Pure Storage CEO: More and more, a software company

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Written By Tiernan Ray

Flash-memory-based storage pioneer Pure Storage is going through a “model transition” where it’s picking up more software investors, says CEO Charlie Giancarlo. The benefits of the transition will be multiple, including expanding market share and having revenue upside in a “consumption” form. But in the meantime, it will requiring some decoding by investors.

 
 

The venture capitalist Marc Andreessen famously said software is “eating the world.” It appears, too, that the accounting of software is eating the world.

Time was, there was a pretty clear distinction between hardware and software companies. If you sold a hardware product like a disk drive, you recorded those widgets as revenue, your cost to manufacture was your main concern, and what was left over was your profit.

Software, on the other hand, has for a long time had a bestiary of novel accounting maneuvers, with line items for “billings,” “bookings,” “RPO,” and all kinds of other exotic ways to slice and dice the P&L statement.

Nowadays, however, the distinction is dissolving.

“Do you follow any of the software-as-a-service [SaaS] companies?” asks Charlie Giancarlo, CEO of flash storage maker Pure Storage, in a chat we had at his New York satellite office a week ago. “I’m on the Zscaler board — pure SaaS — and the number of metrics it takes to track these companies — you know, a wide variety of things,” he says, referring to the cybersecurity industry heavyweight.

“We're going to have to go increasingly into that environment,” he says, meaning, the world of non-GAAP metrics similar to Zscaler and other software firms, because the Pure business is becoming more complex to track, quarter to quarter, as it becomes more like a software business.

Pure sells equipment that has flash memory chips to hold corporate data in large volumes, and software that manages those chips. It was, once upon a time, a pure hardware sale, no pun intended. Increasingly, customers buy it as a “subscription,” where they pay ratably over time, rather than paying for the full value of the equipment up-front.

THE FINER POINTS OF SUBSCRIPTIONS

We were talking about Pure’s quarterly report of November 29th, which was a mixed bag that sent the stock down sharply. Pure’s revenue and profit topped expectations, but the revenue forecast for this quarter missed consensus. Pure has a very consistent record of at least meeting, and mostly beating, expectations, so it was an unsettling event.

Giancarlo, and his CFO, Kevan Krysler, explained to analysts that the company is selling so much gear now as a subscription that there is a measurable impact on reportable revenue growth. People pay less up-front for the product when it’s subscription, so it depresses revenue in the near-term.

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“Subscription is now, roughly, forty percent of our reported revenue,” notes Giancarlo, “and it’s reached a level where it’s more than doubling, so we can’t hide it.” Subscription services revenue of $310 million rose twenty-six percent last quarter, but for the full fiscal year ending this month, Giancarlo has told the Street it will double from last year’s total.

In fact, because of the changing nature of revenue, he is going to start disclosing “some additional metrics” this quarter, he has told the Street. “So that we don't have another surprise, we'll be allowing our analysts to understand what the effect on our revenue was by increased subscription,” he says. “We’re going to give 'em a secret decoder ring.”

“A number of our investors have told us, directly, they said, ‘You know, some of your analysts just don't understand this at all,’ meaning, they don't even understand the concept of how the financials change” to more and more subscription.

The whole business is about to pivot to emphasize the SaaS aspects, he says. “You'll see more and more of our marketing, of the way we describe ourselves, of the way we incentivize our team, and our channel, is going to go to this as-a-service model."

A MODEL TRANSITION

Investors get it, says Giancarlo; analysts are the problem. “A number of our investors have told us, directly, they said, ‘You know, some of your analysts just don't understand this at all,’ meaning, they don't even understand the concept of how the financials change” to more and more subscription. Which means, says Giancarlo, the investors “are telling us, indirectly, we do understand that.”

In actuality, “Our investor class, if I could call it that, is shifting from a traditional hardware/semiconductor investor class to more of a software-as-a-services investor class,” concedes Giancarlo.

That often happens when a company is going through what’s called a “model transition,” as in, the business model is changing. The most famous example of that is Adobe, which several years back transitioned from selling traditional multi-year licenses to selling a monthly subscription. And it’s now happening to Pure, which was once just selling widgets and now sells subscriptions.

“There are enough investors who don’t like to be in the transition itself that it affects the stock,” observes Giancarlo. “You have enough investors who will say, ‘Well, we’ll wait until the transition is largely done’.” That’s true: many investors headed for the exits while Adobe was in the early part of the transition. It was just too disruptive to expectations.

Pure Storage shares trailed the market in 2023, rising thirty-three percent versus the Nasdaq’s forty-three percent. Still, it is one of the best-performing of the TL20 stocks worth considering, rising over forty-one percent since picked in July of 2022, versus twenty-seven percent for Nasdaq.

“We have been told by Adobe and other companies that have gone through this that fifty percent is roughly the turning point,” meaning, half of revenue from subscription versus the current forty percent, he says. “That’s when investors start paying attention.” The timing to reach fifty percent, says Giancarlo is “the next twelve to twenty-four months.”

MORE AND MORE A SOFTWARE BUSINESS

The pivot to a subscription accounting model is interesting because more and more aspects of the business now rely upon software capabilities. Riding on top of the hardware itself is the company’s operating system software, called Purity, which Giancarlo emphasizes is the same piece of code across each hardware product.

“That means that for the first time, a storage company has one operating environment that operates on all of our systems,” he boasts. “Whereas, let’s take Dell: Dell can satisfy a customer’s storage needs, but it requires over half a dozen different systems.”

The unity of software is important, maintains Giancarlo, because it simplifies operations. If one wants to run multiple machines, the management process for an IT person is uniform across them, rather than having a different tool for each one. Traditionally, “You can have one storage array for one application, and then another array, ten feet away, tied to another application,” in the data center, “and even though they’re very similar, you can’t share the storage between the two.”

With the Purity software, the Pure products look to the customer like a “virtual pool of storage,” which lets Giancarlo sell a subscription for the customer’s own data center, but also for machines that run in the cloud, called “Pure Fusion,” so that Pure can cover the entire waterfront. Giancarlo’s pitch is that “customers save more than half of their cloud costs” with his gear, which is not hard to imagine given widely reported sticker shock with cloud computing.

If the customer wants, they can pay Pure to run the storage as a service, called “Evergreen//One.”

All of that required Pure to do lots of software work, he notes. “Last year, we finally caught up in the feature department” with Dell and Hewlett Packard Enterprise in traditional storage equipment features, especially capabilities for handling individual files as they are moved across storage media.

File handling doesn’t yet work in the cloud, which is based on something called “block storage.” For the moment, the distinction is less important, says Giancarlo, as customers are still keeping a lot of file-based storage local on their own premises. “You can assume we’ll get file onto the cloud as well,” he says.

VIRTUAL UPSIDE

The grand goal with the subscription transition is two-fold.

One, by “virtualizing” storage as something the customer just pays to have delivered as they need it, local or in the cloud, Pure comes closer to that day when flash-memory-based equipment can replace all forms of storage, including spinning disk-based storage, even though flash chips themselves cost multiples of the price of disk for a given capacity of storage.

“I’ve predicted that there won’t be any new disk systems sold in five years,” he reminds me, referring to a conversation we had two years ago. “I’m sticking with that.” That is a big deal, because disk-based storage still makes up more than fifty percent of all storage deployed in enterprise, and ninety percent inside of cloud computing companies.

“We’ve put it together now as a coherent whole,” says Giancarlo. “We are now the one storage company that can provide a single solution, a single operating environment, right across the full price-performance range of storage.”

Two, and more important to software investors, subscription presumably makes Pure’s revenue more predictable over time. The lower up-front cost of subscriptions on the front-end generally leads to more steady rates of sales for such a business over many years.

And, in an ideal scenario, subscription sales can actually expand in a way that hardware sales don’t, because a subscription customer can dial-up more storage rather than buying new equipment. The purchase of the subscription is a minimum, Giancarlo emphasizes. If customers want more storage, that’s called “consumption,” which can lead to upside.

Pure doesn’t disclose amounts of consumption-based revenue each quarter within the overall subscription business. “If I told you, my CFO would probably kill me,” says Giancarlo. All you need to know is that consumption can be a swing factor that makes each quarterly report very exciting, as you’ll know if you follow the poster child for consumption pricing, Snowflake, the database software company.

My main question for Pure stock is, will it get a “re-rating” as a result of the software transition, meaning, an expansion of its valuation multiple? At three and a half times next year’s projected revenue, or, alternately, seventeen times Ebitda, the stock trades well below software names such as Adobe, at eleven times and twenty-two times, respectively, and Snowflake, at nineteen times and one hundred and forty-one times.

I would expect the stock will, indeed, get re-rated at some point. For the moment, however, Pure’s 2024 performance probably hinges more on the general outlook for storage, which hinges on the economy, to an extent. The macro-economic environment can shift Pure’s customers between subscription and traditional, up-front hardware purchases, depending on how flush they’re feeling, notes Giancarlo.

“That said, data doesn’t know about the macro,” says Giancarlo. “Data keeps growing.” As a result, there’s a limit to how much a customer can economize with their existing storage purchases. “You can sweat your assets for a while, but only for so long” before you need to upgrade your storage, is how Giancarlo puts it.

“I think this year being a bit slow,” meaning, 2023, “I would hazard a guess that we will see a bit of a pickup next year.”

Disclosure: Tiernan Ray owns no stock in anything that he writes about, and there is no business relationship between Tiernan Ray LLC, the publisher of The Technology Letter, and any of the companies covered. See here for further details.

Tiernan Ray
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