Liz Lemon - VP, Finance & Development Scott Dietzen - CEO Timothy Riitters - CFO Matt Kixmoeller - VP, Products.

Steven Milunovich - UBS Aaron Rakers - Stifel Kathryn Huberty - Morgan Stanley Simona Jankowski - Goldman Sachs Alexander Kurtz - Pacific Crest Securities Simon Leopold - Raymond James Jayson Noland - Robert W. Baird & Co.

Eric Martinuzzi - Lake Street Capital Markets Tim Long - BMO Capital Markets James Kisner - Jefferies Richard Kugele - Needham & Company John Lucia - JMP Securities Mehdi Hosseini - Susquehanna International Steven Fox - Cross Research.

Good afternoon. My name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 Fiscal 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you.

Liz Lemon, VP of Finance and Development, you may begin your conference..

Good afternoon. Welcome to Pure Storage's Q3 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..

Thanks, Liz. Good afternoon and thanks for joining the Pure Storage third quarter earnings call. We have a special guest today, our VP of Products, Matt Kixmoeller, who will add color in our Q&A. And as usual, there are new blog posts on our website with more detail that we encourage interested investors to read.

Pure is winning in the marketplace because our storage platform is enabling customers to derive unique value from their data. Modern analytics, including machine learning fundamentally depend on faster access to larger and evolving datasets.

Only Pure combines this scale, density, performance, and low cost of ownership necessary to develop next generation data intensive applications, as well as the bandwidth to connect that data to all applications.

Legacy and commodity storage alternatives are too slow, too siloed, and too expensive to meet the demand of the data driven cloud or enterprise. Pure has the right platform for our customers’ more strategic data at the right time. Our financial performance confirms our unique value proposition.

Q3 revenues grew 50% year-over-year to $197 million, 3% above the midpoint of our guidance. We also saw improved leverage; non-GAAP operating margin was 11 points better year-over-year and five points ahead of the midpoint of guide. In the quarter, Pure added more than 300 new customers, increasing our customer count to more than 2,600.

Cloud deployments continue to account for more than a quarter of our sales driven our service over 400 software-as-a-service, infrastructure-as-a-service, and consumer cloud customers. Meanwhile, Pure's international business remains robust, growing 70% in the latest quarter.

Repeat purchase rates also remain strong with our top 25 cohorts spending $12 more over the next 18 months for each dollar they spend initially. We added many noteworthy new customers in Q3; I'll touch on just a few. Hyatt Hotels is relying on Pure to change IT processes around app development, deployment, and management.

We also added the commercial real estate firm, Cushman & Wakefield; wireless service provider, Telecom Italia; CallidusCloud, a provider of SaaS sales and marketing software; Bill.com, a SaaS business payments company; and LAIKA, an Academy Award-winning animation studio.

Competition in the enterprise remains fierce as our legacy competitors fight to protect their installed bases. Nevertheless, our win rate has held strong and are on par with where they were a year ago. As a result, we now count more than 100 of the Fortune 500 as customers, up roughly 10% from last quarter.

We win for multiple reasons; we have the most innovative products. Gartner placed us in the Leaders Magic Guadrant, we have the happiest customers, that metrics calculates our net promoter score at 83.5 among the top 1% of all business-to-business companies; and we have the most reliable platform.

FlashArray-M delivered six nine's of uptime in its first year, that's less than 32 seconds of downtime per year and we did so uniquely without maintenance windows. Pure was a pioneer in all FlashArrays and we are ahead of the competition again with NVMe.

NVMe offers the potential for a 100-fold increase in performance to processing many requests simultaneously rather than one at a time.

By extending NVMe across the network, petabytes of data in Iraq can be accessed as if they were a local resource, enabling shared storage to offer better performance and better economics than the server local storage or DAZ model popular in many clouds. We believe all NVMe is going to prove as bigger disruptor as all Flash.

Of the mainstream storage solutions, only Pure has been shipping NVMe Technology since 2015 and only Pure is ensuring customers current investments are protected en route to that all NVMe future. Our competitors face extensive re-writes of their software while their customers face having to buy all new storage and migrate their data.

At the same time, we are ramping for the full launch of FlashBlade, our new product line for unstructured and Big Data. Customer feedback reaffirms that FlashBlade will revolutionize capacity [indiscernible] storage, the same way FlashArray re-wrote the rules for performance storage.

While revenue from FlashBlade won't be material this year, GA remains on-track and customer enthusiasm is sky-high. Some recent examples include, CUProdigy, a provider of private cloud solutions for credit unions.

It was using FlashBlade to elastically scale operations transparently to their applications, and Paylocity; it was employing FlashBlade to support its SaaS payroll and human capital management software. Pure's growth has been supported by strong channel partners. In the latest quarter, 76% of our net new logos came through the channel.

That expanding partner leverage which now includes key global systems integrators is essential to extending our reach. We are also seeing strong traction for our FlashStack partnership with Cisco delivering converged infrastructure that combines best of reach servers and networking from Cisco with Pure's best-in-class storage.

FlashStack is growing triple digits year-over-year today. To sum up, we are very well satisfied with our Q3 and even more excited about the road ahead. We are tracking toward our long-term goal of building a profitable multi-billion dollar revenue company that will lead the global storage industry.

We are winning in cloud; we are winning in the enterprise. Demand for FlashArray remains strong with NVMe set to tip the scales further in our favor, and FlashBlade is ramping in a growth market that moves in our direction as Flash costs drop. We are providing the data platform that uniquely empowers our customers to maximize the value of their data.

And with that, I'll turn the call over to our CFO, Tim, to provide further detail on Q3, as well as our guidance for Q4.

Tim?.

Thanks, Scott. Q3 was indeed an excellent quarter and I'm very pleased with strong execution around our operating model which calls for consistent topline growth balanced with meaningful year-over-year improvements in operating leverage. We are making great progress towards becoming a profitable multi-billion dollar revenue company as Scott mentioned.

Before I dive into Q3 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, Q3 total revenue grew 50% year-on-year and 21% quarter-on-quarter to a record $197 million, which is 3.1% above the midpoint of our guidance. Product revenue in Q3 grew 41% year-on-year and 23% quarter-on-quarter to $160.5 million, driven in part by over 300 new customer additions and excellent demand from our existing customer base.

Some of you have asked for more insight into our repeat business, so beyond the Top 25 that we have reported in the past, I'm happy to say that across our entire customer base, our repeat business is thriving. For every $1 that our customers spend initially, they spend an average of more than $2 additionally within the next 24 months.

We continue to ramp our FlashBlade business which had solid quarter-on-quarter revenue growth. We are excited about the long-term opportunity it represents though as expected, the revenue contribution was immaterial to our Q3 results.

Support revenue in Q3 grew 105% year-on-year, and 13% quarter-on-quarter to $36.5 million, driven by revenue recognition of ongoing support contracts. We continue to drive loyalty among our customers demonstrated by a strong customer retention rate in mid-90% and our industry-leading NPS score of 83.5.

Looking at Q3 from the geographic perspective, 77% of our revenue came from the U.S. and 23% from international compared to an 80-20 split in the prior fiscal year. We are seeing notable success in regions across the board. Q3 total gross margins of 65.5% improved 3.8 percentage points year-on-year.

Total gross margin declined 0.8 percentage points quarter-on-quarter. We continue to be in the range of our target long-term model of between 63% and 68% for total gross margin. Product gross margin of 66.0% improved 2.9 percentage points year-on-year and declined 1.4 percentage points sequentially.

The year-on-year improvement reflects the shift to the higher capacity, higher gross margin, FlashArray M-series products. Consistent with our Q3 guidance, the Q-on-Q decline was driven primarily by lower margin FlashBlade shipments as we continue the manufacturing ramp of this new product.

Support gross margins of 63.2% improved 10.4 percentage points' year-on-year and 1.2 percentage points sequentially. This is driven by our expanding customer base and the deferred support revenue associated with increasing product revenue. We continue to drive operational efficiencies within our support organization as we scale.

Moving on to expenses, as Scott mentioned, we continue to drive significant operating leverage year-on-year and sequentially, while making strategic investments in the business. In Q3, R&D expense was $46.3 million or 24% of revenue versus $34.9 million or 27% of revenue in the year-ago quarter.

R&D expense in absolute dollars increased 33% year-on-year, driven primarily by continued investments relating to our next generations of FlashArray and FlashBlade hardware and software. Sales and marketing expense of $82.5 million represented 42% of revenue in Q3 versus $59.2 million or 45% a year ago.

Sales and marketing expense in absolute dollars grew 39% year-on-year, as we invest thoughtfully in sales and marketing headcount and programs. We remain focused on capturing the current market share opportunity, balanced by careful attention to sales productivity.

G&A expense were $19.6 million or 10% of revenue in Q3 versus $15 million or 11% of revenue a year ago. G&A expenses -- spend grew 30% on a year-on-year basis driven primarily by increased spend on legal outside services and finance as we scaled and continue to grow our business.

Total headcount at the end of Q3 was over 1,650, up from over 1,600 at the end of Q2 and up from over 1,200 a year-ago. Turning to operating margin, we continue to make excellent progress in our drive to profitability and toward our long-term operating margin goal of between 15% and 20%.

For Q3, non-GAAP operating loss was $19.4 million or negative 9.8% of revenue compared to non-GAAP operating losses $28.1 million or negative 21.4% of revenue in the year-ago quarter. This represents an 11.6 percentage point improvement in operating margin year-on-year, and 9.5 percentage point improvement sequentially.

We are making significant progress in making this fiscal year our turning point in terms of absolute operating losses. Operating losses in absolute dollars have decreased by $27 million year-to-date over the same period last year, 23% ahead of our flat year-on-year operating loss guidance from the beginning of the year.

Our non-GAAP net loss for the quarter was $20 million or negative $0.10 per share. This compares to the year-ago quarter non-GAAP net loss of $29.1 million or negative $0.18 per share. The weighted average shares used for the per share calculations were $195.8 million and $164.9 million, respectively.

For those of you comparing to our Q3 fiscal 2016 period, 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 at the beginning of the quarter.

Please note, that for Q3 fiscal 2017, our non-GAAP operating loss, non-GAAP operating margin, non-GAAP net loss and non-GAAP net loss per share also exclude a $30 million one-time cash charge related to a legal settlement. Moving on to the balance sheet and cash flow, we finished the October quarter with cash and investments of $518 million.

Our free cash flow was negative $35.8 million or negative 18% of revenue compared to negative $13.0 million or negative 10% of revenue in the year ago quarter. Please note, that this includes $5.4 million of an impact related to our employee stock purchase plans.

Excluding this amount, free cash flow would have been negative $30.4 million or negative 15% of revenue. For Q3 fiscal 2017, our free cash flow also excludes the $30 million one-time cash payment related to the legal settlement I mentioned above. Let's turn now to our Q4 guidance.

We are experiencing seasonality consistent with last year; strong topline growth in our second half, driven by sales investments we made in our first half. As a result, our operating margin tends to be stronger in the second half relative to the first half.

With that in mind, for the fourth quarter of fiscal year 2017, we expect revenues between $219 million and $227 million driven by several key dynamics.

We are entering a seasonally strong period for our business, we have excellent repeat purchase rate across our entire customer base, we are now one of the Top 10 vendors in storage and we are seeing many more deals today than we were a year ago.

Our partner momentum remains strong fuelled by a geographically diverse combination of partners who are increasing their commitments with Pure, and perhaps most important, we have a superior storage portfolio moving strongly into under-structured data with a software advantage that customers value.

With regard to revenue contribution from FlashBlade for this fiscal year, I'll remind investors that while we are excited about the long-term opportunities for this product, revenue contribution is not expected to be significant in the near future. Turning to gross margins, we expect Q4 non-GAAP gross margins in the range of between 64% and 67%.

With the initial manufacturing ramp of FlashBlade behind us, our overall gross margin has now stabilized. This performance fits within our long-term model of between 63% and 68% gross margin and we remain focused on execution in this area.

We expect Q4 non-GAAP operating margins of between negative 5% and negative 9% as we continue to drive absolute operating losses lower year-on-year. In summary, our Q4 guidance implies for our current year that we will drive nearly 65% year-on-year revenue growth while cutting our absolute operating losses by over 20%.

We continue to manage the business towards sustained positive free cash flow in the second half of calendar year 2017 as we drive consistently towards our long-term operating margin targets of between 15% and 20%. With that, we will open the call for questions.

Operator?.

[Operator Instructions] Your first question comes from Steve Milunovich from UBS. Your line is open..

All right, thank you very much. Last quarter I think you talked about pushing expenses forward into the October quarter, I don't really see that, I mean R&D certainly did increase much, SG&A and G&A seemed kind of up with what I expected.

So did that not happen, is that yet to come, or is that really embedded in those numbers?.

Steve, this is Tim. What you're seeing really in Q3 is the leverage that we talked about here in the earlier remarks and so that's dropping, a lot of that is dropping to the bottom line which we expected.

I'm always on the lookout, I think we're always on the lookout here for good quality count on R&D, but we're kind of happy where we are right now with the OpEx for Q3 and then the implied guide out in the Q4 as well..

Okay.

And then Scott, I wonder if you could talk a little bit about your position relative to the hyper converged options, particularly Nutanix; do you compete against them and what do you view as your advantages?.

Thanks, Steve. So we do see hyper converged in a low single percent of our -- of our single-digit percent of our deals.

Pure is competing for the more strategic data that our customers have, and where we see hyper converged sweet spot, if you look at the report, we've actually cited on the blog that’s 67% by their measure of the hyper converged deployments in the world are for remote and branch offices in VDI which is not the most business critical data in the data center.

The larger data centers very much tend to specialize their infrastructure into multi-Tier. There is an application and compute Tier, and then there is a separate data and storage Tier.

That combination provides additional scale, additional performance, and actually better economics because you can refresh and scale the compute and storage Tiers independently of one another. And maybe I'll pass the baton here to Matt Kixmoeller who can provide some more color..

Yes, the only thing I would add is that I think it's important to remind us that hyper converged was born in the era of disk, and so the whole base architectural assumption was, there would be lots of cheap disk you could throw in servers and you can kind of get a storage layer for free.

I think the challenge with that, I think you know is that's ultimately quite a compromised storage layer, it doesn't have the performance, doesn't have the scale and resiliency that enterprise customers expect, and so we really see this plan in new spaces that Dietz mentioned earlier, and a remote office VDI-type use cases as opposed to the mission critical data intensive analytics and business applications that Pure tends to serve..

And I guess I would add four cloud and enterprise, it's where we're less likely to see hyper converged infrastructure..

Great, thank you..

Thank you..

Your next question is from Aaron Rakers from Stifel. Your line is open..

Yes, thanks, a couple of real quick questions if I can. First, I want to touch on the gross margin, you talked about getting through the initial ramp, a FlashBlade, I think that was expected to be about a 100 basis point negative impact this last quarter.

So as we look at the guidance, is that 100 basis points kind of lifting out and in that how do we think about the current trends that we're seeing on NAND Flash pricing as it relates to your gross margin in the current quarter or even thereafter as we've seen continued price increases out in the market? And then I do have a follow-up..

Yes, so Aaron, this is Tim. And I think on your observations on FlashBlade, you're absolutely correct. We're through that first phase now, FlashBlade margins, where we want to be -- now FlashBlade will become a bigger part of the overall revenue, so that also factors in the gross margin and that's why we got it the way we did.

As it relates to the overall cost of goods sold or the NAND pricing you talk about, we have seen some NAND increases, but I think as we've said in calls before and I'll reiterate here, we've got -- strategic supplier relationships across many of the manufacturers that have allowed us to go out and source the most cost effective NAND for the job which we've done.

So we've modeled all of that into our pipeline, and I'm really confident in terms of what we're seeing in terms of maintaining and keeping that gross margin right where we wanted, right where we guided..

Okay..

And maybe I'll add on, on that topic. From the outset we designed our products to allow us to plug and play the Flash from different vendors. And we're using the same consumer grade Flash that goes into mobile devices and laptops which gives us a much broader supply that we can access.

So we feel like we're in a very strong position, in fact we think we're in a well better position than our competition, maybe, Matt has some thoughts on that..

Yes, just to double click there, if you look at the traditional pure deal, because of our advantage in the data reduction software, our competitors will often have to configure between two and four X more Flash, just to get the same usable amount of Flash for the customer, and so that puts them at a much riskier position when you look at any kind of supply stock in the system, those prices rise, it's going to -- really we think clean out the market and kind of put the hurt on them, just doing these kind of low-cost deals to try to compete with Pure..

And these blips are very much part of normal operations, we move through them, the broad trend line is that Flash prices will continue to drop in the quarters and years ahead, and that only brings more of the market to us..

Okay.

And then just -- I guess kind of following up a little bit on a competitive comments made there, I mean we've seen a lot of talk about EMC and the positioning of their flash solution, obviously now being a little bit tougher to see that under the Dell umbrella but there has been some discussion in the market about the repositioning or lack [ph] of the extreme IO product relative to the off-Flash or VMAX product.

So I'd be curious of what you're seeing competitively from EMC post the Dell transaction? And in particular, as it relates to extreme IO versus let's say the VMAX or Flash offering?.

Aaron, Dell EMC of course remains our most frequent competitors, thrilled to say that in the quarter our win rates overall held strong, as good as they've been in a year. And our win rates specifically against Dell EMC, we maintained a two-thirds POC win rate that we've historically enjoyed.

Now I think we are benefiting from the fact that the combined entity has nine different all Flash storage offerings and that's creating some confusion in the field about which tech for which solution.

I will say broadly in our own experience we are seeing a lot more of Flash VMAX, then we are extreme IO to-date, possible that moves overtime but it's certainly seems that their cadence has shifted there.

I would say the biggest opportunity uptake we've seen is committed Cisco channel partners that really want to bring in our products that they proceed to be long-term friendly, the Cisco networking and Cisco compute; and so our FlashStack is enjoying triple digit growth as a result of that..

Thank you..

Tim, anything you wanted to add?.

No, I think that's good..

Perfect. Thanks guys, good luck..

Your next question comes from Kathryn Huberty from Morgan Stanley. Your line is open..

Thanks for the questions and congrats on the quarter.

The profitability upside at the back half, Tim, how are you thinking about that flowing through into the next couple of years and in particular, are you thinking that you hit profitability at quarter two earlier than you would have thought a quarter ago?.

I think Katy, it's too early to tell, again, as you -- we might imagine, we're not going to guide going out but what I will say is that Q3 and Q4 is really when we reap the rewards of those investments that we make and this has been a game plan that we followed for the last several years now.

So I think into 2017, the first half becomes -- that growth or that investment portion of the business as well as we go back out to the last half or we'll see those rewards come again. So I think nothing fundamentally has changed in terms of how we think about the investment and then the return cycle in the business..

Okay.

Now that you have another quarter of FlashBlade under your belt, how you're thinking about the incremental TAM that adds to your business? And what -- you know, what made that contribution to growth next year look like from that product in particular?.

Yes Katy, this is Kix. We did a blog post about a month ago now, updating our TAM with a result of the number of the expansions that we've done recently including FlashBlade to restate that to a $35 billion target market. And I'd say as we've gotten into the first three quarters now, it should be in FlashBlade.

We really have been enthused and encouraged by the wide variety of used cases. So when we first started, we began really positioning the product for some high end used cases or analytics, software development, chip design.

As we had a quarter now really coming on with a broader salesforce, I think we've been excited to see the diversity, so if you look at this last quarter, we've seen online gaming, a great example where the online experience plus the kind of creative development experience or both accelerated by FlashBlade.

Medical imaging and pox [ph] whole new area, security log analysis, IAS, and service rate environments; so we're just kind of -- I think, continue to have confidence in the breadth of used cases in the platforms going on and it's still just really early days..

So, and -- we're proving out that time to value in the key verticals that we are targeting and we're on-track to hit general availability this quarter which was always part of the plan but we're going to avoid making specific guidance for next year's performance of FlashBlade at this time..

And just generally speaking, would you expect a material revenue contribution in the first half of next year or is it more back half weighted?.

So Katy, I appreciate where you're headed with the question but again, this is just too early to guide next year. We're happy with the momentum but it's still really is early days..

It's a good effort though Katy, I admire that..

Okay, thank you very much..

Your next question comes from Simona Jankowski from Goldman Sachs. Your line is open..

Hi, this is Mack [ph] on behalf of Simona. I guess I wanted to circle back to one of the earlier questions about the competitive landscape. I heard the commentary about EMC but it also seems like now NetApp is running over $1 billion of all Flash revenue, HPE is upto about $750 million or so over run rate.

So I'm just curious if you've seen any change and how often you're going up against those two, and what you feel your real competitive advantage are against both of those?.

So, again no -- no material change to the competitive environment, we have maintained our win rate. We've been going up against all Flash for multiple years now, all of the core competitors took the effort to swap out the mechanical disc in their legacy systems and put in Flash. You know, the key thing is that doesn't change the challenges, right.

Those platforms are still too slow, too siloed [ph] and too expensive. So Pure is competing for the most strategic data in the enterprise because we're able to do things that our customers can't do with the legacy retrofitted products. And you're seeing that in our success in the market in our overall growth.

I would say the best way to look at this market is not just growth in the Flash business but compare that relative to the overall company's performance.

So if somebody's Flash business is growing but their overall business is shrinking in double-digits, then really all they are doing is share shifting inside of a shrinking installed base which is not compelling going forward.

So I would say that we're very happy with where our win rates are now but if you look forward, I think we have the wind at our backs, in a sense that FlashArray demand is holding strong and we've got the NVMe differentiator just now coming to market and FlashBlade ramping with -- there is just nothing like FlashBlade out there in the market and that is a huge and growing TAM, that's going to continue to shift our way as Flash prices fall..

One extra comments from Kix here. I would say if you look at the discussions we've been having technically with customers over the last couple of quarters; two net new things. I would say the FlashBlade discussion has materially even held the FlashArray business.

And at the end of the day, every customer has both structured and unstructured data and the product is just so strategic, also if you look at the competition, there has just really been anemic [ph] response, NetApp really hasn't responded at all.

EMC recently came out with a version of Isilon where it's simply retrofitted big slow SSPs and the existing Isilon products. And so we really feel like the combination of FlashArray and FlashBlade is changing that longer term strategy discussion around Flash. And then the second thing I'd say is, this path [indiscernible] becoming real for customers.

You know, one of the things that I think I was recently talking with the Gartner analyst and he said, look, I think the customer race is finally starting to internalize the rapid pace of change of Flash and this isn't the three/five year cycle anymore, you have to invest in an architecture [ph] that's always going to evolve, and we're showing that very clearly with some announcements we've recently made with NVMe.

NVMe transition is going to happen faster than people think and we're out there really differentiate our platform being built for NVMe today, so that customers understand that they are investing in a platform that absolutely can be upgraded to the latest and greatest Flash next year..

Got it. And then just a quick follow-up, I just wanted to clarify that the $30 million legal settlement in the quarter, that was all cash and that was the big drag [ph] and free cash flow, I just wanted to clarify that.

And then -- I'm sorry if I missed this earlier, but I just wanted to make sure that you're still on-track to hit free cash flow breakeven in the second half of the calendar year?.

So Matt, Tim here. On free cash flow, so -- yes, we did make the $30 million payment to legal settlement in the quarter. It has been stripped out at the FCF numbers that you saw in the presentation, so that -- that excludes that calculus but if you look at our overall cash balance change, $30 million actually did have to do with the legal settlement.

And then on terms of cash flow positive, no change in that, still signaling sustained cash flow positive in end of calendar -- towards the end of calendar 2017..

Thank you..

Your next question is from Alex Kurtz with Pacific Crest. Your line is open..

Yes, thanks for taking the question guys.

Tim, back on the questions that Aaron was asking around, product margin; would you say that that 100 basis point estimate on the FlashBlade impacts were played down the quarter?.

Yes, I was in that ballpark. Certainly the majority of the change Alex is indeed due to FlashBlade..

And you know, should we be thinking about a similar kind of impact as you scale the FlashBlade business in the January quarter here and start to think about product margins, maybe in the same levels because of that?.

Yes, so we've guided the implied midpoint of our guidance is about flat quarter-on-quarter and I think that's exactly it.

I mean you're going to see FlashBlade become a bit of a bigger portion of the overall revenue, it's gross margin is going to probably improve as well, so I think when you scroll those together, you get kind of that stabilization that we've seen.

And that the other thing that I look at is, I look at overall momentum in the business on the FlashArray business on a gross margin business, I think one of the important takeaways here is that the gross margin business that we were writing at the end of the quarter was stronger than the gross margin that we are writing at the beginning of the quarter.

And really -- go ahead..

No, just to tie this into the service margin discussion with Scott for a second around competitive opportunity; so it looks like you're improving your efficiency on the services side, which is going to give you some flexibility if services margins continues to trend up here into the middle of 60s [ph].

Are you going to use that opportunity to take some margin from services and apply to product to go out through some incremental accounts, is that how you're thinking about it?.

Yes, this is Tim again, Alex. You know that's very deliberately why we've guided the overall gross margin number the way we have -- you will note that we don't guide between product or support because we've got the leverage and the capability to do a variety of things as you alluded to.

The things outside to point out is, we are best-in-class in product margins and best-in-class in gross margins, a lot of our competitors have numbers that have five's or four's in front of them and so we're really proud of that, it speaks for the differentiate of the technology and gives us that flexibility to go out and capture share and grow the business..

All right, thank you..

Thanks..

Your next question comes from Rod Hall with JP Morgan. Your line is open..

Hi, this is Warkey [ph] on behalf of Rod. Thanks for taking my questions. I have one question and one follow-up if I may.

Could you let us know what led to the upside in that quarter in terms of both revenue, as well as the EBIT margins?.

Yes, on the revenue side it really comes down to demand and it comes down to demand on both the product or on the -- on the FlashArray product and the FlashBlade product.

We had sort of good momentum on both of them, really good solid sales productivity and pipeline generation capabilities in the quarter, and so again, it's really a testament to the technology and the quality of the product and service offering that we have in the business.

And then on the bottom line, a handful of things I'd point out to; number one, naturally upside on the revenue side will drive to the bottom line which certainly helped the bottom line, and then we're starting to get some benefits in leverage, in terms of productivity that I talked to and alluded to.

And then the other thing I would say is we're now starting to see reductions in some of our legal spend as well as a function of settling the trail..

Okay, great. Also, I wanted to make a clarification about FlashBlade; I think last quarter you alluded to FlashBlade revenues being material next year.

I wanted to confirm if that's true or not? And if so, if you're recreating it now?.

No, what we said was that FlashBlade was not material for the current fiscal year and that we were not offering guidance on FlashBlade out into the next year, so calendar 2017. So if you want to make it clear on that, we're not providing any guidance on FlashBlade, any further then -- or not at all into 2017..

Okay.

And could you give us any indication on how much lower FlashBlade gross margins are compared to your FlashArray?.

We don't provide that and the reason being it's early days, we talked a little bit about this on the last call, very similar to happens with our 400 series products in the old days and the M-series product; there is a ramp -- a manufacturing ramp, and so it's really until we hit the stability that we would start talking about FlashBlade gross margins.

The other thing I would say in FlashBlade gross margins, they will run right in our long-term margin targets overtime. It's just a question of getting it ramped up over the next couple of quarters..

Okay.

And lastly, whether any other factors like -- other than FlashBlade like international makes or pricing which impacted your gross margins this quarter?.

No, the predominance was again FlashBlade gross margins. It's that what we have talked about and signaled. It came in largely as we expected..

Okay, great. Thank you..

Your next question comes from Simon Leopold with -- from Raymond James. Your line is open..

Great, thank you for taking my question.

You made a comment in the prepared remarks about the fourth quarter seasonality; I'm wondering if you could talk a little bit about what you anticipate for seasonality longer term? And really the basis for the question is not simply to get guidance for fiscal '18 but to get a better understanding of how to think about the cadence through the year because when I look back at the April '16 quarter, it was a negative 6.8% sequential versus the April '15 quarter that was 12.5% sequential rise.

So moving in opposite directions, with current consensus indicating that the expectations for first fiscal quarters are down quarter -- I just want to get a better understanding of what's -- what are the drivers as it's related to things like sales incentives or customer behavior. Help us understand what seasonality to expect? Thank you..

Yes, Simon, great question. In terms of seasonality, enterprise storage has always been a very, very seasonable business. Q1 tends to be the weakest quarter, Q4 tends to be the strongest quarter and that's why you typically see most companies have this sequential decline.

What that really is driven on is it's a largely to do with part to customer buying behavior, so the classic budget flush at the end of the quarter and then the starting of the new quarter.

But I think you're thinking about it absolutely correct, and the other thing I would say is that as we think forward, again, we're not offering guidance for next year but as we think forward, we've got two dynamics in the business going on.

We've got -- kind of what I call the secular growth which has been growing very, very fast, hyper growth; and then the seasonal trend which has always been there.

And so what I -- how I think about it here internally is that that seasonal growth trend will always be there and that circular growth trend will be slowing down, it's natural in terms of large numbers and just factoring that into your over and thinking, how you're thinking about the modelling..

Great, I appreciate that. .

Sorry what -- I mean I agree with Tim, it's predominantly customer behavior that the end of the year is the time that storage is purchased.

We do have the extra impact that in Q1 we're ramping new hires into our salesforce, that's when we add the most people and we're re-jittering [ph] territories and segmentation and so on, and so that's another reason that Q1 is likely not to be as strong as Q4.

So we would expect that same seasonality that we experienced last year to occur again next year..

And just in terms of your October quarter, do you have material federal exposure and is that a factor in terms of your October quarter performance and trending into the January quarter?.

Yes, your federal quarter, the October quarter is always the federal quarter, their buying cycles; you're spot-on there. We have a nice federal business, our state-local government business as well, and so that's some of the dynamics that you're seeing and why Q3 was a bit stronger than Q2..

Great. Thank you for the help on that..

Absolutely..

Your next question comes from Menal [ph] from Wells Fargo. Your line is open..

Hi, thank you. So regarding this $30 million settlement in the quarter, I just want to -- Steven [ph] clarified that -- are you making any ongoing quarterly payments as part of the settlement? I guess I'm trying to figure out whether or not that had any impact on the gross margins other than the quarter going forward.

And then if you can help us quantify the OpEx benefit, if I'm not mistaken, I think the last time a legal issue went to court, I think there was an associated increase in OpEx related to legal fees that I think might have been $1 million or $2 million, but if you can help us with the quantification, that would be helpful. Thanks..

It's Tim. On your first question of the $30 million, all rear-view mirror, so nothing in gross margin, no ongoing royalty payments, we are completely closed off on that topic.

And then on a go-forward basis in terms of legal spend, I'd like to offer a specific number but as you saw in some of the leverage in our guidance Q4, relatively to where consensus was it was born about less expenses from a legal perspective, so it does make a difference on the bottom line and one of the reasons why we're happy to put this behind us..

Great. And then just lastly, you talked about Flash pricing dropping, helping you as more of the market starts to come to you. But can you just talk about your expectations for when you expect to start seeing more material declines in Flash pricing because we've seen the NAND pricing actually going flat to up more recently.

So I'm just wondering when you expect that will start to help you more significantly? Thanks..

Yes, our earlier comments were actually in reference to I guess my anticipated questions about bit of a supply bubble that's happening right now. So we're anticipating slight increases over the next few quarters.

Those tend to be seasonal and nothing we're critically worried about writing out and as we said earlier, we have multiple suppliers, we've architected our product for that from day one and because of our superior data reduction technologies, we believe we're much, much less impacted by any shifts in NAND price in some of our competitors who rely on low cost pricing and raw [ph] Flash to win..

And just to be clear, the trend we were outlining is a very long-term trend that we believe that cost will continue to come down for Flash as we see more capacity ramp, just because it's -- an explosively growing business..

Great, thank you..

Thank you..

Our next question comes from Jayson Noland from Baird. Your line is open..

Okay, great, thank you. Scott, I wanted to ask about your blog post where you say NVMe will be as big as all FlashArray and you mentioned an all NVMe Array.

Could you talk a little bit about the timing and any required investment on the part of here [ph]?.

So we're going to avoid making new product announcements at this particular juncture but I would say we have been making R&D investments as I prepare for that all NVMe future for more than 18 months now.

And so we are tracking to our long-term plan and we absolutely believe this is going to be a profound differentiator in terms of how much value customers can extract from their data, how many different applications can use that data, how much more real-time analytics we can accommodate.

So we are shipping NVMe Technology in the current FlashArray end product and we have providing our customers within investment protecting path that will non-disruptive to their business, to get the full benefits of all NVMe going forward and I think we're the only major storage vendor doing that..

Just to give you a little more clarity on why we think this is going to be so disruptive. If you look at the way most storage arrays are built today, all FlashArrays, they use SAS technology, Serial Attached SCSI. So the first S there is Serial, that means that kind of a single point-to-point link from CPUs down to the Flash.

Moving to NVMe literally gives you 64,000 parallel queues, and so it really helps us take advantage of multi-core CPUs connected to massive amounts of Flash. And as we move to these denser and denser all FlashArrays, that becomes critical.

And so you first of all need a hard work that actually can support that and we of course own our entire hard work and sure design that from scratch. But more importantly, you really need the software technology; they will take advantage of it. You can't just plug it in and exploit that parallelism easily.

And so we believe this is a pretty major transformation, it's one that we saw coming anticipated three years ago when we started building FlashArray and kind of build NVMe from the start; and it's one that we intend to lead the transformation industry around.

And so as Scott says, we're not ready to enter [ph] new product set but like we said from the early days of FlashArray-M, we've built the -- build for that upgrade to come within the product already and we anticipate taking customers there in a totally non-disruptive fashion..

And we think this is going to be a substantial challenge and hurdle for our competitors that are starting the legacy technology. It is likely a multi-year software re-write, as well -- that's for the vendor and then for the customer, it is a repurchase of the storage, as well as a data migration.

So they're going to sacrifice investment whereas our customers get to preserve investment.

And it's better across the boards, it's going to allow us to deliver a lot more technology in a smaller foreign factor, so we're not just going to be able to add more performance, we're going to be able to cut cost of our customer infrastructure with this technology..

And one final thing I'll add. We really are excited about this, not only because of the customer benefit but we view it as TAM expansionary. If you look over the last few -- maybe call it five years, many of the newer skill kind of web generation applications were built in a world of local data storage.

NVMe allows us to go in and attack that market now with a shared storage footprint. We can take those local SSPs, those local Flash cards out of those servers and replace them with a shared array that offers all the benefits.

And so from a customer's point of view, it's just kind of best of both worlds; they can potentially get the performance of local Flash into the server but all the benefits of manageability, reliability and economics of a shared environment..

Okay, I appreciate the color on that. And then a follow-up on international, it looks like you saw strong growth year-on-year.

Which market is that coming out of? And is it a trend that we should expect to continue?.

Yes, on international, we had momentum in a number of markets; I guess I'd highlighted two of them. We talked about Telecom Italia on the call, a named customer reference in Europe; very, very strong momentum there. Our sales leader, James Petter in EMEA did a phenomenal job in terms of growing that region in general.

Another one I call out is Germany; we installed a new leader there recently and had a very, very strong big win in a large German financial services firm as well. So a lot of things kicking on all cylinders both there, as well as the APJ market as well..

You know, there is so much addressable market globally, and we were so excited with the prospects that we have to continue to expand. I would say, we have to continue to get better in our consistency, we have countries that are exploding, we have others that are still ramping.

And so we just got to keep doing our work and you will see that international growth continue in the years ahead..

Thanks guys..

Your next question comes from Eric Martinuzzi from Lake Street Capital. Your line is open..

Thanks.

You commented a little bit on the gross margin linearity in Q3, what about the revenue linearity?.

Revenue linearity in terms of -- in quarter Eric or just trying to get to understanding that question?.

Within the quarter, I mean typically I was thinking October quarter would be very -- kind of September/October loaded with doldrums in the summer months; what did you see?.

That's exactly. That's the dynamic we've seen for several years is that, particularly some of our international market -- August is a very slow time just because people are away and so I think you've characterized it perfectly, consistent sort of behavior that we've seen in years past as well..

Okay.

And then also for the services side of the house, I know your -- the primary support revenue is around maintenance contracts but as far as professional services to the extent that you're performing for services is that similar as well?.

Yes, and Pure services, as you alluded to -- very, very small portion of the business. The vast majority of the number you see on that line is just amortization of the support contracts..

And key part of our practice is, we try to encourage the services business to go to our partners because it's a key place for them to add value around our product offerings..

I understand. Thank you..

Your next question comes from Tim Long with BMO Capital Markets. Your line is open..

Thank you. Two questions if I could. Just following-up on the services line, you talked earlier about the gross margin having flexibility between the businesses but you've had a nice ramp in the services line.

Is there more runway there for you to play with and then separately, just curious on the -- you said the win rates been pretty stable despite some of the incumbents maybe catching up with all FlashArray products; anything standout as far as win rates by different verticals or geographies or is there any area that you think your win rates are little bit better than the competitors and more defensible? Thank you..

It's Tim. On the first question, is there a leverage in the support number, I'll give you just a very short and simple answer, yes. You've seen that grow very, very nicely overtime and we still see line of sight that sort of greater things there..

And on win rates, it is consistent, right; so we're measuring across all of our competitive engagements and all GOs [ph], and you know the fact that those win rates are holding strong is reflective of our performance broadly. I just want to hit again, the differentiation gap is not closing.

You take these legacy and community storage platforms and you put Flash into them, they are still too slow, they are too siloed [ph] and they are too expensive and too complicated. They do not do the things that Pure does, that's why we've been able to sustain these win rates for the past couple of years despite the competition doing the best.

And that's why we're growing and our competitors are shrinking in their overall market footprint..

Okay, thank you..

Our next question comes from James Kisner from Jefferies. Your line is open..

Thank you. I just want to tell Scott, I think you must have misread the script because you didn't mention Jefferies as an important new customer. But can you talk about linearity in the quarter? DSOs are spiking up a bit, last October DSOs went down.

I think separately also in gross margin, if FlashBlade were excluded from your guidance, would you have expected margins to be up or flat for product? I was hoping to be up given the Flash that would be -- I guess actually this will be flat if we're not seeing the pricing pressure. Thanks..

Yes, James, on your first question; so from a DSO perspective, DSO just in terms of timing of billing as you alluded to can go up and down a little bit. The internal metric that we use a weighted average days to pay and that's been nice and stable, it sort of gives me confidence that the overall business is performing well.

As it relates to gross margin, what I'll say again is that yes, we've hit that period of stability, we're happy where the FlashArray margins are right now and FlashBlade will blend in very nicely as reflected in our guidance..

And James, thank you so much for working in the product [ph], we're extremely grateful to have you as a customer, as well..

Thank you very much..

Your next question comes from Richard Kugele from Needham & Company. Your line is open..

Thank you, good afternoon.

Just one last technology question on NVMe, you know as you said you have been shipping it in systems that are capable but what is the inflection point this year that makes -- or this coming year that makes NVMe sort of like adopted? And is there any of work that has to happen on the customer end in order to make that? And then Tim, if you could just talk about the hiring plans for next year relative to what happened this year? Thanks.

Yes, so on the NVMe, first of all, just to clarify how we've been shipping it; when we first shipped FlashArray-M, we actually built our own dual port NVMe and we ran devices, so every catching device in our product since FlashArray-M shipped have been dual-ported NVMe devices.

We also lay the groundwork on the product kind of the plumbing if you will to support NVMe Flash drives for the bulk storage. And so we've been kind of anticipating this transition. What we think is going to push the transition is the adoption of NVMe across the broad industry, especially in the consumer space.

Consumer demand always pushes Flash and so if you've bought a modern laptop recently, if you bought a brand new phone, it's got NVMe Flash inside and so that transition is starting to happen where the entire industry is gearing over towards the NVMe as the volume product.

And then the third reason I think is just the better gateway to open up and create a next level of industry for data; and if you look at our highest end customers that are trying to do things haven't been done before in the data path; this opens up the next level of performance and it's just good for the industry, and so as a leader we intend to push it because we believe the customer impact is going to hugely positive..

This is one of a very pragmatic consideration. If you just look at SSDs in the data center, when Pure got started they were just 256 gigabytes and now the SSDs that are used can range from 8 terabytes upto 32 terabytes and the road map to go well higher than that.

The problem with the interconnects that we have for those SSDs is that they are just way too slow, so the capacities have gone up a 100-fold and we are still stuck with the same access model. And so that has to be replaced otherwise we can't continue to scale and drive density and density is -- is what allows you to mine a lot more value from data.

So NVMe is coming along at the perfect time to allow us to continue to advance the data platform..

And two other things I'll just say about kind of the way we do things at Pure; one is that, we believe in making Flash mass-market technologies, and so in the early days of Pure, Flash was just high-end exotic thing, people thought it was only for the 1% of storage used cases and we really broke the market open by making it mainstream and let others flow in that strategy.

We intend to take the same path with NVMe and be very aggressive about allowing it to really hit a broad swap [ph] of the market.

And then the second thing is, we really believe in anonymous upgrade path and so customer shouldn't have to ditch their first generation storage of FlashArray and move to brand new all FlashArray to support the NVMe; and so we built that transformation right in.

When we look at our competitors, let's pick on -- let's say EMC for a minute, they are following the opposite strategy, right. They've got a protocol DSSD, and so the Uber [ph] high-end of the market from the cost of performance perspective, and its complete island in terms of upgradability from any other eight odd old FlashArray..

And Rich, I want to make sure we cover off on your question around sort of investment and how we think about next year.

Obviously, too early there to talk about guidance but I'll give you a framework about how we think about it and really it's the playbook and we talked a little bit early on the call about it, if that playbook of invest early and then reap the rewards in the latter half of the year, it's when the best sales people are coming available to us, they are coming off of a good year somewhere else and we'll pull them up.

So I think in terms of just sequencing and seasonality of investments, you're going to see this coming year be very similar to how you have seen years past. It's also when we have our big demand generation events, our user conference which was a significant success for us last year, we're going to do that again this year.

So that's how to think about investments as we get in the next year..

Great, thank you..

Your next question comes from John Lucia from JMP Securities. Your line is open..

Hey guys. Thanks for taking my question. You announced an expansion of your Cisco partnership in mid-October and you've talked about triple digit growth with that partnership.

Can you just touch on the Cisco partnership and what's driving the momentum there in the longer term? And what kind of opportunities does Cisco represent as a partner for you?.

Yes, so I guess I'd start with – there is an absolute segment of the market that once the [indiscernible] solutions, and you know it's a full stock kind of mentality, customers wanted end-to-end tested solutions that's designed for the highest end kind of environments.

And so when we first looked at this market space a few years ago, we really saw the first generation of CI solutions built in the era of disk, they're more particularly efficient and they were pretty complex and there was huge kind of services wrap around getting them to work.

And so we saw an opportunity to do a lot of stimulation we did in Flash base for CI in general, to go in, to bring Flash, to make it more efficient and just modernize for next-generation sort of applications. So we've seen a lot of positive here and there.

I said other thing that's important to realize is that there is lot of pull of CI from the channel because what the channel partners want to do, they want to sell complete solutions to their customers; and so CI makes that easy, and I'd say now this transition particularly in the channel around the Dell-EMC merger, we're seeing a lot of excitement around FlashStack and wanting to look towards the next generation of CI solutions..

And it's why we have invested to make pure as channel friendly or partner friendly a storage company as an industry because it is such a great opportunity for us to align with these committed Cisco partners that are looking for storage that fits very well into the overall solutions..

Okay.

In the press release you talked about thousands of deployments for Cisco, that would suggest it's a pretty large partnership; can you give us any sense for the relative size of the partnership with Cisco?.

So when you talk about thousands of deployments we do indeed have thousands of configurations where Pure Storage is interconnecting with Cisco systems. And then we also sell this converged infrastructure where the technology is combined before it goes into the customer site.

So both of those are key parts of our business, right, we sell independently and our infrastructure gets used, our platform gets used along with Cisco systems but then through our channel, in particular, a lot of our customers are buying FlashStack converged infrastructure, it's that FlashStack converged infrastructure that's growing at triple digit rates right now..

Okay, thank you..

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

Thanks. Two follow-up questions for Scott; can you help me understand how the cost per gigabyte for your customers are changing; so we can better understand the value you are creating? And I have a follow-up..

Sorry, so how the cost is changing per gigabyte?.

Yes, the effective cost per gigabyte including the dutification [ph] and all the proprietary savings that you provide for the customer..

Yes, so I think the best proxy for that Mehdi is that our product margins are stable.

So what that means is as we slowly drive down cost in our supply chain, we are handing some of those savings along to our customers, and that we continue to drive the industry's most efficient technology in terms of having the best data reduction and the most efficient ratio [indiscernible] that will allow us to get the most mileage out of common hardware.

So we don't specifically publish dollars per gigabyte but I would say our customers purchase the storage based on how much data they can store on it, not how much Flash that comes with the device..

Okay. And then moving on to my second question which is more of a bigger picture.

I understand your commentary about the hyper converged, it's entirely different than what you're doing, but how is the hyper converged could be like a hundred plus billion TAM? Your focus on 10, 20, 30 billion TAM, in that context, are you just being very diligent with your R&D dollar and focused on your next two/three year road map because I see both converged and hyper converged co-existing, but hyper converged could be a much bigger TAM and I get a feeling that you just want to stay focused.

But why not think about the bigger picture such in longer terms, so I want to better understand your thought process.

Is it just being diligent with the R&D dollar or and then -- not wanting to encroach into other TAM or it's just something else?.

Maybe we're extremely excited about our target market. You know, being the preferred platform for our customers most strategic data, the data that they are seeking to mine the most value from, we think is a supremely large terrific market opportunity, maybe the biggest available market opportunity.

We see growth in cloud, we're substantially exposed to cloud software, the service -- infrastructure of the service, as well as consumer cloud company, we're seeing great growth in the Fortune 500; so I would say we're right where we want to be and playing for a market that we think is growing and tipping in our direction..

Good, thank you..

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

Yes, just one quick one for me, please.

Looking at your SG&A expenses for the closing, like it was a decent amount unless I was thinking, I could be off but I was wondering if you maybe realizing that normal amount of sales productivity during the quarter or if there were some spending that was deferred or maybe that's about where you expected it to be? Thanks..

Steve, this is Tim. I think largely we're expected to be -- I think, you know, the R&D line could have been up a little bit and then we did start seeing some savings and kind of what we call outside services or professional services as our legal spend starts winding down a little bit..

Okay.

So productivity is pretty much tracking as you thought overall from a salesforce standpoint?.

We're happy with productivity, yes..

Okay, thank you..

There are no further questions. I will now turn the call -- now turn it over to Scott Dietzen for the closing remarks..

Thank you, operator. Thanks for your time today. We're tremendously excited about the position we're in. Pure's data platform is allowing our customers to extract value from data they can't get from any other solution.

We're big, we're fast, we're easy, we're elastic and we have the lowest total cost of ownership of any other solutions in the marketplace. More importantly, we're uniquely capable of building the most data intensive applications and supporting many different apps, all using that data simultaneously.

The legacy and commodity storage we compete against is too slow, it's too siloed [ph], it's too complicated and it's too expensive. FlashArray demand is strong, and with NVMe, it's poised to tip the scales further our way.

FlashBlade is just ramping now into a huge and growing TAM as I've mentioned earlier, as Flash prices decline overtime, evermore of that Big Data market opportunity is going to tip in our direction.

With our platforms well differentiated, operating at scale, one of the biggest, if not the biggest available market intact; the future is incredibly bright in front of Pure. We want to wish you a happy holidays, we're very grateful to have your time and we'll see you in three months.

Cheers!.

That is the end of today's conference call. You may now disconnect..