Liz Lemon - Investor Relations Scott Dietzen - Chief Executive Officer Timothy Riitters - Chief Financial Officer.

Kathryn Huberty - Morgan Stanley & Co. LLC Simona Jankowski - Goldman Sachs Group Inc Steven Milunovich - UBS Aaron Rakers - Stifel, Nicolaus & Company, Inc. Alexander Kurtz - Pacific Crest Securities, Inc.

Brian Alexander - Raymond James Richard Kugele - Needham and Company, LLC John Lucia - JMP Securities LLC Edward Parker - BTIG Research Jayson Noland - Robert W. Baird & Co.

James Kisner - Jefferies, LLC Patrick Falzon - Evercore ISI Nehal Chokshi - Maxim Group LLC Mehdi Hosseini - Susquehanna International Group Steven Fox - Cross Research George Iwanyc - Oppenheimer & Co. Eric Martinuzzi - Lake Street Capital Markets, LLC..

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

I will now turn the call over to Liz Lemon, Head of Investor Relations. Please go ahead..

Good afternoon and welcome to Pure Storage's Q2 fiscal 2017 earnings call. Joining me today are CEO, Scott Dietzen; and CFO, Tim Riitters. Before we begin, I'd like to remind you that during this call, management will make forward-looking statements which are subject to various risks and uncertainties.

These include statements regarding competitive, industry, and technology trends; our strategy, positioning and opportunity and our products, business and operations, including our revenue and margin guidance, operating model and growth prospects.

Our actual results may differ materially from the results predicted and reported results should not be considered as an indication of future performance. A discussion of risks and uncertainties relating to our business is contained in our filings with the SEC and we refer you to these public filings.

Also, during this call, we will discuss non-GAAP measures in talking about the Company's performance. Reconciliations to the most directly comparable GAAP measures are provided in our earnings release. This call is being broadcast on the web and is being recorded for playback purposes.

An archive of the webcast will be made available on Pure Storage's Investor Relations website for approximately 45 days and is the property of Pure Storage. With that, I'll turn the call over to our CEO, Scott Dietzen..

Good day, and thank you for joining the Pure Storage second quarter earnings call, our fourth quarter reporting as a public company. In Q2, Pure enjoyed record revenues of $163 million, up 93% year-over-year and 5 points above the midpoint of our guidance.

At a time when many of our competitors are shrinking, our strong growth reflects Pure's highly differentiated technology.

Our customers are replacing complex, services-intensive storage, designed for mainframes or client server with what we call Smart Storage, storage that offers the simplicity, automation, resiliency, and customer-friendly business model essential for cloud IT.

Smart Storage allows customers to keep more data for far less costs, protected with strong security and delivers the bandwidth necessary to mine that data for new analytic insights or even machine learning. Smart Storage is revolutionizing the storage user experience, just as the smartphone transformed that for mobile devices.

In the quarter, we increased our customer count by over 350 to more than 2,300 in total. We now provide storage to nearly 100 firms within the Fortune 500, about double that of a year ago.

Key new customer wins in the quarter include Marc Jacobs, Fox Television Stations, Beam Suntory the world’s number three premium spirits company, and Sally Beauty Supply, the world's largest retailer of professional beauty products. We had an especially strong quarter internationally, growing 110% year-over-year.

International now accounts for about one quarter of our business. Noteworthy new international customers include British Airways, Air New Zealand, The University of Tokyo, UniCredit, and NIFTY Corporation, the leading public cloud provider in Japan. At the same time, Pure is delivering unprecedented growth at scale.

We are increasing our operating leverage. Non-GAAP operating margin at negative 19% improved more than threefold from our one-year ago quarter. Our use of cash since IPO has been modest. We spent $32 million in combined free cash flow over the past four quarters, while driving $585 million in revenue over the same period.

We remain on track to hit sustained cash flow positive next year and our balance sheet remains strong with more than $570 million in cash and zero debt. Let's turn to FlashBlade. Also, in the second quarter and one quarter ahead of schedule, we completed our first sales of FlashBlade, a new storage platform for big data.

Today, storage for un- and semi-structured data is still based on mechanical disk. Such storage, whether in the public cloud or private data center, is big and slow, while FlashBlade is big in terms of the data it can store and fast.

FlashBlade is poised to transform the capacity-oriented storage market the same way FlashArray redefined performance storage. FlashBlade is currently being used for software development, chip design, self-driving cars, genomics, Internet of Things, and movie making. Early customers include Baylor Miraca Genetics Labs and the Farm Bureau of Michigan.

As with FlashArray, we believe we are roughly three years ahead in embracing the inevitable shift to storage optimized for Moore's Law rather than gated by disk-centric designs.

While we don't expect FlashBlade to be material to revenues this year, with the market for un- and semi-structured data storage growing at greater than 20% year-over-year, we expect FlashBlade to one-day be as larger business as FlashArray.

Together and over time, FlashArray and FlashBlade will allow us to extend our reach across the whole of the $24 billion storage TAM. Now some thoughts on differentiation.

Pure continues its unprecedented growth by driving a dramatically better customer experience, while saving customers roughly $2,000 per terabyte per year over the legacy storage we are replacing. Putting SSDs into storage design more than 20 years ago simply cannot deliver on the demands of modern IT.

Relative to the competition, Pure is differentiated on at least three fronts. First, Pure Storage is effortless. One of our larger customers, one part-time VMware admin now looks after a 50-plus array footprint that used to require 15 consultants. Second, Pure Storage is efficient.

Back in 2012, it took six refrigerators worth of Pure Storage to store one petabyte of data, and that was still roughly five times better than the disk alternative. Next year, that one petabyte fits into something the size of two pizza boxes of Pure.

And third, Pure Storage is evergreen, and the customers receive a subscription to future plug-compatible software and hardware innovation, rather than having to rebuy the same storage every few years and disrupt their business with painful data migrations. To date, our competitors have been unable to match Pure on any of these three fronts.

Evidence of Pure's differentiation can be found in Gartner's 2016 Magic Quadrant released this week. For the third year in a row, Pure Storage is positioned in the upper right-hand quadrant and we have expanded our lead.

In our latest Satmetrix-audited Net Promoter Score of 83, placing Pure in the top 1% for customer advocacy and more than 50 points higher than the third-party accountings of the NPS of our major competitors.

In the healthy repeat purchase rates we see across our customer base, including that for every dollar spent on initial purchase, our top 25 customers continue to average about another $12 in orders over the next 18 months; and in our industry-leading product gross margins of 67%.

Pure's differentiation is also validated by the unique success we are enjoying in the cloud. Over 25% of our business is coming from companies providing Software as a Service, Infrastructure as a Service, and consumer cloud services. We now have over 150 SaaS companies using Pure Storage.

These companies are all building their own specialized clouds for their customer-facing performance intensive applications, finding that they can deliver higher service levels for lower costs and with the hyper-scale public cloud alternative. Analysts continue to see even greater growth in SaaS and consumer cloud than in AWS and Google Cloud.

Now a couple of words on partners. Pure maintained strong channel momentum in the quarter with nearly 80% of new logos being brought to Pure by our resellers. Our top five channel partners are driving triple-digit annual growth in their Pure businesses.

Also this quarter, Pure and Cisco teamed up to deliver two new partner-friendly Cisco-validated designs of converged infrastructure, combining best-of-breed service and networking from Cisco with best-of-breed storage from Pure. Let me close by reiterating that Pure had an excellent quarter.

We are tracking well toward our longer-term goal of building a profitable, multibillion-dollar revenue company and a leading global brand in storage. With FlashBlade ramping and exciting FlashArray innovations yet to come, we are only getting started. With that, I'll turn the call over to our CFO, Tim Riitters, to give you more details of the quarter.

Tim?.

Thanks, Scott. Indeed, Q2 was a great quarter. I am particularly pleased with execution around our operating model, which calls for strong topline growth balanced with consistent improvement in operating leverage.

Before I dive into Q2 specifics, please note that the gross margin, operating margin, OpEx, EPS and free cash flow numbers I will use are non-GAAP, unless otherwise noted.

A reconciliation of these non-GAAP metrics to the GAAP comparables is available in our press release and in our earnings slide deck, which are available on our website at investor.purestorage.com.

As Scott said, Q2 total revenue grew 93% year-on-year and 17% quarter-on-quarter to a record $163.2 million, which is 5.3% above the midpoint of our guidance.

Product revenue in Q2 grew 84% year-on-year and 17% quarter-on-quarter to $130.9 million, driven by strong repeat trends and over 350 new customer additions, another record quarter for new customer acquisition. Of particular note, we shipped our first FlashBlade orders, though the revenue contribution was immaterial to our Q2 fiscal 2017 results.

Support revenue in Q2 grew 140% year-on-year and 14% quarter-on-quarter to $32.3 million, driven by continued revenue recognition of ongoing support contracts. We continue to drive loyalty among our customers, demonstrated by strong customer retention rate in mid-90s - 90%.

Looking at Q2 from a geographic perspective, 75% of our revenue came from the U.S. and 25% from international. International was a notable success, growing over 110% year-on-year. This compares to a 78/22 split in the prior fiscal year. Q2 total gross margin was 66.3%, improving 7.1 percentage points year-on-year.

Total gross margin declined one percentage point quarter-on-quarter. We continued to be in the range of our target long-term model of 63% to 68% for total gross margin. Product gross margin of 67.4% improved 6.2 percentage points year-on-year and declined 2.2 percentage points sequentially.

The year-on-year improvement reflects the shift to the new higher gross margin FlashArray M products. The Q-on-Q decline is primarily driven by pricing incentives that allowed us to expand footprint worldwide.

Our unique cost structure allows us to compete effectively while maintaining industry-leading margins, so we took margins down a little bit from the 69.6% of last quarter.

Excluding the impact from FlashBlade in the next couple of quarters, which we will discuss in a moment, we believe these product gross margin levels are appropriate and are within our long-term model. Support gross margins of 62.0% improved 13.8 percentage points year-on-year and 4.0 percentage points sequentially.

This is driven by our expanding customer base and the deferred support revenue associated with increasing product revenue. We also continued to drive operational efficiencies within our support organization as we scale.

Moving on to expenses, as Scott mentioned, we continued to drive significant operating leverage year-on-year and sequentially, while making consistent investments in the business. In Q2, R&D expense was $44.6 million or 27% of revenue versus $31.4 million or 37% of revenue in the year-ago quarter.

R&D expense in absolute dollars increased 42% year-on-year, driven primarily by investments in our FlashArray M and FlashBlade products. Sales and marketing expense of $78.8 million represented 48% of revenue in Q2 versus $57.0 million or 67% a year ago.

Sales and marketing expense in absolute dollars grew 38% as we increased sales and marketing headcount. We remain focused on capturing the current market share opportunity, balanced by careful attention to sales productivity. G&A expense was $16.3 million or 10% of revenue in Q2 versus $13.3 million or 16% of revenue a year ago.

G&A spend grew 22% on a year-on-year basis. Total headcount at the end of Q2 was over 1,600, up from over 1,500 at the end of Q1. Turning to operating margin, we continued to make good progress in our drive to profitability and toward our long-term operating margin goal of between 15% and 20%.

For Q2, non-GAAP operating loss was $31.4 million or negative 19.3% of revenue compared with the year ago quarter non-GAAP operating loss of $51.6 million or negative 61.0% of revenue. This represents a 41.7 percentage point improvement in operating margin year-on-year and a 10.1% percentage point improvement sequentially.

Also note our operating losses in absolute dollars decreased by over $20 million year-on-year, while we grew revenue more than 90% in the same period. While this performance is consistent with our strategy to drive leverage while investing in the business, some marketing spend and R&D hiring moved out of Q2 into Q3.

This is partly why we posted a notable beat to our operating profit guidance. We will continue to execute on our strategy of driving leverage, but investors should not expect the same magnitude of outperformance on operating margin in Q3. Our non-GAAP net loss for the quarter was $31.5 million or negative $0.16 per share.

This compares to the year ago period non-GAAP net loss of $52.0 million or negative $0.33 per share. The weighted average shares used for the per share calculations were $192.7 million and $156.0 million, respectively.

For those of you comparing our Q2 fiscal 2016 results, please note that the share count numbers used to calculate net loss per share in that period assumed the conversion of all of our preferred stock. Moving on to the balance sheet and cash flow, we finished the July quarter with cash and investments of $570.2 million.

Our free cash flow was negative $33.3 million or negative 20% of revenue compared to negative $45.5 million or negative 54% of revenue in the year ago quarter. Please note this includes $6.2 million of cash received related to our employee stock purchase plan.

Excluding this amount, free cash flow would have been negative $39.5 million or negative 24% of revenue. Let's turn now to our guidance. With regard to seasonality of our investments and revenue, we expect a similar pattern to last year. We typically have strong topline growth in our second half, driven by sales investments made in the first half.

In parallel, our operating margin tends to be stronger in the second half relative to the first half. For the third quarter of fiscal year 2017, we expect revenues of between $187 million and $195 million, which implies a 45% year-on-year growth and a 17% sequential growth.

Investors will recall that revenue in Q3 of last year was particularly strong due to pent-up demand for our FlashArray M, making this Q3 a tougher growth comparison. We expect Q3 revenue to be driven by several dynamics. We are entering a seasonally strong period for our business as reflected in current consensus revenue estimates for Q3.

We continue to see solid repeat business trends and high customer retention rates. Our partner engagement is stronger than ever. More partner salespeople are transacting with Pure than ever before and major global national integrators are increasing their commitments to Pure. And finally, the storage market is rapidly tipping to flash.

And as you saw in the latest Magic Quadrant published this week, we are very well positioned to lead the next generation of storage.

With regard to revenue contribution from FlashBlade this fiscal year, I'll remind investors that while we are excited about the opportunities for this product, revenue contribution is not expected to be significant in the near future. We expect Q3 non-GAAP gross margins in the range of between 64% and 67%.

You will note that this is a slight guide down from what we delivered in Q2 and we expect this to be a temporary dip due to the manufacturing ramp of FlashBlade. We expect to gain operational efficiencies around FlashBlade in the next quarter or two and expect continued improvement in our support margins.

Even accounting for these temporary factors, we expect to remain within our long-term model of between 63% and 68%. We expect Q3 non-GAAP operating margins of between negative 17.5% and negative 13.5%.

As I said earlier, we moved some marketing and R&D spend from Q2 to Q3, so investors should not expect the same strong outperformance to operating margin guidance in Q3 that we saw in Q2. However, I would like to remind investors that next to revenue growth, profitability is our top priority.

You can see this as we focus on our operating model to make fiscal year 2017 the turning point in terms of absolute losses. In fact for the first half of fiscal year 2017, we are ahead of this plan.

We continue to manage the business towards sustained positive free cash flow in the second half of calendar year 2017 as we drive consistently toward our long-term operating margin of between 15% and 20%. As Scott said, we are making excellent progress toward becoming a profitable, multibillion-dollar Company.

With that, we'll open the call for questions.

Operator?.

[Operator Instructions] Your first question comes from the line of Katy Huberty from Morgan Stanley..

Thanks. Good afternoon. Congrats on the quarter. As it relates to the sequential downtick in gross margin, you mentioned pricing.

And just curious whether that's just broader discounting and pricing in the market or if the dynamics this quarter, better linearity allowed you to see the upside and have time to reinvest in placing more units in international markets? Just trying to understand if that was market-driven versus a position of strength on your part.

And then I have a follow-up..

Katy, this is Tim. On the question of gross margin, it really is about expanding the footprint worldwide. You heard us talk about international growing now at triple digits again. As we reflected on the previous quarter, we delivered 69.6%, and I think everyone felt that was a very, very high number.

So when we thought about Q2, we really wanted to make sure that we were striking that right balance between gross margin and maximum revenue velocity. And we felt that the right thing to do is to take that down a little bit, but just keep going fast from a revenue perspective. When we talked to our investors, they concurred.

I mean, the dialogues I have with them and we’ve had with them over time suggests that, that 67% range is probably the right – the better range to sort of make sure that we're maximizing revenue, at the same time being very, very cautious and focused on gross margin at that mid-60s range..

Okay.

And on FlashBlade, why is it immaterial this year? What are the bottlenecks? And then how do you think about the broader TAM expansion created by that product?.

Hey, Katy. We are using the definition of 10% of revenues roughly as material criteria, and given the scale of the FlashArray business and the fact that FlashBlade is a new product offering, it's not fair to ask us to take on that much load that quickly. That's not due to lack of demand. There is so much excitement that we have in the market.

We are well oversubscribed relative to our ability to serve these directed availability to customers, but we want to give the product time to mature and get great feedback around these different workloads that we're testing out.

So I would say we're incredibly excited to be exposed to Internet of Things including self-driving cars and genomics and large-scale software development chip design, big data analytics. We are mining the insights from these customers successes.

I would say we're particularly thrilled that the large majority of these customers are either, one, putting us up against the biggest and baddest boxes they can get from EMC Isilon or NetApp, and we're doing phenomenally well in performance.

Or they're actually running workloads that they couldn't even fit on a standard storage product in the past and bringing those into the fold for a storage offering like FlashBlade.

So material, the expectation is certainly next year after GA, but not material other than proving out the ability of FlashArray plus FlashBlade to allow us to dominate over time in this $24 billion storage market we're playing in..

Thank you..

Thanks, Katy..

The next question is from the line of Simona Jankowski from Goldman Sachs..

Hi, thank you very much. In terms of the push out into next quarter of some R&D and marketing, can you just comment on what drove that? And was there any slowdown in terms of sales headcount hiring? I know you guys typically do that in the first half in preparation for the second half.

I just wanted to see if you feel like you're as ramped up as you want to be from that perspective..

Simona, on your first question, two primary drivers of the push in OpEx, first of all, some marketing and related spend. As you may have seen and we talked about it in our prepared remarks, Gartner Magic Quadrant went out for example. And that went out in early Q3 versus late Q2, we’re originally planning it for the Q2.

So that gives you some examples of some of these marketing programs that sometimes straddle one quarter or the other. And then on the engineering side, we are continuing to focus on hiring the best and brightest in technology to continue to innovate for the future. And so we want to make sure that hiring bar is high.

So we didn't hire as much as we wanted to from an R&D perspective. It was slightly behind there. And so that will naturally push into next quarter as well. To your second question on sales headcount, in general we are very happy with the sales headcount and hiring that we did at the beginning of the year. That was a big quarter.

Q1 is always a big quarter for us. So we feel very, very well positioned for Q3 and Q4..

Thank you..

Your next question comes from the line of Steve Milunovich from UBS..

Thank you. I wondered if you could talk a bit about competitive dynamics. I know that you kind of pooh-poohed the 20-year-old architectures of your competitors, but it seems like they're migrating in that direction. You've said in the past you're seeing more all-flash VMAX and VNX than XtremIO.

NetApp seems to be having some success with their All Flash FAS line as opposed to some of their kind of FlashArray type products that they've killed.

How do you read that? Is there an advantage if you're an EMC customer, for example, and sticking with VMAX from a software perspective or service perspective as opposed to switching to XtremIO? So are you going to face more of those types of situations? And is that an impediment to you at all?.

So Steve, the shift to flash is being driven in part by economics. The performance storage market that we are playing in, flash has dropped below the cost of performance desk. So where it's in our competitors interest, that actually accelerates the share shift. That doesn't change the fact that this is a completely different market over time.

You look at the 20-year-old architecture, they simply don't allow customers to store the amount of data they want to store at the price they want to store it with the security they need to protect it, and the performance of bandwidth, even in flash, to be able to mine the insights there in for analytics and even machine learning.

So this change to the storage market is about the customer experience, right. This is not about the flash media, it’s about how you use the storage and what value you can get out of it. So it's Moore's Law for efficiency. These legacy products, they insert ever-bigger SSDs inside of their offerings, thinking that's going to get them there.

The problem is as you transition; we're seeing competitors talk about very large SSDs, even up to 100 terabytes. These SSDs can store a lot of data, but they don't offer any additional performance over the smaller ones that they're replacing.

Pure doesn’t is not so constrained because we're using modern protocols like NVMe to support access to the data in a much more performing fashion. We've got the cloud automation for simplicity and agility they're missing. I mentioned the security. And Pure's products are Evergreen, right.

It’s the only tech in the data center that gets more valuable over time. So if these factors that are changing the storage landscape and I would say you see our differentiation most of all in our growth, right, where our competitors are shrinking generally double-digits. We're growing at 93%.

I think you can see it in the Gartner MQ which was released this week. I think you see it in our customer satisfaction scores as measured by Net Promoter with third-party audit. So we feel like this market is coming to us. The competitors are attempting to position and compare themselves to Pure, but they're coming up short..

Yes.

I thought your analogy to Apple in your blog was rather interesting and talking about customer experience and some of your competitors potentially being blackberry?.

Yes, that analogy has been used before. We subscribe..

Thank you..

Thank you, Steve..

Your next question comes from the line of Aaron Rakers from Stifel..

Yes. Thank you for taking the questions and also congratulations on the quarter.

Just going back on FlashBlade, I'm curious if first of all, can you just remind us again of the size of your beta program? And how we think about those beta customers rolling into potentially revenue, as now you've gone into, I guess it was late July, went into direct availability? And then I have a follow-up..

So I think we quantify the beta program as representing low dozens of installations. And certainly, we've had some of those customers choose to become paying customers of the product. Although it's exciting to us that many of the customers that have purchased the technology weren't even in the beta program.

We've had customers buy the product that had not even tried it out as of yet. So speaking to the credibility of the brand and the excitement they have around the innovation that FlashBlade is bringing to market and the impact it can have on their businesses..

Okay. And then as a follow-up kind of more off a kind of high-level question to think about running the business. I mean, you guys have put up cumulatively over 20% upside of revenue versus the initial post-IPO expectations. You drop significant leverage to the bottom line.

I'm just curious as you guys think about looking forward, what do you think you could do better? I guess I'm looking at this market inflecting I'm looking at the opportunity with FlashBlade.

And I'm just curious how you think operationally, maybe you could even take it a step further, and whether or not it could accelerate revenue?.

Aaron, we're obviously quite gratified with the success we've enjoyed to date. I think we have the luxury of competing with competitors that are richly deserving of the competition we're bringing to market and the innovation changing the landscape.

So in that fragmented market, going up against the 20-plus-year-olds, we ought to be continue to be able to drive the best-in-class growth we've driven to date. No doubt there is opportunity to get better.

We look at innovations we have teed up for the core, the core product in FlashArray, the innovations to come with FlashBlade and the hardening of that product, I mean I think – we have so much excitement around that.

We got to get the scheduling of that right and lead the innovation to bring them to market at the right time, to continue to grow our lead that we enjoy over the competitors. And I think we've got also continue to attract the best and brightest Puritans to come join the cause.

We have the luxury of our customers are so happy with our products, the corporate culture that we've built has been really well received, so we become a bit of a destination. So we can't relax on that. We've got to continue to make sure we're hiring the best and giving them and empowering them and making our partners successful.

It's really gratifying to see 80% roughly of our net new logos coming to us from the partner channel. How do we make that even higher over time? How do we make our partners even more self-sufficient in driving the business, so that will give us that much more leverage..

Okay. Thank you, Scott..

Thank you, Aaron..

Your next question comes from the line of Alex Kurtz from Pacific Crest..

Hey, thanks guys for taking a couple of questions here. I just want to clarify on Katy's question about gross margin at the outset, Tim. The 100 basis point downtick into October.

Is that specifically related to discounting or the FlashBlade commentary I heard you in prepared remarks?.

Yes, Alex, it really relates going forward into Q3 as FlashBlade. So as we ramp up production volumes, as we optimize the bill of materials, those are the things that are going on as we get into a longer-term gross margin with FlashBlade. It's something that we've seen in our 400 series product in the path as well.

So we now how do this, but that's the ramp period..

So the downtick on the gross margin is unrelated to your discounting in the quarter, or expected discounting?.

Yes, into Q3 for the guide, yes..

Great.

And then just my first question here is really just about how you feel about your account reps and hitting their productivity metrics and sort of I know you've hired a lot at the end of last year and beginning of this year and sort of what the trajectory of your North American reps look like right now, in terms of how that gives you confidence around the October quarter?.

Yes, Alex on productivity question, we’ve talked I think most calls about this. We think about it as three broad groups. The longest-serving AEs are have been at and are continuing to perform above what we call the magic number, which is the long-term number to drop to our long-term operating profit targets. So that's staying the same.

That middle-aged cohort, if you will, is continuing to climb very well. And our newest folks coming out of the gate are strong. They're stronger than their predecessors. So productivity stayed relatively stable and in a good place since last time we talked about 90 days ago..

Thank you..

Your next question comes from the line of Brian Alexander from Raymond James..

Just another question on FlashBlade, so you guys hit $175 million in revenue in your second full-year I believe of shipping FlashArray.

Is that attainable for FlashBlade under the same timeframe? What are the gating factors that could cause FlashBlade to grow faster or slower than FlashArray over the next one to two years? I realize this year it's going to be immaterial, but the next one to two years?.

So I think we need to avoid setting any specific guidance for FlashBlade. I would say though, FlashBlade did incorporate some original technology from FlashArray. It's since been specialized. It also uses the same Pure1 framework. So there are hardening advantages over time that will allow us to mature that product even faster, we believe.

I would say the bigger factor though is the reach that we enjoyed, both through our own sales force as well as that through our partner network that can help grow this business even faster, right. In the early days, we were more constrained I think on go to market than we were on product.

We don't have those constraints today, given the scale that we're operating the business. There's certainly very little in terms of constraint on the market opportunity. We have this unstructured and semi-structured data market that has not seen the kind of innovation we're bringing in storage in a very long time.

And it's a business, it's a need that's growing significantly in the customer base, 20% year-over-year, whereas the performance end of the storage market has been flatter. And so we couldn't be more excited about this combination and what it's going to allow us to do in taking share over time..

Thanks, Scott. For Tim, a follow-up. Can you quantify the expenses that shifted from Q2 to Q3? I'm just trying to understand the slowing improvement in operating leverage that we're seeing in the third quarter for your guidance on a year-over-year basis. Thanks..

Yes, the way I look at it, there were two reasons for the bottom line beat relative to our guidance. The majority of that is the fact that the revenue over performance did drop to the bottom line. I think about that as kind of 4.5, even maybe 5 points. And then the expenses are the remainder, kind of 2.5-ish point.

So that's how I look at it from a percent perspective relative to the guidance hopefully that's helpful..

Yes. Thank you..

Your next question is from the line of Rich Kugele from Needham and Company..

Thank you. Good afternoon. Again, returning to FlashBlade, just want to understand your go-to-market strategy.

Are the customers typically the same? So do you have an opportunity where you can go and sell like full fabric offerings, both M Series and FlashBlade? Or does your sales force, and therefore the channel have to be somewhat specialized?.

So we're certainly very confident that our current sales force and channel can service the customer demand. That being said, we are reaching new opportunities with the technology.

So significant portion of the deals we've done to date, that’s the majority in fact, have been done, the customers that were not existing FlashArray customers, although some of them became FlashArray customers right along with FlashBlade.

So I think we have an opportunity to extend our reach into markets that are more gated on this un- and semi-structured data than they are on the structured data market that we've been playing in.

And give us a chance to fully serve this $24 billion TAM, the biggest perhaps available in tech that we think we are in a position to build the leading share in..

Great. And then just one last follow-up. Tim, if you look at the Company you envision when you hit cash flow positive status. Do you have all the elements in place, and they just need to kind of grow into the Company that would be at that time? Or do you see further investments driving new product categories before we get there? Thanks..

Well, I would say two things. We continue year-over-year driving leverage. That's really been the focus on how we manage the operating model, while we drive revenue as fast as anybody's done it in the storage industry. As Scott said earlier, we're going to continue to innovate, and we will always continue to do that.

So we're going to be an innovative Company at heart. So we can keep spending from an R&D perspective. But we're well on the path. It's a very disciplined march that you've seen now for the last four quarters, and we continue to do that going forward..

Congratulations on the quarter. Thank you..

Thank you..

Your next question is from the line of John Lucia from JMP Securities..

Hey, guys. Thanks for taking my questions. You added 28 Fortune 500 customers in the quarter. And I think last quarter, you added six, so it was pretty good improvement there. It sounds like you're doing very well in the Fortune 500.

Can you just explain what drove that growth, and then how you expect that to trend going forward? And then will you have an opportunity to sell FlashBlade into those accounts as well?.

So John, I think the key ingredient was focus. We segmented our sales force earlier this year in order to make sure that we were sufficiently focused on these enterprise accounts that really expect you to be knocking on their door in a sustained and consistent way over time. So I think those efforts are starting to pay off.

We are absolutely convinced that we can sell FlashBlade into these accounts, the Fortune 500. All of them have a mix of structured and unstructured data workloads. And of course, they have really large footprints of both, which is what's so exciting.

We have enterprise customers today on that list that are running north of 70 arrays, and we're still underpenetrated in their overall use case. So there's just phenomenal amount of opportunity in that market..

Okay. And then on FlashBlade, can you just go into a little bit more detail on the initial momentum you're seeing in directed availability? It sounds like it's going very well. Are you seeing more use cases than you had originally expected? Any more color there would be great..

Well, I would say we went into this market knowing there was an opportunity for a new kind of product, right for a product that provided much greater performance, much greater density as well as lower cost to store and manage and secure the data over time.

So this is a market that hasn't seen a lot of innovation and disruption, so we were incredibly excited. We went in with certain use cases in mind. So we knew we were going to be focused on software development and chip design. I could say we were happily surprised with the excitement around self-driving cars and machine learning.

I think Internet of Things was something we had in mind. But then, we've been pushed on genomic sequencing and image processing in ways that maybe we hadn't calculated in advance. So the key thing is to have enough of these use cases represented. So we are proving out the value proposition for the product.

So we're in a position to really scale the business quickly next year..

Okay, last question. You said you're oversubscribed with FlashBlade.

Is that to suggest you haven't built enough inventory to satisfy the current demand? And if that's the case, would you expect a pretty strong uptick when you do release the product for GA?.

So it is the case that we have more demand today for – in our directed availability than we are prepared to serve. And that's because we want to make sure we make these early customers successful and prove out the value in the technology and take the feedback in order to mind those insights and put ourselves in a position to scale the business.

I do think this business can grow rapidly. But certainly for the rest of the year, it is already factored into the guidance that we’ve issued to the street..

Okay. Thank you..

Your next question comes from the line of Edward Parker from BTIG..

Hi, thanks. I wanted to ask you about your [indiscernible] business. And you mentioned that SaaS and infrastructure as a service is contributing to about one of quarter of revenues.

And I guess how do you see that mix trending over time? And secondly, who are you seeing in those environments? Are you seeing similar win rates and pricing dynamics as your broader Enterprise business? And then lastly, what's the interest been like for FlashBlade in that customer segment? Thanks..

So as I said in the call, the cloud has definitely been a catalyst for the business, Software as a Service and consumer cloud as well as we have customers doing infrastructure as a service also. I don't have data specifically on our win rate. I have to believe they're higher.

I know our repeat purchase rates are significantly better in the cloud segment.

I think because of the scale that these guys operate, there is no question that there is a phenomenally large opportunity for FlashBlade in the cloud segment over time, I think we will continue to see a disproportionate part of our growth in that segment, both for FlashArray and for FlashBlade, given the investment and the rapid growth in SaaS and the consumer cloud and [IIS] segments..

The next question is from Jayson Noland from Robert Baird..

Okay, thank you. I wanted to ask on international, the success there. Which GEOs was that? And is that something that can – where the momentum can continue? And I have a follow-up..

Yes, Jayson. On international, both regions we think of EMEA and APJ as two regions. Both performed very well. EMEA in particular, we have British Airways, as you saw in the press release.

And just a lot of good momentum in the various markets in EMEA as well, and it certainly something that we are looking forward to continue to sustain and keep moving forward. A lot of that TAM is outside of United States and we'll be focusing on, no question about it..

Thanks, Tim. And then the follow-up on FlashBlade go-to-market, I understand that development was mostly independent.

But lead gen, sales teams, direct and indirect mix, is that largely the same motion as M series or something different?.

Very much the same motion, right. So we're using the same sales force. We're using the same channel partnerships. We are building out some experts think of them as an overlay.

We have the same sort of expert overlays for some of our solution selling around VMware, Oracle, SAP and we're doing that to make sure that the sales team has what they need to support customers with the technology.

So that small overlay is what trains up the sales force and put us in a position where we can really hit the gaps with FlashBlade next year..

Thanks, Scott..

Sure thing..

Your next question is from the line of James Kisner from Jefferies..

Thank you for taking my question. So last night, we heard HP say they were stockpiling NAND and DRAM and LCDs. I'm just wondering – in advance of the potential shortage. I was wondering are you doing anything to prepare for the potential shortages in NAND? Thanks..

Hey, James. So we do maintain strategic supplier relationships with the top three fabs, right? So we want to work directly with the manufacturers of the NAND to make sure we're in a strong position.

We also enjoy unique a cog structure because of how efficient our product design is and because we have far and away the best data reduction in the industry. I mean, we're getting two to five times the value per flash cell versus our competitors.

And that puts us in a much better position to insulate our partners and our customers for many fluctuations in pricing. So I would say it’s the three factors, it's the long-term supplier contracts.

It's the efficiency in our design both hardware in general, and then the optimizations we've done to get the most value out of the NAND relative to our competitors..

Just a follow-up on that.

I mean are you saying that in these agreements they are guaranteeing you supply, the quantity that you need over the coming quarter or two?.

I would say we have supply assurances built into our supplier contracts in general, not just in NAND, but across all of our hardware suppliers to make sure we're in a position to run the business..

Okay. Thank you..

Sure thing..

Your next question is from the line of Kirk Materne from Evercore ISI..

Hi. This is actually Patrick Falzon on for Kirk. Thanks for taking my question.

You touched on this briefly before, but could you provide any additional color around the mix of new versus existing customers selecting FlashBlade and how you expect that to trend going forward?.

I think, Patrick the reality is it's early for us to be able to generalize, because we're generalizing from a pretty small sample set. So I did mention the majority of our first round of customers were pulled not from existing customers, but otherwise, but we're going to see a lot of business for FlashBlade into the FlashArray market.

But again, it’s great to get access to new customers too, just for FlashBlade and then when it pull FlashArray as well. But it's too early for us to have a trend on how that mix progresses..

Okay. Thanks a lot..

Your next question is from the line of Nehal Chokshi from Maxim Group..

Thank you. I think this is a larger than usual guidance range.

Can you talk to the reasons for that?.

Nehal, this is Tim. The business has scaled pretty substantially from when we started issuing guidance three, four quarters ago. And so it was right, on a percentage basis, it was time to widen – keep it constant, so widen that out in absolute dollars. That's why you saw that..

Okay. And I know on the last conference call, and I think this has been cleared up, but I think it's worthwhile to just go through it again here.

Is the policy on fiscal year 2017 guidance I know you guys gave it at the after January quarter call, and then just I think reiterating what you guys expect to do there would be helpful and why you are not I guess efficiently reiterating it would be helpful?.

Yes, Nehal, the first thing I'd say is that we are confident. We’ve had two good great quarters here in the first half of the year, and we are confident about the year and our execution capabilities.

From a principal perspective and philosophical perspective, what we wanted to do, and we talked about this at the start of the year, is to provide a one-year marker for analysts to think about from a modeling perspective, but then shift into giving 90-day updates only in terms of what's going on with the business.

It was really about striking a balance. Several of our high-growth infrastructure peers companies like Palo Alto, companies like Arista, don't provide full-year guidance at all. And so it was really something we wanted to provide a little bit more information, but still move into that 90-day cadence as we get into the year..

All right. Thank you..

Your next question is from the line of Mehdi Hosseini from SIG..

Yes. Thanks for taking my question. Two follow-ups. Assuming that FlashBlade would become material starting FY2018, would that be enough, or material enough, to help and smooth out some of seasonality that you typically see in the Q1, Q2 FY times. And then I have a follow-up..

Hi, Mehdi. Again, it's probably too early for us to have data, but my guess is we will find the same seasonality in the FlashBlade business that we have in the FlashArray business. And that's the nature of how customers want to buy storage. We just need to ride that curve..

Okay. And then one of the modeling question with your cash flow. Let's assume that the current supply of NAND were to remain tight and prices were to actually uptick.

How should we think about operating cash flow and your inventory management, especially as you start buying more than product shipment volume picks up in the three to six month time frame?.

This is Tim. On cash flow, the vast majority of our transactions are just in time from a purchase perspective. So Scott talked about the long-term supplier relationships we have. So don’t have inventory substantial amounts of raw material on the balance sheet. So it's really – that wouldn't have really a significant impact at all on cash flow..

Got it. Thank you..

Your next question is from the line of Steven Fox from Cross Research..

Thanks, good afternoon. Just one question for me. You highlighted again the healthy repeat purchases from your top customers.

I was curious how that plays out across a broader base of customers at this point, and what it implies that sort of the – how much growth is being driven by new customer acquisition versus repeat customers in the recent quarter? Thanks..

Steve, on repeat business, those trends have stayed very, very stable throughout the rest of the cohorts that we track. We bucket them in various buckets, and they all look very good. We haven't talked about it. It's not a statistic that we share publicly in terms of numbers.

But what I can tell you is that we're very happy with those repeat cohorts down through the staffing..

And in terms of the growth from new customers versus existing customers?.

Yes, another statistic that we don't talk about publicly. But again, we've seen those statistics stay about the same here quarter-on-quarter and for the last couple of quarters.

We're really happy about the new customer acquisition, all-time record in terms of new customer adds in absolute terms this quarter – very, very strong new customer add last quarter as well. So we're excited about what that means.

Because when people buy the technology and see how easy and how differentiated it is relative to our competition, they keep coming back for more..

Great. Thank you..

Your next question is from the line of George Iwanyc from Oppenheimer..

Thank you for taking my question. Just one as well.

On the lower end of the market in SMB, what type of feedback are you getting for the M10 at this point?.

Hey, George. Again, it's relatively early, but I think there was some pent-up desire. We did have a product that was really designed to serve the 50k and below market opportunity. But even more exciting to us is the fact that these customers can deploy and start with an M10 and then non-disruptively and seamlessly upgrade as far as they want, right.

You can actually go from an M10 and 10 terabyte all the way to our highest M product and M70 and more than a petabyte of usable data, and do it with no disruption in service and no performance impact. So very excited to see how M10 can increase our reach, especially internationally, and get that many more customers excited in hooked on Pure Storage..

Was that a factor at all in the customer adds yet?.

Not a significant factor because as Scott points, M10 is still relatively new product for us..

Okay. Thank you..

Your last question is from the line of Eric Martinuzzi from Lake Street Capital..

Thanks. With regard to the Gartner study, one of the things that the study talks about is competitors starting to match some of the things that you guys were really groundbreaking when it came to things like Evergreen Storage and really the long-term TCO.

Have you seen any of those matching programs have any incremental impact on your deal closure rates, where maybe in the past someone has not had an Evergreen equivalent long-term maintenance agreement, and they did, and they introduced it, and that caused you to not be able to close the deal or win the business?.

Hey. Eric, I think we are very confident that Evergreen is still profoundly differentiated. The challenge most of our competitors have as they don't have compatibility across different generations of their technology.

So when they ship our product in a particular point of time, they're not able to refresh it in place the way Pure Storage is because they have a new tech – new family of technology that ultimately have – they have to do a rip and replace as opposed to the incremental evolution that we support.

So that plug compatibility across all generations of our hardware, the ability to service the systems without maintenance windows non-disruptively and very low cost of COGS that our unique architecture allows us to offer hardware well below the cost footprint of our competitors is what makes Evergreen so special.

So people will talk about trying to match us, but they will cap it on some certain number of years. They’ll say, okay, we'll protect the flash for more than the two years we were originally going to do it. Or we'll build in one round of upgrade. But we're talking about Evergreen, right. People can run the same logical storage for a decade or more.

And we'll morph the hardware and software as needed to make sure that they're continuing to get the best possible service. There's nothing else like that that we are aware of today in the storage industry..

Understand. I appreciate the clarification. End of Q&A.

That was our last question. Mr. Scott Dietzen, I'll turn the call back over to you..

Thank you, sir. And thank you to everyone for joining us. We are chasing perhaps the largest available market intact, this $24 billion TAM that we are convinced is moving away from the 20-year-olds and toward technology that delivers on the modern use cases that I was talking about earlier.

FlashArray, our original product remains highly differentiated. In fact, it's more differentiated today than it was when we launched it four years ago. And you could see that evidence in our growth, in the Gartner Magic Quadrant, and our audited customer satisfaction scores around Net Promoter.

The repeat purchase rates, competitive win rates that we have are all best in class. And now with FlashBlade, we are poised to be able to serve the end-to-end storage market over time. We think we can duplicate the success that FlashArray enjoyed and disrupting the capacity oriented market for semi and unstructured data.

We've got great FlashArray innovation teed up, and those are going to complement the work we are doing around FlashBlade. So you added all up and it's hard to imagine us being more excited than we are about our path toward building multibillion-dollar profitable number one global brand in storage.

That is the goal and the trajectory that we are on and executing against. We will look forward to talking to you again in 90 days. Have a great day..

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