Earnings Call Transcript - NTNX Q2 2020

Operator, Operator

Thank you for joining us for the Nutanix Q2 Fiscal 2020 Earnings Conference Call. I will now hand it over to Tonya Chin, Vice President of Investor Relations and Corporate Communications. Please proceed.

Tonya Chin, Vice President of Investor Relations and Corporate Communications

Good afternoon and welcome to today’s conference call to discuss the results of our second quarter of fiscal 2020. This call is also being broadcast over the web and can be accessed in the Investor Relations section of the Nutanix website. Joining me today are Dheeraj Pandey, Nutanix’s CEO; and Duston Williams, Nutanix’s CFO. After the market closed today, Nutanix issued a press release announcing financial results for the second quarter of fiscal 2020. If you’d like the release, please visit the Press Releases section of the Nutanix website. During today’s call, management will make forward-looking statements regarding our business plans and financial targets in future periods, the timing and impact of our transition to a subscription business model, the factors driving our growth and the benefits and capabilities of our new and existing products. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially and adversely from those anticipated by these statements. For a detailed description of these factors, please refer to our SEC filings including our most recent quarterly report on Form 10-Q as well as the earnings press release. These forward-looking statements apply as of today and we undertake no obligation to update these statements after this call. As a result, you should not rely on them as representing our views in the future. Please note, unless otherwise specifically referenced, all financial measures we use on today’s call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We provided, to the extent available, reconciliations of these non-GAAP financial measures to GAAP financial measures in the Investor Relations section of our website and in our earnings press release. Turning to our upcoming conferences, Nutanix management will be at the Morgan Stanley, TMT Conference on March 2 and the KeyBanc Emerging Technology Summit on March 3. Both conferences are in San Francisco. We hope to see many of you there. Lastly, we’ll be hosting our Investor Day 2020 in New York City on Thursday, March 26. The event will be webcast on our Investor Relations website. Institutional investors and analysts interested in attending in person should contact IR at Investorday@nutanix.com for registration information. And with that, I’ll turn it over to Dheeraj.

Dheeraj Pandey, CEO

Thanks, Tonya. Q2 was another strong quarter and I’m pleased to see continued execution from across our organization. Our TCV billings came in on the high end of our guidance range and our TCV revenue, gross margin, and EPS all exceeded our guidance despite a softer US federal business. Further, our deferred revenue surpassed $1 billion for the first time this quarter, growing 35% year-over-year. Business is robust and our transition is well ahead of our internal plans. But we’re also in an environment that is very challenging due to the impact of the Coronavirus. Dealing with the unknown for the first time in the company’s decade-long history, hence we’re cautious about our second half guidance, which Duston will elaborate on soon. Since we began our transition to a subscription business model in Q1 of FY 2019, we’ve regularly highlighted the areas of our business that are evolving along the way. After another strong quarter of progress, I would like to emphasize a few areas of the business that stood out: first, a faster than expected transition to subscription; second, our growing number of large deals and the continued adoption of new products and solutions beyond our core; third, the momentum we’re seeing in our commercial business; and finally, our promising partnership with HPE, which continues to bring us new customers and once again outperformed our expectations during the quarter. A key driver for our improved sales execution over the past year has been the strong leadership of Chris Kaddaras in the Americas and EMEA in the years before that. Chris joined us as an EMEA sales leader more than three years ago, right around when we went public. We were a tiny company back then—almost one-third the revenue, one-fourth the number of customers, an appliance business model and a single product in our portfolio. We’ve come a long way since then. The sales force in this time has endured a dramatic transition in the business model, learned to sell software, and really strived to master the portfolio selling approach that most companies could only dream of. Chris has also focused on careful segmentation of the upmarket business in the last two years, both in EMEA and in Americas. If you recall, we set out to segment our business almost three years ago as the muscle to go beyond a billion in annual sales required large customers, a profound customer success culture, and a strong portfolio of products that are secure and reliable. Large customers do not buy point products; they buy a platform and operating system that can address multiple use cases. I’m happy to report that our large enterprise business has flourished in the last 18 months ever since we started down the path of the subscription transition. We now have 18 customers with lifetime spend greater than $20 million, up from 12 a year ago. Their aggregate lifetime spend is almost $600 million, up 56% year-over-year. The largest three cohorts of lifetime spending—$10 million to $15 million, $15 million to $20 million, and $20 million plus—have now collectively grown more than 60% year-over-year, both in number of total accounts and in aggregate dollars spent. There are 60 customers that fall into those cohorts and those 60 customers now account for more than $1 billion of lifetime spend with us. We have 220 accounts that have each spent more than $4 million in lifetime spend, accounting for more than $2 billion lifetime, and this cohort has grown nearly 50% year-over-year. Subscription compression notwithstanding. Specifically in Q2, we closed 52 deals worth over $1 million in the quarter, including 11 deals worth over $3 million, which includes three deals over $5 million. Eleven of these customers also spent at least $1 million with us last quarter, and more than half substantially increased their node count with us during the quarter. Notably, TCV bookings from our top 10 customers in Q2 increased approximately 30% from the previous quarter. We now have 1,060 customers with at least $1 million in lifetime spend, up 36% year-over-year. We have 880 of the Global 2000 as customers, including three of the Forbes Global 5, eight of the Forbes Global 10, and 70 of the Forbes Global 100. All in all, we’ve done a pretty good job of selling and competing in the large account segment, profoundly disrupting the hardware and perpetual software incumbents. This is why I’m happy to announce the thoughtful architect of this enduring transition, Chris Kaddaras, is now going to be a global leader of the company as Executive Vice President of Worldwide Sales. He’s equally passionate about the commercial mid-market and has been busy working in the other end of the go-to-market barbell in US commercial. More on this later. Speaking of our ongoing subscription transition, which Chris is also a big champion of, we outperformed our own internal plans, seeing our percentage of billings attributed to subscription increased to 79%, up from 73% in Q1; that well surpassed the guidance of 75% by Q4 of FY ‘20 we laid out earlier this year. Our large deals and our existing large customers are migrating to subscription at a rapid pace. For example, the largest lifetime customer who has spent $78 million lifetime with us sparked the idea of building our own hypervisor AHV with us more than six years ago. They spent more than $5 million this quarter to convert some of their renewals to subscription. Similarly, a large Fortune 500 insurance company that is an existing customer spent an additional $1.5 million worth of our software subscription, bringing their lifetime purchase to more than $6 million. This repeat purchase is due in part to Nutanix delivering on its commitment to mission-critical availability and disaster recovery SLAs. The simplicity of our solution is the reason why government agencies are such large repeat customers of Nutanix, as they’re constantly challenged and talent and skill sets. These agencies are now embracing subscription without friction. One such example is our existing customer, an agency in EMEA that supports asylum seekers, who spent $1.5 million this quarter, bringing their lifetime spend to more than $4 million. New customers are also looking at subscription terms by default. For instance, a large multinational banking firm, a top 10 Global 2000 company, did a subscription deal that was worth $1 million this quarter as a first-time customer. Our biggest deal of the quarter exemplified the partnerships, subscription model, and new products all together in the same opportunity. This repeat Fortune 10 Company invested more than $17 million in subscription licenses this quarter to continue modernizing their IT infrastructure. This valued customer, which now has nearly $58 million in lifetime bookings with us, just in the last 18 months views us as a critical partner in their journey to hybrid cloud, which requires secure, reliable, and easy-to-manage cloud services. Their purchase also included Nutanix Files, our software-defined scale-out filer, and Xi Frame, our desktop and service offering. Speaking of portfolio selling, we saw continued momentum in the adoption of new products in the quarter; 31% of deals on a rolling four-quarter basis included at least one product outside of the company’s HCI offering, up from 21% in Q2 of last year. In addition, TCV billings from new products reached a record high in the quarter, growing 99% year-over-year. We believe we are one of the reasons for the increased attach rate of new products to our core software— increased focus on package solutions. Solutions to us is about offering our customers a choice between good, better, and best and more often than not speaking their language, which many a time is vertical specific. For example, in an end-user computing solution, we now offer our customers a progressively curated experience modernizing legacy three-tier hardware to selling one-click filers and data protection, to selling one-click disaster recovery, to selling data and network security. With this approach, we’re working the whole body of IT transformation to simple yet profound themes: simplicity and reliability. Case in point, in how our simple and reliable message is resonating. There’s a net new Fortune 50 telecom customer who spent more than $3 million with us, all due to our Files to modernize their call center infrastructure. A similar customer highlighted traction for solution selling was with a financial services provider in EMEA. They subscribed to more than $3 million of Xi Leap cloud services this quarter for their end-user computing and disaster recovery needs. This solution-based, workflow-driven approach also drove traction with an existing customer leading back in Mexico, who spent more than $1.5 million in subscription licenses. They purchased our product for operations management, multi-cloud orchestration, and multi-cloud cost management; but a large part of their purchase decision was to use Nutanix’s ERA to offer a true database-as-a-service experience for the internal cloud. ERA was also a significant reason why we won a large $1.5 million deal with a government ministry in Saudi, where their Oracle database is extremely popular and private cloud is in high demand. In a world that is rethinking globalization and doubling down on data sovereignty, private clouds and customer premises are becoming a pervasive discussion. An example of that was a deal in Europe worth $1 million with one of the busiest airports in the world, who selected us to be the standard for their private cloud as they transition from legacy hardware and perpetual license software to a true web-scale, software-defined infrastructure driven by subscription licensing. Our multi-cloud control planes for automation, security compliance, and cost management were instrumental in our sales campaign here. Our automation and multi-cloud orchestration tools Calm are all about DevOps. We’re going deeper into DevOps with application lifecycle management, containers, databases, and object storage. An existing Global 2000 customer in the aerospace and defense industry increased their lifetime spend with Nutanix to $2.5 million by purchasing Nutanix’s newer products to support the organization’s DevOps. They are big users of Calm and also Flow for consumer-grade networking and security. Flow and subscription licensing roles are the two big reasons why we did a large $2 million deal with a mission-critical communications customer in EMEA. Not only did they select our core HCI software and native hypervisor AHV, but they also selected several of our new products, including Flow, as the simplicity of micro-segmentation was key to their cybersecurity modernization. Security has become a core value proposition for our overall portfolio, both on-prem and off-prem, as the Zero Trust cybersecurity culture becomes pervasive in the enterprise. Zero Trust is a security concept centered on paranoia, a belief that organizations should not automatically trust anything outside or inside their perimeters and that machines and applications are already compromised. We recently hired a Chief Product Security Officer, Indu Keri, with vast experience in cybersecurity from his previous roles. Indu is bringing an encrypt-everything, micro-segment-everything, audit and analyze everything, and an integrated approach to a Zero Trust security posture. Our DNA of simplicity and reliability is now key to making security invisible, just like Apple did with its devices. On top of our software, our customers are not just running Splunk security and virtual firewalls, but also building fraud detection applications, as illustrated by a more than $5 million deal with a large credit card financial services firm this quarter. This Fortune 500 company has nearly $13 million of lifetime TCV spend with us and values our ease-of-use, simple upgrade process, and most importantly, platform security, which was core to their decision-making. On the subject of innovation in reliable and secured products, we continue to make steady progress across our multi-cloud, multi-product portfolio. In Q2, we made our hyper-converge backup products, Nutanix Mine with Veeam and HYCU, generally available. This integrated data protection solution combines the power of the leading backup software offerings with all the benefits of our platform, including HCI for compute and block storage and files and objects for deep storage. Backup and Splunk are killer use cases for our semi-structured and unstructured data offerings, files, and objects. Our Objects product has performed exceptionally well in its first full quarter since general availability. In a deal worth nearly $1 million, a managed service provider in the US chose our full stack to create their own cloud offering for backup and archival services that provide a simple consumption model for DevOps, disaster recovery, and analytics workloads. Nutanix’s Objects was a critical factor in their decision to go all in with us and replace multiple competitors. We also launched Karbon 2.0, Karbon with a K, which dramatically simplifies the configuration, deployment, and lifecycle management of Kubernetes container clusters. Karbon brings the simplicity of containers in the public cloud to a multi-cloud environment. Responses from customers, including a major US airline and a leading consumer packaged goods company, have been very positive. Karbon has enabled them to fast-track their production Kubernetes deployments and has enabled a public cloud user experience. Beyond the DevOps ecosystem during the quarter, we also announced that our software is optimized around Epic’s Operational Database, the most prevalent database system for healthcare companies in the US. We’re going deep into the Epic healthcare EMR community at a time when Epic is very carefully choosing its cloud partners. On partnerships, while we’ve done a good job with Dell, Lenovo, Fujitsu, and others, our synergy with HPE is looking strong in our first full quarter of joint selling. Under our Chief Commercial Officer, Tarkan Maner’s leadership, both parties are bringing deals and customers to each other to learn co-selling and co-marketing. As an example, in a deal worth more than $4 million, a Global 2000 healthcare company, which has a lifetime spend of $14 million, took advantage of subscription licensing to run our cloud services on HPE servers. There’s one of three deals greater than $3 million in the pharmaceutical industry, a vertical that is increasingly turning to Nutanix to build secure private clouds. In financial services, we took a similar approach with HPE—one of the big four accounting firms in a deal worth $1 million and an account that has spent almost $12 million with us lifetime, on the strength of our core software and our multi-cloud automation offering. We also saw another $4 million subscription deal this quarter with HPE at a Fortune 100 financial services customer that has spent more than $23 million lifetime with us. Similar to Q1, well over half of the HPE customers are new logos to Nutanix. Customers clearly see the value of working with two world-class technology partners, and together we’re winning competitive deals. Nearly one-quarter of our new customers in the commercial segment purchased Nutanix software on HPE servers. As we mentioned before, the other end of the barbell, namely the commercial midmarket, is extremely important for a company that has done so well in large enterprises and aspires to reach its third billion in annual subscription sales. We saw a solid quarter in terms of new customers, but we could do better. Our approximately 920 new customers raised our total customer count to 15,880. I’m happy to report that our focus in the commercial segment has produced positive returns on our investment. The hard work we’ve done to ramp partners is paying off. We saw a strong uptick in partner-initiated deals in this segment. Our commercial business focus is also leading to more predictable revenue streams that complement the larger, chunkier enterprise deals. Big market accounts can also be very large, especially in US commercial, and both Chris and our US commercial leader, John, know this well. A leading provider of business legal, tax, and digital brand services to companies around the globe spent more than $30 million over the course of our relationship and converted from their removals to subscription in a deal worth an incremental $3 million this quarter. They’re using our multi-cloud orchestration services Calm, our database service offering Era, and our Kubernetes platform, Karbon. The commercial segment is proving to be fertile ground for our new product adoption, particularly with Era and Files. One of the reasons why partnerships such as HP and Citrix are flourishing is that we’ve built a reliable platform that has an extremely good business profile. A large multinational pharmaceutical company and existing customer spent $3.5 million with us this quarter, bringing their lifetime spend to $10 million. We’ve become a strategic partner to them as our platform runs most of their primary applications to help them discover, develop, and launch breakthrough medicines. The reliability of our products is also the reason why another large existing customer, a Fortune 500 healthcare company, which has spent nearly $35 million with us lifetime, bought $4 million worth of additional software to build their dispersed private cloud across more than 100 hospitals. The exact same story occurred with a large electric utility company in the US, which doubled down with our software in a $3 million deal this quarter, bringing their lifetime spend to $14 million. This investment reflects Nutanix’s objective to build applications and services to help their customers reduce power consumption. The reliability of web-scale applications and commodity service is the reason why we had another of our large Fintech customers in the US spend $2.5 million this quarter, bringing their overall spend to $16 million lifetime. The reliability of customer service has reflected in the average Net Promoter Score or NPS of 90, which was a big reason for one of our other large existing Fortune 500 customers, a large professional services firm dealing with risk and strategy, spending an additional $1.5 million on our software for their end-user computing needs, bringing their lifetime spend to $15 million. The reliability and simplicity of our disaster recovery and business continuity solutions were the primary reasons why we won another $2 million deal with a large EMEA government agency dealing with public pensions, bringing their lifetime spend to $11 million. The voices of these happy repeat customers are a big part of the reason why we have been recognized as a leader for the third year in a row in the Gartner Magic Quadrant for hyper-converged infrastructure, scoring the highest of all evaluators in the ability to execute access. Our obsession with simplicity, design, and customer delight is what sets us apart. This is also why we were awarded Champion Status in the 2019 Canalys EMEA Channel Leadership Matrix. This honor was a result of partners who ranked Nutanix the highest among all hyper-converged infrastructure companies in channel management across EMEA based on our continued investments in channel incentives, enablement resources, and customer support. Our culture and principles have been our internal compass to help us through the highs and lows of company building and have guided us in navigating the complexities of growth and global presence. Despite 2019 being the toughest year in our 10-year history and business model transitions, public markets do make you tough. We were thrilled to be on the Fortune 100 Best Companies to Work for list. Nutanix was one of only eight new companies to be added to the list in 2020 and one of only two information technology companies. The best part about achieving this certification is that it’s predominantly driven by employee feedback, and our employees have resoundingly expressed that they care for the mission. Speaking of the mission, the cloud is the new server for us. As we strive to make on-prem infrastructure invisible and to make cloud locations invisible, our true worth remains steadfast: delivering simplicity, choice, and delight to our customers. With that, I’ll turn it over to Duston.

Duston Williams, CFO

Thank you, Dheeraj. In Q2, we made outstanding progress on our continued shift to a subscription business. Subscription billings increased significantly and now account for 79% of total billings, up from 73% in Q1. Subscription revenue now accounts for 77% of total revenue and that’s up from 69% in Q1. We have repeatedly stated that it’s our desire to move through the subscription transition as quickly as possible, and we made great progress on this goal in the quarter. Our execution in this area far exceeded our expectations in Q2, significantly surpassing our FY ‘20 Q4 goal of 75% and almost equaling our stated CY ‘21 goal of 80% mentioned at least year’s Investor Day. It should come as no surprise that the short-term downside to this faster than expected push to subscription is the impact on the top line. This is due to both term compression when compared to life of device deals and some pricing differentials between our life of device licenses and our term-based offerings. We expect to recover this top line impact as renewals come in over time. This impact of the faster than expected push to subscription is reflected in our Q3 fiscal year 2020 top line guidance. Exclusive of our professional services billings, our goal is to ultimately drive our subscription billings to 100% of total billings. The average dollar-weighted term length in Q2 ‘20, including renewals, was 3.9 years, flat with the 3.9 years we reported in Q1 ‘20. As with last quarter, this calculation assumes life of device licenses or five-year terms. Some specific Q2 financial highlights: TCV revenue, or software and support revenue for the second quarter, exceeded our guidance range of $330 million to $335 million, coming in at $338 million, up 14% a year ago and up 11% from the previous quarter. TCV billings, our software and support billings were $420 million versus our guidance of $410 million to $420 million, up 12% from the year-ago quarter and up 13% from the prior quarter. The TCV billings were negatively impacted by approximately $5 million due to the faster than expected shift to subscription. ACV booked in the quarter was $130 million and was up 18% from the year-ago quarter. As a reminder, with our discussion in Q1, we defined ACV as the annual contract value of new business plus the annual contract of renewals, and we calculate ACV by taking the value of each transaction booked in the quarter, including renewals but excluding professional services, divided by its term length and then summing the total of those values. While we saw several positives to our expectations, our federal business underperformed our expectations in the quarter. This business has always been somewhat lumpy in terms of timing and a significant portion of the federal miss was related to large deals that we believe were not lost but rather pushed out to future quarters; however, the time to close these deals is uncertain. New customer bookings represent 24% of total bookings in the quarter versus 26% in Q2, 2019, and up from 23% in Q1, 2020. Our HPE DX-related business continued its strong performance and accounted for 117 new customers. For the second quarter in a row, the Americas was our best-performing region in Q2. TCV bookings, our software and support bookings from our international regions, represent 49% of total bookings versus the same 49% in Q2, 2019. Our non-GAAP gross margin in Q2 was 81.4%, exceeding our guidance of 80%. We expect gross margins to hover in the 80% range plus or minus a little bit over the next several quarters. Operating expenses were $396 million, below our guidance range of $400 million to $410 million, and our non-GAAP net loss was $116 million for the quarter or a loss of $0.60 per share. Now looking at a few quick things on the balance sheet, we closed the quarter with cash and short-term investments of $819 million. We used $52 million of cash flow from operations in Q2, which was positively impacted by $19 million of ESPP inflow. Free cash flow during the quarter was negative $74 million, and this performance was also positively impacted by the $19 million of ESPP inflow. Now turning to the details of our fiscal 2020 guidance on a non-GAAP basis, for fiscal 2020, TCV, we expect TCV billings to be between $1.6 billion and $1.67 billion, versus our previous guidance of between $1.65 billion and $1.75 billion. TCV revenue to be between $1.29 billion and $1.36 billion, versus our previous guidance of $1.3 billion to $1.4 billion. Gross margin of approximately 80.5%. Operating expenses between $1.63 and $1.65 billion versus our previous guidance of $1.65 to $1.7 billion. This guidance is impacted by a much faster than expected transition to subscription and a more cautious view on our business activities in the greater APJ due to the anticipated impact of the Coronavirus. Further, this FY 2020 guidance yields an operating loss and free cash flow that is roughly in line with current consensus estimates of $550 million and $250 million, respectively. The implied ACV based on the FY ‘20 guide is approximately $505 million. The guidance for FY 2020 assumes no change to the current dollar-weighted average deal terms, currently at 3.9 years. Our guidance also does not assume any meaningful disruption to the global server-related supply chain linked to the temporary factory closures in China. For additional clarity, of the $50 million to $80 million decrease in TCV billings guidance range, approximately $25 million to $30 million is related to the faster than expected transition to subscription, with the remaining amount attributed to the reduction in our APJ region sales plan. Our APJ region is more dependent on new business in any given quarter, and with the shutdown in China and the slowness and uncertainty being exhibited in other APJ countries, we believe it’s prudent to take a cautious view of APJ performance for the next few quarters. Our cautious APJ view also includes Japan, which generally operates under a March fiscal year-end period. We have a few large deals pending in Japan, and we assume a reduced portion will close in Q3. Based on our current outlook, both the Americas and EMEA regions seem to be in a good position to deliver their expected results for the second half of fiscal 2020. This, of course, assumes that the business interruptions in the APJ region from the Coronavirus do not spread to these regions too. As our updated operating guidance suggests, excluding sales teams and a few other select roles, we are currently taking a pause on a significant portion of our planned headcount in the second half of our fiscal year, contributing to a $20 million to $50 million expense reduction from our previous guidance range. Regarding our hiring, we have slowed headcount for the following two reasons: first, we would like to have more clarity to see if there might be any further potential disruption related to the impact of the Coronavirus and whether that disruption spreads to other portions of the world. And second, quite honestly, it puts us in a better position to more efficiently integrate the approximately 1,400 employees we’ve added over the last year. Regardless of this headcount pause, we still plan to hire for critical roles on an as-needed basis. We view this selected headcount pause as simply the right thing to do, and is in no way related to any change to our overall positive view of our business going forward. Now, turning to our Q3 guidance. On a non-GAAP basis for Q3, we expect TCV billings to be between $365 million and $385 million, reflecting a year-over-year growth of 13% to 19%. TCV revenue to be between $300 million and $320 million, reflecting year-over-year growth of 13% to 20%. Gross margin of approximately 80%; operating expenses between $420 million and $430 million; and a per share loss of approximately $0.89, using weighted average shares outstanding of approximately $196 million. The Q3 guidance also reflects the much faster than expected transition to subscription and a more cautious view of our business activities in the greater APJ region due to the Coronavirus, consistent with my comments on our fiscal year 2020 guidance. Additionally, the sequential decline in our FY ‘20 Q3 implied booking guidance, which at the midpoint of the guide assumes a 7% sequential decline, is actually better than what we experienced for actual FY ‘18 and FY ‘19 Q2 to Q3 sequential historical bookings performance, which was approximately a 10% sequential decline. Furthermore, the sequential increase in our FY ‘20 Q4 implied booking guidance, which at the midpoint of the guide assumes a 25% sequential increase, is also in line with our FY ‘18 and FY ‘19 actual Q3 to Q4 sequential historical bookings performance, which was a financial increase of 33% and 25%, respectively. The current consensus numbers for TCV sequential growth from Q2 to Q3 and from Q3 to Q4 are quite misaligned with the historical averages. Our Q3 guidance and the applied Q4 guidance bring these sequential growth rates back in line with historical averages. As you are aware, FY ‘20 was our first year providing annual guidance. With this approach, the yearly guidance gets updated each quarter, and we also provide quarterly guidance for the upcoming quarter. For example, during the Q1 earnings call, we provided an updated annual guidance as well as our guidance for the upcoming quarter, that being Q2. At this time, we obviously did not opine on Q3 and Q4, which put the shaping and the sizing of these quarters in the hands of the analyst community. Going forward, during our initial annual guidance setting at the start of any fiscal year, we will add some additional clarity on how we see the fiscal year shaping up, specifically around quarterly seasonality. If we had provided this insight at the beginning of the fiscal year, the sequential growth rate for the Q3 and Q4 top line consensus might have been more in line with historical trends and with our current guidance. And one last comment before we open the call up for questions. You know, clearly the company has been through a tough couple of transitions over the last few years with significant top line impact related to the hardware elimination and the current subscription transition. Although, when you cut through all the messiness and focus on one simple metric, total revenue, it is nice to see, like so many other companies that have been through subscription transitions, that finally the year-over-year growth rate has now started to re-accelerate once again. Our total revenue year-over-year growth rate appears to have bottomed out in Q3 and Q4 FY ‘19, growing at a negative 1%. That growth accelerated to 1% in Q1 FY ‘20, 3% in Q2 FY ‘20. And based on the midpoint of the Q3 guidance and implied Q4 guidance, we anticipate that the year-over-year growth rate will further accelerate to approximately 10% in Q3 and 25% in Q4. With that, operator, if you could now please open the call up for questions, that’d be great. Thank you.

Operator, Operator

Your first question comes from the line of Rod Hall from Goldman Sachs. Your line is open.

Unidentified Participant, Analyst

Thank you. This is RK. I wanted to ask about ACV. You reported 18% growth versus your guidance for 24%. So is the delta all driven by the Federal business or are there any other factors to consider, and could you give us more color there? And I have a follow-up.

Duston Williams, CFO

Sure. So a vast majority was driven by the Federal underperformance in the quarter and also just the subscription impact. We mentioned $5 million of TCV, so there’s some ACV in there. And, you know, if you look at this ACV metric, it is a real-time metric of the business and we decided to provide that last quarter because I thought it was important to give that kind of metric that you can’t hide from anything. It is what it is. And I think it’s an important metric during a subscription transition; things are messy, and you can’t really get a good feel for the business going forward. But I think we’ll continue that through this fiscal year and then probably end up transitioning to a more conventional ACV metric, which is more of a waterfall—kind of fourth quarter waterfall type ACV metric that most companies show there. But, yes, it was mostly clearly mostly Federal, and a little bit of the subscription top line impact.

Unidentified Participant, Analyst

Thank you. And I wanted to take a step back and talk about your subscription transition. You had some problems with setting the pricing and the sales motion and the discounting. So could you talk about where you are with each of these challenges and how you see that moving forward?

Duston Williams, CFO

Sure, Dheeraj, you want to?

Dheeraj Pandey, CEO

Yes, I mean, both of us should probably chime in. I think, you know, pricing was a big change almost a year and a half ago, I would say, and we have mostly passed it. Sales and customers have been surprisingly very receptive. I think, you know, we thought that the large customers would probably not move to subscription this quickly, but we’ve been pleasantly surprised at how much they’ve actually been forthcoming and willing to actually move from the old license model to the new license model. Even the channel, for that matter, including the global system integrators, have actually moved in that direction quite well. I think we had a conservative view on when we’d get to 80%. That was in December, January of 2020-2021, when we said we’d get to 80%. But one of the things we learned along the way is that we have to plow through this as fast as possible. And as we realized that the large customers are willing to take this, we went ahead and said, let’s get ready to take 80%, even if it means it’s a year and a half ahead of schedule, actually.

Duston Williams, CFO

And on the discounting that you asked about, there, we continue to focus on that, obviously a lot in the back office work there and changed some processes and things. So that’s ongoing. It will continue to be ongoing. I think we’ve made some pretty good progress there, but clearly, we have some more progress to go. And then we’ve realigned some of the pricing—list pricing and things like that, but it takes a while for that to flush through. But we continue to focus on both those.

Unidentified Participant, Analyst

Thanks, guys. Good luck.

Operator, Operator

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

Aaron Rakers, Analyst

I want to go back to the sales kind of motion. Can you talk a little bit about your plans to kind of pause the spending or the investments in the sales organization? How should we think about the guidance relative to the productivity ramp you’re seeing in some of the new sales hires? And I think if I calculate productivity right, it looks like you’re down 20% or 25% versus what you were a year ago on a billings basis. Do you think we can see productivity back at the levels that we’ve seen a year plus ago? And I have a follow-up.

Duston Williams, CFO

Yeah, let me start and Dheeraj can chime in here. Two things. First of all, we mentioned that we’re not pausing sales teams. So that’s very important that that comes across clearly. We’ll continue to hire sales teams because any downturn period, the worst thing you can do is halt sales teams because you have a little pause. In this case, it’s completely out of our hands. I think we’re being prudent. But if you start pausing on sales teams then it takes you twice as long to get back to accelerated growth because you then have to go hire folks and ramp them and things like that. So we’ll continue with the vast majority of our sales team hiring there. And then the productivity you mentioned, I’m not sure how you’re calculating that. But it’s not close to what we’ve seen from a productivity degradation that came down a little bit in ‘19. It came pretty close to what we expected here in Q2. Q1 was up from Q4.

Dheeraj Pandey, CEO

And ACV.

Duston Williams, CFO

Yes. And we really look at it on an ACV basis because it takes any term change out of the equation and puts it on an equal playing field.

Dheeraj Pandey, CEO

If anything, that has only stayed better.

Aaron Rakers, Analyst

Okay, fair enough. And then as a quick follow-up, you talked to in this quarter about the engagement with HP Enterprise. I think there’s 117 new customers. I think, last quarter you did 25. So, as you kind of continue to deepen the engagement there, how are you seeing that relationship evolve? Is there more to potentially come or deepen with regard to the HP go-to-market? When might that happen if there is? Thank you.

Dheeraj Pandey, CEO

It’s an ongoing partnership discussion. Every quarter we get to know more about their aspirations as well. And, obviously, primarily, they have a pretty large server-centric business. And while we have done a commendable job with Dell, Lenovo, Fujitsu, and others, I think HP is becoming a pretty substantial portion of our both enterprise and commercial go-to-market. So, you know, I don’t want to speculate about the future, but all I can say is that it’s looking like it’s a win-win for both sides. There is demand for more things to come with subscription of our software in their hand with GreenLake and, especially some of the things around how we can go to market together and sell together, including their existing products.

Aaron Rakers, Analyst

Thank you.

Operator, Operator

Next question comes from the line of Jason Ader from William Blair. Your line is open.

Jason Ader, Analyst

Thanks. Duston, just on the APJ impact from the virus. Is it right to think that’s all demand and not supply at this point?

Duston Williams, CFO

Correct. Yes, we’ll have to look at the supply thing. I think Q3 is, from what I see and what I’m told here, that Q3 looks to be okay, and maybe a little tight, and then depending on what happens with the factories and folks coming back to work here, it’s a little bit—we’ll have to see there. But, yes, that’s not a supply issue. And what’s happening in the region, quite honestly, is that if you look at this, nothing happening in China. There are really no meetings happening in several other countries, and we’ve got—if you look at the impacts of the Coronavirus in general in the verticals that it hits, it's retail, transportation, manufacturing, hospitality, and travel. So it’s kind of a ripple effect of this. We got our initial roll up from our APJ folks. And, as I mentioned, we’ve got a couple of very intriguing interests and deals in Japan that we feel really good about, but the timing of those we just can’t take aggressive stance on that at this point.

Jason Ader, Analyst

Okay. All right, because Microsoft just preannounced.

Duston Williams, CFO

Yes.

Jason Ader, Analyst

I mean, I don’t know if you saw that. But they talked about supply.

Duston Williams, CFO

Jason, I think the important thing to understand here is that we feel good about the business. There are two things happening: one that’s got 100% completely in our control, and there’s another thing that’s 100% out of our control. And we’re really happy about the subscription transition because, again, the quicker we get through here, the better it sets up the model when the renewals come—start to flow in here. So we’re really pleased on that. And we’ll take the hit on the top line any day to go faster there. And then, you know, hopefully, we’re taking a reasonably prudent view on some unknown factors related to the virus, so we’ll see how that plays out. But the business itself, which we talked about in the script and everything else, we feel good: large customers, repeat purchases, big Global 2000, new products—everything is tilted in the right direction, except, we’ve got one big unknown here that we can’t control.

Jason Ader, Analyst

Yes, and so qualitatively just.

Dheeraj Pandey, CEO

That’s why we keep asserting that business is robust, and quantitatively, we just have to be a little bit more cautious.

Jason Ader, Analyst

And on the subscription transition, do you have a forecast? You had it at 75. Obviously, you’re going to far surpass that. What would you say would be a good guesstimate for Q4 right now in terms of percentage of billings from subscription?

Duston Williams, CFO

Yes, it’s probably going to bounce around a little bit. We had a pretty good acceleration this quarter, so probably not too much different. But we’ll again, update a couple of these thoughts at Investor Day here coming up on March 26th.

Dheeraj Pandey, CEO

Yes. For the first time, you put this new sales comp this past.

Duston Williams, CFO

Yes, yes, and we’re starting to tweak our sales comp. We put a roadmap in over the next several years for sales comp and how we end up morphing the sales comp ultimately to take advantage of the leverage effectively of our subscription business and the renewals and things like that. And this is the first period that we’ve actually put a negative multiplier on some LOD business, and in the next six months, we’ll put a negative multiplier on any LOD business. So I think that naturally there will start shifting some of our bigger legacy customers over to subscription over the next six here too.

Jason Ader, Analyst

Thank you.

Operator, Operator

Your next question comes from the line of Wamsi Mohan from Bank of America. Your line is open.

Wamsi Mohan, Analyst

Thank you. Just to follow up a little more on the Coronavirus situation. Can you give us some color on how you’re coming up with that estimate? I mean, when you say that it’s based purely on APJ demand, it seems like demand in other regions is also getting impacted as this situation remains quite fluid. And secondarily, supply—for the server supply chain seems like that might be impacted very near term, so is there more clarity—can you give us some clarity on why you think supply might not really be an issue in the near term? And I will follow up.

Duston Williams, CFO

No, what I mentioned is Q3, from what we’re being told, it looks tight but doesn’t look at this point to be a serious issue from our perspective. Q4, I don’t know—it depends on how this progresses here. I think the reason why we have a little bit more of a point of view on APJ is that there’s been a longer issue there. And we’ve had a chance to kind of digest that and get some forecasts and things like that. We mentioned that EMEA looks good, and we’ve got a good pipeline there, and the second half looks really good. But this assumes that there is not significant impact that migrates into there. And we just can’t at this point guess what might happen or guess what might happen with the server supply chain.

Dheeraj Pandey, CEO

And then, I think HP hasn’t told us anything to the contrary. And some of our legacy supply chain is in Taiwan, not China. So I think it’s not in the list of countries that people at least have talked about in the past. So, I mean, we are making an educated guess in this, but we do feel like this is a pretty good guess for the next half.

Wamsi Mohan, Analyst

Okay, thanks for that. And then, Dheeraj, there have been some high-profile changes in management at IBM and Google Cloud. How do you think this changes the competitive landscape? Do you think it does or not? And also the M&A landscape around this? Thank you.

Dheeraj Pandey, CEO

Well, I think we definitely feel like we will be becoming more and more of a software company running—I mean, as I mentioned in the last paragraph of the script that the cloud becomes the new server for us. And the big issue with the public cloud right now is enterprise workloads have a tough time to lift and shift. And all of a sudden if our software can bring that level of virtualization where it doesn’t matter where it’s running, on commodity servers on-prem, or commodity servers off-prem, I think it really opens up new surface area for our software. I think we are looking at the next three to four years to be such a transition. No different than when we transitioned from pure appliances to OEM with Dell back in 2014. Over the course of the next 3-4 years, a quarter of our business was running on Dell nodes. I think a lot of that stuff we expect to see from hyperscalers too actually. So, you know, IBM, with the Red Hat acquisition, will definitely be a partnership opportunity for us, especially around containers and hybrid cloud and IBM Cloud as well. And also, some of the work that we’re doing with them on their Power and AIX software—they have an operating system in AIX that we believe we can modernize. I think in Amazon and Azure, there is really good engineering work going on. You will see this year to be the year when the hyperscalers get really close to us and we do the same with them. We think that will prepare them for a true lift and shift that is not at the mercy of just global system integrators coming and trying to rearchitect the approximately, because re-architecting the app to move it to the public cloud is really, really hard and risk-prone.

Wamsi Mohan, Analyst

Thanks, Dheeraj.

Operator, Operator

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

Katy Huberty, Analyst

Thanks for the question. Going back to Duston, to your reference to sales force compensation changes. What are you doing around shifting compensation from TCV to ACV? And then related, you mentioned that you’re confident that you can close the gap between term and life of device pricing on renewal. Is it the sales force compensation changes that can help you around pricing? Have you seen renewals yet? Such that you have confidence that you could raise prices as customers come up on their renewal?

Duston Williams, CFO

Well, we haven’t seen many renewals, quite honestly, on true subscription. Most of these haven’t timed out yet from that perspective. We do know—we can show a graph here at Investor Day if you simply take an average three-year CBL deal, and assume that renews for another three years, with a two to three-year CBL deal compared to a five-year life of device, and if that renewed for one-year of support, so you had comparable six-year periods. The two to three-year CBL deals clearly exceed the value of that life of device five-year plus one-year renewal. So, there’s no doubt when you look at the averages of what we’re pricing things; it’s just that we take a hit up front. But through that six-year period, we’re much better off. So we just have to wait a little bit here. And then on the sales comp, I think the good news about the sale comp is that we can again we do commissions in six months period, which is really great in a period like this that we can kind of morph things every six months instead of year. So we will, highly likely morph to ACV way before we need to, because we’re kind of being seen from that perspective we believe. And then will kind of run with that mentality and photo setting and things like that. So when the renewals flow in, I think we’ll be in pretty good shape to actually get some leverage from those renewals because, just like any subscription business, those renewals have to come in at a much higher efficiency factor. Hopefully, we can show this in a reasonably thoughtful and interesting way at Investor Day and how we see leverage playing in once these subscription renewals come at various efficiency factors and how the percentage of the business becomes a pretty large portion in the outer years, as subscription renewals and things like that. I mean we’re really happy about the faster pace to subscription, but a lot of the benefits are going to come in a couple of years.

Katy Huberty, Analyst

So the shift to ACV that will be six months out or more—that’s not in the current sales compensation changes?

Duston Williams, CFO

Correct. Yes. What we’ve done in the current sales comp is that we started to put some negative multipliers on LOD business.

Katy Huberty, Analyst

Okay, and just lastly from me. Sorry.

Duston Williams, CFO

And to the next phase, we’ll probably have some type of ACV transition.

Katy Huberty, Analyst

Okay, and just lastly, you surpassed margin guidance and took it up for the full year. Can you just talk about the drivers of upside and gross margin?

Duston Williams, CFO

Yes, it’s pretty simple when you look at it because right now the cost of bucket that we operate within, obviously software is 100% margin, but the cost bucket now is with the support model, and now the support teams historically done a pretty good job of gaining leverage there, and so in this case, we had a pop up in the top line, and we can leverage that support structure. So, it’s just more top line, a small increase in the support cost and other cost internally here. So I know we guided 80% next quarter, but that’s just because it’s a smaller top line base on a similar cost structure. But as I think we can continue to leverage that slightly as the top line continues to increase.

Katy Huberty, Analyst

Great, thank you.

Operator, Operator

Your last question comes from the line of Mehdi Hosseini from Susquehanna. Your line is open.

Unidentified Participant, Analyst

This is Nick filling in for Mehdi. So turning to the full stack of next fruition, how much is that impacting your billings, and specifically, what percentage of the billings are actually for the entire stack?

Dheeraj Pandey, CEO

I think we mentioned last quarter it was 11%, and this quarter it’s 13% of our bookings.

Duston Williams, CFO

Yes, it’s concerning new products.

Dheeraj Pandey, CEO

New products on top of the core product itself. I think they are fairly accretive in many ways. There’s a lot that we talked about in my earnings script as well, where many of these customers actually are buying our entire stack because they’re really comparing it to cloud. The private cloud has to look like the public cloud in many ways. If anything, we’re really pleasantly surprised to see that this attach in the overall contribution in Global 2000 is higher than the overall company average—that number, 13% is higher in the Global 2000, which basically tells us that this is not one of those conventional mid-market-first sort of portfolios that we’re actually selling, compared to let’s say our hypervisor which really started more in the mid-market for the first three or four years before it went upmarket. I think many of our new products, especially the ones around automation, databases, and security, are really starting equally, if not better, actually in the Global 2000.

Unidentified Participant, Analyst

And do you break down that 13% based off of new customers versus maybe existing customers who are upgrading, or do you not have those numbers?

Duston Williams, CFO

We don’t. I mean, the only interesting statistic there than the 13% when you look at the Global 2000—that 13% is actually a little bit bigger. So you might have some perception that this might be mid-market-type customers trying things out. It’s actually playing very well in our—these new products are playing well within our big customers.

Unidentified Participant, Analyst

Okay, perfect. I just have one follow-up regarding cash burn. I know the balance sheet looks a bit better, but could you discuss that a little more?

Duston Williams, CFO

Even with a little bit of change in the top line guide, we still believe we’re in the same range that we’ve been talking about, with the consensus being roughly today, $250 million or so. So we’ll try to continue to manage that bucket.

Operator, Operator

Your last question comes from the line of Jack Andrews from Needham. Your line is open.

Jack Andrews, Analyst

I was wondering if you could shed some additional light on just where things stand with your solutions-based approach on the go-to-market side. Nice to hear that you’re seeing some success, but could you provide some broader context in terms of just how much your sales force is fully enabled with this approach? And similarly, where do you stand with your partners in terms of getting them to embrace this solutions-based approach?

Dheeraj Pandey, CEO

Great question. I mean, you know, there’s two parts to this. One is, the way we talk to our customers, which are new customers or new campaigns, call it more North South, and there we are really leading with things like databases, end-user computing, private cloud, and remote-edge, and things like that. All our sellers, especially in the—I would say Global 10,000—are really selling solutions because when you start to get lower in the mid-market, it’s hard to sell a solution to a first-time commercial customer. Obviously, there’s a lot of HCI, plus Files, maybe a little bit of operations management that’s going on in the mid-market. So, the answer is a little bit more nuanced because of the segment. But I would say that all of our enterprise sellers have been really doing this, and that’s the way they actually can go create a pipeline. The pipeline is not created. We’re just doing bottom-up selling off infrastructure. It’s more workload driven and solution driven, actually. The channel is getting there. I think we’ve not yet started to track the pipeline for solutions—that’s where the next sort of evolution of this solution-driven approach is when we start to really track entire funnels that are driven by pipeline itself, but that’s the next phase of the journey.

Jack Andrews, Analyst

Got it, thank you very much.

Operator, Operator

This concludes today’s earnings call. We thank you for your participation. Have a great day.