especially in the area of commercial – right commercial and net new logos. Given that, that was down to that of course depressed overall revenues. But I wouldn’t say that it was outside of commercial that it was centered on any particular area. It was really just the reduction in the U.S. overall. We did see overall across the portfolio, the kind of balance that we generally like to see in our products be it a strong FlashBlade, FlashBlade sales growth, both across the world, but again, especially in Europe and the new products are doing well. So, the balance is pretty much what we would expect, but we did see lackluster U.S.

[Pinjalim Bora, JPMorgan]

Understood. And Kevan, on the guidance, it seems like a decline of about 6%, if my math is right, is that mainly on just the composition of the pipeline that you mentioned? Is there a factor of headwind from the subscription transition, anything to call out?

[Kevan Krysler, Chief Financial Officer]

No, I wouldn’t call out a factor on the headwind from the subscription, I really would focus it on the pipeline, and the fact that we are actually quite pleased to see what pipeline has done. It’s an early signal for us, but we did see some sequential improvement in pipeline build, which we actually hadn’t seen for some time. And then just the fact that that’s earlier stage for us really had us come in with some informal views of where we would land for Q3 revenue.

[Operator]

Your next question comes from Simon Leopold from Raymond James.

[Simon Leopold, Raymond James]

Great, thank you very much for taking the question. First, I wanted to see if maybe you could unpack the subscription business a little bit in terms of helping us understand the split and the trends of how much of your subscription business is on-prem and how much is in cloud? Is that something you can offer?

[Charlie Giancarlo, Chief Executive Officer]

Yes, absolutely. The vast majority remains on-prem, because the cloud is a relatively new business, whereas Evergreen of course has been since our inception. And the way that a – the way that subscription operates as you build revenue, it takes time to actually build – to build revenue in it, but we are very pleased with the adoption of the cloud – of the cloud portion of the revenue. And of course, I will say that Pure as-a-Service, which includes both the ratable service-oriented sale of storage on-prem, which is combined with a subscription to Cloud Block Store has really unleashed a lot of opportunity for us and has really driven a lot of sales and in fact a lot of new customer sales. So we are very pleased with that. But there are lot of customers that certainly are planning for cloud that haven’t yet made the jump, but want to make sure that the purchases that they make are both ratable that is subscription, but also transparent and allows them to move to the cloud at any time.

[Simon Leopold, Raymond James]

Thanks. And then just as a follow-up, I wanted to see if you could talk a little bit about the linearity or the patterns you saw in the months of May, June and July versus what you have seen historically. Thank you.

[Kevan Krysler, Chief Financial Officer]

Yes, in terms of linearity, it probably was a little bit worse, as we saw it later in Q2, but nothing that I would view as out of the norms in terms of what we saw. Obviously with Q1, we saw some great tailwinds throughout the quarter, really driven by companies purchasing for mission-critical events and needs. And as a result of that tailwind dissipating in Q2, we saw more normalized linearity.

[Operator]

Your next question comes from Ittai Kidron from Oppenheimer.

[Ittai Kidron, Oppenheimer]

Hey, guys. I guess, I want to drill into this last point of the guidance, and I guess the early cycle of the pipeline as it looks like right now versus previous periods. Charlie, is there a way to correlate this with execution quality on the sell side? Is there a thesis to be made that perhaps in the last quarter or two you over harvested the installed base, didn’t pay perhaps enough attention into getting new customers and now you are just kind of left with not much to harvest and on the flip side, customers that have been squeezed already for what they need to buy?

[Charlie Giancarlo, Chief Executive Officer]

Yes. Ittai, I don’t believe so. That’s the first time that I have heard that thesis to be direct. Our view is that we had seen, as Kevan mentioned, tailwinds in Q1. We did kind of expect them to continue through potentially May but that did not occur, to be clear. Also, you have to understand that, from a sales force perspective, they go from the way of selling that we and that everyone has been selling for years to where everybody is now inside sales. So it’s a completely new way of selling and for customers, a new way of buying. But I think the majority, and I said this in my prepared remarks, the majority of the change was customers now living in a very new environment, both economically, but also are completely reconsidering their digital transformation and what’s important to them and whenever you have a re-consideration or re-planning, you have some stasis. You have an interruption in buying patterns, and I think that’s exactly what’s taken place in Q2. The good news is we have seen it in Europe, that when countries come out of a – the recessionary environment, when they come out of the pandemic environment and the lockdown, then they start to reopen their purse strings and we saw a tremendous quarter in Europe. And I would expect that we would see the same country by country as they come out of the pandemic. Unfortunately in the U.S. we are going in and out repeatedly and it’s almost state by state. And I think that it’s certainly delayed the kind of recovery that we hope to see soon.

[Ittai Kidron, Oppenheimer]

Well, that’s why it’s hard for me to reconcile the comments. I mean if you saw what you saw in the second quarter international properties, why wouldn’t we not see that in the U.S. kind of third quarter where all – a lot of the opening has happened already in the May-June timeframe. How much of a – in any given quarter how much of your business activity really comes from new customers versus existing ones expanding? I feel like new ones don’t contribute that much for an in-quarter. It’s a lot of existing in which case, again, why guide flat, why should that number not be higher?

[Charlie Giancarlo, Chief Executive Officer]

Yes. Well, actually, let me just challenge you a little bit. I mean, we have not seen – we have seen reopening and then re-closing in the U.S. over the last couple of months. And if you just consider the infection rates and the amount of lockdown that’s taken place, there is – it’s a very different picture today in the U.S. than it is in Europe. And so we are still seeing the effects of a muted U.S. economic response currently. But I will let Kevan handle the second part of that question.

[Kevan Krysler, Chief Financial Officer]

For sure. And on net new logos for customers, as I said in my prepared remarks, it actually is quite substantial for us. And even in this quarter, the amount of bookings really generated from net new logos was over 20%, which we were quite pleased with. And just as a quick follow-on to Charlie’s point, any upside that we get on the U.S. has not been considered in our Q3 and formal views, to Charlie’s points that he laid out in terms of the uncertainty and timing and extent of the U.S. recovery. But if there is a significant recovery that we see in Q3, we would see that come through on our results as well.

[Operator]

Your next question comes from Aaron Rakers from Wells Fargo.

[Aaron Rakers, Wells Fargo]

Yes, thanks for taking the question. I have two as well. The first question I just – I think it’s the first time you have actually in the reported results disclosed the RPO balance. And when I look at that balance at $956 million, up about 24% year-over-year, what to me stands out actually is the expansion that you are seeing above the deferred line. And so that being up over 40%, can you just help us unpack what exactly sits in the RPO balance that’s not in deferred? And how we should think about that kind of translating to revenue going forward?

[Kevan Krysler, Chief Financial Officer]

Yes, absolutely. When we think about the expansion over deferred, especially sequentially throughout the last several quarters that’s really due to the momentum that we are seeing from a unified subscription business, that’s really the primary driver of that. And then before that we may have some integrated sales of solutions that are unbilled that would be part of the RPO balance that would not be in deferred revenue, but as we see the sequential increases over the last several quarters that’s really being driven by unified subscription momentum.

[Aaron Rakers, Wells Fargo]

Okay, that’s helpful. And then just as a second question, you talked a little bit about now that having the second generation of the C Series product with QLC in the market, I believe when that was launched, there is a lot of discussion about that being just a natural expansion of opportunity for you guys. So, can you talk a little bit about what you are seeing in terms of the C Series product and how you are seeing acquisitions or leverage relative to your traditional FlashArray systems and the TAM expansion that you are actually starting to see?

[Charlie Giancarlo, Chief Executive Officer]

You bet. So FlashArray//C continues to be one of the fastest product launches we have ever had. And now the second generation is not 100% QLC, but even less expensive because of that. And so we believe it’s actually less expensive than hybrid arrays. So now you get an all-flash array with all-flash performance at a lower price than hybrid arrays. So – and it’s a unique product in the market not only has no other vendor come up with a competitive product, no other vendors come up with a competitive announcement, which after 9 months of the first generation being in the market is really quite remarkable.

[Operator]

Your next question comes from Tim Long from Barclays.

[Tim Long, Barclays]

Thank you. Just the first one if I could just talk a little bit about competition gross margins, any impacts there obviously still pretty strong product gross margin, but down a little bit from last quarter. So, just talk a little bit about that. It seems like in the guidance, it’s kind of staying around these levels? And then I have a follow-up.

[Charlie Giancarlo, Chief Executive Officer]

Yes. Thanks, Tim. I am going to start with the – on the first part of the question around competition and let Kevan handle the gross margin side. Our win rates have stayed about the same. That’s pretty much where we would like – of course, we always like to see more, but about where we would like to see. So the competition, I would think – or sorry the competition, I would say is generally consistent with prior quarters. I will say that customers have been perhaps a bit more demanding in the COVID period. So we are seeing a little bit of that, but on the – I am going to let Kevan handle the gross margin question.

[Kevan Krysler, Chief Financial Officer]

Yes. Thanks, Charlie. And just to reiterate what Charlie indicated, our win rates have been solid and consistent even compared to pre-COVID. So that was a great signal for us as we look at it from the competitive landscape. Back to gross margins and product gross margins, we really do continue to be pleased with our gross margin performance, which is in line with our long-term view and really best in industry. Gross margins were year-over-year relatively consistent. We did see some movement as you suggested sequentially, Tim. I would attribute that to really kind of two factors, one is growth of our international business was representing a higher proportion of our sales and that was a factor in this quarter as our international business traditionally has a little bit lower product gross margins and there was also some larger opportunities we saw during this quarter, where we made an investment in terms of pricing. These are opportunities where we are very excited about the long-term opportunities, including follow-on purchases and commits from these customers.

[Tim Long, Barclays]

Okay, great. Thanks. And then just follow-up, you talked about kind of the vertical mix with small commercial accounts being little bit more challenging. Just talk a little bit I think there has been a directive of the company to push more into the larger enterprise. Can you discuss a little bit how maybe this economic situation might accelerate that move and where is Pure with further penetrating the larger enterprise accounts? Thank you.

[Charlie Giancarlo, Chief Executive Officer]

Yes, No, your question is right on. We did see obviously both at the beginning of the COVID period and continuing stronger results up in the enterprise accounts. It’s been very – on the one hand, it’s been very reassuring to us that not only has it been in existing enterprises where they have brought us in further into their infrastructure, but even winning new large enterprises with large first time sales into the large enterprise. So I believe we have now become the safe choice in many ways, even for large enterprise. But commercial is struggling as a – I think that’s well known throughout all of the IT industry that commercial accounts are having a harder time in the COVID environment and that is, of course, causing us to shift how we focus our sales teams attention with putting more with shifting more resources into larger enterprise, and for the time being, managing commercial with the appropriate amount of sellers and support.

[Operator]

Your next question comes from Karl Ackerman from Cowen.

[Karl Ackerman, Cowen]

Hey, good afternoon. And I hope you are healthy and avoiding the plume of wildfire smoke surrounding the Bay Area. Two questions, if I may. You did very well internationally this quarter I was hoping you could address the competitive environment and whether bids have become more competitive. I asked because while your, I guess, primary competitor EMC has introduced a Midrange Array, that is what we expected, but Huawei recently also introduced OceanStore arrays. But the U.S. Department of Commerce I think has severely restricted that company’s access to silicon. So if you could address the puts and takes in your ability to perhaps gain share in Asia going forward, that would be helpful?

[Charlie Giancarlo, Chief Executive Officer]

Sure. As you may know – our sales in India and China and even South America are relatively small portion of our overall sales, and that tends to be where Huawei has its greatest strength. We don’t see – we do see Huawei, but we don’t see them a lot in Western Europe. We – they have crept up a little bit more over the years, but still a relatively small amount of our engagement is with them. With – the majority of our engagement continues to be with Dell. And frankly our win rates against Dell continue to be very strong overall. You asked about their new PowerStore, honestly, I would have expect – I did expect to see them much more often or PowerStore much more often than we have. Honestly, we see PowerMax much more often than we see PowerStore, and PowerMax was brought in as a last gasp by Dell when they were losing the account to us on extra discount. So it’s – PowerStore, we think, is actually continues to be a great opportunity for us because Dell has effectively said we have to replace four products in the field, need another forklift upgrade by them. It’s not a good time to be introducing a 1.0 product, which is what it is. And whenever a customer now is running up against the end of sale of those other four products, we can claim to be and we are the safe bet for them. So with our Evergreen which we introduced with our first product six or seven years ago, customers know they will never have to do a forklift upgrade again and that’s been proven over six generations. So, Dell is just – they are our biggest competitor, but we feel very confident in terms of our positioning against them.

[Karl Ackerman, Cowen]

That’s very helpful. For my follow-up, if I may, there has been much discussion on the growth of how distributed storage architectures from edge computing should drive significant opportunity in object-based storage software and hardware development. How do you see your role evolving with object-based storage particularly in software and with your FlashBlade offering? As edge computing evolves over the next few years, I guess, how does that influence your strategic planning for augmenting your Pure as-a-Service offerings around software? Thank you.

[Charlie Giancarlo, Chief Executive Officer]

Yes, it’s – that’s a really interesting area, and of course an up and coming one that’s very important. First of all, we do believe in the container world and we believe that’s going to be a very strong new set of implementations and changes that are going to be going into the entire virtualization environment. Of course, there are going to be applications that are developed directly on top of a container environment, and we feel like we are well placed with the FlashBlade to be able to support those very high-performance, very needy container environment with respect to being able to get high-speed of object in particular. But in addition to that, there will be many customers that want to transition their existing application environments over to containers to make them more portable, more resilient. And for them we have our Pure Service Orchestrator which is now in place with hundreds of customers. It enables those customers to use their existing storage environment with – in any one of our products and even with our Cloud Block Store with containerized applications that they create from their existing environments. And then again, it allows them to operate it on our Unified subscription and so forth. So we feel like we are – it’s obviously a very new space, but we feel like we are – like we are innovating in the right path for those customers that are going to be increasingly developing our containers.

[Matt Kixmoeller, Vice President, Strategy]

Yes, this is Kix. I mean, I will just add on specific to your question on the object part of it. When we developed FlashBlade 4 years plus ago now, we made a bet to make it a unified file and object platform. And frankly at the time, people looked at that and said, object, that’s the protocol people usually use for low-end, low-performance, low-cost storage. What’s there – what’s the reason for an all-flash object store? But the reason has really been cloud-native and modern applications that are increasingly using object as their primary storage and so just a great part of our FlashBlade business has been the growth of object. And as you brought in the edge architectures, we very commonly see data created at the edge, but then centralized for an analytics and that ability to have an on-prem centralized really fast object store for analytics of data and IoT-type deployments is a key use case. And one we expect will keep growing.

[Charlie Giancarlo, Chief Executive Officer]

And just to give you a sense of how far advanced we are, Pure Service Orchestrator just had a more recent release where we are actually the first to support the latest version of the CSI, Container Storage Interface put out by – in Kubernetes. So we are tracking this very closely. Both object and containers are a core area of focus for us.

[Operator]

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

[Unidentified Analyst]

Hi, thanks for taking my questions. It’s [indiscernible] filling in for Wamsi today. I was just wondering if you can help us bridge the sequential – expected sequential decline in operating margins between fiscal 2Q and 3Q. What are the puts and takes there? It looks like it’s about a 480 basis points decline. So any color there would be helpful.

[Charlie Giancarlo, Chief Executive Officer]

Thank you. We are – we continue to invest – well, first of all, I will say that it is our intention and our expectation that the company will show an operating profit for the year. And so that’s the focus that we are operating on. At the same time, as we have stated at the very beginning of the crisis, we intend to continue to invest in our customers, our support and most particularly in our innovation capability and in our products because I believe what Alan Greenspan once said which is that, the one thing you know about all recessions is that they all end. And we believe that we are going to exit this recession in a position to be able to reaccelerate once we come out of it. And we think it’s going to be technology-led and customers will respond and respect those vendors that continue to invest during the downturn.

[Unidentified Analyst]

Okay, thanks for that, Charlie. And just for my follow-up, last quarter you launched Purity 3.0 for FlashBlade. I mean, how has the reception been, has that helped you get incremental customers? And if you can just comment on, how bookings are trending currently in the third quarter? Thanks.

[Charlie Giancarlo, Chief Executive Officer]

Yes. So I will start with the FlashBlade 3.0. This is really – it’s already deployed on literally hundreds of arrays. So it’s been a very fast uptake of the 3.0 and it’s been really notable how many customers have deployed the fast file and object replication. And they have done it for a number of different use cases, data protection, data – excuse me, disaster recovery, and they have done it between both on-prem and public cloud sites. So the – and I think illustrative is what we just did with Cohesity. We really have designed a system with them, but we have also added additional capabilities to our product to add additional security and features with respect to ransomware so that customers can not only detect ransomware and protect themselves against it, but recover very rapidly, such as within an hour after a ransomware attack. So what – the strength, of course, of FlashBlade and especially so with the 3.0 release is that it is unified for both our fast file and object the big use cases are big data analytics, log analytics, machine learning, as we have said in the past, but increasingly, especially with the new features, chip design, genomics, geophysical modeling. So all of the – as you might imagine the high-performance use cases and then lastly, what I will mention is it’s being increasingly used for mixed-use cases, which is something very different than in the past. In other words, it could be – it will be used by some customers for analytics and at the same time rapid recovery and ransomware protection, as well as just large scale file repositories all at the same time. And it can do that just because of the performance and the scale of the product.

[Kevan Krysler, Chief Financial Officer]

And then in specific to Q3 in terms of current views, any of the views that we have seen early days really were part of what we have shared in our prepared remarks and how we’re looking at Q3 in terms of our internal views and the informal guide. But that also plays into how – what we are seeing on pipeline in terms of increasing pipeline build sequentially from what we saw in Q2.

[Operator]

Your next question comes from Nehal Chokshi from Northland.

[Nehal Chokshi, Northland]

Yes. Thank you. So, good to see you continue the traction with the overall bookings growth and looks like you had about $28 million in unbilled contract bookings so I think all that is associated with the Cloud Block Store and Pure as-a-Service. Can you give us a sense as to how it splits out between those two though?

[Kevan Krysler, Chief Financial Officer]

We really look at that, Nehal, as a Unified subscription, because that’s how we sell it, that’s how we go to market and so when we look at our subscription services as a category, you really have really two major categories, one being Evergreen, which has been out there for some time and is still growing at an accelerated rate, and the other one is our Unified subscription. But we don’t track to – nor do we talk about it from a public standpoint, the breakout of our Unified subscription, given that our selling motion and how customers are utilizing at both on-prem and in the cloud, it doesn’t make a lot of sense for us.

[Nehal Chokshi, Northland]

Right, okay. And then your current view basically implies that there is going to be a pretty significant step down in the year-over-year growth of product revenue. And if you look at – look out at various companies that have a hardware element, it doesn’t, at least, come as a surprise to me, I guess – and thank you for providing that view, I think that’s going to prove to be unique, but I am going to push you a little bit further here. Do you have a view on when on-premise hardware bottoms in terms of their year over year trajectory?

[Charlie Giancarlo, Chief Executive Officer]

I – it’s hard to say, but we do think that as the economy improves, you will see – let me phrase this another way. I think it’s very clear now that the dominant view of our enterprise is that their future is hybrid, that is some combination of on-prem and in the cloud, and really what they want to do is to unify that to be able to create an environment where that choice for them is more economic than it is a decision about technologies, and where that they can negotiate both with on-prem vendors, as well as with cloud vendors to get the best possible economic and performance, as well as full application and services position that they can possibly be in. So we’re seeing a very strong uptake of the hybrid cloud idea. So, what that really says is it’s about – your question really goes to when those IT spending start to really recover. I think it depends a lot upon the trajectory of the pandemic in the U.S. and I would expect that when we see the – when we start to see the economy recover, that is GDP start to pick up and IT spending start to free up, that we will see a recovery and as you phrase it, a bottoming out of our on-prem equipment spend.

[Operator]

Your next question comes from Erik Suppiger from JMP Securities.

[Erik Suppiger, JMP Securities]

Yes, thanks for taking the question. First off, you had noted the commercial market soft. Can you just remind us how much contribution you have from commercial accounts and how you size commercial accounts? And then secondly, you have a number of new product cycles, I’d be curious to know how you kind of size the opportunity for the unified services versus the size of the opportunity for your FlashArray//C. I know they are very different products, but how do you see those if you look out say, 3 to 5years?

[Charlie Giancarlo, Chief Executive Officer]

Yes. Well, of course, one always expects the new products to grow faster than the company overall. As we mentioned, FlashArray//C has had a huge start to it. We expect that to continue to for some time, because it extends into a large market or because its part of a very large market that we didn’t part to that no one has participated in before. If we look at FlashRecover, that’s an – data protection is an $8 billion market and we are just getting started in that. And then if you look at our new release, which we just released in the last week of our last quarter, which is file services on FlashArray//C, standard general purpose file stores is a market that we haven’t participated in at all and again is a multibillion dollar market. So, I think as we look forward 3 to 4 years if we have the kind of success in those products that we individually had in FlashBlade over the same 3 to 4-year period, we are talking well over $1 billion and close to $2 billion or more. So, it’s a great – we just see great upside in the portfolio overall.

[Matt Kixmoeller, Vice President, Strategy]

Yes. One other data point I might just add, if you look at the overall enterprise storage market, we are still in a zone where more disc is sold than flash and flash has obviously come in and eroded all of the high-end of the use cases. But there is still a lot of hybrid arrays that are sold out there that are a little bit of flash and a lot of disc on the back end. One of the unique things now with FlashArray//C, when we first launched it, we talked about how it got kind of in the neighborhood of hybrid arrays, we now believe it’s substantially less expensive to deploy FlashArray//C than a hybrid array, about 30% cheaper. And so as we talk to our larger scale enterprise customers, it’s just becoming a no-brainer to not to look beyond the Tier 1 and now look at their Tier 2 franchises that used to really have hybrid arrays to have the final transition to flash happen.

[Charlie Giancarlo, Chief Executive Officer]

And then just to answer your question on enterprise and we talked about from a new customer, total customers – our total customer base about what 45% of those are Fortune 500. And I think that’s a good way to look at it. Bookings as a total share for enterprise would be north of that, generally is a good way to think about that. And then obviously, you would still have commercial and in public sector with FED and SLED.

[Kevan Krysler, Chief Financial Officer]

And actually just to make sure there is no confusion, we are in about 45% of Fortune 500.

[Charlie Giancarlo, Chief Executive Officer]

That’s right.

[Kevan Krysler, Chief Financial Officer]

Yes, rather than it’s – but then as a percentage of share of bookings, it’s a good way to think about it north of 45%.

[Matt Kixmoeller, Vice President, Strategy]

Maybe one final thing I will mention, I think often we are asked how big the flash market is and Pure from the early days has said look, don’t define us in the all-flash market define us in the enterprise storage market as a whole. And we have now talked really about three key areas that I think when you ask most people in the market, they would say, no, that’s still disk, where we have built substantial businesses in flash. One is in object storage, one is in backup and recovery and now Tier 2 applications. And so I think we are proving that we can really push flash into the broad part of the market that people assumed was really the disk market previously.

[Erik Suppiger, JMP Securities]

Very good. Thank you.

[Operator]

Your next question comes from Mehdi Hosseini from Susquehanna.

[Mehdi Hosseini, Susquehanna]

Yes, thanks for taking my question. I actually have a follow-up to your very last statement. When I look at the backup recovery is about a $1 billion of business, 8% of external storage and then the hybrid is about half of the external storage market. And in that context, my question to you is when you announced the agreement with Cohesity, is that aimed at displacing the backup recovery with FlashArray or are you expecting incremental market opportunity? And then back to hybrid, if half of the external storage is hybrid, how quickly do you think we are going to get to a third or less, is that a matter of a year or two and an improvement in global economy or is this going to be a slow death? And I have a follow-up.

[Charlie Giancarlo, Chief Executive Officer]

Yes, let me start with the discussion on the Cohesity partnership and then I will turn it over to Kix on the specific market sizes. So, on the Cohesity product that we are putting out, we see it as enabling – it’s – think of it as an appliance that is pre-configured, easy to set up, our customers can install in less than a couple of hours and it immediately provides them with a rapid recovery solution to protect them from any data outage and in particular against ransomware attacks, etcetera. We really view that as perhaps the first in Pure of what we would call Pure-validated designs, where we simplify the task of a variety of different storage application environments for our customers, this one being ransomware attack and offered as a – in this case, as an appliance, but perhaps in the future with other partners and other solutions provided by the channel as an integrated solution.

[Matt Kixmoeller, Vice President, Strategy]

And then just to put some numbers around that, because I am not sure I agree with the one you threw out there. The overall backup and recovery market is about $8 billion and that goes down to about half software and half hardware solutions. On the hardware side, that was traditionally just basic backup appliances historically like Data Domain. We are really going after that whole market with this partnership because we can present an opportunity to really modernize the entire backup and recovery spend to modernize the software and the hardware side of things. And so we believe it’s a financial opportunity there to go after backup and recovery, and particularly drive faster recovery there. And regards to your question around the hybrid storage environment overall, look, the hybrid market for hybrid arrays is pretty broad from very large scale enterprises who deploy them in mass for their kind of Tier 2 franchises, all the way down to people who spend $5,000, $10,000, $15,000 for the only array they own. That’s – latter part is not a market we’re interested in going after. But we believe for large enterprises who historically used hybrid arrays as their Tier 2 platform, that’s really the sweet spot for FlashArray//C and we think it’s increasingly clear that when you are a large-scale enterprise, it’s just too expensive to run disk anymore. And you just look at the operational pain and the overhead and the complexity and the reliability issues disk introduces, it’s just time to go all-flash.

[Mehdi Hosseini, Susquehanna]

Got it. Thanks for clarification. And just a quick follow-up, last quarter you highlighted FlashBlade and actually, to my surprise, you attached a $55 million of revenue you recognized in the April quarter. Anything you can share with us regarding July quarter?

[Kevan Krysler, Chief Financial Officer]

No, and actually that was a sizing we provided last quarter in connection with total sales, which is a little bit different than revenue, but we haven’t updated that sizing. But we were very pleased with what we saw in terms of FlashBlade performance.

[Operator]

Your next question comes from Eric Martinuzzi from Lake Street.

[Eric Martinuzzi, Lake Street]

Yes, I wanted to explicitly address the Q3 gross margin assumption, given roughly flat sequentially on the revs. You guys have talked about a long-term range between 65% and 70%, but I am wondering why Q3 gross margin would be substantially different from where we finished up Q2, given strength in international and continued growth in subscription.

[Kevan Krysler, Chief Financial Officer]

And so we did not give any formal views or informal views around gross margin. We are pleased, as you mentioned, with our performance on gross margin. I wouldn’t see anything unusual as I think about our gross margin performance in Q3. I did talk about our views of operating margin for Q3 and that might be what you are referring to.

[Eric Martinuzzi, Lake Street]

Yes, I was just kind of back – you said the bulk of the delta between EBIT was on the OpEx side and I was trying to get you to explicitly talk about the GM but I got my question answered. The headcount that you saw increase there, roughly 200 between the end of Q1 and Q2, is the impact in the OpEx going to be a full quarter of the 3700 employees or do you plan to add additional heads in Q3?

[Kevan Krysler, Chief Financial Officer]

Yes, I think there will be a mix in terms of how those costs come through for Q3. And then in terms of our hiring in the second half, still looking to have some incremental hires, really focused on the innovation front and will be less so than what we saw in the first half in terms of total hiring – of net-net hiring in terms of increase of total headcount.

[Operator]

Your next question comes from Katy Huberty from Morgan Stanley.

[Katy Huberty, Morgan Stanley]

Yes, thank you. Good afternoon. Sorry, I jumped on a little bit late. I know this has been asked a couple of times, but would love for you to double-click a bit more on the below-the-normal seasonality revenue trend in October. And specifically you have significant exposure to cloud customers, which is a great secular growth market. Do you feel like there were some pull forward of demand from those customers and so that pipeline is a little bit less mature, drier than it typically would be? Is there a lagged effect from the economic declines that we saw on the calendar second quarter? Just sort of some of the factors that you think are playing into the much weaker than seasonal outlook for the calendar of 3Q with October quarter.

[Charlie Giancarlo, Chief Executive Officer]

Yes, Katy. Thank you. Much more of the second item that you mentioned we think, which is a delayed effect from the lowered Q2 performance by U.S. across the board, just kind of being reflected then in Q3 actual numbers. Actually, whatever acceleration we might have had from cloud in large enterprise in Q1, I don’t feel that it was of such a substantial nature that it’s really affecting a lot of quarters.

[Katy Huberty, Morgan Stanley]

Okay, thank you. And then just secondly, can you talk about the – is there any makeup of customers that are driving the really strong 37% subscription growth? Is it skewed to certain regions? Are there particular verticals that are early adopters? Like is there a trend in terms of customer size where you are seeing the demand or is it truly just broad-based across the customer set?

[Charlie Giancarlo, Chief Executive Officer]

Well, the trend is that it actually is going to broad-based. It started out with being dominated by one or two customers a quarter, very large customers a quarter dominating the revenue that we would get in a pass deal. And now it is much more balanced across all million dollar plus customers, but just much larger numbers of them. And so that was – that’s very good to see obviously, going to more broad-based and larger average customer size.

[Kevan Krysler, Chief Financial Officer]

Yes, I would actually split it out between broad-based both for the Evergreen, Charlie, which we are getting huge interest and continued interest in Evergreen. And so our strong renewal rates are definitely contributing to that. That’s broad-based. And then what we are seeing on the Unified subscription is also broad-based with a lot of increase on net new logos.

[Charlie Giancarlo, Chief Executive Officer]

Yes, yes.

[Operator]

Your next question comes from Steven Fox from Fox Advisors.

[Steven Fox, Fox Advisors]

Hi, good afternoon. Thanks for taking my question. Just on – one quick question on Slide 5. I am just trying to understand the discrepancy between how incremental purchases grow with your top-25 customers versus the overall number, which is only like $2 after the first 24 months. Is that macro related or is there some other trends in there that we should be aware of? Thank you very much.

[Kevan Krysler, Chief Financial Officer]

No, and this has been pretty consistent with what we have showed in the past, so nothing new to highlight on that front.

[Steven Fox, Fox Advisors]

Okay, thank you. And then if I could just squeeze another since that one was, I guess, pretty obvious. Just on vendor discounting and vendor financing that’s picked up, how is that impacting either closing deals or how you have to price deals overall? Thank you.

[Charlie Giancarlo, Chief Executive Officer]

Yes. As you may well know, we don’t provide ourselves vendor financing, instead we provide Pure as-a-service that provides pay-as-you-go consumption model, which in most cases is a less expensive and more resilient purchase capability or purchasing option for our customers because they only need to pay for what they use when they use it. And so, we have found that to be very competitive and in many ways a superior offering to vendor financing of our own gear. And it’s why you see many of our competitors attempting to come up with consumption type of services on their own, but given the limitations of their products, they are rarely able to – be able to do anything similar.

[Operator]

And that was our last question. At this time, I will turn the call back over to Charlie Giancarlo for closing remarks.

[Charlie Giancarlo, Chief Executive Officer]

I want to thank you all for taking the time to join us today. Pure, like many companies, but we’re very focused on how we can improve the experience of our customers and our employees. I do want to send my sympathies out to all of our West Coast employees, many of whom are not just sheltered in place, but in some cases packing up and ready to flee their homes from fires and smoke. And I want to send my thoughts and prayers out to all of them and everybody on the West Coast that are suffering from fires and frankly, also many of our suppliers that are in the eye or at least in the bull’s eye of the upcoming hurricanes. So we continue to be there for you. We do believe – we continue and we believe that the investments that we make in our customers, our channels and our products in this extremely difficult period is going to truly allow us to accelerate our growth when the global economies, country by country, start to recover. So with that, let me ask you all to stay safe, stay socially connected, but physically distant, and we look forward to speaking with you next quarter. Thank you.

[Operator]

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.