Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - Pure Storage, Inc.ex-321q3fy2019.htm
EX-31.2 - EXHIBIT 31.2 - Pure Storage, Inc.ex-312q3fy2019.htm
EX-31.1 - EXHIBIT 31.1 - Pure Storage, Inc.ex-311q3fy2019.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q
 
 

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2018
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from    to    
Commission File Number: 001-37570
Pure Storage, Inc.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
27-1069557
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
650 Castro Street, Suite 400
Mountain View, California  
94041
(Address of principal executive offices, including zip code)
(Zip Code)

 (800) 379-7873
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x     No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x     No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a small reporting company)
Smaller reporting company
o
 
 
 
Emerging growth company
o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of November 28, 2018, the registrant had 216,507,814 shares of its Class A common stock outstanding and 25,108,923 shares of its Class B common stock outstanding. As of the date hereof, all outstanding shares of our Class B common stock have been converted into the same number of shares of Class A common stock pursuant to the terms of our amended and restated certificate of incorporation. See further discussion in Part II, Item 5 of this Quarterly Report on Form 10-Q.




Table of Contents
 
 
 
Page
 
PART I.
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II.
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.



NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), about us and our industry that involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this report, including statements regarding our future results of operations and financial condition, business strategy and plans and objectives of management for future operations, are forward-looking statements. In some cases, forward-looking statements may be identified by words such as “anticipate,” “believe,” “continue,” “could,” “design,” “estimate,” “expect,” “intend,” “may,” “plan,” “potentially,” “predict,” “project,” “should,” “will” or the negative of these terms or other similar expressions.  
Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements regarding our ability to sustain or manage our profitability, expansion and growth, our expectations that average sales prices may decrease over time, our plans to expand and continue to invest internationally, our plans to expand the research and development organization as well as the sales and marketing function and channel programs, our expectations regarding fluctuations in our revenue and operating results, our expectations that we may continue to experience losses despite significant revenue growth, our ability to successfully attract, motivate, and retain qualified personnel and maintain our culture, our expectations regarding our technological leadership and market opportunity, our ability to realize benefits from our investments, our ability to innovate and introduce new or enhanced products, our expectations regarding product acceptance and our technologies, products and solutions, our competitive position and the effects of competition and industry dynamics, including those of retrofitted or new products from incumbent vendors, hyperconverged products, defined as server compute and storage combined within a single chassis, or public cloud, our expectations concerning relationships with third parties, including partners and customers, the adequacy of our intellectual property rights, and expectations concerning potential legal proceedings and related costs.
We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, and financial needs. These forward-looking statements are subject to a number of known and unknown risks, uncertainties and assumptions, including risks described in the section titled “Risk Factors.” These risks are not exhaustive. Other sections of this report include additional factors that could harm our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time, and it is not possible for our management to predict all risk factors nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ from those contained in, or implied by, any forward-looking statements.
Investors should not rely upon forward-looking statements as predictions of future events. We cannot assure investors that the events and circumstances reflected in the forward-looking statements will be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report or to conform these statements to actual results or to changes in our expectations. Investors should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed as exhibits to this report with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

ii


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.
PURE STORAGE, INC.
Condensed Consolidated Balance Sheets
(in thousands, except per share data, unaudited)
 
As of
January 31, 2018
 
As of
October 31, 2018
 
(As Adjusted*)
 
 
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
244,057

 
$
406,641

Marketable securities
353,289

 
737,020

Accounts receivable, net of allowance of $1,062 and $1,052 as of January 31, 2018 and October 31, 2018
243,001

 
305,649

Inventory
34,497

 
50,737

Deferred commissions, current
21,088

 
24,100

Prepaid expenses and other current assets
47,552

 
44,657

Total current assets
943,484

 
1,568,804

Property and equipment, net
89,142

 
115,266

Deferred commissions, non-current
66,225

 
72,340

Intangible assets, net
5,057

 
21,126

Goodwill

 
10,997

Deferred income taxes, non-current
1,060

 
1,766

Restricted cash
14,763

 
15,822

Other assets, non-current
4,264

 
5,245

Total assets
$
1,123,995

 
$
1,811,366

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
84,420

 
$
101,979

Accrued compensation and benefits
59,898

 
53,213

Accrued expenses and other liabilities
26,829

 
43,633

Deferred revenue, current
191,229

 
232,570

Liability related to early exercised stock options
320

 

Total current liabilities
362,696

 
431,395

Convertible senior notes, net

 
443,212

Deferred revenue, non-current
182,873

 
228,618

Other liabilities, non-current
4,025

 
5,813

Total liabilities
549,594

 
1,109,038

Commitments and contingencies (Note 7)


 


Stockholders’ equity:
 

 
 

Preferred stock, par value of $0.0001 per share— 20,000 shares authorized as of January 31, 2018 and October 31, 2018; no shares issued and outstanding as of January 31, 2018 and October 31, 2018

 

Class A and Class B common stock, par value of $0.0001 per share— 2,250,000 (Class A 2,000,000, Class B 250,000) shares authorized as of January 31, 2018 and October 31, 2018; 220,979 (Class A 129,502, Class B 91,477) and 241,359 (Class A 216,252, Class B 25,107) shares issued and outstanding as of January 31, 2018 and October 31, 2018
22

 
24

Additional paid-in capital
1,479,883

 
1,761,597

Accumulated other comprehensive loss
(1,917
)
 
(3,099
)
Accumulated deficit
(903,587
)
 
(1,056,194
)
Total stockholders’ equity
574,401

 
702,328

Total liabilities and stockholders’ equity
$
1,123,995

 
$
1,811,366

*Prior period information has been adjusted to reflect the adoption impact of Accounting Standards Codification 606, Revenue from Contracts with Customers (ASC 606), which we adopted on February 1, 2018.
 See the accompanying notes to condensed consolidated financial statements.

2


PURE STORAGE, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share data, unaudited)

 
Three Months Ended October 31,
 
Nine Months Ended October 31,
 
2017
 
2018
 
2017
 
2018
 
(As Adjusted*)
 
 
 
(As Adjusted*)
 
 
Revenue:
 

 
 

 
 
 
 
Product
$
227,772

 
$
298,863

 
$
550,291

 
$
735,449

Support subscription
49,819

 
73,916

 
134,615

 
202,159

Total revenue
277,591

 
372,779

 
684,906

 
937,608

 
 
 
 
 
 
 
 
Cost of revenue:
 

 
 

 
 
 
 
Product
75,392

 
96,610

 
179,289

 
241,292

Support subscription
20,467

 
27,049

 
56,569

 
74,716

Total cost of revenue
95,859

 
123,659

 
235,858

 
316,008

 
 
 
 
 
 
 
 
Gross profit
181,732

 
249,120

 
449,048

 
621,600

 
 
 
 
 
 
 
 
Operating expenses:
 

 
 

 
 
 
 
Research and development
68,927

 
90,783

 
203,716

 
253,306

Sales and marketing
116,971

 
146,903

 
326,286

 
413,019

General and administrative
25,406

 
38,651

 
67,664

 
99,572

Total operating expenses
211,304

 
276,337

 
597,666

 
765,897

 
 
 
 
 
 
 
 
Loss from operations
(29,572
)
 
(27,217
)
 
(148,618
)
 
(144,297
)
Other income (expense), net
1,138

 
(2,889
)
 
6,399

 
(7,920
)
Loss before provision for income taxes
(28,434
)
 
(30,106
)
 
(142,219
)
 
(152,217
)
Income tax provision (benefit)
970

 
(1,926
)
 
2,755

 
390

Net loss
$
(29,404
)
 
$
(28,180
)
 
$
(144,974
)
 
$
(152,607
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.14
)
 
$
(0.12
)
 
$
(0.69
)
 
$
(0.66
)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted
213,274

 
235,205

 
209,456

 
229,505


* Prior period information has been adjusted to reflect the adoption impact of ASC 606, which we adopted on February 1, 2018.
 
See the accompanying notes to condensed consolidated financial statements.

3


PURE STORAGE, INC.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands, unaudited)


 
Three Months Ended October 31,
 
Nine Months Ended October 31,
 
2017
 
2018
 
2017
 
2018
 
(As Adjusted*)
 
 
 
(As Adjusted*)
 
 
Net loss
$
(29,404
)
 
$
(28,180
)
 
$
(144,974
)
 
$
(152,607
)
Other comprehensive loss:
 

 
 

 
 
 
 
Change in unrealized net loss on available-for-sale securities
(439
)
 
(273
)
 
(157
)
 
(1,182
)
Comprehensive loss
$
(29,843
)
 
$
(28,453
)
 
$
(145,131
)
 
$
(153,789
)

* Prior period information has been adjusted to reflect the adoption impact of ASC 606, which we adopted on February 1, 2018.
 

See the accompanying notes to condensed consolidated financial statements.

4


PURE STORAGE, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands, unaudited)


 
Nine Months Ended October 31,
 
2017
 
2018
 
(As Adjusted*)
 
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net loss
$
(144,974
)
 
$
(152,607
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
45,525

 
51,381

Amortization of debt discount and debt issuance costs

 
14,414

Stock-based compensation expense
107,920

 
155,938

Deferred income taxes
(121
)
 
(4,402
)
Other
1,000

 
(635
)
Changes in operating assets and liabilities, net of effects of acquisition:
 
 
 
Accounts receivable, net
(33,630
)
 
(62,623
)
Inventory
(14,314
)
 
(17,103
)
Deferred commissions
(13,969
)
 
(9,127
)
Prepaid expenses and other assets
(112
)
 
1,996

Accounts payable
11,808

 
11,800

Accrued compensation and other liabilities
359

 
7,592

Deferred revenue
54,264

 
87,005

Net cash provided by operating activities
13,756

 
83,629

CASH FLOWS FROM INVESTING ACTIVITIES


 


Purchases of property and equipment
(44,351
)
 
(70,807
)
Acquisition, net of cash acquired

 
(13,899
)
Purchases of marketable securities
(151,998
)
 
(558,248
)
Sales of marketable securities
46,067

 
18,802

Maturities of marketable securities
99,021

 
156,049

Net cash used in investing activities
(51,261
)
 
(468,103
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
  Net proceeds from exercise of stock options
15,761

 
43,342

  Proceeds from issuance of common stock under employee stock purchase plan
22,137

 
33,444

  Proceeds from issuance of convertible senior notes, net of issuance costs

 
562,062

  Payment for purchase of capped calls

 
(64,630
)
  Repayment of debt assumed from acquisition

 
(6,101
)
  Repurchase of common stock

 
(20,000
)
Net cash provided by financing activities
37,898

 
548,117

Net increase in cash, cash equivalents and restricted cash
393

 
163,643

Cash, cash equivalents and restricted cash, beginning of period
196,409

 
258,820

Cash, cash equivalents and restricted cash, end of period
$
196,802

 
$
422,463

 
 
 
 
CASH, CASH EQUIVALENTS AND RESTRICTED CASH AT END OF PERIOD:
 
 
 
Cash and cash equivalents
$
182,039

 
$
406,641

Restricted cash
14,763

 
15,822

Cash, cash equivalents and restricted cash, end of period
$
196,802

 
$
422,463

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
 
 
Cash paid for income taxes
$
2,410

 
$
4,121

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING INFORMATION
 

 
 
Property and equipment purchased but not yet paid
$
9,831

 
$
14,605

Acquisition consideration held back to satisfy potential indemnification claims
$

 
$
3,725

Vesting of early exercised stock options
$
794

 
$
320

 * Prior period information has been adjusted to reflect the adoption impact of ASC 606 and Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which we adopted on February 1, 2018.
See the accompanying notes to condensed consolidated financial statements.

5


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 1. Business Overview
Organization and Description of Business
Pure Storage, Inc. (the Company, we, us, or other similar pronouns) was originally incorporated in the state of Delaware in October 2009 under the name OS76, Inc. In January 2010, we changed our name to Pure Storage, Inc. We are headquartered in Mountain View, California and have wholly owned subsidiaries throughout the world.
We help innovators to build a better world with data. Our data platform replaces storage systems designed for mechanical disk with all-flash systems optimized end-to-end for solid-state memory. Our Pure1 cloud-based support and management platform simplifies storage administration and provides real-time scanning to find and fix issues. Our business model replaces the traditional forklift upgrade cycle with Evergreen Storage subscriptions to hardware and software innovation, support and maintenance.
 
Note 2. Basis of Presentation and Summary of Significant Accounting Policies
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Unaudited Interim Consolidated Financial Information
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP) and applicable rules and regulations of the Securities and Exchange Commission (the SEC) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended January 31, 2018.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, comprehensive loss and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full fiscal year 2019 or any future period. Certain prior period amounts have been adjusted as a result of adoption of new accounting pronouncements. Refer to "Recently Adopted Accounting Pronouncements" below for further information.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and accompanying notes. Actual results could differ from these estimates. Such estimates include, but are not limited to, the determination of standalone selling price for revenue arrangements with multiple performance obligations, useful lives of intangible assets, property and equipment and deferred sales commissions, stock-based compensation, provision for income taxes including related reserves, valuation of intangible assets and goodwill, and contingent liabilities. Management bases its estimates on historical experience and on various other assumptions which management believes to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Restricted Cash
Restricted cash is comprised of cash collateral related to our leases and for a vendor corporate credit card program. As of January 31, 2018 and October 31, 2018, we had restricted cash of $14.8 million and $15.8 million on the condensed consolidated balance sheets.

6


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Marketable Securities
We classify our marketable securities as available-for-sale at the time of purchase and reevaluate such classification at each balance sheet date. We may sell these securities at any time for use in current operations even if they have not yet reached maturity. As a result, we classify our securities, including those with maturities beyond twelve months, as current assets in the accompanying condensed consolidated balance sheets. We carry these securities at fair value and record unrealized gains and losses, in accumulated other comprehensive loss, which is reflected as a component of stockholders’ equity. We evaluate our securities to assess whether those with unrealized loss positions are other than temporarily impaired. We consider impairments to be other than temporary if they are related to deterioration in credit risk or if it is likely we will sell the securities before the recovery of their cost basis. Realized gains and losses from the sale of marketable securities and declines in value deemed to be other than temporary are determined on the specific identification method. To date, there have been no declines in value deemed to be other than temporary in any of our securities. Realized gains and losses are reported in other income (expense), net in the condensed consolidated statements of operations.
Business Combination
We allocate the purchase price to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of the assets acquired and liabilities assumed is recorded as goodwill. The results of operations of the acquired businesses are included in our condensed consolidated financial statements from the date of acquisition.  Acquisition-related expenses are expensed as incurred. 
Deferred Commissions
Deferred commissions consist of incremental costs paid to our sales force to obtain customer contracts. Deferred commissions related to product revenues are recognized upon transfer of control to customers and deferred commissions related to support subscription revenue are amortized over an expected useful life of six years. We determine the expected useful life based on an estimated benefit period by evaluating our technology development life cycle, expected customer relationship period, and other factors. We classify deferred commissions as current and non-current on our condensed consolidated balance sheets based on the timing of when we expect to recognize the expense. Amortization of deferred commissions is included in sales and marketing expense in the condensed consolidated statements of operations.
Changes in total deferred commissions during the periods presented are as follows (in thousands):
 
Three Months Ended October 31, 2018
 
Nine Months Ended October 31, 2018
Beginning balance (1)
$
91,469

 
$
87,313

Additions
31,884

 
71,887

Recognition of deferred commissions
(26,913
)
 
(62,760
)
Ending balance as of October 31, 2018
$
96,440

 
$
96,440

____________________ 
(1) Balance as of January 31, 2018 was adjusted to reflect the adoption of ASC 606.

Of the $96.4 million total deferred commissions balance as of October 31, 2018, we expect to recognize approximately 25% as commission expense over the next 12 months and the remainder thereafter.
There was no impairment related to capitalized commissions for the three and nine months ended October 31, 2017 and 2018.

7


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Deferred Revenue
Deferred revenue primarily consists of amounts that have been invoiced but that have not yet been recognized as revenue and performance obligations pertaining to support subscription services. The current portion of deferred revenue represents the amounts that are expected to be recognized as revenue within one year of the condensed consolidated balance sheet dates.
Changes in total deferred revenue during the periods presented are as follows (in thousands):
 
Three Months Ended October 31, 2018
 
Nine Months Ended October 31, 2018
Beginning balance (1)
$
413,247

 
$
374,102

Additions
122,681

 
290,463

Recognition of deferred revenue
(74,740
)
 
(203,377
)
Ending balance as of October 31, 2018
$
461,188

 
$
461,188

____________________ 
(1) Balance as of January 31, 2018 was adjusted to reflect the adoption of ASC 606.

During the three and nine months ended October 31, 2017, we recognized $47.3 million and $108.2 million in revenue pertaining to deferred revenue as of the beginning of each period. During the three and nine months ended October 31, 2018, we recognized $67.0 million and $151.4 million in revenue pertaining to deferred revenue as of the beginning of each period.
Of the $461.2 million remaining performance obligations as of October 31, 2018, we expect to recognize approximately 50% as revenue over the next 12 months and the remainder thereafter.
Substantially all of our contracted but not invoiced performance obligations are subject to cancellation and, therefore, are not considered in our remaining performance obligations.
Revenue Recognition
We derive revenue from two sources: (1) product revenue which includes hardware and embedded software and (2) support subscription revenue which includes customer support, hardware maintenance, and software upgrades on a when-and-if-available basis.
Our product revenue is derived from the sale of storage hardware and operating system software that is integrated into the hardware. We typically recognize product revenue upon transfer of control to our customers. Products are typically shipped directly by us to customers, and our channel partners do not stock our inventory.
Our support subscription revenue is derived from the sale of support subscription, which includes the right to receive unspecified software upgrades and enhancements on a when-and-if-available basis, bug fixes, parts replacement services related to the hardware, as well as access to our cloud-based management and support platform. Revenue related to support subscription is recognized ratably over the contractual term, which generally ranges from one to six years and represents our performance obligations period. The vast majority of our products are sold with support subscription agreements, which typically commence upon transfer of control of the corresponding products to our customers. Costs to service the support subscription are expensed as incurred. In addition, our Evergreen Storage program provides our customers who continually maintain active support subscription agreements for three years with an included controller refresh with each additional three year support subscription renewal. In accordance with revenue recognition guidance, the controller refresh represents an additional performance obligation and the allocated revenue is recognized in the period in which these controllers are shipped.
We recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration we expect to be entitled in exchange for those goods or services. This is achieved through applying the following five-step approach:

8


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Identification of the contract, or contracts, with a customer
Identification of the performance obligations in the contract
Determination of the transaction price
Allocation of the transaction price to the performance obligations in the contract
Recognition of revenue when, or as, we satisfy a performance obligation
When applying this five-step approach, we apply judgment in determining the customer's ability and intention to pay, which is based on a variety of factors including the customer's historical payment experience and/or published credit and financial information pertaining to the customer. To the extent a customer contract includes multiple promised goods or services, we determine whether promised goods or services are capable of being distinct in the context of the contract to be accounted for as a combined performance obligation. We allocate transaction price to each performance obligation for contracts that contain multiple performance obligations based on a relative standalone selling price, taking into account available information such as market conditions and internally approved pricing guidelines related to performance obligations.
Recently Adopted Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB), issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09 or ASC 606), requiring an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASC 606 supersedes nearly all existing revenue recognition guidance under U.S. GAAP upon its effective date. The standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of applying the standard recognized at the date of application (cumulative catch-up transition method).
We adopted the standard using the full retrospective method beginning February 1, 2018, for the year ending January 31, 2019, and our historical financial information for the years ended January 31, 2017 and 2018 has been adjusted to conform to the new standard.
The most significant impact of the standard related to the removal of limitation on contingent revenue, resulting in an increase in product revenue and a decrease in support subscription revenue. In addition, the adoption of ASC 606 also resulted in differences in the timing of recognition of sales commissions. While the adoption of the standard changes certain line items within the net cash flow from operating activities, it had no impact on the net cash provided by or used in operating, investing, or financing activities on our condensed consolidated statements of cash flows.

9


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

The following line items on our condensed consolidated balance sheet as of January 31, 2018 have been adjusted to reflect the adoption of ASC 606 (in thousands):
 
As of January 31, 2018
 
As Previously Reported
 
Adjustment
 
As Adjusted
Assets:
 
 
 
 
 
Deferred commissions, current
$
22,437

 
$
(1,349
)
 
$
21,088

Deferred commissions, non-current
20,288

 
45,937

 
66,225

Total deferred commissions
$
42,725

 
$
44,588

 
$
87,313

Liabilities:
 
 
 
 
 
Deferred revenue, current
$
209,377

 
$
(18,148
)
 
$
191,229

Deferred revenue, non-current
196,632

 
(13,759
)
 
182,873

Total deferred revenue
$
406,009

 
$
(31,907
)
 
$
374,102

Stockholders' equity:
 
 
 
 
 
Accumulated deficit
$
(980,082
)
 
$
76,495

 
$
(903,587
)

The following line items on our unaudited condensed consolidated statement of operations for the three and nine months ended October 31, 2017 have been adjusted to reflect the adoption of ASC 606 (in thousands, except per share data):
 
Three Months Ended October 31, 2017
 
Nine Months Ended October 31, 2017
 
As Previously Reported
 
Adjustment
 
As Adjusted
 
As Previously Reported
 
Adjustment
 
As Adjusted
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
223,196

 
$
4,576

 
$
227,772

 
$
536,634

 
$
13,657

 
$
550,291

Support subscription
54,478

 
(4,659
)
 
49,819

 
148,132

 
(13,517
)
 
134,615

Total revenue
$
277,674

 
$
(83
)
 
$
277,591

 
$
684,766

 
$
140

 
$
684,906

 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
$
181,815

 
$
(83
)
 
$
181,732

 
$
448,908

 
$
140

 
$
449,048

Sales and marketing
$
129,299

 
$
(12,328
)
 
$
116,971

 
$
346,896

 
$
(20,610
)
 
$
326,286

Total operating expenses
$
223,632

 
$
(12,328
)
 
$
211,304

 
$
618,276

 
$
(20,610
)
 
$
597,666

Loss from operations
$
(41,817
)
 
$
12,245

 
$
(29,572
)
 
$
(169,368
)
 
$
20,750

 
$
(148,618
)
Loss before provision for income taxes
$
(40,679
)
 
$
12,245

 
$
(28,434
)
 
$
(162,969
)
 
$
20,750

 
$
(142,219
)
Net loss
$
(41,649
)
 
$
12,245

 
$
(29,404
)
 
$
(165,724
)
 
$
20,750

 
$
(144,974
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.20
)
 
$
0.06

 
$
(0.14
)
 
$
(0.79
)
 
$
0.10

 
$
(0.69
)


10


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Unaudited revenue by geographic location based on bill-to location, which reflects the adoption impact of ASC 606, are as follows (in thousands):
 
Three Months Ended October 31, 2017
 
Nine Months Ended October 31, 2017
 
As Previously Reported
 
Adjustment
 
As Adjusted
 
As Previously Reported
 
Adjustment
 
As Adjusted
Revenue:
 
 
 
 
 
 
 
 
 
 
 
United States
$
192,977

 
$
(58
)
 
$
192,919

 
$
504,937

 
$
108

 
$
505,045

Rest of the world
84,697

 
(25
)
 
84,672

 
179,829

 
32

 
179,861

Total revenue
$
277,674

 
$
(83
)
 
$
277,591

 
$
684,766

 
$
140

 
$
684,906


In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and restricted cash. We adopted ASU 2016-18 effective February 1, 2018 on a retrospective basis. Upon adoption, restricted cash is included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The adoption of this standard increased our previously reported net cash flow from investing activities for the periods in which there were changes in restricted cash but did not impact our net cash flow from operating activities or financing activities presented on our consolidated statements of cash flows.
The following line items in our unaudited condensed consolidated statement of cash flows for the nine months ended October 31, 2017 have been adjusted to reflect the adoption of ASU 2016-18 and ASC 606 (in thousands):
 
Nine Months Ended October 31, 2017
 
As Previously Reported
 
Adjustment
 
As Adjusted
Net loss (1)
$
(165,724
)
 
$
20,750

 
$
(144,974
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
 
Deferred commissions (1)
$
(7,629
)
 
$
(6,340
)
 
$
(13,969
)
Accrued compensation and other liabilities (1)
$
14,629

 
$
(14,270
)
 
$
359

Deferred revenue (1)
$
54,404

 
$
(140
)
 
$
54,264

Cash provided by operating activities
$
13,756

 
$

 
$
13,756

Net increase in restricted cash (2)
$
(2,029
)
 
$
2,029

 
$

Net cash used in investing activities (2)
$
(53,290
)
 
$
2,029

 
$
(51,261
)
Net increase (decrease) in cash, cash equivalents and restricted cash (2)
$
(1,636
)
 
$
2,029

 
$
393

Cash, cash equivalents and restricted cash, beginning of period (2)
$
183,675

 
$
12,734

 
$
196,409

Cash, cash equivalents and restricted cash, end of period (2)
$
182,039

 
$
14,763

 
$
196,802

_____________________________________________________
(1) Adjustment pertaining to the adoption of ASC 606.
(2) Adjustment pertaining to the adoption of ASU 2016-18.
In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718) (ASU 2018-07). ASU 2018-07 aligns the accounting for share-based awards to employees and non-employees to follow the same model. The new standard is effective for fiscal years beginning after December 15, 2018 using a modified retrospective transition approach. Early adoption is permitted. We adopted this standard for the three and nine months ended October 31, 2018 and the adoption of this standard did not materially impact our consolidated financial statements.

11


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Recent Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 requires lessees to recognize all leases with terms in excess of one year on their balance sheet as a right-of-use asset and a lease liability at the commencement date. The new standard also simplifies the accounting for sale and leaseback transactions. ASU 2016-02 requires the use of the modified retrospective method for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. In July 2018, the FASB issued ASU No. 2018-10, Leases (Topic 842), Codification Improvements to Topic 842, Leases (ASU 2018-10) and ASU No. 2018-11, Leases (Topic 842), Targeted Improvements (ASU 2018-11). ASU 2018-11 provides a new transition method in which an entity can initially apply the new lease standards at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. These standards will be effective for us beginning on February 1, 2019 and early adoption is permitted. We expect to apply the new transition method prescribed by ASU 2018-11 at the adoption date. We are currently evaluating the impact of these standards on our consolidated financial statements and expect that most of our operating lease commitments will be subject to the new standard and recognized as lease liabilities and right-of-use assets, which will increase our total assets and total liabilities upon adoption.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13). ASU 2016-13 amends guidance on reporting credit losses for assets held at amortized cost basis and available-for-sale debt securities to require that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down. The measurement of credit losses for newly recognized financial assets and subsequent changes in the allowance for credit losses are recorded in the statements of operations. The amendments in this update will be effective for us beginning on February 1, 2020 with early adoption permitted on or after February 1, 2019. We are currently evaluating the impact of this standard on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350)Simplifying the Test for Goodwill Impairment, which eliminates Step 2 from the goodwill impairment test. This standard is effective, on a prospective basis, for our goodwill impairment tests beginning February 1, 2020. Early adoption is permitted. We are evaluating the impact of this standard on our consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This standard allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the Tax Act) and requires certain disclosures about stranded tax effects. This standard will be effective for us beginning February 1, 2019 and should be applied either in the period of adoption or retrospectively. Early adoption is permitted. We do not expect this standard to have any impact on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13) which amended its conceptual framework to improve the effectiveness of disclosures in notes to financial statements. ASU 2018-13 eliminates such disclosures around the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy. The guidance also adds new disclosure requirements for Level 3 measurements. ASU 2018-13 is effective for us beginning February 1, 2020. Early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (ASU 2018-15). ASC 2018-15 aligns the requirements for capitalizing implementation costs in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This standard will be effective for us beginning February 1, 2020 and should be applied either retrospectively or prospectively. Early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated financial statements.

12


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. This final rule was effective on November 5, 2018. We are evaluating the impact of this guidance on our condensed consolidated financial statements and expect to adopt this guidance in the first quarter of fiscal 2020.
 
Note 3. Financial Instruments  
Fair Value Measurements
We measure our cash equivalents, marketable securities, and restricted cash at fair value on a recurring basis. We define fair value as the exchange price that would be received from sale of an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We measure our financial assets and liabilities at fair value at each reporting period using a fair value hierarchy which requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:

Level 1 - Observable inputs are unadjusted quoted prices in active markets for identical assets or liabilities;

Level 2 - Observable inputs are quoted prices for similar assets and liabilities in active markets or inputs other than quoted prices that are observable for the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full term of the financial instruments; and

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These inputs are based on our own assumptions used to measure assets and liabilities at fair value and require significant management judgment or estimation.
We classify our cash equivalents, marketable securities and restricted cash within Level 1 or Level 2 because they are valued using either quoted market prices or inputs other than quoted prices which are directly or indirectly observable in the market, including readily-available pricing sources for the identical underlying security which may not be actively traded. Our fixed income available-for-sale securities consist of high quality, investment grade securities from diverse issuers. The valuation techniques used to measure the fair value of our marketable securities were derived from non-binding market consensus prices that are corroborated by observable market data or quoted market prices for similar instruments.
In addition to our cash equivalents, marketable securities, and restricted cash, we measure the fair value of our convertible senior notes (the Notes) on a quarterly basis for disclosure purposes. We consider the fair value of the Notes at October 31, 2018 to be a Level 2 measurement due to limited trading activity of the Notes. Refer to Note 6 for further information.

13


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Cash Equivalents, Marketable Securities and Restricted Cash
The following tables summarize our cash equivalents, marketable securities and restricted cash by significant investment categories as of January 31, 2018 and October 31, 2018 (in thousands):
 
 
As of January 31, 2018
 
Amortized
Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Fair
Value
 
Cash Equivalents
 
Marketable Securities
 
Restricted Cash
Level 1
 

 
 

 
 

 
 

 
 

 
 
 
 

Money market accounts
$

 
$

 
$

 
$
32,057

 
$
17,294

 
$

 
$
14,763

Level 2
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government treasury notes
131,643

 

 
(651
)
 
130,992

 
10,172

 
120,820

 

U.S. government agencies
47,229

 

 
(333
)
 
46,896

 

 
46,896

 

Corporate debt securities
186,506

 
116

 
(1,049
)
 
185,573

 

 
185,573

 

Total
$
365,378

 
$
116

 
$
(2,033
)
 
$
395,518

 
$
27,466

 
$
353,289

 
$
14,763


 
As of October 31, 2018
 
Amortized
Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Fair
Value
 
Cash Equivalents
 
Marketable
Securities
 
Restricted Cash
Level 1
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market accounts
$

 
$

 
$

 
$
26,298

 
$
10,476

 
$

 
$
15,822

Level 2
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government treasury notes
323,212

 

 
(891
)
 
322,321

 
62,392

 
259,929

 

U.S. government agencies
73,362

 

 
(355
)
 
73,007

 
2,992

 
70,015

 

Corporate debt securities
377,468

 
31

 
(1,830
)
 
375,669

 

 
375,669

 

Foreign government bonds
6,657

 
1

 
(14
)
 
6,644

 

 
6,644

 

Asset-backed securities
24,804

 

 
(41
)
 
24,763

 

 
24,763

 

Total
$
805,503

 
$
32

 
$
(3,131
)
 
$
828,702

 
$
75,860

 
$
737,020

 
$
15,822

 

14


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

The amortized cost and estimated fair value of our marketable securities are shown below by contractual maturity (in thousands):
 
 
As of October 31, 2018
 
Amortized Cost
 
Fair Value
Due within one year
$
367,860

 
$
366,886

Due in one to five years
372,255

 
370,134

Total
$
740,115

 
$
737,020

 
The gross unrealized losses on our investments as of October 31, 2018 were temporary in nature. The following table presents gross unrealized losses and fair values for those investments that were in a continuous unrealized loss position as of October 31, 2018, aggregated by investment category (in thousands):
 
 
Less than 12 months
 
Greater than 12 months
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
U.S. government treasury notes
$
282,905

 
$
(535
)
 
$
39,416

 
$
(356
)
 
$
322,321

 
$
(891
)
U.S. government agencies
47,927

 
(143
)
 
25,080

 
(212
)
 
73,007

 
(355
)
Corporate debt securities
270,140

 
(1,080
)
 
72,743

 
(750
)
 
342,883

 
(1,830
)
Foreign government bonds
5,145

 
(14
)
 

 

 
5,145

 
(14
)
Asset-backed securities
24,763

 
(41
)
 

 

 
24,763

 
(41
)
Total
$
630,880

 
$
(1,813
)
 
$
137,239

 
$
(1,318
)
 
$
768,119

 
$
(3,131
)
 
Realized gains or losses on sale of marketable securities were not significant for all periods presented.

Note 4. Business Combination

In August 2018, we completed the acquisition of StorReduce, Inc. (StorReduce), a privately-held, cloud-first software-defined storage solution for managing large-scale unstructured data. Acquisition-related costs were immaterial and were expensed as incurred.
The purchase consideration was $20.5 million in cash (net of cash acquired) after repayment of $6.1 million of debt assumed and payment of $1.1 million in transaction fees on behalf of StorReduce.
The purchase price was allocated as follows: $17.7 million in developed technology which will be amortized over seven years, $11.0 million of goodwill, $4.5 million in net liabilities assumed, and $3.7 million in deferred tax liabilities. The deferred tax liability was primarily a result of the difference in the book basis and tax basis related to the developed technology. Goodwill is primarily attributable to the assembled workforce and synergies from integrating StorReduce's technology with our storage portfolio and is not expected to be deductible for tax purposes. We held back approximately $3.7 million in cash to satisfy potential indemnification claims through August 2019.
In addition, we granted 622,482 RSUs to former StorReduce employees with a total grant date fair value of $13.6 million, subject to continuous employment. These awards are recognized as stock-based compensation over the related vesting period.
The results of StorReduce are included in our consolidated statements of operations since the acquisition date, including revenues and net loss, and are not material. Pro forma results of operations have not been presented because the acquisition is not material to our results of operations.



15


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 5. Balance Sheet Components
Inventory
Inventory consists of the following (in thousands):
 
As of
January 31, 2018
 
As of
October 31, 2018
Raw materials
$
1,181

 
$
4,880

Finished goods
33,316

 
45,857

Inventory
$
34,497

 
$
50,737

Property and Equipment, Net
Property and equipment, net, consists of the following (in thousands):
 
 
As of
January 31, 2018
 
As of
October 31, 2018
Test equipment
$
142,311

 
$
166,936

Computer equipment and software
72,329

 
103,366

Furniture and fixtures
5,363

 
5,619

Leasehold improvements
15,032

 
31,707

Total property and equipment
235,035

 
307,628

Less: accumulated depreciation and amortization
(145,893
)
 
(192,362
)
Property and equipment, net
$
89,142

 
$
115,266

 
Depreciation and amortization expense was $15.2 million and $16.9 million for the three months ended October 31, 2017 and 2018, and $44.4 million and $49.8 million for the nine months ended October 31, 2017 and 2018.
Intangible Assets, Net
Intangible assets, net consist of the following (in thousands):
 
 
As of
January 31, 2018
 
As of
October 31, 2018
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Amount
Technology patents
$
10,125

 
$
(5,068
)
 
$
5,057

 
$
10,125

 
$
(6,196
)
 
$
3,929

Developed technology

 

 

 
17,700

 
(503
)
 
17,197

Intangible assets, net
$
10,125

 
$
(5,068
)
 
$
5,057

 
$
27,825

 
$
(6,699
)
 
$
21,126

 
Total intangible assets amortization expense was $0.4 million and $0.9 million for the three months ended October 31, 2017 and 2018, and $1.1 million and $1.6 million for the nine months ended October 31, 2017 and 2018. The weighted-average remaining amortization period is 2.6 years for technology patents and 6.8 years for developed technology. Amortization expense related to the technology patents is included in general and administrative expenses. Amortization of developed technology is included in cost of product revenue.

16


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

As of October 31, 2018, future expected amortization expense for intangible assets is as follows (in thousands):
 
Fiscal Years Ending January 31,
Estimated 
Future
Amortization
Expense
Remainder of 2019
$
1,008

2020
4,032

2021
4,032

2022
3,074

2023
2,529

Thereafter
6,451

Total
$
21,126

Goodwill
The change in the carrying amount of goodwill is as follows (in thousands):
 
Amount
Balance as of January 31, 2018
$

Goodwill acquired
10,997

Balance as of October 31, 2018
$
10,997

Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following (in thousands):
 
 
As of
January 31, 2018
 
As of
October 31, 2018
Taxes payable
$
4,052

 
$
6,907

Accrued marketing
5,928

 
8,561

Accrued travel and entertainment expenses
4,386

 
4,108

Acquisition consideration held back

 
3,725

Other accrued liabilities
12,463

 
20,332

Total accrued expenses and other liabilities
$
26,829

 
$
43,633

 

Note 6. Convertible Senior Notes

In April 2018, we issued $575.0 million in principal amount of 0.125% convertible senior notes due 2023, in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act and received proceeds of $562.1 million, after deducting the underwriters’ discounts and commissions. The Notes are governed by an indenture (the Indenture) between us, as the issuer, and U.S. Bank National Association, as trustee. The Notes are our senior unsecured obligations. The Indenture does not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness, or the issuance or repurchase of securities by us or any of our subsidiaries. The Notes mature on April 15, 2023 unless repurchased or redeemed by us or converted in accordance with their terms prior to the maturity date. Interest is payable semi-annually in arrears on April 15 and October 15 of each year, beginning on October 15, 2018.


17


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

The Notes are convertible for up to 21,884,155 shares of our common stock at an initial conversion rate of approximately 38.0594 shares of Class A common stock per $1,000 principal amount, which is equal to an initial conversion price of approximately $26.27 per share of Class A common stock, subject to adjustment. Holders of the Notes may surrender their Notes for conversion at their option at any time prior to the close of business on the business day immediately preceding October 15, 2022, only under the following circumstances:

during any fiscal quarter commencing after the fiscal quarter ended on July 31, 2018 (and only during such fiscal quarter), if the last reported sale price of our Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price for the Notes on each applicable trading day;

during the five business day period after any five consecutive trading day period (the measurement period), in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our Class A common stock and the conversion rate for the Notes on each such trading day;

if we call any or all of the Notes for redemption, at any time prior to the close of business on the second scheduled trading day immediately preceding the redemption date; or

upon the occurrence of specified corporate events.

On or after October 15, 2022 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or any portion of their Notes at any time regardless of the foregoing circumstances. Upon conversion, holders will receive cash, shares of our Class A common stock, or a combination of cash and shares of our Class A common stock, at our election. We intend to settle the principal of the Notes in cash.

The conversion price will be subject to adjustment in some events. Following certain corporate events that occur prior to the maturity date or following our issuance of a notice of redemption, we will increase the conversion rate for a holder who elects to convert its Notes in connection with such corporate event or during the related redemption period in certain circumstances. Additionally, upon the occurrence of a corporate event that constitutes a “fundamental change” per the Indenture, holders of the Notes may require us to repurchase for cash all or a portion of the Notes at a purchase price equal to 100% of the principal amount of the Notes plus accrued and unpaid contingent interest.

We may not redeem the Notes prior to April 20, 2021. We may redeem for cash all or any portion of the Notes, at our option, on or after April 20, 2021 if the last reported sale price of our Class A common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending not more than two trading days immediately preceding the date on which we provide notice of redemption at a redemption price equal to 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No sinking fund is provided for the Notes.

In accounting for the issuance of the Notes, we separated the Notes into liability and equity components. The carrying amount of the liability component was determined by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was calculated by deducting the fair value of the liability component from the principal amount of the Notes as a whole. The difference between the principal amount of the Notes and the liability component (the debt discount) is amortized to interest expense in the condensed consolidated statements of operations using the effective interest method over the term of the Notes. The equity component of the Notes is included in additional paid-in capital in the condensed consolidated balance sheets and is not remeasured as long as it continues to meet the conditions for equity classification.

In accounting for the transaction costs related to the issuance of the Notes, we allocated the total amount incurred to the liability and equity components using the same proportions as the initial carrying value of the Notes.

18


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Transaction costs attributable to the liability component were netted with the principal amount of the Notes in the condensed consolidated balance sheets and are being amortized to interest expense in the condensed consolidated statements of operations using the effective interest method over the term of the Notes. Transaction costs attributable to the equity component were netted with the equity component of the Notes in additional paid-in capital in the condensed consolidated balance sheets. Upon the issuance of the Notes, we recorded total debt issuance costs of $12.9 million, of which approximately $9.8 million was allocated to the Notes and approximately $3.1 million was allocated to additional paid-in capital.

The Notes consisted of the following (in thousands):
 
As of
October 31, 2018
Liability:
 
Principal
$
575,000

Less: debt discount, net of amortization
(122,891
)
Less: debt issuance costs, net of amortization
(8,897
)
Net carrying amount of the Notes
$
443,212

 
 
Stockholders' equity:
 
Allocated value of the conversion feature
$
136,333

Less: debt issuance costs
(3,068
)
Additional paid-in capital
$
133,265


The total estimated fair value of the Notes as of October 31, 2018 was approximately $586.5 million. The fair value was determined based on the closing trading price per $100 of the Notes as of the last day of trading for the period. The fair value of the Notes is primarily affected by the trading price of our common stock and market interest rates. Based on the closing price of our Class A common stock of $20.18 on October 31, 2018, the if-converted value of the Notes of $441.6 million was less than its principal amount.     

The following table sets forth total interest expense recognized related to the Notes for the three and nine months ended October 31, 2018 (in thousands):
 
Three Months Ended October 31, 2018
 
Nine Months Ended October 31, 2018
Amortization of debt discount
$
6,084

 
$
13,441

Amortization of debt issuance costs
441

 
973

Total amortization of debt discount and debt issuance costs
6,525

 
14,414

Contractual interest expense
181

 
405

Total interest expense related to the Notes
$
6,706

 
$
14,819

 
 
 
 
Effective interest rate of the liability component
5.6
%
 
5.6
%

In connection with the offering of the Notes, we paid $64.6 million to enter into capped call transactions with certain of the underwriters and their affiliates (the Capped Calls), whereby we have the option to purchase a total of 21,884,155 shares of our Class A common stock upon any conversion of Notes and/or offset any cash payments we are required to make in excess of the principal amount of the Notes, as the case may be, with such reduction or offset subject to a cap initially equal to $39.66 per share (which represents a premium of 100% over the last reported sales price of our Class A common stock on April 4, 2018), subject to certain adjustments (the Cap Price). The cost of the Capped Calls was accounted for as a reduction to additional paid-in capital on the condensed consolidated balance sheet. The Capped Calls are intended to reduce or offset potential dilution of our common stock upon any conversion of the Notes, subject to a cap based on the Cap Price.

19


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)


Impact on Earnings Per Share
The Notes will not impact our diluted earnings per share until the average market price of our Class A common stock exceeds the conversion price of $26.27 per share, as we intend to settle the principal amount of the Notes in cash upon conversion. We are required under the treasury stock method to compute the potentially dilutive shares of common stock related to the Notes for periods we report net income. However, upon conversion, there will be no economic dilution from the Notes until the average market price of our Class A common stock exceeds the Cap Price of $39.66 per share, as exercise of the Capped Calls offsets any dilution from the Notes from the conversion price up to the Cap Price. Capped Calls are excluded from the calculation of diluted earnings per share, as they would be anti-dilutive under the treasury stock method.

Note 7. Commitments and Contingencies

Operating Leases
 
As of January 31, 2018 and October 31, 2018, the aggregate future minimum payments under non-cancelable operating leases were approximately $113.0 million and $149.9 million.
Letters of Credit
In connection with a lease amendment executed in March 2018, we issued a letter of credit of $1.5 million. As of January 31, 2018 and October 31, 2018, we had outstanding letters of credit in the aggregate amount of $9.6 million and $10.8 million, in connection with our facility leases. The letters of credit are collateralized by restricted cash and mature on various dates through August 2029.
Legal Matters
From time to time, we have become involved in claims and other legal matters arising in the normal course of business. We investigate these claims as they arise. Although claims are inherently unpredictable, we currently are not aware of any matters that we expect to have a material adverse effect on our business, financial position, results of operations or cash flows. Accordingly, we have not recorded any loss contingency on our condensed consolidated balance sheet as of October 31, 2018.
Indemnification
Our arrangements generally include certain provisions for indemnifying customers against liabilities if our products or services infringe a third party’s intellectual property rights. Other guarantees or indemnification arrangements include guarantees of product and service performance and standby letters of credit for lease facilities. It is not possible to determine the maximum potential amount under these indemnification obligations due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. To date, we have not incurred any material costs as a result of such obligations and have not accrued any liabilities related to such obligations in the condensed consolidated financial statements. In addition, we indemnify our officers, directors and certain key employees while they are serving in good faith in their respective capacities. To date, there have been no claims under any indemnification provisions.
 
Note 8. Stockholders’ Equity
Preferred Stock
We have 20,000,000 authorized shares of undesignated preferred stock, the rights, preferences and privileges of which may be designated from time to time by our board of directors. As of October 31, 2018, there were no shares of preferred stock issued or outstanding.

20


Class A and Class B Common Stock
We have two classes of authorized common stock, Class A common stock and Class B common stock. As of October 31, 2018, we had 2,000,000,000 shares of Class A common stock authorized with a par value of $0.0001 per share and 250,000,000 shares of Class B common stock authorized with a par value of $0.0001 per share. As of October 31, 2018216,252,136 shares of Class A common stock were issued and outstanding and 25,107,173 shares of Class B common stock were issued and outstanding. Subsequent to October 31, 2018, all outstanding Class B common stock converted to Class A common stock as discussed in Note 13.
Repurchase of Common Stock
Concurrent with the issuance of the Notes (see Note 6), we repurchased and retired 1,008,573 shares, or $20.0 million, of our Class A common stock at $19.83 per share, which was equal to the closing price per share of our Class A common stock on April 4, 2018, the date of the pricing of the offering of the Notes. The repurchased shares were recorded as a reduction of additional paid-in capital on the condensed consolidated balance sheet.

 
Note 9. Equity Incentive Plans
Equity Incentive Plans
We maintain two equity incentive plans: the 2009 Equity Incentive Plan (the 2009 Plan) and the 2015 Equity Incentive Plan (the 2015 Plan). In August 2015, our board of directors adopted, and in September 2015 our stockholders approved, the 2015 Plan, which became effective in connection with our initial public offering (IPO) and serves as the successor to the 2009 Plan. The 2015 Plan provides for grants of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards, and other forms of stock awards to our employees, directors and consultants.
The exercise price of stock options will generally not be less than 100% of the fair market value of our common stock on the date of grant, as determined by our board of directors. Our equity awards generally vest over a two to four year period and expire no later than ten years from the date of grant.  
2015 Employee Stock Purchase Plan
In August 2015, our board of directors adopted, and our stockholders approved, the 2015 Employee Stock Purchase Plan (2015 ESPP), which became effective in connection with our IPO.
The 2015 ESPP allows eligible employees to purchase shares of our Class A common stock at a discount through payroll deductions of up to 30% of their eligible compensation, subject to a cap of 3,000 shares on any purchase date or $25,000 in any calendar year (as determined under applicable tax rules). The 2015 ESPP provides for 24 month offering periods beginning March 16th and September 16th of each year, and each offering period consists of four six-month purchase periods, subject to a reset provision. If the closing stock price on the offering date of a new offering falls below the closing stock price on the offering date of an ongoing offering, the ongoing offering would terminate immediately following the purchase of ESPP shares on the purchase date immediately preceding the new offering and participants in the terminated ongoing offering would automatically be enrolled in the new offering (ESPP reset), resulting in a modification. On each purchase date, eligible employees will purchase our Class A common stock at a price per share equal to 85% of the lesser of the fair market value of our Class A common stock on (1) the first trading day of the applicable offering period or (2) the purchase date. There was an ESPP reset in the three months ended April 30, 2017 that resulted in a total modification charge of $9.0 million, which is recognized over the new offering period ending March 15, 2019.
We recognized stock-based compensation expense related to our 2015 ESPP of $4.7 million and $11.6 million during the three months ended October 31, 2017 and 2018 and $12.6 million and $26.2 million during the nine months ended October 31, 2017 and 2018. As of October 31, 2018, there was $36.3 million of unrecognized stock-based

21


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

compensation expense related to our 2015 ESPP, which is expected to be recognized over a weighted-average period of approximately 0.9 years.
Stock Options
A summary of stock option activity under our equity incentive plans and related information is as follows:
 
 
Options Outstanding
 
Number of
Shares
 
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual Life (In Years)
 
Aggregate
Intrinsic
Value (in thousands)
Balance as of January 31, 2018
46,359,949

 
$
7.75

 
6.3
 
$
574,224

Options exercised
(8,249,893
)
 
5.26

 
 
 
 

Options forfeited/canceled
(1,360,202
)
 
10.04

 
 
 
 

Balance as of October 31, 2018
36,749,854

 
$
8.22

 
5.6
 
$
439,185

Vested and exercisable as of October 31, 2018
26,221,996

 
$
6.38

 
5.2
 
$
361,783

 
 
The aggregate intrinsic value of options vested and exercisable as of October 31, 2018 is calculated based on the difference between the exercise price and the closing price of $20.18 of our Class A common stock on October 31, 2018.
As of October 31, 2018, total unrecognized employee compensation cost related to outstanding options was $40.2 million, which is expected to be recognized over a weighted-average period of approximately 1.9 years.

Restricted Stock Units
A summary of the restricted stock unit activity under our 2015 Plan and related information is as follows:
 
Number of Restricted Stock Units Outstanding
 
Weighted-
Average
Grant Date
Fair Value
 
Aggregate
Intrinsic
Value (in thousands)
Unvested balance as of January 31, 2018
17,682,646

 
$
12.60

 
$
356,117

Granted
11,098,371

 
22.49

 


Vested
(6,429,146
)
 
12.84

 


Forfeited
(1,719,729
)
 
15.57

 


Converted
(1,142,838
)
 
11.86

 
 
Unvested balance as of October 31, 2018
19,489,304

 
$
17.92

 
$
393,270


As of October 31, 2018, total unrecognized employee compensation cost related to unvested restricted stock units was $316.1 million, which is expected to be recognized over a weighted-average period of approximately 3.0 years.

In March 2017, we granted 750,000 performance stock units (net of 77,000 canceled units), at a target percentage of 100%, with both performance and service vesting conditions payable in common shares, from 0% to 150% of the target number granted, contingent upon the degree to which the performance condition is met. In March 2018, a total of 780,000 shares was earned based on the performance condition achieved and these shares are subject to service conditions through the vesting periods. Stock-based compensation expense for these performance stock units, recognized on an accelerated attribution method, was $1.3 million and $0.4 million for the three months ended October 31, 2017 and 2018, and $2.9 million and $1.9 million for the nine months ended October 31, 2017 and 2018.


22


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

In August 2017, we granted 464,744 performance stock units, at a target percentage of 100%, with both performance and service vesting conditions payable in common shares, from 0% to 150% of the target number granted, contingent upon the degree to which the performance condition is met. The grant date for these awards was subsequently established when the performance condition was determined in March 2018, and these awards were contemporaneously converted to restricted stock. See below for further discussion.

Restricted Stock

In March 2018, we converted certain restricted stock units and performance stock units that were previously granted into 1,375,210 shares of restricted stock for corporate tax benefit purposes. Of the 1,375,210 shares of restricted stock, 697,116 shares are performance restricted stock and 678,094 shares are subject to service vesting conditions only. The conversion did not change the fair value or vesting conditions and therefore no modification accounting was required.
During the nine months ended October 31, 2018, we issued 1,954,908 shares of performance restricted stock at the maximum performance percentage of 180%, with vesting contingent upon the degree to which the performance condition is met. The shares may be earned from 0% to 180%. Actual shares earned may be lower than the aggregate maximum number dependent on the degree to which the performance condition is met, and cannot be higher than the aggregate maximum number. Any portion of shares that are not earned will be canceled.
A summary of the restricted stock activity under our 2015 Plan and related information is as follows:
 
Number of Restricted Stock Units Outstanding
 
Weighted-
Average
Grant Date
Fair Value
 
Aggregate
Intrinsic
Value (in thousands)
Unvested balance as of January 31, 2018

 
$

 
$

Granted and converted
3,330,118

 
19.25

 
 
Vested
(116,186
)
 
12.84

 
 
Unvested balance as of October 31, 2018
3,213,932

 
$
19.49

 
$
64,857


All unvested restricted shares are subject to cancellation to the extent vesting conditions are not met. Stock-based compensation expense for performance restricted stock is recognized on an accelerated attribution method. In the three and nine months ended October 31, 2018, we recognized $7.5 million and $17.7 million in stock-based compensation expense relating to restricted stock. As of October 31, 2018, total unrecognized employee compensation cost related to unvested restricted stock was $26.3 million, which is expected to be recognized over a weighted-average period of approximately 2.4 years.
Stock-Based Compensation Expense
The following table summarizes the components of stock-based compensation expense recognized in the condensed consolidated statements of operations (in thousands):
 
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2017
 
2018
 
2017
 
2018
Cost of revenue—product
$
143

 
$
862

 
$
898

 
$
2,190

Cost of revenue—support subscription
2,422

 
3,327

 
6,441

 
8,940

Research and development
18,073

 
24,634

 
51,632

 
67,956

Sales and marketing
12,104

 
18,681

 
34,169

 
49,890

General and administrative
6,121

 
10,825

 
14,780

 
26,962

Total stock-based compensation expense
$
38,863

 
$
58,329

 
$
107,920

 
$
155,938


23


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)


The tax benefit related to stock-based compensation expense for all periods presented was not material.
 
Note 10. Net Loss per Share Attributable to Common Stockholders
Basic and diluted net loss per share attributable to common stockholders is presented in conformity with the two-class method required for participating securities.
Basic net loss per share attributable to common stockholders is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase. Diluted net loss per share attributable to common stockholders is computed by giving effect to all potentially dilutive common stock equivalents including our outstanding stock options, common stock related to unvested early exercised stock options, common stock related to unvested restricted stock units and restricted stock awards, convertible senior notes to the extent dilutive, and common stock issuable pursuant to the ESPP. For purposes of calculating basic and diluted net loss per share attributable to common shareholders, these potentially dilutive common stock equivalents have been excluded from the calculation of diluted net loss per share attributable to common stockholders as their effect is anti-dilutive.
The rights, including the liquidation and dividend rights, of the holders of our Class A and Class B common stock are identical, except with respect to voting. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis and the resulting net loss per share attributed to common stockholders will, therefore, be the same for both Class A and Class B common stock on an individual or combined basis. Subsequent to October 31, 2018, all outstanding Class B common stock converted to Class A common stock as discussed in Note 13.
The following table sets forth the computation of basic and diluted net loss per share attributable to common stockholders (in thousands, except per share data):
 
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2017
 
2018
 
2017
 
2018
 
(As Adjusted*)
 
 
 
(As Adjusted*)
 
 
Net loss
$
(29,404
)
 
$
(28,180
)
 
$
(144,974
)
 
$
(152,607
)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted
213,274

 
235,205

 
209,456

 
229,505

Net loss per share attributable to common stockholders, basic and diluted
$
(0.14
)
 
$
(0.12
)
 
$
(0.69
)
 
$
(0.66
)

* Prior period information has been adjusted to reflect the adoption impact of ASC 606, which we adopted on February 1, 2018.


24


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

The following weighted-average outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share attributable to common stockholders for the periods presented because including them would have been anti-dilutive (in thousands):
 
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2017
 
2018
 
2017
 
2018
Stock options to purchase common stock
51,685

 
37,814

 
53,786

 
41,201

Restricted stock units
17,201

 
19,493

 
14,913

 
19,488

Restricted stock and early exercised stock options
196

 
3,277

 
287

 
2,938

Employee stock purchase plan
585

 
236

 
585

 
80

Total
69,667

 
60,820

 
69,571

 
63,707

 
Note 11. Income Taxes
Our income tax provision (benefit) was primarily due to taxes on international operations and state income taxes. The difference between the income tax provision (benefit) that would be derived by applying the statutory rate to our loss before income taxes and the income tax provision (benefit) recorded was primarily attributable to changes in our valuation allowance, non-deductible stock-based compensation expense and the tax rate differential between the U.S. and foreign countries.
In connection with the StorReduce acquisition, we recorded a net deferred tax liability which provides an additional source of taxable income to support the realizability of the pre-existing deferred tax assets and, accordingly, during the three months ended October 31, 2018, we released $3.7 million of our U.S. valuation allowance. We continue to maintain a valuation allowance for our U.S. Federal and state deferred tax assets.
As of October 31, 2018, there were no material changes to either the nature or the amounts of the uncertain tax positions previously determined for the year ended January 31, 2018.
The Tax Act was signed into law on December 22, 2017. The new legislation decreases the U.S. corporate federal income tax rate from 35% to 21% effective January 1, 2018.
The Tax Act also includes a number of other provisions including the elimination of loss carrybacks and limitations on the use of future losses, limitations on the deductibility of executive compensation, limitation or modification on the deductibility of certain business expenses, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and the introduction of a base erosion and anti-abuse tax. Under the Tax Act, the Global Intangible Low-Taxed Income (GILTI) provision taxes foreign income in excess of a deemed return on tangible assets of foreign corporations. Under U.S. GAAP, companies are allowed to make an accounting policy election to either (i) account for GILTI as a component of tax expense in the period in which a company is subject to the rules -- the period cost method, or (ii) account for GILTI in a company’s measurement of deferred taxes -- the deferred method. Because of the complexity of the new tax rules, we have not yet made an accounting policy election and are continuing to assess the impact of the Tax Act during the one-year measurement period from the Tax Act enactment date as allowed by Staff Accounting Bulletin No. 118 (SAB 118) issued in connection with the Tax Act. We expect to complete the accounting for the tax effects of the Tax Act in calendar year 2018.
 
Note 12. Segment Information
Our chief operating decision maker is a group comprised of our Chief Executive Officer, our Chief Financial Officer, and our President. This group reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. We have one business activity and there are no segment managers who are held accountable for operations or operating results. Accordingly, we have a single reportable segment.

25


PURE STORAGE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Disaggregation of Revenue
The following table depicts the disaggregation of revenue by geographic area based on the billing address of our customers and is consistent with how we evaluate our financial performance (in thousands):
 
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2017
 
2018
 
2017
 
2018
 
(As Adjusted*)
 
 
 
(As Adjusted*)
 
 
United States
$
192,919

 
$
263,488

 
$
505,045

 
$
678,166

Rest of the world
84,672

 
109,291

 
179,861

 
259,442

Total revenue
$
277,591

 
$
372,779

 
$
684,906

 
$
937,608

* Prior period information has been adjusted to reflect the adoption impact of ASC 606, which we adopted on February 1, 2018.

Long-Lived Assets by Geographic Area
Long-lived assets by geographic area are summarized as follows (in thousands):
 
 
As of
January 31, 2018
 
As of
October 31, 2018
United States
$
85,430

 
$
110,850

Rest of the world
3,712

 
4,416

Total long-lived assets
$
89,142

 
$
115,266

 
Note 13. Subsequent Events

Housing Trust Silicon Valley Note
In November 2018, we purchased a $5.0 million 1.5% senior note issued by Housing Trust Silicon Valley, a nonprofit community development financial institution, to support affordable homes in the San Francisco Bay Area. This note matures on October 31, 2023. Interest is payable semi-annually on April 30 and October 31 of each year.

Conversion of Class B Common Stock to Class A Common Stock
On December 4, 2018, all outstanding shares of our Class B common stock automatically converted into the same number of shares of our Class A common stock pursuant to the terms of our amended and restated certificate of incorporation, which provided that each share of our Class B common stock convert automatically into Class A common stock when the outstanding shares of Class B common stock represent less than 10% of the aggregate number of shares of the then outstanding Class A common stock and Class B common stock. No additional Class B shares may be issued following the conversion. The conversion does not impact our basic or diluted net loss per share attributable to common stockholders or our financial performance.



26



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition, results of operations and cash flows should be read in conjunction with the (1) unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended January 31, 2018. This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors”, set forth in Part II, Item 1A of this Form 10-Q and in our other SEC filings. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Our fiscal year end is January 31.
Overview
We help innovators to build a better world with data. As the demand for data and the need for real-time analytics increase, we are focused on delivering software-defined all-flash solutions that are uniquely fast and cloud-capable, enabling customers to implement a data-centric architecture, maximize the value of data, gain competitive advantage and keep pace with cutting edge developments. Our innovative data platform replaces storage systems designed for mechanical disk with all-flash systems optimized end-to-end for solid-state memory. Our cloud-based support and management platform simplifies storage administration and provides real-time scanning to find and fix issues. At the same time, our innovative business model replaces the traditional forklift upgrade cycle with an Evergreen Storage subscription to hardware and software innovation, support and maintenance.
We were incorporated in October 2009 and are headquartered in Mountain View, California, with operations throughout the world. Our primary offerings include: our FlashArray and FlashBlade products, inclusive of our Purity Operating Environment (Purity OE) software, our Pure1 cloud-based management and support software powered by our Cloud Data Services, META AI Engine, FlashStack, our joint converged infrastructure solution with Cisco, and Artificial Intelligence Ready Infrastructure (AIRI), our joint converged AI Infrastructure offering with NVIDIA.
Since launching in May 2012, our customer base has grown to over 5,450 customers, including over 35% of the Fortune 500. We target a variety of large and mid-size cloud service providers, commercial enterprises, federal, state, and local governments, schools and healthcare organizations globally, and have deployed our platform at customers across multiple industry verticals. Our platform has been deployed in some of the largest and most sophisticated enterprises in the world as well as smaller organizations with limited IT expertise or budget, including hospitals, municipalities and school districts. Hundreds of our customers have invested north of a million dollars in leveraging our platform across their business-critical applications. We define a customer as an end user that purchases our products and services either from one of our channel partners or from us directly. No end user customer represented 10% or more of revenue in the three and nine months ended October 31, 2017 and 2018.
We have continued to experience substantial growth, with revenue for the three months ended October 31, 2017 and 2018 of $277.6 million and $372.8 million, representing year-over-year growth of 34%. For the nine months ended October 31, 2017 and 2018 our revenue was $684.9 million and $937.6 million, representing year-over-year growth of 37%. Our revenue growth rate may continue to decline as our business scales, even if our revenue continues to grow in absolute terms. We have continued to make significant expenditures and investments, including in personnel-related costs, sales and marketing, infrastructure and operations, and we have incurred net losses in each period since our inception, including net losses of $29.4 million and $28.2 million for the three months ended October 31, 2017 and 2018, and $145.0 million and $152.6 million for the nine months ended October 31, 2017 and 2018.
Since our founding, we have invested heavily in growing our business. Our headcount increased from over 2,100 employees as of January 31, 2018, to over 2,650 employees as of October 31, 2018. We intend to continue to invest in our research and development organization to extend our technology leadership, enhance the functionality

27


of our existing products and introduce new products. By investing in research and development, we believe we will be well positioned to continue our rapid growth and take advantage of our large market opportunity.
We also intend to continue to invest in and expand our sales and marketing functions and channel programs, including expanding our global network of channel partners and carrying out associated marketing activities in key geographies. By investing in sales and technical training, demand generation and partner programs, we believe we can enable many of our partners to independently identify, qualify, sell and upgrade customers, with limited involvement from us.
In addition, we intend to expand and continue to invest in our international operations, which we believe will be an important factor in our continued growth. Our revenue generated from customers outside of the United States was 26% and 28% for the nine months ended October 31, 2017 and 2018.
As a result of our strategy to increase our investments in research and development, sales, marketing, support and international expansion, we expect to continue to incur operating losses and negative cash flows from operations in the near future and may require additional capital resources to execute strategic initiatives to grow our business.
Recent Developments
    
In March 2018, we announced Artificial Intelligence Ready Infrastructure (AIRI), the industry’s first AI-ready converged infrastructure solution, in partnership with NVIDIA.
    
In April 2018, we issued $575.0 million of 0.125% convertible senior notes due 2023 (the Notes), in a private placement and received proceeds of $562.1 million, after deducting the underwriters' discounts and commissions. The Notes are unsecured obligations that do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness, or the issuance or repurchase of securities by us or any of our subsidiaries. See further discussion in Note 6 in Part I, Item 1 of this Quarterly Report on Form 10-Q.

In May 2018, we held Pure//Accelerate, our annual user conference, and introduced a number of new product and service offerings including:

New FlashArray//X, delivering 100% NVMe-capable storage across our FlashArray product line, with the ability to unite SAN and DAS into a single, consolidated, shared, and more efficient data-center architecture.

AIRI Mini, enabling customers to gain competitive advantage through AI at a price point accessible for many organizations.

Evergreen Storage Service (ES2), a cloud-like, storage consumption offering that enables customers to purchase on-premises or offsite-hosted private storage on a pay-per-month-per-terabyte basis, after a baseline commitment.
    
In August 2018, we acquired StorReduce, Inc., a cloud-first software-defined storage solution. The acquisition is expected to help us offer a broader portfolio of data solutions to customers on premise and in the public cloud.
In November 2018, we announced the launch of our Cloud Data Services, a suite of new cloud offerings that will enable customers to invest in a single storage architecture that unifies application deployments on-premises and on the cloud.



28


Our Business Model
We sell our data platform predominantly through a high touch, channel-fulfilled model. Our sales force works collaboratively with our global network of distribution and channel partners, which provides us broad sales reach while maintaining direct customer engagement and is responsible for large account penetration, global account coordination, and overall market development. Our channel partners help market and sell our products, typically with assistance from our sales force. This joint sales approach provides us with the benefit of direct relationships with substantially all of our customers and expands our reach through the relationships of our channel partners. In certain geographies we sell through a two-tier distribution model. We also sell to service providers that deploy our products and offer cloud-based storage services to their customers. We intend to continue to invest in the channel to add more partners and to expand our reach to customers through our channel partners’ relationships. One channel partner represented 10% or more of revenue for the three and nine months ended October 31, 2017 and 2018.
Our business model enables customers to broadly adopt flash for a wide variety of workloads in their data centers, with some of our most innovative customers adopting all-flash data centers. We do not charge separately for software, meaning that when a customer buys a FlashArray, FlashBlade, FlashStack, or AIRI, all Pure Storage array software functionality is included in the base purchase price, and the customer is entitled to updates and new features as long as the customer maintains an active support subscription agreement. By keeping our business model simple and efficient, we allow customers to buy more products and expand their footprint more easily while allowing us to reduce our sales and marketing costs.
To deliver on the next level of operational simplicity and support excellence, we designed Pure1, our integrated cloud-based management and support platform. Pure1 enables our customers, support staff and partners to collaborate to achieve the best customer experience and is included with an active support subscription agreement. In addition, our Evergreen Storage Service program provides our customers who continually maintain active and eligible maintenance and support for three years with an included controller refresh with each additional three year support subscription renewal. In this way, our customers improve and extend the service life of their arrays, we reduce our cost of support by keeping the array modern and encourage capacity expansion. In accordance with revenue recognition accounting guidance, we recognize the allocated revenue of the controllers and expense the related cost in the period in which we ship these controllers.
The combination of our high-performance, all-flash products, our exceptional support and our innovative business model has had a substantial impact on customer success and loyalty and is a strong driver of both initial purchase and additional purchases of our products. Of all the customers that have been with us for at least 12 months as of October 31, 2018, our top 25 customers on average spent approximately $11 on new product purchases for every $1 of initial product purchase, in the first 18 months following their initial purchase.
Trends in Our Business and Industry

Demand for Data in the Multi-Cloud Environment

In today’s digital economy, we believe that data is key. Data is the strategic core that enables competitiveness and differentiation for businesses in the multi-cloud environment -- collecting vast amounts of data, analyzing it rapidly, discovering new insights, and ultimately delivering new innovations and experiences otherwise impossible without data. We continue to make significant investments in our business to enable data-centric architecture to support today and tomorrow’s volume and velocity of data and to ensure the performance and reliability required for new data-driven applications, while substantially reducing costs and complexity for our customers. We believe that the shift in consumption models, like our ES2 offering, and in deployment models, as demonstrated by the desire for hybrid deployment technologies, like our Cloud Data Services, are at the core of the trend toward multi-cloud environments. Data-centric architecture supports a wide range of classic business applications as well as modern webscale-architecture applications so that our customers can manage their existing applications more efficiently while they modernize their applications both on-premise and on the cloud.


29


Adoption of All-Flash Storage Systems

Organizations are increasingly replacing traditional disk-based systems with all-flash storage systems, including those based on NVMe technologies, due to their higher performance, reliability and efficiency. Flash continues to penetrate the data center at a rapid rate, and our success depends on the adoption of all-flash storage systems. To the extent more organizations recognize the benefits of all-flash storage and the adoption of all-flash storage increases, our target customer base will expand, and demand for all-flash storage will rise.

Adding New Customers and Expanding Sales to Our Existing Customer Base

In order to capture long-term strategic opportunities, we intend to continue to target new customers, including large enterprises, service providers and government organizations, by continuing to invest in our field sales force and extending our relationships with key channel partners. We also expect that a substantial portion of our future sales will continue to be sales to existing customers, including expansion of existing arrays.

Seasonality in our Business Operations

Consistent with the seasonality of enterprise IT as a whole, we generally experience the lowest demand for our products and services in the first quarter of our fiscal year and the greatest demand for our products and services in the last quarter of our fiscal year. Furthermore, we typically focus investments into our sales organization, along with significant product launches, in the first half of our fiscal year. As a result, we expect that our business and results of operations will fluctuate from quarter to quarter, reflecting seasonally softer revenue and operating margin in the first half of our fiscal year, followed by a stronger second half, the relative impact of which will grow as we operate at a larger scale.
Components of Results of Operations
Revenue
We derive revenue from the sale of our FlashArray and FlashBlade products and support subscription services. Provided that all other revenue recognition criteria have been met, we typically recognize product revenue upon transfer of control to our customers. Products are typically shipped directly by us to customers, and our channel partners do not stock our inventory. We expect our product revenue may vary from period to period based on, among other things, the timing and size of orders and delivery of products and the impact of significant transactions.
We provide our support subscription services pursuant to support subscription agreements, which involve customer support, hardware maintenance and software upgrades for a period of generally one to six years. We recognize revenue from support subscription agreements ratably over the contractual service period. We expect our support subscription revenue to increase as we add new customers and our existing customers renew support subscription agreements.
Cost of Revenue
Cost of product revenue primarily consists of costs paid to our third-party contract manufacturers, which includes the costs of our components, and personnel costs associated with our manufacturing operations. Personnel costs consist of salaries, bonuses and stock-based compensation expense. Our cost of product revenue also includes allocated overhead costs, inventory write-offs, amortization of intangible asset pertaining to developed technology, and freight. Allocated overhead costs consist of certain employee benefits and facilities-related costs. We expect our cost of product revenue to increase in absolute dollars, as our product revenue increases.
Cost of support subscription revenue primarily includes personnel costs associated with our customer support organization and parts replacement costs, as well as allocated overhead costs. We expect our cost of support subscription revenue to increase in absolute dollars, as our support subscription revenue increases.

30


Operating Expenses
Our operating expenses consist of research and development, sales and marketing and general and administrative expenses. Salaries and personnel-related costs, including stock-based compensation expense, are the most significant component of each category of operating expenses. Operating expenses also include allocated overhead costs for employee benefits and facilities-related costs.
Research and Development. Research and development expense consists primarily of employee compensation and related expenses, prototype expenses, depreciation associated with assets acquired for research and development, third-party engineering and contractor support costs, as well as allocated overhead. We expect our research and development expense to increase in absolute dollars and it may decrease as a percentage of revenue, as we continue to invest in new and existing products and build upon our technology leadership.
Sales and Marketing. Sales and marketing expense consists primarily of employee compensation and related expenses, sales commissions, marketing programs, travel and entertainment expenses as well as allocated overhead. Marketing programs consist of advertising, events, corporate communications and brand-building activities. We expect our sales and marketing expense to increase in absolute dollars and it may decrease as a percentage of revenue, as we expand our sales force and increase our marketing resources, expand into new markets and further develop our channel program.
General and Administrative. General and administrative expense consists primarily of compensation and related expenses for administrative functions including finance, legal, human resources, IT and fees for third-party professional services as well as amortization of intangible assets pertaining to defensive technology patents and allocated overhead. We expect our general and administrative expense to increase in absolute dollars and it may decrease as a percentage of revenue, as we continue to invest in the growth of our business.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income earned on cash, cash equivalents and marketable securities, interest expense from the Notes and gains (losses) from foreign currency transactions.
Income Tax Provision (Benefit)
Income tax provision (benefit) consists primarily of income taxes in certain foreign jurisdictions in which we conduct business and state income taxes in the United States. We have recorded no U.S. federal income tax and provided a full valuation allowance for U.S. deferred tax assets, which mainly includes net operating loss, carryforwards and tax credits related primarily to research and development. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that the deferred tax assets will not be realized based on our history of losses.

31


Results of Operations
The following tables set forth our results of operations for the periods presented in dollars and as a percentage of total revenue (dollars in thousands, unaudited): 
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2017
 
2018
 
2017
 
2018
 
(As Adjusted*)
 
 
 
(As Adjusted*)
 
 
Consolidated Statements of Operations Data:
 
 
 
 
 
Revenue:
 

 
 

 
 
 
 
Product
$
227,772

 
$
298,863

 
$
550,291

 
$
735,449

Support subscription
49,819

 
73,916

 
134,615

 
202,159

Total revenue
277,591

 
372,779

 
684,906

 
937,608

Cost of revenue:
 

 
 

 
 
 
 
Product (1)
75,392

 
96,610

 
179,289

 
241,292

Support subscription (1)
20,467

 
27,049

 
56,569

 
74,716

Total cost of revenue
95,859

 
123,659

 
235,858

 
316,008

Gross profit
181,732

 
249,120

 
449,048

 
621,600

Operating expenses:
 

 
 

 
 
 
 
Research and development (1)
68,927

 
90,783

 
203,716

 
253,306

Sales and marketing (1)
116,971

 
146,903

 
326,286

 
413,019

General and administrative (1)
25,406

 
38,651

 
67,664

 
99,572

Total operating expenses
211,304

 
276,337

 
597,666

 
765,897

Loss from operations
(29,572
)
 
(27,217
)
 
(148,618
)
 
(144,297
)
Other income (expense), net
1,138

 
(2,889
)
 
6,399

 
(7,920
)
Loss before provision for income taxes
(28,434
)
 
(30,106
)
 
(142,219
)
 
(152,217
)
Income tax provision (benefit)
970

 
(1,926
)
 
2,755

 
390

Net loss
$
(29,404
)
 
$
(28,180
)
 
$
(144,974
)
 
$
(152,607
)

 
(1) 
Includes stock-based compensation expense as follows:
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,