# Everpure, Inc. (P) FY 2024 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Everpure, Inc.'s 10-K for fiscal year 2024.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1474432/000162828024013860/pstg-20240204.htm
Accession: 0001628280-24-013860
Filing date: 2024-04-01
Report date: 2024-02-04
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/P/
All MD&A years: /company/P/mda/
Previous year: /company/P/mda/fy2023/ (FY 2023)
Next year: /company/P/mda/fy2025/ (FY 2025)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Investors should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed in the section titled” Risk Factors” and in other parts of this Annual Report on Form 10-K. See also the section titled “Note Regarding Forward-Looking Statements” in this report. Our fiscal year end is the first Sunday after January 30.

The following discussion of our financial condition and results of operations covers fiscal 2024 and fiscal 2023 items and year-over-year comparisons between fiscal 2024 and fiscal 2023. Discussions of fiscal 2022 items and year-over-year comparisons between fiscal 2023 and 2022 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended February 5, 2023, that was filed with the SEC on April 3, 2023.

Overview

Data is foundational to our customers’ business transformation, and we are focused on delivering an innovative and disruptive data storage platform that enables customers to maximize the value of their data.

We are a global leader in data storage and management with a mission to redefine the storage experience by simplifying how people consume and interact with data. Our vision of an all-flash data center integrates our foundation of simplicity and reliability with four major market trends that are impacting all organizations large and small: (1) increasing demand to consume data storage as a service; (2) the shift to modernizing today's data infrastructure with all-flash; (3) the increase of modern cloud-native applications; and (4) increasing demand for data storage to support the acceleration in artificial intelligence (AI) adoption while managing rising energy costs.

Our data storage platform supports a wide range of structured and unstructured data, at scale and across any data workloads in hybrid and public cloud environments, and includes mission-critical production, test and development, analytics, disaster recovery, backup and restore, AI and machine learning.

Components of Results of Operations

Revenue

We derive revenue primarily from the sale of our products and services that comprise our data storage platform. Our data storage platform includes our FlashArray and FlashBlade solutions, and our Evergreen and Portworx subscription services. Subscription services also include our professional services offerings such as installation and implementation consulting services.

Provided that all other revenue recognition criteria have been met, we typically recognize product revenue upon transfer of control to our customers and the satisfaction of our performance obligations. For Evergreen//Flex, product revenue is recognized upon the commencement of the underlying subscription services. Products are typically shipped directly by us to customers, and our channel partners generally 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 generally recognize revenue from the fair value of subscription services provided ratably over the contractual service period or on a consumption basis for usage above a minimum usage commitment and professional services as delivered. We expect our subscription services revenue to increase and continue to grow faster than our product revenue as more customers choose to consume our storage solutions as a service and our existing subscription customers renew and expand their consumption and service levels.

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Cost of Revenue

Cost of product revenue primarily consists of costs paid to our third-party contract manufacturers, which includes the costs of our raw material components, and personnel costs associated with our supply chain operations. Personnel costs consist of salaries, bonuses and stock-based compensation expense. Our cost of product revenue also includes allocated overhead costs, adjustments to inventory and purchase commitments, product warranty costs, amortization of intangible assets pertaining to developed technology and capitalized internal-use software, 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 subscription services revenue primarily consists of personnel costs associated with delivering our subscription and professional services, part replacements, allocated overhead costs and depreciation of infrastructure used to deliver our subscription services. We expect our cost of subscription services revenue to increase in absolute dollars, as our subscription services revenue increases.

Operating Expenses

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, facilities, and certain information technology costs.

Research and Development. Research and development expenses consist primarily of employee compensation and related expenses, prototype expenses, depreciation associated with assets acquired for research and development, data center and cloud services costs, third-party engineering and contractor support costs, as well as allocated overhead. We expect our research and development expenses to increase in absolute dollars and it may decrease as a percentage of revenue.

Sales and Marketing. Sales and marketing expenses consist 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 expenses to increase in absolute dollars and it may decrease as a percentage of revenue as we continue to realize efficiencies from scaling our business.

General and Administrative. General and administrative expenses consist primarily of employee compensation and related expenses for administrative functions including finance, legal, human resources, facilities, 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 expenses to increase in absolute dollars and it may decrease as a percentage of revenue.

Restructuring, Impairment and Other. Restructuring, impairment and other consist primarily of employee severance and termination benefits, and certain lease impairment and abandonment charges.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest income related to cash, cash equivalents and marketable securities, interest expense related to our debt and gains (losses) from foreign currency transactions.

Provision for Income Taxes

Provision for income taxes consists primarily of income taxes in certain foreign jurisdictions in which we conduct business and current federal and state income taxes in the United States. Our foreign subsidiaries earn a profit margin based upon transfer pricing principles which require an arm’s length return. Our foreign subsidiaries' sales and marketing expenses are expected to increase over time as we grow, resulting in higher pre-tax foreign earnings and higher foreign income taxes.

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We have provided a full valuation allowance for U.S. deferred tax assets, which includes net operating loss carryforwards, capitalized research costs, 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 assets will not be realized based on our history of losses.

Results of Operations

Basis of Presentation

We operate using a 52/53 week fiscal year ending on the first Sunday after January 30. Fiscal 2023 and 2024 were both 52-week years that ended on February 5, 2023 and February 4, 2024, respectively. Unless otherwise stated, all dates refer to our fiscal years.

Year Over Year Comparisons

Revenue

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[[/GREPCENT_TABLE]]

Total revenue increased in fiscal 2024 by $77.2 million, or 3%, compared to fiscal 2023. The decrease in product revenue during fiscal 2024 compared to fiscal 2023 was attributable to increasing sales of our Evergreen//One consumption and subscription based offering, as well as macro-economic conditions. Revenue for Evergreen//One is recognized over time and included in subscription services revenue. As such, we expect continued growth of our Evergreen//One sales will negatively impact, in the near term, both product revenue growth and total revenue growth rates. The increase in subscription services revenue was largely driven by increases in sales of our Evergreen subscription services, including Evergreen//One, as well as recognition of revenue from previously contracted Evergreen subscription services.

During fiscal 2024 compared to fiscal 2023, total revenue in the United States remained consistent at approximately $2.0 billion while total rest of the world revenue grew by 9% from $781.7 million to $851.3 million.

Subscription Annual Recurring Revenue (ARR)

We use Subscription ARR as a key business metric to evaluate the performance of our subscription services. Subscription ARR should be viewed independently of revenue, deferred revenue and remaining performance obligations and is not intended as a substitute for any of these items.

Subscription ARR is calculated as the total annualized contract value of all active customer subscription agreements at the end of a fiscal quarter, plus on-demand revenue for the quarter multiplied by four. Contract values are established prior to any adjustments made in accordance with ASC 606.

The following table sets forth our Subscription ARR for the periods presented (dollars in thousands):

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[[/GREPCENT_TABLE]]

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Remaining Performance Obligations

Total remaining performance obligations (RPO) which is total contracted but not recognized revenue was $2.3 billion at the end of fiscal 2024. Total RPO includes $77.5 million in non-cancelable product orders that we expect to fulfill subsequent to fiscal 2024. RPO consists of both deferred revenue and non-cancelable amounts that are expected to be invoiced and recognized as revenue in future periods. Product orders are generally cancelable until delivery has occurred, and as such, unfulfilled product orders that are cancelable are excluded from RPO. Cancelable orders will fluctuate depending on numerous factors. Of the $2.3 billion RPO at the end of fiscal 2024, we expect to recognize approximately 47% over the next 12 months, and the remainder thereafter. RPO is expected to increase as our subscription services business grows over time.

Our RPO includes non-cancelable Total Contract Value (TCV) sales for our Evergreen//One and Evergreen//Flex consumption and subscription based offerings. TCV sales for Evergreen//One and Evergreen//Flex offerings is a key business metric we use to evaluate the performance of our consumption and subscription based offerings. TCV sales for these offerings include recurring subscription fees, any non-recurring charges such as initial setup fees, and any other billable services directly tied to the execution of the underlying service contract. We expect in fiscal 2025 TCV sales for our Evergreen//One and Evergreen//Flex consumption and subscription based offerings will grow approximately 50 percent.

Cost of Revenue and Gross Margin

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[[/GREPCENT_TABLE]]

Cost of revenue decreased by $46.4 million, or 5%, for fiscal 2024 compared to fiscal 2023. The decrease in product cost of revenue was primarily attributable to lower product sales and lower component costs, partially offset by higher excess and obsolete inventory charges. The increase in subscription services cost of revenue was primarily attributable to supporting our growing Evergreen subscription installed base, including Evergreen//One and Portworx.

Foundational to our strong product gross margins are the advantages created from our Purity software architecture that works natively with raw flash. One of the key advantages is we directly source our raw flash, both TLC and lower cost QLC. QLC flash represents the majority of the capacity we ship and is also a contributor to our higher product gross margin expansion when comparing fiscal 2024 to fiscal 2023. Product and customer mix also was a driver in the year-over-year increase in product gross margins, including, sales of our FlashBlade//S solutions which have a higher gross margin when compared to our older generation FlashBlade solutions. Lower material pricing, including flash, has also favorably impacted gross margins.

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The increase in subscription services gross margin for fiscal 2024 compared to fiscal 2023 was driven by higher subscription services revenue growth from sales of Evergreen//One and higher renewals in Evergreen subscriptions coupled with continued focus on operational efficiencies.

Operating Expenses

Research and Development

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[[/GREPCENT_TABLE]]

Research and development expense increased by $44.2 million, or 6%, during fiscal 2024 compared to fiscal 2023, as we continue to innovate and develop technologies to enhance and expand our platform portfolio. The increase was primarily driven by a $26.1 million increase in employee compensation and related costs and a $19.0 million increase in equipment depreciation and facilities-related costs.

Sales and Marketing

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[[/GREPCENT_TABLE]]

Sales and marketing expense increased by $61.4 million, or 7%, during fiscal 2024 compared to fiscal 2023, primarily due to an increase of $55.4 million in employee compensation and related costs relating to increasing sales capacity and a $6.0 million increase in outside services associated with our sales and marketing events.

General and Administrative

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[[/GREPCENT_TABLE]]

Restructuring, Impairment and Other

During fiscal 2024, we recognized $33.6 million of restructuring, impairment and other costs related to severance and other termination benefits related to workforce realignment, and the cease use of our former corporate headquarters in Mountain View, California.

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Other Income (Expense), Net

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[[/GREPCENT_TABLE]]

Other income (expense), net increased during fiscal 2024 compared to fiscal 2023 primarily due to an increase in interest income due to a higher interest rate environment and, to a lesser extent, a decrease in net foreign exchange losses as the U.S. dollar weakened relative to certain foreign currencies and a decrease in interest expense following the full repayment of the convertible senior notes in April 2023. These increases were partially offset by an increase in interest expense on the outstanding balance on our revolving credit facility.

Provision for Income Taxes

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[[/GREPCENT_TABLE]]

Provision for income taxes increased during fiscal 2024 compared to fiscal 2023 primarily due to an increase in U.S. income taxes driven by IRC Section 174 capitalization, as well as an increase in profits generated in foreign jurisdictions.

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Liquidity and Capital Resources

At the end of fiscal 2024, we had cash, cash equivalents and marketable securities of $1.5 billion. Our cash and cash equivalents primarily consist of bank deposits and money market accounts. Our marketable securities generally consist of highly rated debt instruments of the U.S. government and its agencies, debt instruments of highly rated corporations, debt instruments issued by foreign governments, asset-backed securities, and municipal bonds.

We believe our existing cash, cash equivalents, marketable securities and revolving credit facility will be sufficient to fund our operating and capital needs for at least the next 12 months. The following table sets forth our non-cancelable contractual obligations and commitments associated with agreements that are enforceable and legally binding at the end of fiscal 2024. Obligations under contracts that we can cancel without a significant penalty are not included.

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[[/GREPCENT_TABLE]]

_________________________________

(1) Consists of (i) principal, interest, and unused commitment fees on our August 2020 revolving credit facility based on rates in effect on February 4, 2024, and (ii) principal and interest on a four year loan and a five year loan.

(2) Represents aggregate future minimum lease payments under non-cancelable operating and finance leases.

(3) Includes primarily non-cancelable inventory purchase commitments, software service contracts, and hosting arrangements. Purchase orders are not included as they represent authorizations to purchase rather than binding agreements.

Our future capital requirements will depend on many factors including our sales growth, the timing and extent of capital spending to support development efforts, growth of our Evergreen//One offering, the addition or closure of office space, ongoing construction of our new headquarters facility, the timing of new product introductions, workforce realignment restructuring activities, and our share repurchases. We may continue to enter into arrangements to acquire or invest in complementary businesses, services and technologies, including intellectual property rights. We may seek additional equity or debt financing in the future.

Revolving Credit Facility

In August 2020, we entered into a Credit Agreement with a consortium of financial institutions and lenders that provides for a five-year, senior secured revolving credit facility of $300.0 million (Credit Facility). Proceeds from the Credit Facility may be used for general corporate purposes and working capital. The Credit Facility expires, absent default or early termination by us, on August 24, 2025. In March 2023, we amended the Credit Facility to transition LIBOR to the Secured Overnight Financing Rate (SOFR) effective April 1, 2023. The annual interest rates applicable to loans under the Credit Facility are, at our option, equal to either a base rate plus a margin ranging from 0.50% to 1.25% or term SOFR (based on one, three, or six-month interest periods), subject to a floor of 0%, plus a margin ranging from 1.50% to 2.25%. Interest on revolving loans is payable quarterly in arrears with respect to loans based on the base rate and at the end of an interest period in the case of loans based on term SOFR (or at each three-month interval, if the interest period is longer than three months). We are also required to pay a commitment fee on the unused portion of the commitments ranging from 0.25% to 0.40% per annum, payable quarterly in arrears.

In April 2023, we borrowed $100.0 million under the Credit Facility to fund the repayment of the Notes. The outstanding loan bore weighted-average interest at an annual rate of approximately 6.73% based on a one-month term SOFR period resulting in interest expense of $5.5 million during fiscal 2024.

Loans under the Credit Facility are collateralized by substantially all of our assets and subject to certain restrictions and two financial ratios measured as of the last day of each fiscal quarter: a Consolidated Leverage Ratio not to exceed 4.5:1 and an Interest Coverage Ratio not to be less than 3:1. We were in compliance with all covenants under the Credit Facility at the end of fiscal 2024.

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Convertible Senior Notes

In April 2018, we issued $575.0 million of 0.125% convertible senior unsecured notes (the Notes) in a private placement and received proceeds of $562.1 million, after deducting the underwriters' discounts and commissions. In April 2023, we repaid the entire principal balance with approximately $575.0 million in cash and 1,065 shares of our common stock. See further discussion about our Notes in Note 6 in Part II, Item 8 of this report.

Letters of Credit

At the end of fiscal 2023 and 2024, we had outstanding letters of credit in the aggregate amount of $8.0 million and $7.7 million in connection with our facility leases. The letters of credit are collateralized by either restricted cash or the Credit Facility and mature on various dates through September 2030.

Share Repurchase Program

In March 2023, our Board of Directors authorized $250.0 million to repurchase shares of our common stock, of which $145.4 million remained available at the end of fiscal 2024. In February 2024, our Board of Directors authorized an additional $250.0 million to repurchase shares of our common stock, increasing the total authorization amount to $395.4 million. The authorization allows us to repurchase shares of our common stock opportunistically and will be funded from available working capital. Repurchases may be made at management’s discretion from time to time on the open market through privately negotiated transactions, transactions structured through investment banking institutions, block purchase techniques, 10b5-1 trading plans, or a combination of the foregoing. The share repurchase program does not obligate us to acquire any of our common stock, has no end date, and may be suspended or discontinued by us at any time without prior notice.

During fiscal 2024, we repurchased and retired 4.7 million shares of common stock at an average purchase price of $28.96 per share for an aggregate repurchase price of $135.7 million.

Cash Flows

The following table summarizes our cash flows for the periods presented (in thousands):

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[[/GREPCENT_TABLE]]

Operating Activities

The year-over-year decrease in net cash provided by operating activities was impacted by lower revenue growth and growth of our Evergreen//One sales that include flexible payment terms, employee compensation payments, and timing of certain vendor payments and receipt of rebates.

Investing Activities

Net cash provided by investing activities during fiscal 2024 was driven by net maturities of marketable securities of $198.4 million, partially offset by capital expenditures of $195.2 million relating to test equipment for new product innovation, and equipment supporting our growing Evergreen//One offering, as well as the construction of our new headquarters facility.

Net cash used in investing activities during fiscal 2023 of $221.4 million was driven by capital expenditures of $158.1 million, and net purchases of marketable securities of $61.3 million.

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Financing Activities

Net cash used in financing activities of $560.2 million during fiscal 2024 was primarily driven by cash outflows related to the repayment of the principal amount of the Notes of approximately $575.0 million, share repurchases of $135.8 million, and tax withholdings on equity awards of $30.0 million, partially offset by proceeds from borrowing under the Credit Facility of $100.0 million, issuance of common stock under our employee stock purchase plan (ESPP) of $45.1 million, and exercise of stock options of $39.8 million.

Net cash used in financing activities of $431.2 million during fiscal 2023 was primarily driven by our repayment of the $250.0 million outstanding under the Credit Facility, share repurchases of $219.1 million, and $19.6 million in tax withholdings on vesting of equity awards, partially offset by proceeds of $40.0 million from issuance of common stock under our ESPP, and $24.8 million from the exercise of stock options.

Off-Balance Sheet Arrangements

Through the end of fiscal 2024, we did not have any relationships with any entities or financial partnerships, such as structured finance or special purpose entities established for the purpose of facilitating off-balance sheet arrangements or other purposes.

Critical Accounting Policy and Estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these financial statements requires us to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. A summary of significant accounting policies applicable to our consolidated financial statements is included in Note 2 of our Notes to Consolidated Financial Statements in Part II, Item 8. We deem an accounting policy to be critical if the nature of the estimate or assumption it incorporates is subject to material level of judgment related to matters that are highly uncertain and changes in those estimates and assumptions are reasonably likely to materially impact our consolidated financial statements.

We evaluate our estimates and assumptions on an ongoing basis. Our estimates and judgments are based on historical experience, forecasted events and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

We believe the accounting policy below has the most significant impact on our consolidated financial statements and require management's most difficult, subjective, or complex judgments.

Revenue Recognition

Our revenue is derived from sales of our integrated storage hardware and embedded licensed software products and subscription services which also includes support and maintenance and professional services. We enter into contracts with customers that may include combinations of these products and subscription services, resulting in arrangements containing multiple promised performance obligations.

Determining whether our products and subscription services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. For these contracts, we account for individual performance obligations separately if they are distinct.

Revenue is recognized when, or as, control of the promised products or subscription services is transferred to the customer at the transaction price. The transaction price is determined based on the consideration which we will be entitled to in exchange for transferring goods or services to the customer. Transaction price may be adjusted for variable consideration which we estimate by applying the expected value or most likely estimate and subsequently update at each reporting period as additional information becomes available.

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To recognize revenue for the products and subscription services for which control has been transferred, we allocate the transaction price for the contract among the identified performance obligations on a relative standalone selling price (SSP) basis. We establish SSP for most of our products and subscription services based on the observable price of the products or subscription services when sold separately in similar circumstances to similar customers. When the SSP is not directly observable through historical transactions, we estimate SSP based on management judgment by considering available data, such as internal margin objectives, pricing strategies, approved pricing guidelines, market/competitive conditions, historical profitability data, as well as other observable inputs. We establish SSP ranges for our products and subscription services and reassess them periodically.

Recent Accounting Pronouncements

Refer to “Recent Accounting Pronouncements” in Note 2 of our Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.

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