Everpure, Inc. (P) Earnings Call Transcript & Summary

All right. I think we'll go ahead and get started. I'm pleased to be joined here today by Charlie Giancarlo, the CEO of Pure Storage; and Kevan Krysler, the CFO. Charlie and Kevan, thanks so much for being here.

It's our pleasure.

To start off, maybe we could start from kind of a macro level. And for a few quarters now, you've talked about kind of an improving demand environment. Can you maybe touch on the current spending backdrop you're seeing and how hopefully, coming out of the pandemic here, customers are looking to build and optimize their application and storage footprint?

Yes. Well, starting in Q4 of last year, we started to see already -- I know we don't like to be reminded of this history, but COVID really started hitting in a significant way in March of last year. And at first, we actually saw some accelerated buying, but then, of course, it fell off as corporations adjusted to working from home, the COVID environment trying to figure out what the economy had in-store for them and so forth. As we got into Q4 of last year, we started to see enterprises, in particular, really pick up their spending and their investment, really getting back into deciding what they were going to do in the COVID environment from a digital transformation basis and starting to pick up their buying. We also saw the first glimmer of an improvement in commercial. And since that Q4 and growing through this year, we've seen improvement -- steady improvement in both areas, led by enterprise, to be sure, but seeing slow and steady improvement in commercial as well. And we're seeing that improvement both in terms of their spending in their private data centers as -- and obviously -- and we're seeing improvement in spend on cloud properties as well.

And last week, you guys reported a pretty strong fiscal 3Q results that were -- came in ahead of your own expectations on both revenue and profitability. And besides kind of a stronger demand environment, can you talk about what were the key factors that drove that outperformance?

Absolutely. And we've been asked on this several times, and it's very, very, very clear to us that it's really been the sum total of us now seeing the results of investments we've been making over the last couple, 3 years. And in particular, we've invested heavily in broadening our product line. Remember, only 4 or 5 years ago, we were a single-product company. We went public in 2015 largely on the basis of a single product line, if you will, in block storage. In 2017, we introduced our first file-based products. And since that time, we've been investing to be able to provide a broad range of capabilities to satisfy a wide range of our customers' needs. And at the same time, around 2019, we started investing heavily in building out an enterprise capability. Up until that point, we have been selling primarily into what we call the commercial market, meaning midsized companies, largely through a channel model. And since 2019, we started investing very heavily in the enterprise capabilities. That's everything from sales to support to how our products operate and, of course, broadening that product line. And we're seeing all that come together now in broader demand, wider demand for our product, especially in enterprise, but across the board, it's allowed us to enter into new spaces, such as AI and machine learning, and it's allowed us to now even penetrate the large SaaS companies as well as our first hyperscaler win, which we had last quarter to go back -- come back to last quarter.

And what Charlie is referring to is really all about the outperformance on the top line in terms of revenue. And we also did -- we're quite pleased with it in terms of operating leverage and what we achieved there. And obviously, the revenue outperformance was helpful on that front. But we've made some great strides really around our sales and marketing operating discipline, sales efficiency. Our channel, we're working in terms of the effectiveness of the channel. All is playing a part in terms of the improvement we're seeing in terms of operating leverage, increased operating leverage. Now we've got part of that, which is a tailwind with the COVID impact as well less travel, less physical marketing events. We talked about the fact that our hiring is a little bit behind where we want it to be. But still, when we normalize for that, we still have a really nice healthy performance on the operating leverage side as well.

And one of the other kind of factors that was impressive about Q3 results is that came during a time when you were in a challenging supply environment, both from a component standpoint and also logistics. And so I was wondering if you could talk a little bit about how you're navigating this and your kind of expectations for supply availability and cost in the fourth quarter and then as we begin to look into next year.

Yes. We've, over the years, built a really very, very strong operations team. And really, we are -- we take our hats off to them. The -- what they've been going through the last several quarters from a supply chain standpoint has been incredible. And at the same time, our customers have seen 0 impact to them in terms of our ability to ship, provide capability and so forth. And at the same time, our operations team, working with our suppliers as well as our engineering team to make up for parts that are in short supply and therefore, engineering around so that we could use other parts and so forth. The amount of work that's been going on there has been absolutely incredible. So -- and the last thing I would like to mention is that from early on, but certainly, through the last couple of years, we have worked and built very strong partnerships with our supply partners. When they got into trouble early on in the COVID period, we helped them. And that returned dividends when supply chains seized up over the last couple of quarters where they've helped us. So I think that building that partnership has really made a great difference. Now to be sure, costs are up. And we estimated, and we believe that costs on average, I'm talking about supply chain costs, will be up about 10% across the board. That is not evenly, but resulting in about a 10% increase in cost of goods sold this year. Because of the dynamics of our market, it tends to also improve pricing to customers, meaning that largely, it doesn't affect us from a gross margin standpoint. It affects us somewhat, but we're able to manage through a lot of that. So costs are up, supply chain challenges continue. We think they're bottoming it out, but it's a very dynamic environment, difficult to really predict. Do you want to add to that, Kevan?

No, I think that's great, Charlie.

If we look beyond kind of recent results, I was hoping we could dig in a little bit to the long-term outlook that you laid out at your Financial Analyst Day in September. And you kind of highlighted a TAM that you overall kind of expect to grow kind of a 14% CAGR to over $60 billion by in 2024, and you broke it into, I think, 4 components. And maybe starting with the first one, just kind of the core all-flash array market, which I think still represents the largest portion of revenue for you guys right now. You talked about kind of industry expectations for this to grow in the roughly 10% range for the next couple of years. And I was hoping you guys could talk a little bit about your confidence in your ability to kind of drive accelerating share gains here in this market versus, I think, the last couple of years with some COVID disruptions and things like that. The share has been more flattish if you look at some of the third-party sources.

Yes. Well, actually, the third-party sources, and we've had direct conversations with them, they acknowledge the fact that they undercount our share. And the reason is because of a capability that only we provide which is called Evergreen. Now when they count the share of a competitive vendor, the competitive vendor will sell an array, and 5 years later, that array will be old and discontinued. And if the competitor gets the deal again, they'll sell a new array to replace the old array, and that counts as a sale, and it goes into their market share. We on -- to the extent that a customer wants to buy our array, as opposed to subscribe to our services, if they want to buy our array, we will sell it to them but they never have to buy that array ever over again because our Evergreen service makes sure that, that array is always new. It's like -- and it's always new, not just from the standpoint of us upgrading it consistently, but the customer never has to take their application environment down or adjust it as it's being improved. We call it nondisruptive upgrades. So it would be like you taking off on your morning commute to go to your office, not that anybody does that anymore. But to the extent you would take your car on your morning commute, when you arrived at your office, you'd be -- without stopping along the way, you'd be in an entirely new car. That's how we deliver it. And that undercounts our market share because we don't have that repeat buying pattern. But what it does do is it increases our subscription revenue over time, which, again, is something that we're very proud of. Subscription revenues now are over 1/3 of overall revenues and growing very rapidly. So we -- as when we look at it in total, we continue to build share. Secondly, we're still -- after 2 years is still the only company that is selling product now into the secondary-tier storage market. So even though these flash -- when you quote the 10% growth, that's looking at only primary storage. When you look into the secondary tier storage, flash storage is expected to grow actually quite a bit beyond that, and we think we're in the driver seat as far as exploiting that right now.

Yes, definitely. I wanted to dig in a little there, too. You talked about as the second bucket that moving beyond kind of the Tier 1 market for all flash, where you're leveraging some of your technical and cost advantages with FlashArray//C and the use of QLC NAND to target traditional disc-based use cases. And you kind of quantified this as a $10 billion potential market opportunity. Could you kind of expand on the opportunity you see here? And also, I'd be curious to know kind of how you think about what portion of your overall product mix do you think FlashArray//C could ultimately become?

Yes. So to -- you provide context for the audience. So the primary storage market now, which are things like databases and desktop -- remote desktop and so forth, that's about -- that's the majority. That's all-flash at this point in time. There's no more disc in that market because of the price performance of flash. But for the secondary-tier market, which are things like file shares, where -- and data being served up, even for low-level analytics environments, that stayed stubbornly disk because of its lower cost. We're now the first, and as I mentioned, only vendor now that can compete with that with our FlashArray//C product, and we expect to expand that, expand that ability with QLC to go into ever more use cases, including large-scale analytics as well. So the QLC opportunity -- FlashArray//C by itself might only be -- it might be a $10 billion market opportunity as we expand into that area, but that entire area of second-tier storage that has stayed primarily disk, which today is about a $30 billion market, maybe more, we think that, that becomes open to us over the next 2 to 3 years.

Yes. And your question, too, in terms of what percentage do you think FlashArray//C and what we're doing with the second-tier would represent as our total product mix, the thing is we're actually growing pretty significantly with our entire portfolio, right? Whether that's -- even our core offerings, which is the kind of the FlashArray//X offering, is continuing to grow. We saw some really nice growth with that offering. Fast file and object and unstructured data opportunity in front of us with our FlashBlade offering is growing incredibly fast. So currently, the Tier 2 opportunity is growing the fastest, but we're also getting really solid growth across the board with our portfolio. And obviously, behind that, from a strategic perspective, you still have Portworx, which is growing at a rapid rate, but still smaller in terms of meaningful top line.

And in addition to some of the progress that you've seen with your enterprise and commercial clients and making good strides there, this past quarter, you also had a large sale, which you mentioned, to a top 10 hyperscaler. As we kind of look out into your financial model and targets, are hyperscalers a material contributor to that kind of new market? Or would these opportunities kind of be above and beyond what you've kind of incorporated into those targets?

Yes. We've not incorporated that into our targets. They're too lumpy and difficult to predict, so those would be upside to our targets.

Yes. And I think the important thing there is that's not really a sales motion. It really becomes more of a joint product development cycle surrounded with some business development. And so once we get through an analysis with the engineering team, and obviously, they're looking at all options, build themselves as well as the competitive landscape, then you start to get some visibility. But to Charlie's point, when we look at these types of opportunities that we highlighted in Q3, that would not be built into our run rate.

Yes. Got it. And maybe switching over to services. The largest bucket that you actually broke out within the $60 billion TAM was storage subscription and as a service. And your subscription service business, as you mentioned, is currently running a little bit over 1/3 of revenue, but is growing very rapidly, I think, north of 30%. And I think the biggest part of this is still Evergreen. And as we think about kind of the durability of Evergreen's contribution to services growth, is this ultimately tied to product revenue? Or are there other kind of tier upgrades or other important factors to consider as we think about that?

Currently, it's mostly tied to product revenue. But remember, it doesn't expire. And what I mean by that is a service contract on a hardware sale, it expires when the hardware expires. But because in our -- in the way that Evergreen works, the hardware never expires and therefore, the service -- the subscription number. And in fact, we look back on a product we sold 6 years ago -- more than 6 years ago and 97% of it is still in place. So -- and it's not just in place as it was then, it's in place as a new system today. So it's very, very sticky. But I would say that while it depends on product revenue, we are consistently upgrading and improving what customers get with Evergreen. And from that standpoint, it has upside capability as well.

Yes. And I would just add on to that. I think it also serves very nicely as a natural extension for customers who are purchasing on day 1, but maybe 5, 6 years later, still leveraging our Evergreen subscription and then deciding that they want to expand with us as Pure as-a-Service completely. And obviously, the architecture that we leverage with the Evergreen subscription is the same that we're leveraging with Pure as-a-Service. And so it's a natural evolution for a customer to move from an Evergreen subscription to a full-on services agreement with Pure as-a-Service combined with Cloud Block Store. And we're finding customers -- we've actually got some examples where customers have done that, and that's worked out very well. And obviously, there's a premium attach that if a customer wants to fully move to our peer as a service offering. But it is a natural next step for them to move to a full-service offering.

And if I could, I'd like to just explain that a little bit further that -- for people maybe not familiar with Pure as-a-Service. With Pure as-a-Service, a customer gets to access data storage and data services entirely as an SLA. So if you were to subscribe to a data service on a hyperscaler or any other data storage environment, you would do so based on the performance that you need and the capacity that you use as you use that capacity. Well, that's what we provide, and we provide it in a hybrid cloud approach, meaning that it could be on their premise, it could be on a colo or could be on a hyperscaler or it could be on all 3, customer's choice. It all looks the same to the customer. What Kevan was referring to, which is a really interesting thing is, let's say, a customer did buy an array 5 years ago. On their books, it's been completely depreciated, but it's still brand new. And now they want more flexibility in terms of how they use it, meaning that if they want to add capacity or even reduce capacity, we'll transition that from an Evergreen, which is where they own the hardware, to a Pure as-a-Service, where we own it. And now, they transact with us completely electronically and we manage the entire environment. So it's a very convenient and easy. And for the customer, much more comprehensive service than what they would get on their own.

I think you mentioned a little bit about the financial upside of something like that. I mean can you kind of talk about that model of the transition from Evergreen to Pure as-a-Service and kind of the upside that you get from a financial standpoint?

Kevan, I'll let you.

Yes. I mean, obviously, from a pricing perspective, I think a good rule of thumb is generally about a 30% to 40% premium on top of the Evergreen subscription, which is great because, obviously, we would then take the infrastructure from the customer and bring it back. To Charlie's point, generally, that infrastructure from a customer's viewpoint is fully depreciated, but you still have brand-new arrays that you're working with. And so there's -- from a margin perspective, it's actually quite beneficial, both from a gross margin as well as from an operating margin. Because the other benefit that we have with our Pure as-a-Service offering is because of the Evergreen subscription, we're bringing back hardware that we're replacing with new modern infrastructure. We didn't refurbish that back to a modern state and then redeploy that in terms of our Pure as-a-Service offering to meet the SLA requirements that we negotiate with our customers. So if you think about that from a 360 lens, it's very beneficial from a financial perspective. And then that also lends itself to a lot of benefits from an environmental and sustainability perspective, where we're getting really a significant amount of interest and momentum with customers seeing how much we're doing for them, from a sustainability standpoint, to help them reach their goals. A lot more to be said on that as we come out with our sustainability reports, hopefully, early next year.

Terrific. Maybe moving on to the kind of fourth bucket within the TAM that you talked about, which is app modernization and the hybrid cloud. And I think you're kind of targeting this with Portworx. Can you discuss a little bit about Portworx as a data platform for shared storage services and how this enables kind of multi-cloud environments that we continue to hear so much about? And then from a financial perspective, any kind of insights into when we could expect to see Portworx maybe be a more significant contributor to the top line?

Yes, absolutely. So again, providing context. So as we are all familiar with, customers started developing on hyperscalers, perhaps -- obviously, the early ones started maybe 8 years ago, more recently, about 5 years ago. And what customers found was that if they developed on Amazon, well then moving that workload to Azure was almost impossible because they were using -- you could think of each of the hyperscalers as having their own operating system. And as you know, moving software from one operating system to another, very difficult. Customers generally don't do that. So technology came around about 5 years ago and now very popular, which is called containers. And then another technology to manage those containers called Kubernetes. Containers allow customers to build applications in an environment that can be moved from one hyperscaler to another. And in fact, even onto their servers on their own premise. So it allows that multi-cloud capability. Kubernetes is the orchestration layer. It is the management layer that allows that container migration movement, scaling up and down, to take place. It's an open source technology initially by Google, but now, available from a variety of different vendors. And that allowed customers to start writing applications in such a way that it could be moved across clouds. Well, it turns out that the data structures on these clouds are also very different. And so while you can move the application, you might not be able to move the data. Or at least an application when you moved it, couldn't access the data on the other cloud. So Portworx allows that same multi-cloud environment to exist for the data structures that these applications use. So if a customer builds their applications on containers using Portworx, now not only does it make it easier for the developer, because they have their data needs addressed without the developer having to build specific software to do it, but it also means that they can now move both the applications and the data from one hyperscaler to another and to on-prem. So we're seeing just a huge growth. It's early days for all of this, to be clear. It's early for containers, early for Kubernetes, early for us with Portworx. But over 90% of new projects that enterprises are building are on containers and Kubernetes. So we're seeing great growth in this area. The great growth is starting with development. Eventually, that will move to production. And when it hits production, that everyone will start to see large revenue growth in this. I suspect it will be making a substantial difference to the top line in about 2 years, where we'll start to need to -- I refer to it, but along those lines.

Got it. And maybe, Kevan, this one -- for you. As you take a step back and look at these opportunities in your financial model, you're targeting revenue growth plus free cash flow margin to reach about 35% to 40% by 2025. Can you talk about why you've kind of settled on this framework and kind of how you thought about it versus giving more explicit targets on growth and profitability?

Yes, absolutely. I mean a couple of things that we were focused on. We still have a lot of conviction and energy that top line revenue growth is our priority. But we're also balancing that with a priority of really emphasizing our subscription business. And so obviously, when we have an agenda of moving from 30-plus percent of our business being subscription up to 50%, you've got a bit of a headwind in terms of your top line revenue. And obviously, that was considered as part of the rule of 40 model that we presented and discussed for FY '25. The other element that was important for us is notwithstanding our priority of growing top line revenue and emphasizing the subscription business, we also believe there's a strong opportunity for us to continue driving more operating leverage in the business, especially with the scale and the size of our business at this point. And with our Q4 guide, expecting to be over $2 billion in revenues this year. And you saw this year a really strong move in terms of improved sales efficiency and operating discipline in our sales and marketing group. I think we can get some more improvement on that to a lesser scale as we move forward. But over the next few years, we see opportunity there. We see opportunity, especially in the R&D side. We're very right now focused on the West Coast, that's where the top talent has been. And frankly, that talent from a software engineering perspective has really delivered the innovation that we've seen. But we also are growing pretty fast in Prague, and then we'll have another location as well to expand our global engineering force, which will give us more efficiencies and leverage longer term. And then lastly, I think, around our subscription business, we really think we can get some more operating leverage, especially on gross margin as we continue to scale our Pure as-a-Service offering and Portworx, which obviously, Portworx is a pure software solution.

And to your point, this year, I think your non-GAAP operating margin now after the third quarter is about 10% for the year is what your guidance is. You also mentioned, I think, 2 to 3 points of kind of a tailwind from some COVID-related aspects, like reduced travel, marketing, things like that. I know you guys probably don't want to give guidance at this point, but when you think about going forward, can you kind of maybe just frame some of the puts and takes in terms of the operating leverage that you hope to continue generating versus some of those costs coming back into the model?

Yes, absolutely. And I think if you, first of all, normalize out the COVID impact and benefit, if you will, that we saw this year, that puts us -- that would put us -- assuming we're on track that would put us between 7% to 8% normalized operating margin. We believe against that normalized operating margin, we can continue driving more leverage and improving that margin. Specific to the COVID tailwinds, we see a lot of that coming back next year, especially around hiring. We're getting some good cadence that we're seeing here recently. We expect that to continue with our talent acquisition engine as we move to early next year. And obviously, I want our folks traveling a bit more, especially, obviously, our sales -- on the sales side. I think we've got an opportunity in front of us that still could grow and accelerate around new customer acquisition. And I do think that's going to take more a physical presence with our sales force interacting with our customers.

And alongside with the Analyst Day, you also had a couple of product announcements. So you announced Pure Fusion, Portworx data services and some new tools for the Tier 1 portal, and so I was wondering if you could just touch on these and also the kind of the role of increased automation and other things you're doing to help simplify the management process for storage as a real competitive advantage for Pure.

Well, a lot of what I talked about earlier, if I were to put it in a nutshell, we're trying to create a cloud operating model for our customers across their entire multi-cloud environment. So what does that mean? Our customers, when they build out an IT infrastructure, they would love to be able to provide their developers with the ability to access it with the same flexibility, ease and on-demand nature that Amazon or Azure provides to individual developers. Today, that's largely not the case. Today, a developer of -- in an enterprise who wants capabilities goes to IT. IT has to order equipment. They have to put it together. They have to go through a procurement process. And so the developer has to wait for quite a while. Impatient developers will just go to the cloud if they're able to. Our goal is to give the enterprise the ability, not only to do it for their own private cloud, but to do it for their hybrid cloud environment. And so Pure Fusion, which we announced, is really, we believe, a breakthrough capability. It will allow enterprises to be able to define data storage classes and data management classes, where the classes is defined as a performance level but also a backup level, a disaster recovery level. We'll have things such as data sovereignty, all of the compliance requirements that large organizations are subject to built into the class. And then the IT organization will be able to offer that on demand to their developers. So the developers now can be developing the applications and just say they need storage of a certain class and it's delivered on demand. And that's what Pure Fusion is. And it will work, not just within a single data center, but across the enterprise's entire footprint. So it's a really remarkable and new and different service that we provided. Portworx data services builds on top of that and allows, not just the standard data services, such as disaster protection, recovery and so forth, but also things like the ability for developers to be able to add on advanced services such as search, such as disaster recovery, such as databases -- popular databases to their data without having to go through all the programming configurations themselves. So these are big advances in bringing that cloud operating model to a multi-cloud enterprise environment.

Great. Unfortunately, I think we're out of time, and we're going to have to leave it there. Charlie and Kevan, thanks so much for joining us.

Thank you.

Appreciate it.