Pure Storage Inc (PSTG) 2017 Q1 法說會逐字稿

Good afternoon and welcome to the Pure Storage first quarter FY17 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Liz Lemon, Investor Relations. Please go ahead.

Good afternoon and welcome to Pure Storage's Q1 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 the course of this call, management will make forward-looking statements which are subject to various risks and uncertainties. These include statements regarding 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 the course of this call, we may discuss some non-GAAP measures in talking about the Company's performance. Reconciliations to the most directly comparable GAAP measures on a historical basis are provided in our earnings release.

This conference 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 it over to our CEO, Scott Dietzen.

Thanks, Liz. Good afternoon and thank you for joining the Pure Storage first-quarter earnings call, our third quarter reporting as a public company.

Pure delivered another quarter of robust results. Q1 revenues were $140 million, slightly above our guidance range and up 89% from the year-earlier quarter. That growth rate is well above the annual growth rate Gartner projects for the solid-state array market, meaning we are increasing share in a highly competitive environment. We also reported significant year-over-year improvements in both gross and operating margin, as Tim Riitters, our CFO, will detail in a moment. Our balance sheet remains strong, with more than $600 million in cash and zero debt.

Our results continue to stand in contrast to those of many of our competitors, who sometimes attribute their declines to a slowdown in IT spending. While we agree that businesses are being careful with every IT dollar, it remains our view that the more fundamental dynamic at work is a rethinking of data center infrastructure, including the shift to flash and cloud friendly storage and away from complex, disk-centric designs from the past century. Many of our customers have found that Pure Storage pays for itself, either in reduced total cost of storage ownership or by enabling them to improve their businesses through accelerated application performance, or both.

According to IDC, in just four short years of selling, Pure Storage has cracked the top-10 storage vendors worldwide; and we are growing approximately 10 times faster than anyone else on that list. In the latest quarter, Pure's customer count increased by almost 300, bringing the total to more than 1,950. Pure now serves 72 of the Fortune 500, up from 66 one quarter earlier.

The World Bank became a Pure customer in the quarter, as did Bank of New York Mellon, which is using Pure to build its own private cloud. Softbank, one of Japan's largest wireless carriers, chose Pure to support its cloud-based desktop-as-a-service offering, vastly boosting performance and operational efficiency. The University of Melbourne, one of the top-50 universities in the world, now uses Pure to support 1,200 virtual machines. And GMO CLOUD, Japan's largest Internet hosting company, also chose Pure for its cloud service.

Pure is gaining ground across all industry verticals, one happy customer at a time, as those institutions seek storage that provides greater performance, higher resiliency, reduced complexity, power and floor space savings, and best-in-class customer service. Pure Storage remains highly differentiated in our software, our hardware, our cloud automation, and our cloud-like evergreen business model. Today we still do not have a major competitor that has gotten any one of these right.

Q1 also marked the launch of Pure Storage's second product in FlashBlade, which was unveiled in March at our inaugural Pure Accelerate user conference. FlashBlade was three years in the making and there is nothing else like it in the market. FlashBlade, which is optimized for more capacity-oriented, scale-out, file and object storage, is the perfect complement to FlashArray. Just as FlashArray redefined the category of performance-optimized block storage, FlashBlade delivers the benefits of all-flash for unstructured and semi structured, often called big data storage and does so at compelling economics.

FlashBlade has been extensively tested on customer workloads over the past year. Use cases include Internet of Things, machine log analysis, security event correlation, genomics, software development, chip design, bio informatics, machine learning, and media production and transcoding. Feedback thus far on FlashBlade has been as enthusiastic as it was for the early customers of FlashArray.

With FlashArray and FlashBlade, Pure is positioned to address the full $24 billion market for data center storage and related software, enjoying a two- to three-year lead in innovation on the major competitors. First directed availability of shipments of FlashBlade for revenue are on schedule for Q3, and we are targeting GA for later this year.

At Pure, we're often asked about the impact of the rapid growth of public cloud players, like Amazon Web Services, on storage. As we have remarked in the past, we see cloud as a catalyst for our business, even though we do not anticipate selling to hardcore do-it-yourselfers, like AWS and Google. Cloud continues to account for about 25% of our business. As we provide a platform for Software as a Service clouds, we now count seven of IDC's top-20 SaaS companies as customers, Infrastructure as a Service clouds and consumer clouds.

These customers, as well as many enterprises building private clouds, are doing so for a number of reasons. One, greater performance via tighter proximity between data, users, and systems. Whereas the public cloud is big but slow, Pure-powered clouds are big and fast.

Two, because they see technology as a core competency, something on which they differentiate their business every day, and their specialized needs cannot be realized on infrastructure they see as least common denominator. Three, to achieve cost savings at the scale at which they operate. And four, to meet data security and regulatory requirements.

While the public cloud is thriving, the truth is it simply can't do it all. Looking forward, the team at Pure is hugely excited about the road ahead. Our customer satisfaction, retention, and repeat purchase statistics we believe to be far and away the best in storage. All are the result of our highly differentiated products and service.

What's more, our 100% channel go-to-market model is working. In Q1, we estimate that close to 70% of our net new logos were brought to us by partners. This channel momentum, when coupled with the uncertainty the Dell-EMC merger creates for both customers and partners, is accelerating our market opportunity.

We will continue to invest in the business, so that over time Pure can indeed play to win the number one position in this $24 billion market. At the same time, in the near term we will continue to improve our business efficiency year over year to deliver on our commitment of sustained, positive cash flow in a second half of calendar 2017.

And with that, I'll turn the call over to Tim and then we'll move on to Q&A. Tim?

Thanks, Scott.

We are very pleased with Q1 execution, especially during a seasonally slower quarter in enterprise infrastructure when many in storage are struggling. As promised, our continued focus is on strong top-line growth in balance with improving operating leverage.

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, in Q1 total revenue grew 89% year on year to $139.9 million, which is slightly above our Q1 revenue guidance. As expected, we saw a modest Q-on-Q decline in revenue of 7%, which is seasonally typical for enterprise IT in the first quarter of the year.

Product revenue in Q1 grew 76% year on year, driven by strong repurchase trends and steady performance in new customer additions. Product revenue decreased 12% quarter on quarter to $111.7 million, due to the seasonality I mentioned earlier.

Support revenue in Q1 grew 170% year on year and 23% Q-on-Q to $28.2 million, driven by continued revenue recognition of ongoing support contracts. Support accounted for 20% of total revenue in Q1 versus 14% in the year-ago period.

Looking at Q1 from a geographic perspective, 79% of our revenue came from the US and 21% from international. This compares to a 78%/22% split in the prior fiscal year.

Turning to gross margins, in Q1 total gross margin of 67.3% improved 6.8 points year on year and 1.3 points quarter on quarter. Product gross margins of 69.6% improved 5.2 points year over year and 1.3 points sequentially. The year-on-year improvement in product gross margin continues to be driven by a mix shift to the new higher gross margin FlashArray//m Series product.

Support gross margins of 58.0% improved over 20 points year on year and over 4 points sequentially. This is attributed to increases in our customer base and associated deferred revenue support, as well as operational efficiencies within our support organization. We continue to move consistently toward our target model of mid-60%s support margins and will continue to drive efficiencies toward that goal.

Moving on to expenses, as Scott mentioned, we continue to drive operating leverage year on year while making consistent investments in the business. In Q1, R&D expense of $41.2 million represented 29.5% of revenue, versus 37.9% of revenue in the year-ago quarter. R&D investment in absolute dollars increased 47.0% year on year, as we continue to invest in both our FlashArray and FlashBlade products.

Sales and marketing expense of $75.1 million represented 53.7% of revenue in Q1, versus 60.6% a year ago. Sales and marketing investments grew 67.4% year on year.

G&A expense of $18.9 million represented 13.5% of revenue in Q1, versus 15.2% a year ago. G&A spend grew 67.8% year on year. Total headcount at the end of Q1 was over 1,500, up from over 1,300 at the end of Q4, largely attributable to our Q1 focus on sales hiring.

Turning to operating margin, we continue to be pleased with results of our dual focus on strong growth and consistent improvement in operating leverage. For Q1, non-GAAP operating loss was $41.1 million, or negative 29.4% of revenue, compared with the year-ago quarter non-GAAP operating loss of $39.4 million, or negative 53.2% of revenue. This represents a 23.8 point improvement in operating margin year on year. Also note, our operating losses increased by $1.7 million year on year, while we grew our revenue by nearly 90% during the same period.

Our non-GAAP net loss for the quarter was $40.8 million, or negative $0.22 per share. This compares to the year-ago period non-GAAP net loss of $40.3 million, or negative $0.26 per share. The weighted average shares used for the per-share calculations were 189.3 million and 154.9 million, respectively. For those of you comparing to Q1 fiscal 2016, please note that the share count numbers used to calculate net loss per share in that period assume the conversion of all of our preferred stock as of Q1 of fiscal 2016.

Moving on to the balance sheet and cash flow, we finished the April quarter with cash and investments of $607 million, reflecting a modest uplift from our Q4 ending balance. Our free cash flow was negative $17.6 million, or negative 13% of revenue, compared to negative free cash flow of negative $20.9 million, or negative 28% of revenue, in the year-ago quarter. Please note that the free cash flow for the quarter included $8.7 million of cash used related to our employee stock purchase plan. Excluding this amount, free cash flow would have been negative $8.9 million, or negative 6% of revenue.

Let's turn now to our guidance. As a reminder, we provide annual guidance only once at the beginning of the fiscal year, which we did last quarter. We also remind investors that our full-year guidance included all product launches and contributions for the fiscal year.

For the second quarter of FY2017, we expect revenue of between $153 million and $157 million, driven by several key dynamics. We are well-positioned for the rapid transition in storage, where customers are choosing modern flash and cloud solutions over legacy retrofit products. We have strong momentum in new logos. We continue to see solid repeat business trends and high customer retention rates, and we continue to deepen our channel relationships.

We expect Q2 non-GAAP gross margin in the range of between 65% and 68%. We are at our long-term model for product gross margin and we expect continued improvement in our support margins. We expect convergence to our long-term model of between 63% and 68% over the next several quarters.

Turning to operating margin, we expect Q2 non-GAAP operating margins of negative 26% to negative 30%. This guidance implies significant year-on-year improvements in operating margin and a decrease in absolute operating losses year on year.

As we said last quarter, investors should note that the first half of our fiscal year represents a period of seasonal investment, as we hire aggressively in sales and other marketing activities and continue to invest in product innovation consistent with last year. We expect this first-half investment period will then be followed by a seasonally strong second half, characterized by strong operating leverage, similar to what we saw in Q3 and Q4 of last year.

Moving on to cash flow, though we performed very well on free cash flow in Q1, driven by strong cash collection efforts, Q2 does tend to be a slower cash flow quarter, due to the timing of cash collections and continued investments in this period. Investors should expect lower free cash flow in Q2 versus Q1.

Our long-term operating model calls for operating margins of between 15% and 20% and we continue to manage the business towards sustained positive free cash flow in the second half of calendar year 2017. Investors will recall that in the last quarter's earnings announcement, we pulled in this date from calendar year 2018, reflecting solid leverage in our operating model as we drive revenue growth.

Finally, I'd like to remind investors that we are on plan to make FY2017 the turning point in terms of absolute losses. We encourage investors to measure our operating efficiency progress on a year-on-year basis, as we march steadily and deliberately towards our long-term targets.

With that, we will open up the call for questions. Operator?

(Operator Instructions)

Brent Bracelin, Pacific Crest Securities.

Thanks for taking the question. Scott, a couple for you and then one for Tim. First, was wondering on the competitive front, did you notice any changes to the competitive environment now that EMC's out with the all-flash VMAX and I guess, now VNX?

Yes, I would say there is a material change in the sense that EMC now seems to be leading with their disk retrofit designs built in the pre-flash mainframe era of the last century. In that competition, we continue to do supremely well. We have the best data reduction, so we're looking at two to five times less flash, which makes our financial dynamic dramatically better. Our hardware efficiency will often mean that their cost of goods, in a competitive situation, is more than our street price. We're also substantially better performing. And the solution appeals extremely well to NextGen data set. We have much greater exposure to software as a service and the consumer clouds, which indicates longer term growth dynamics. And there's this level of simplicity that just doesn't come along with those legacy designs.

So we've been able to hold our competitive win rates against the EMC. POC win rates have held up, and we think that market continues to bode very well for us to be able to compete. You see this across our customer satisfaction stats, our repeat cohorts. Our top-tier of customers spend $12 over the next 18 months for each initial dollar; our product margins are best-in-class, and our growth rates are far and away best-in-class.

Fair enough. And then second question for you is really on FlashBlade. I know it's still early access, you rattled off several workloads that you're seeing beta customers use it for, but what have you learned so far? And is there a sweet spot from a workload standpoint that that product is well-suited for?

We've actually gotten exposure to all of the core file and object-oriented workloads for the scale-out market, the capacity-oriented market, the bigger data market that we're targeting, and the feedback has been tremendous. Not only are we delivering dramatic performance acceleration, but we have the same kind of simplicity, density, and total cost of ownership advantages that we're able to bring to market with FlashArray. So we see FlashBlade as being similarly transformative, and there's literally nothing else like it in the industry.

Interesting. And then for Tim, real quickly here, on product gross margins, I know you cited the mix shift to //m Series, there?s a lift there, but you're getting close to 70% product gross margins in a very competitive market. So help us understand the levers that you have, and potentially could that product gross margin tick above 70%?

Brent, this is Tim. So on product gross margins, we are very, very happy about our 69.5 point gross margin for the quarter, really speaks to the differentiation that we have in the business against our competitors, as you heard Scott talk about. We continue to believe that, that mid- to high-60%s gross margin number is that sweet spot, because it's the right balance of having a differentiated product and yet not being too high priced and you can go and compete in any single deal that we want to. Our goal is to grow revenue, and being in that mid-60%s range helps us do that.

Okay. Fair enough. Thank you.

Thanks, Brent. Next question.

Aaron Rakers, Stifel.

Yes, a couple questions if I can, as well. Thank you. So first of all, Tim, I'd like to understand how you think about operating leverage. I know that you had talked about the second half of the year to see similar operating margin leverages what we saw in fiscal 2016, but I'm just wondering exactly how you think about that? Is that a rate of revenue change relative to OpEx change, or you think of it differently?

Yes, Aaron, on the question of operating leverage, really again, it's focused primarily on revenue, but at the same time driving that year-on-year improvement both in operating margin, which as you see in this last quarter, we did very, very well. And then also that commitment that we made at the start of the year to have basically flat, if not improving, absolute operating losses. And so those are the two constraints that I think about the business and how we're managing the business as we continue to aspire to grow as fast as we possibly can.

And can you talk a little bit about what you're seeing from a productivity perspective? I know in some of the remarks, you had stated that 70% of your new logos were brought to you through the channel. I'm just curious, though, what are you seeing in terms of productivity from your sales force and how does that metric, that 70% metric, compare to, let's say, what it was a year ago or last quarter?

Yes, on productivity, Aaron, we continue to measure that very, very carefully. And I think what we've said in the past is that we watch each one of our sales cohorts, or sales start classes, if you will. They are progressing right along plan. Our longest-serving cohorts are at and above target model, that long-term target model; and the newer cohorts that we've brought in, and we've had some very, very successful classes, are climbing the same ramp rate. So we are on plan with that long-term productivity model, and very, very happy about it. On channel, the statistics, as you said, 70%. We're very pleased with that, as well. Channel has always been a go-to-market lever for us and we'll continue to lever it going forward.

And Aaron, I might chime in. I think the merger between Dell and EMC is actually creating additional headroom for us in the channel. EMC has historically done about a third of their business through the channel. Dell is known for their direct-sales DNA. And as we?ve remarked on our blog, the combined entity will have nine distinct all-flash storage offerings. That combination of factors is creating confusion in the channel about which products are the long-lived ones and what the go-to-market model is going to look like, and that's created a little bit of a vacuum that we've been able to fill.

Perfect. And then final quick question for me, the FlashBlade product, I know you talk about direct availability. Can you talk about the relative size of your direct availability, or beta program, and just remind me exactly when we go into that direct availability, would you recognize revenue for that product in the fiscal third quarter? Is that the way to think about it?

Yes, so you can think about it, Aaron, is we're doing order dozens of beta deployments right now across -- we wanted to get pretty much every capacity-oriented workload represented so that we were mining really great data that we could use. Once we declare the product certified for production deployment and the customer gets the production-ready software, that would be the revenue recognition event. We are planning on directed availability. That will be for select customers in the third quarter of this year, and we are striving to hit general availability before year's end.

And Aaron, on directed availability, that's our trigger for rev rec. So as we have directed availability units, we would trigger rev rec on those units.

Thank you very much.

Simona Jankowski, Goldman Sachs.

Hello. This is Balaji Krishnamurthy on Simona's behalf. So I was wondering if you could comment on the competitive dynamics outside of EMC and Pure. The field is becoming increasingly crowded. Just yesterday, HP cited strength with its flash product, and Nimble also highlighted good traction initially. So I was hoping you could throw some light there, as well?

Balaji, it would be our pleasure. The combination -- all of the major players in the market are continuing to lead with what we would describe as disk-era or mainframe-era retrofits. These are technologies that were designed in the last century and are being positioned as somehow ready for flash and cloud. And yet, we are talking about a technology that we don't believe has any chance of making the leap into these modern data centers.

So the technology that you need to pull off success has become very clear. It's data reduction. We have two to five times better data reduction. That gives us far and away the best hardware efficiency in the space. You see that in our margins, but you see that in competitors not being able to compete without offering products at a loss. The technology is performance intensive. So if you didn't design the product like we did to support parallelism and next generation protocols like NVMe, you just can't measure up to the performance demand.

Most of all, you'll see this in our cloud footprint, the fact that next generation data centers and software as a service, infrastructure as a service, and consumer cloud are 25% of our business. I think that's higher than any of the other players in the storage market. You need to have that focus on DevOps, very simple control, cloud automation, and the evergreen business model that we've pioneered. All of those things are differentiated.

And the evidence for the differentiation is there in our audited customer satisfaction scores. We're the only vendor I'm aware of that's actually publishing audited Net Promoter Scores and putting our customer satisfaction in front of the whole industry. The repeat cohorts are the best in class, and the growth continues to be better than anyone else has done in history. The fact that in just four years, we've made it into the top-10 storage players worldwide and the fact that we're growing on that list more than 10 times faster than pretty much anybody else on the list. That's a staggering achievement for an upstart, and it's reflective of our differentiation in a market that's being profoundly disrupted.

That's helpful. Thanks. And just to follow-up for Tim. So on OpEx, it looks like the R&D expenses were a little below what we were expecting. It was flat sequentially, even though you?ve made the push with your new product. And on the other hand, S&M growth actually accelerated over the last quarter, on a YoY basis. Could you just provide some color on how you see the trajectory for both of those line items through the rest of the year?

Yes, Balaji, on the R&D number, what you're seeing there, if you look at our CapEx number, you'll see our CapEx is up relatively notably Q-on-Q. And what's happening is as we've reached beta stage with our FlashBlade product, you're seeing the test equipment and things that we're procuring moving into the capital, moving into the balance sheet. And so that's why you're seeing a relatively flat quarter on quarter, whereas historically, we've expensed those immediately, but now that we've gotten the technical feasibility. So that's why R&D has slowed down a little bit.

On the sales and marketing side, you?re seeing year-on-year leverage. And really, that's the yardstick that I take a look at. Obviously, the S&M rate is up quarter on quarter. That has to do with just sequential dynamics and seasonal dynamics in our business. But year on year, those numbers are driving, both of them are driving leverage. And that's how I'd think about the rest of the year, as well.

Great. Thanks. (30:46)

Brian Alexander, Raymond James.

Yes, thank you. This is Adam in for Brian. Just wanted to ask a little bit more about FlashBlade. I know it's early, but would you expect FlashBlade to be adopted more by new customers or existing? And if it is for the addition of new customers, do you expect an increase in operating expenses as this ramps? And I have a follow-up, please.

We will see a mix with FlashBlade, both new customers and existing. If you look across the dozens of betas I mentioned, we have a nice representation both of existing and brand new customers. But it's very much the same sales force, the same channel, the same go-to-market cadence that we already have in the business. Keep in mind, we're selling to infrastructure teams, but we're also selling to line of business and we're selling to engineers that are building new products. And that will be true for FlashBlade, the same way it was FlashArray. So we will be able to capitalize on the investments we've already made in our go-to-market, and we think the product can grow even faster than FlashArray did, as a result.

Okay. And on the adjusted DSOs, I think I'm calculating low 60s for the quarter, and I think your previous goal was stated at the mid-50s. Wanted to understand the dynamics there. And it sounds like, based on your guidance, that level is going to continue.

So Adam, this is Tim. On adjusted DSOs, what's happening there, that mid-50s is what I think about a number over the course of an overall year. As we've gotten to the scale that we have, we're seeing some seasonal dynamics you heard us talk about in revenue. And there's seasonal dynamics, as well, on the balance sheet. And so what you're seeing there is really, if you strip out, for example, the change in deferreds, you would see that DSO be much more in line with what it's been historically. I look at weighted average days to pay internally, as well as percent current. And those measures are all tracking very, very well. So there's going to be some volatility and variability, just because of seasonal dynamic, but nothing fundamental has changed in the business.

Okay. Thank you.

Alex Kurtz, Sterne, Agee.

Hello, guys. Just a clarification, then a question. No more annual guidance, is that correct? Because I think you guys gave that last quarter, but you're not giving it this quarter?

Yes, Alex. On that, we basically, it was helping everybody with their underlying yearly models, but then we're going to a 90-day cadence going forward. So that's absolutely correct.

Okay. And Tim, just looking at your sales reps reloading their pipeline coming out of this April quarter, say, versus a year ago, how would you quantify that as far as looking out into the rest of the year and their ability to hit their quotas? Do you feel like the pipeline growth is on track, as here we are on May 25, or because of the macro maybe it's a week or two behind where you'd like it to be?

On pipeline, Alex, pipeline continues to build well. We talked a little about productivity and where our folks are hitting, and those trends are largely the same. So I'm happy with where we're at right now.

But as we look forward across our performance in the second half, so much of the market is breaking our way, we're breaking through to new levels in the channel with the confusion and indecision from the incumbent vendors. So much of this technology is showing its age. It is not able to keep pace with the innovation necessary to play in the modern data set. And it's that differentiation, Alex, that's making a huge difference in the marketplace.

Thanks, Scott.

Jason Ader, William Blair.

Yes, thank you. I have two questions. Scott, maybe people got a little bit spoiled by the last two quarters of convincing revenue beats, but did something change in Q1 where you weren't able to deliver the kind of beat that people have become accustomed to?

Jason, we are very happy with the performance we just turned in. At a $600 million revenue run rate, being able to grow that business at 89%, I would say is unprecedented in storage industry history. We're playing now as one of the top-10 storage providers in the world. And we are profoundly differentiated and distancing ourselves from the rest of the pack in terms of the market we are serving and growth. And I think you also see this differentiation in our best-in-class product margins, our customer CSAT, our competitive win rates. So we are very happy that the business is kicking on all cylinders. And we introduced a second product, which allows us to address with the two products, the whole of the $24 billion storage TAM, with only two products that are designed from the ground up for the all-flash and cloud-friendly future.

I guess what I'm getting at, is there more seasonality in the business than maybe some people had anticipated? I know you have a fair amount of EMC folks, old EMC folks in the sales force. And obviously, we know EMC has always been very seasonal in Q1. Maybe going forward, we should be thinking about more pronounced seasonality in Q1?

Jason, this is Tim. On seasonality, as we get to that $600 million run rate scale that Scott talked about, there is seasonality. We've seen seasonality in the business for a while. This was expected. It was consistent with our guide. So it's certainly not a surprise for us. And I think that's how we're modeling it going forward.

Okay. And then just a quick last one. For the second half -- Tim, maybe this is for you -- I know there's a big revenue ramp baked in to hit the annual target. How should we think about sequentials in Q3 and Q4? Should we expect a similar type of sequential growth in Q3 and Q4?

Well, as we talked a little bit earlier on the call, Jason, we're not offering forward-looking guidance. But I think you can do the A minus B, in terms of how we guided before. You typically see general deceleration year on year as the numbers get bigger. But I'll let you think about how you want to model that, as we're not providing forward guidance.

Okay.

John Lucia, JMP Securities.

Hello, guys. Thanks for taking my questions. My first question is on the cloud segment. Can you just talk about the momentum you're seeing there? It sounded like that's pretty positive. Is that growth rate still higher than the overall growth and also, do you expect that to continue to increase as a percentage of the mix?

So John, the cloud segment is about 25% of our business, breaking it out historically. And I want to be clear, we have a strong litmus test for what we quantify as cloud. It's got to be software as a service, infrastructure as a service across public networks or the large consumer Web services. We count those all as next-generation data center cloud opportunities.

The repeat purchase behavior we're seeing in the cloud cohort is 2x better than we're seeing in the overall business. So you should expect that to grow faster over time. And that's in line with what's happening in the market. If you look at IDC's forecast, you can see some of this on our blog. IDC sees cloud growing substantially faster than the rest of spend. And most compellingly, software as a service and consumer cloud, I believe both growing faster than they have public cloud services, like AWS. And we're very well exposed to those services in our business.

Okay. And then I have a follow-up. It's a follow-up to Jason's question. Pure has all these growth drivers in place, the rapid shift to all-flash, disruption with incumbent vendors, another thing the cloud coming on. My question is, why did we see product revenue growth decelerate below 80% despite these factors? Is there anything in particular in the market that's affecting growth, or is this just a law of large numbers?

John, I think it's the latter, as you're describing. Once you get to this size, growing a business at 80% for multiple years, that's a challenge. And so that's why you're seeing some of that deceleration. But at the end of the day, we are excited and looking forward to the second half. As you recall, our deliberate strategy is to invest at the beginning of the year, where we have seasonally lower revenue; but bring in the star talent, from a sales and marketing perspective, to be armed and ready when it comes time to the seasonally strong second half that you see in the storage industry; and we're going to capture more than our fair share by going after it.

And I would add, if you do compare us to other storage players, our growth looks extraordinary. 4x higher than that of the next closest independent company we're aware of. And most of the incumbents' businesses are flat to declining at this point. And you look at the historic metrics, it's not just storage that we're best-in-class, but we have better, very favorable compares to a Cisco or a Palo Alto Networks. That kind of performance at this scale, we're profoundly excited about.

Okay. Thank you.

(Operator Instructions)

Tal Liani, Bank of America.

Hello, guys. I have a question about, so both competitors grew triple digits, if I look at the big ones, HP and EMC. In their flash product, they grew triple digits, I think they said on the calls. You grew about 89%. It's very impressive. But the question is how big of an opportunity do you think, in terms of -- how long will you have a window of opportunity here before the competition starts to hurt you more than where it is now? Do you see in the market, for example, do you see growing competition or the impact of growing competition? And it doesn't have to be on technology, the way you explained it. It could be just because they are already in the market and they're already selling to certain customers and now they have a product. So I'm just trying to understand whether this past quarter you sensed any change in the competitive environment, just because these guys have grown so much? Thanks.

Hello, Tal. So I want to reiterate, no change to the competitive climate. And we've operated throughout our history in a very, very competitive marketplace in storage. And the fact that we have been able to maintain competitive win rates is reflective of how highly differentiated the product is. We've cited these already, but it's our audited Net Promoter Score of 79, it's the repeat cohorts of $12 for every initial dollar over the next 18 months in the top tier, it's product margins, and it's reflected in that growth.

Unlike the large incumbents, there's no financial engineering that we can do in moving dollars from maintenance on legacy disk arrays over to all-flash. And so the fact that we're growing our business so quickly, the aggregate business, while the incumbents are not seeing that growth, I would say is reflective of the fact that they really can't compete with their products that were designed generally more than 20 years ago in this new world of flash- and cloud-centric storage.

Tal, this is Tim. The other thing I would add in terms of one of the things that we're excited about with the future is customer acquisition. We've talked about our revenue number. But we grew new customers by nearly 130% year on year. And that's an acceleration from our year-on-year growth rates last quarter. So it really talks about how we think about landing those customers and really building those repeat statistics. Because if you add that dynamic to the repeat statistics that Scott talked about you, you really think about what the future holds, we're excited.

Got it. Another question that is related to growth, you said that you expect to reach sustained positive cash flow in second half 2017. If you grow slower, let's say there is a negative scenario, something happens to the market or to you specifically and you grow slower than currently expected, do you have any pulls in your business model where you can still get to positive cash flow second half despite weaker growth? I'm trying to understand whether reaching there, this point, is predicated on the current growth expectations that we have or not?

The short answer is we absolutely have levers, Tal, whether it be in our sales organization or beyond, to manage the bottom line through various scenarios on the revenue top line.

Keep in mind, we've been investing for growth. And this is why we make these investments, we hire additional field personnel in the first half of the year, in order to deliver on that productivity, because the metrics are so strong and solid across the board. Obviously, if we continue to look at all of that and if we didn't see clear line of sight to being able to maintain the tear that we've been on, then we need to manage the business to ensure we're meeting our targets of improved operating efficiency year over year, because that's the commitment is to drive maximal growth within the constraints of materially improving our operating efficiency year over year.

Got it. Thank you.

Thanks, Tal.

Katy Huberty, Morgan Stanley.

Yes, thanks. When you see yourselves grow high double-digit and peers grow triple digits, does that embolden you to accelerate sales spend even more than maybe you had planned? Or is the opposite true and more competitors in the market and higher penetration rates actually shrink the sales cycle and limit your need to have to invest ahead of demand like you have in the past?

Katy, I think the goal is to grow within the constraints of hitting our operating targets. We need to deliver on our sales productivity metrics and have our individual sales people be successful. We need to grow within the constraints of the ramping channel footprint. But the indicators there remain very strong, so we will invest prudently to capture as much of the market as we can within the constraints of those improved operating metrics.

And again, I want to reiterate, we are not conceding fastest growth to anyone in this market. There's no question with a diverse product portfolio, there's more flexibility to move dollars around between buckets. We believe we're growing faster than any other player in this market. They can't all be growing faster than the aggregate Gartner data and the IDC data. So the fact that we're growing materially faster than the analysts say flash is going into the data center, I think is reflective that we're outperforming the competition.

Katy, this is Tim. One other thing on investment. We had a great quarter of hiring, up nearly 200 net. So obviously, a majority of that focused in the sales and marketing organization, which really speaks to that capability, if you will, that we are putting out into the field because of the success we've had in the business. And that's in contrast with many that are seeing flat, if not declining, employee counts that they try to manage through different things going on in their business. So we are still very, very focused on investing and are on plan in terms of what we wanted to bring sales productive capacity to bear.

And as it relates to expanding the product portfolio, you drove a really extreme cannibalization of primary disk and 15K drives over the past year. How you are thinking about the pace of a similar cannibalization of secondary storage and 10K drives over the next couple of years? Does it happen as quickly, or is the disk-based business stickier in those markets?

So Katy, I think we have the opportunity to actually drive the transition even faster. And the reason I would cite is we have much greater reach today than we did. We were ultimately constrained in the early days of FlashArray just in our ability to touch customers and touch channel partners. Because we are so much larger today, literally in the top-10 storage providers in the world, we're in a position to touch a much broader part of the market far, far more quickly.

And the economics are compelling. It's not just the fact that we can deliver better performance. We can deliver dramatically better density. Customers are crying out. There was a third-party survey that was asking about customers about whether they could get access to insights in their data. And 80% of the customers in this survey said that they would be able to increase their top line by 20 points just by mining, if they could only mine insights they have in their existing data sets. This is what flash unleashes. Data that's stored on these large mechanical discs is effectively performance locked, a business can't get at it in order to do anything with it. And this is the revolution that we brought to the market with FlashArray, and history is going to repeat with FlashBlade, and it's going to do so faster.

Interesting. Thanks for the comments.

Thanks, Katy. Next question.

Ittai Kidron, Oppenheimer.

Thanks, Scott. Clearly, you're doing well in the market. You're gaining share. You're displacing your competitors. You're growing at unprecedented growth. But I like to think that you also benchmark yourself not just against your competitors, but also targets you have for yourself. And you came just a hair above the high end of the guide, and I'd like to think that at least internally, you thought that you can do better than the high end of the guide. So it will be great if you can give us a little bit of color on what do you think did not work perfectly to plan in this quarter? Was there a region, a certain sales force, a certain competitive dynamic, whatever that may be? Or maybe macro, because in your prepared comments, you did talk about the difficult macro, maybe that by itself made all the impact. But if you can pinpoint what actually did not work textbooks to your plan that will be great.

Ittai, we are extremely happy with the quarter we just turned in. $600 million revenue run rate, growing at 89% year over year, 69.6 points of product margin, the repeat business cohorts, the customer satisfaction, the channel uptick we're seeing, the net new logo increase, almost 2x the pace of net new logo acquisition from the prior quarter. No question we look across the boards and always think where the Company could do better, because we have aspirations to be number one in a $24 billion market. But we are supremely happy with the quarter we just turned in and we are on track to hit all of our targets.

You talk about your gross margin and your long-term gross margin as something that balances growth and the need to acquire new customers. Your product gross margin is, I must admit, it's very impressive. And I guess it begs the question of, do you think that you're overpricing? Out of curiosity, do you think that if you would have priced products at 1 point below, it would have generated extra revenue or that would not be the case right now?

So Ittai, we are differentiating on value that we are delivering to customers. Keep in mind, in the larger configurations, when we go up against the incumbents, we are often in a situation where our street price is actually below their cost of goods. And so we're delivering so much value because of our hardware efficiency that customers are getting phenomenally better value with Pure than they can get from the competitors.

So why would that change then? Why shouldn't we think your gross margin should go down into the range longer term?

If you're talking about our gross margin occupying the range that we've set for the business, yes, that remains our long-term target. We're not asking people to change their models and say our gross margin, our product gross margins are going to be in a new range. Keep in mind, we set out to put storage on a Moore's Law curve. Storage has not been on a Moore's Law curve, unlike the rest of the data center. And this is very important to customers, because it allows customer workloads to keep pace, storage to keep up with the demands of the data center and demands of the business. And we accelerate the shift to all-flash by continuing to press hard on bringing the Moore's Law value proposition to customers, because it's something that the mechanical-disk era products can't keep up with.

If I may, Tim, one last question. I think you talked about fiscal 2017 being a turning point for losses. I think that was the quote. I hope I got that right. Is that an annual comment or is that a quarterly comment, meaning is 2018 as a year profitable or every quarter in 2018 is profitable?

No, Ittai, what we meant by turning the tide here in fiscal 2017, so the year we're in right now, is that the guide that we provided at the beginning of the year, so the last quarter, we said that our absolute losses this year, our fiscal 2017, will be no higher than the previous year. So we delivered about $140 million of operating loss last year. That's our cap that we're shooting for. And as a statement on how we're doing on that, we were within $1.7 million, just under $2 million year on year in absolute operating losses, while still driving the business nearly 90%. We're very, very happy with that.

All right. Good luck. Thank you.

Thank you, Ittai.

Rich Kugele, Needham and Company.

Thank you. Good afternoon. Just a question about average deal size, even if you're not willing to give it specifically, can you just talk about how that trended in the quarter, especially relative to sequential? And post the launch of FlashBlade, let's say when it's out for more than a quarter or so, like next year, would you expect the average deal size to go up with the launch of FlashBlade? Would you expect those initial deployments to be generally larger scale? Thanks.

So with respect to ASPs, this is not a metric that we have historically broken out. We'd say year over year they are something that we look to see at least hold steady. And in a world of Moore's Law, that's actually a great outcome for us. We have not -- we've built into the annual guidance for the year our expectations around FlashBlade, but we've not stated anything about what FlashBlade's impact can be on average selling price. I would say the way we designed FlashBlade is similar to FlashArray. We want to have easy starter packaging with low hurdles to entry that customers can get in and try the technology out and fall in love with it, because we want to see that same kind of repeat purchase behavior kick in for FlashBlade that we enjoy with FlashArray. When customers fall in love with your storage and then they buy more of it than they do any of the other competitors; that's the best way to grow the business.

Okay. Thank you.

I think we have time for one last question, and then Scott, we'll hand it back to you to sum up. Okay?

Eric Martinuzzi, Lake Street Capital.

I feel like I missed something. Did you -- you said you've reiterated the full-year revenue guidance, or you're no longer reiterating it and just giving Q2?

Eric, this is Tim. We are not reiterating the full-year guidance. We provide one year guidance at the beginning of the year, and now we're just providing quarterlies. And that's just our natural management cadence.

To be clear, last quarter on the call, we stated very clearly that we would give it once per year and once per year only. So this is our policy.

Okay. That's different than most companies, which is why I asked. Thanks.

Sure. Is that your only question?

Yes.

And this will conclude our question-and-answer session. I would like to turn the conference back over to Scott Dietzen for any closing remarks.

Thanks so much for joining us. Pure Storage finds ourselves uniquely well positioned. We have a $24 billion total addressable market that is rapidly shifting to all-flash and cloud-friendly storage. The market's already come to FlashArray. We are increasingly the benchmark to which other companies are doing their compares.

We remain wholly convinced that the mainframe-era designs from the last century that we are competing with, simply cannot make the leap to flash and cloud. It changes so much of the software, the hardware, the automation, and the business model around storage that the incumbent technology, which in the rest of that top-10 list, we're basically always competing with retrofits from the last century. We will be able to continue to win.

And the market is going to come to FlashBlade. FlashBlade was three years in the making. Much like when FlashArray launched, there's nothing else like it in the marketplace, and we are going to enjoy the same kind of robust differentiation around FlashBlade. That combination, FlashArray and FlashBlade, allow us to play for the entire market.

Our product lines remain hugely differentiated from the competition. We have the best customer satisfaction, the best repeat cohorts, sustained competitive win rates over year's, best product margins, and best-in-class growth, not just today but in storage industry history. And we're hugely enthusiastic about the road ahead, our exposure to the cloud side of the business -- but cloud footprint is reflective of what all customers aspire.

Everyone wants their data center to be simpler and easier to manage, like cloud-oriented data centers are, and to bring down cost of ownership and bring up their performance access, so they can mine insights in their data and get the job done for the business. And we've got a channel that we believe is tipping toward Pure, because of our consistent excellence in product and because they're facing unknowns in the way our competitors' product portfolios and business models are going to evolve over time.

So hugely excited about the rest of this year, and we will speak to you again in three months. Thanks so much for joining us.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.