Pure Storage Q3 Results - my review

[anthonyms]

(Cross post from NPI in case the rest of the thread is a useful discussion for folks… https://discussion.fool.com/pure-does-reasonable-34065928.aspx?s…)

Ok Here’s my take on where Pure Storage is at after the results and conf call with highlights from both. I have held throughout and actually topped up during hours in the market yesterday with a very small add. Having looked at the results top line as well as going through the details of the call (I could have copied and pasted the whole lot as it was super impressive but anyhow); I’m actually more confident in Pure than when the results flash across the screen on release (although I don’t feel the market is in good shape right now in general and especially tech).

Most of all I love the beat and raise track record, the exceptional profitability leverage, the subscription growth and business model move beyond hardware, the booking growth, the solution build out with cloud announcement and NVe fabric release this quarter.

Points below are from the earnings slides, the ER transcripts. “Quotes” are direct quotes from the prepared remarks “Quotes in italics” are quotes from the Q&A…

Enjoy.
Ant

1. Revenue growth was 34.3% versus 37.6% growth last quarter versus 39.4% a year ago (it accelerated up to 48% and de-accelerated in between). That compares with NetApp growing total revenues at only 7% and their all flash revenues at 29%.

2. Revenues are guided to increase 30.6% for Q4. They have raised guidance and the new top line mid point at $442m is just above the expectation point of $440m. Pure has always beaten so I expect around 31% growth and has called out 30% CAGR as their mid term potential. They are getting close so this doesn’t leave a lot of room for misses otherwise they hit growth rates in the the 20s and I can’t see the street enjoying that given .

3. Customer additions were over 300 so they grew their base by 5%+. “Our focus on the enterprise, cloud and public sector also yielded results. We improved our traction in the Fortune 500 with almost 40% now Pure customers, our Cloud segments significantly outpaced, our overall company growth and we saw progress in our U.S. Federal and public sector business”

4. “Specifically, FlashBlade had one of the strongest growth quarters since its debut.” “Revenue performance was driven by strong FlashBlade execution in the quarter as well as continued adoption of our X series products.”

5. “FlashArray continues to lead the market transition to NVMe. NVMe represented more than two-thirds of all shipments this quarter.” and also…"and also… Over two-thirds of our shipments are now NVMe and we’re on track to ship the final piece of the puzzle with NVMe over fabric this year. So feeling very good about our leadership there and continuing to see that to be just extraordinarily differentiated in the field when we go out versus the competition.

6. “We’re also seeing nice early momentum in key market segments for our subscription based pricing model, the evergreen storage service. Just like the cloud, ES2 enables customers to consume on-prem solutions on a flexible usage basis.” “Support subscription revenue was $73.9 million or growth of 48% year-over-year.” Subscription values are 19.8% of Q3 revenues versus 17.9% of revenues a year ago. The reason why they have dropped QoQ is that Pure’s revenues are cyclical and Q3/Q4 are much higher than Q1/Q2 - especially for product sales rather than base subscriptions. It is natural for it to have dropped back from 21.9% in Q2 (and 23.6% in Q1 the trough of the cycle).

7. Gross and operating margins were at all time highs at 68.1% and 9.1% respectively. “Product gross margins increased two-tenth of a point sequentially to 68.1%, driven largely by strong performance across both of our FlashBlade and FlashArray product lines.”… “we delivered another quarter of profitability, with Q3 operating margin at 9.1%, representing a five-tenth and four-tenth of a point improvement over the same period a year ago”

8. Net Inc more than tripled from last year to this year - from $10.2m to $33.9m. As it did on a Non-GAAP EPS basis from 0.04 to 0.13 (equalling 0.13 from Q4 last year which was also an all time high).

9. Free cash flow before ESPPs was also at an all time high with $30.6m produced at 8.2%. (I’m not mad about the dilution but it is coming under control and they are not he worst offenders by far.)

10. Ok we talk about billings a lot with Nutanix but I don’t think Pure does a good enough job at spelling this out as they park it in the balance sheet for analysts to dig out. Fortunately someone did. This makes puts the comparison with NetApp into even starker contrast and should reassure holders of this “hardware” stock and worries over only a 30% growth rate…
    "Mark Murphy:- Yes, thank you and congrats on the strong results. Tim, the deferred revenue growth on the balance sheet looks quite robust in Q3. And I’m just curious if there’s anything unusual in that performance, in other words is it more of a correlation with your mainstream new bookings or is there timing of renewals in there or is it possibly something else like the early traction of some of your subscription offerings like the evergreen storage service?
    Tim Riitters:- Yes, Mark, thanks for the question. On deferred revenue a couple of things happening there so more of a longer term trend we’re seeing really a renewals base starting to build. And so, obviously we’ve been at this for several years now and when these folks are on their three year renewal cycles we’re starting to see nice healthy robust renewal business for us. So that’s obviously building the deferred revenue number faster than overall revenue growth. And then this quarter, which was a unique quarter for us we saw a little bit more of the elongation in support contracts. So what that means is people are buying a little bit more longer support contracts, which is great for us as well, they’re making a longer term bet for Pure. So both of those built the deferred revenue balance nicely over 40% year-on-year. So it’s a really healthy indicator of the long-term potential in the business."

11. Coming into this quarter there were concerns about channel checks. Clearly PJ had checked the wrong channels as Pure made massive progress that were picked up in other channel checks in the Fed and Public spaces…
    "Alex Kurtz:- Thanks guys, lots to unbundle here. First congrats on a great quarter and this big product launch today. Hat, our channel work indicated also strong momentum in U.S. Fed and in Cloud AI. So I was hoping you could provide any additional color on the order flow in these two verticals during the quarter and what it meant for the business? And for Tim, how should we think about operating leverage as we go into 2020 or operating margin profile obviously some strong contribution margin in the quarter just as we start to look out into next year?
    Charlie Giancarlo:- Hey, Alex, it’s Hat. We were pleased with the progress in our fed and public sector business. We’ve been working on that, we’ve been talking about that for several quarters and we saw a nice uptick and some strategic wins in both the intelligence community and civilian. So we’re going to continue to focus there, it’s one quarter doesn’t make a trend so we’re going to keep focusing and building that, but we feel confident that nice traction there. And then as we mentioned, FlashBlade had a terrific quarter for us. And it was really driven by the rapid restore and AI used cases and we did have some significant wins in large cloud providers. So that’s a combination of AI and backup."

12. and the other half of that question - operating leverage seems to be a very real feature with Pure. It is something I have always noticed and called out in their investor presentations and charts etc. Having said that they do mention the fact that they are still in investment mode. My hope is that they are profitable enough to turn a profit in Q1 which means that every quarter would be profitable from last Quarter onwards and no more seasonal swings to a net loss in H1.
    “Tim Riitters:- And Alex, this is Tim. On your second part of the question, obviously pleased with Q3 in terms of the over performance on the bottom line, but thinking going into next year, obviously we’re not guiding today on the call. But I think your question is a good one. Really the last couple of quarters have seen a lot of over performance on the bottom line. And I think about that as almost a multiplier of both revenue over performance, as well as very, very strong gross margin performance. Industry leading and certainly at a high point even for us here at Pure. And so those two numbers multiply and typically drop right to the bottom line in any given quarter. And so, I wouldn’t read that over performance that you saw here in Q2 or Q3 as something that continues to go on until into the next year. Really, as we said in our prepared remarks, we are investing aggressively looking at what we launched today and the innovation pipeline, we’re really excited about the lead we have in the business and we will invest aggressively against that. So that’s how I think about next year.”

13)and for those of you who like to keep score, they really put Andrew Nowinski from PJ back in the box when he asked about competitive positioning vs NetApp…
Andrew Nowinski:- Okay, very good. And then with regard to the product growth at 31% year-over-year this quarter, I think, it seem fairly modestly above what NetApps just reported for their all flash revenue. Can you just give us an update on the competitive landscape and where you’re taking share considering your rate is well above the market growth rate? Thanks.
David Hatfield:- Yes, so the competitive landscape I think our win rates still stayed heavy, we’re stable for the quarter. And so, we feel great about our differentiation across all of the major competitors. So, no material change their. Kix, I don’t know anything else you want add?
Matt Kixmoeller:- No, we’ve continue to see great product differentiation out there. And, when we continue to find when we get in and we showcase our product, we win, our biggest challenge is about that since we keep working on making sure we can knock out as many doors we can.
Andrew Nowinski:-Great, thank you.

14. Finally their AWS cloud data services announcement. Basically to summarise they see this as unifying on prem with cloud, they see the go to market still as channel oriented and will incentivise the channel partners (VMWare was called out). They see AWS as a great channel partner but in no way precluding clients with relationships with Azure/Google etc. They see this as additive and also a way of on-boarding new customers. It fits with the new solutions they are bringing to market as well as recent acquisitions.

Sources:
Transcript:-
https://seekingalpha.com/article/4223382-pure-storage-pstg-c…
Press release:-
https://investor.purestorage.com/news-and-events/press-relea…
Earning slides:-
https://s21.q4cdn.com/687136699/files/doc_financials/2019/q3…

[anthonyms]

FWIW, (probably talking to myself here) but I’ve just sent Pure’s IR an email suggesting they consider highlighting bookings, deferred revenues and customer contract length consistently in their earnings releases.
A

Dear IR

First of all I wanted to thank Pure Storage for such high quality earnings communications particularly the ER slides that accompany results announcements. I have rarely seen companies communicate the important highlights with such consistency, accessibility and simplicity. It is first rate.

Secondly and the nature of my question/suggestion is the possibility to enhance this particularly as you are in the process of transitioning the business model. I notice other companies including FireEye and Nutanix, other tech companies operating across hardware, software and the cloud are consistent in referring to a couple of additional useful metrics - specifically highlighting “billings and deferred revenues” in $ and % change as well as average customer contract lengths in months.

I have always found it odd that whilst Pure talks about Software and Subscription Revenues and highlights the Evergreen business model shift as well as needing to find ways to differentiate itself and its performance versus the incumbent competitors like DELL/EMC and NetApp, it doesn’t highlight the amount of billings and deferred revenues. This was the subject of the very first question in this Q3 2018 ER call Q&A session and the analyst had to highlight that he had found it by digging it out of the balance sheet. Wouldn’t this be something worth highlighting in order to demonstrate the business model shift, differentiate itself vs competitors as well as highlight progress beyond top line revenue $ and growth, particularly as growth rates are declining whilst billings and deferred revenues are outgrowing the quarterly amounts.

Average length of customer contracts would also help analysts and investors value the amount of customers secured, the land and expand progress but also importantly the stickiness of the subscription model services.

I look forward to hearing from you on these points. Congratulations on the successful Q3 2018!
Regards
A

[anthonyms]

Ok this really is talking to myself but anyhow… in case you didn’t click across there was an interesting exchange and I added to my thoughts on Pure, so for completeness…

Duma
Ant:

39.4% to 37.4% to 34.3% to 30.6%…that is not the trend of a massively growing business especially when the latter guidance is just a smidgeon higher than NTAP’s Flash growth of 29%.

Obviously you have gone through great pains to try to demonstrate the unrecognized value in PSTG despite the falling growth numbers. Many would have stopped investigating with that growth trend.

But this is a different kind of investing…maybe you will be right one day…but YTD it has been essentially flat and off its highs by 49%.

That is a massive lost opportunity cost for a long this past year conserding other alternatives that despite the market sell off are still well above PSTG’s YTD performance.

Probably worth keeping on the radar but the above trend makes no sense why one would be adding to a position…unless it’s price has found rock bottom.

Tinker
I was about to comment on Pure when Duma beat me to it.

The good is that Pure has industry leading gross margins, and those are growing. That is a financial sign of product differentiation and superior value. Earnings leverage as well. Pure obviously can earn money as NTAP and EMC before them have.

But yes, growth is dramatically slowing. Not like a brick wall or anything, but that is a dramatic slow down in growth. That has to be worrisome, particularly as after all this time (2-3 years anyways) and Pure has grown its business so far, it is back to a bit above its IPO price despite it all. I do expect it to rise again from here of course on good earnings. But then again it did last quarter as well and gave it all up and more, and did so prior to the recent shellackings.

Pure is definitely doing good and exciting things, and it is growing faster than the market, but it does not seem that it will reaccelerate growth anytime soon unless its products take over as a disruptive platform or Flashblade becomes the hidden growth factor.

NVME is clearly a differentiator as Pure brings it mainstream while others keep it high end. I would suspect that Pure’s ability to use lower quality flash, and its ability to more efficiently use flash is aiding their gross margins.

But analogous with Arista, that is still extremely profitable, and still a pain in Cisco’s arse, and still growing faster than the market, its growth rate has fallen to a bit below Pure’s and it has not helped its stock price at all.

As such, still love following the company. It is clearly a successful and prosperous company that has a future, but at 30% and slowing growth…it just is like Arista became, not as fast of a horse.

ABMD is growing as fast (and usually faster) with a much higher CAP. That is my preference in this more moderate but still rapid long-term growth arena.

Tinker

Ant
Hey Duma - ok leaving aside you cannot actually invest in the NTAP AFA business as it comes with a slow moving legacy business loaded in that is growing in single digits in total, my points would be:

1. It is profitable (many of our 40-70% growers are not profitable and may never be profitable) and for a profitable company to be trebling profits and growing top line by 30% with a $1bn run rate is pretty rare

2. They are also going through a business model transition just like Nutanix as they move from hardware to adding in software & services on a subscription basis and whilst they break out the values it needs to be considered

3. Your revenue growth numbers do not account for the increase in billings/deferred revenues that are on the balance sheet. They well have been contracting the same levels of business growth but putting more into deferral. This is something that I am not necessarily seeing in the competition where the AFA is mostly commoditisation of the legacy business rather than net new business and not necessarily building deferrals.

4. Pure is building not just a subscription business but a differentiated business model with NVMe, ES2, Evergreen, Purity software and Shared Accelerated Storage as a vision

5. Pure is highly effective at shareholder communications which lowers the risk of holding compared to unfathomable or nontransparent companies that blow up without warning

6. The cloud data service announced is valued at another $0.5bn opportunity for them (according to competitor benchmarks)

Honestly I think times like this we need to think whether a 30% grower that is profitable at low valuation and only 4bn market cap with potential to 10x and highly transparent is worth considering or whether you want to just look at top line and go for the 70% growing, unprofitable, extreme valuation players that might fizzle out before ever breaking even. There’s a tradeoff to be considered and Friday is a good reminder of risk.

As it happens I’m in the money on this one as I got in a very long time ago and am more ahead with this than some of the other shooting stars that have come back to earth yesterday.

It’s a good challenge though - to ensure you haven’t fallen in love with a stock and to be as ruthless in allocation as possible so I appreciate you raising it.
Ant

[Jimb05]

Here are the PSTG revenue growth rates (%) YOY

2019  40  38  34  32*

* company guidance

looks like it is slowing.

Here it is with 2018

2018  31  38  41  49
2019  40  38  34  32*

Notice the tough comps. the year before

2018/2019 average :  36  38  38  40

Doesn't look likes its slowing at all to me, actually getting better. 

Along with the improving gross and operating margins, good quarter to me.

Jim

[ghonkaba]

Jim,

2018/2019 average :  36  38  38  40

Why did you do that? Seems of no value to average the same Q returns although it makes it appear better than it is.

I’m with Ant though. Growing at 30% and profitable at a much lower valuation than most stocks followed here.

Hey just a tip to make the table posts more readable, especially on mobile devices - you can just use the pre and /pre tags on your table, not the entire post.

Greg