(EDGAR Online via COMTEX) -- 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 fiscal year ended January 31, 2021. 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, impacts on our business and general economic conditions due to the COVID-19 pandemic, 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 the first Sunday after January 30. Overview Data is foundational to our customers' digital transformation and we are focused on delivering innovative and disruptive technology and data storage solutions that enable customers to maximize the value of their data. In our first decade, we completely changed customers' expectations of what they should see from storage arrays and storage vendors, making flash storage widely available to enterprise organizations and revolutionizing the customer experience with our Evergreen Storage subscription model that radically simplified and reduced total cost of storage ownership. Today, we are changing the expectations for data and storage management by providing customers a cloud experience with flexible on-demand data services consumption through delivery of a Modern Data Experience that empowers organizations to run their operations as a true, automated, storage as-a-service model seamlessly across multiple clouds. Our solutions support a wide range of structured and unstructured data, at scale and across any data workloads on-premise, in the cloud, or hybrid environments and include mission-critical production, test/development, analytics, disaster recovery, and backup/recovery. Our Modern Data Experience vision begins with our portfolio of products and subscription services that is transforming and modernizing storage operations for our customers. Our Modern Data Experience vision extends to an innovative and highly-integrated data platform of products and subscription services, consisting of Cloud Data Infrastructure (integrated all-flash hardware and software appliances which run in on-premise data centers), Cloud Data Applications (software and container data applications and services, which run natively in major public cloud infrastructures), and Cloud Data Management (software hosted data management services to manage our entire platform). The Modern Data Experience is based on four key pillars: Fast Matters, Cloud Everywhere, Simple is Smart, and Subscription to Innovation. Fast Matters - Speed is critical to customer experience and engagement, and therefore, we design our high-performance solutions to allow applications, analytics, and development to move and execute quickly in order for our customers to make impactful decisions. We redefine fast by delivering low-latency, high bandwidth, and maximum density technologies. For example, accelerating core applications enables rapid response and deployment which reduces costs while increasing enterprise resilience. Cloud Everywhere - Providing our customers the opportunity to transform their data management to a full or hybrid cloud model. This model reduces costs and adds agility through an API-defined platform, a consistent on-premise and public cloud experience, seamless data mobility and comprehensive data protection. This multi-cloud environment delivers increased flexibility, fast global recovery, and minimized application downtime through automated response. Table of Contents Simple is Smart - From day one, our storage solutions are designed to be simple, allowing our customers to reduce time spent managing the storage platform including issue resolution. Our storage dashboards present real-time and intuitive platform analytics; meanwhile, AI-based optimization proactively analyzes future workloads and global network issues to limit unforeseen infrastructure problems. Subscription to Innovation - Delivering a subscription with low total cost of ownership, eliminating the need for forklift hardware replacements, and providing customizable capacity and mobility, whether on-premise, in the cloud or hybrid cloud. Coronavirus (COVID-19) We continue to actively monitor, evaluate and respond to developments relating to the Coronavirus (COVID-19) pandemic. During the third quarter of fiscal 2022, our operating margin benefited, in part from reduced travel, limited physical marketing events, and slower hiring while navigating the various challenges that arise from the existing COVID-19 environment. Other impacts associated with the COVID-19 environment included higher supply chain constraints and related costs. Key Business Metric Subscription Annual Recurring Revenue (ARR) We have introduced a new business metric, Subscription ARR as a measure of our revenue trend and indicator of our future revenue opportunity from existing recurring customer contracts. Subscription ARR is a management operational performance metric that 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, including our Evergreen Storage subscription contracts, at the end of the fiscal quarter, plus on-demand revenue during the current fiscal quarter ended 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):
At the End of Year-over-Year Growth Third Quarter of Third Quarter of Fiscal 2021 Fiscal 2022 % Subscription annual recurring revenue $ 608,651 $ 788,330 30 % Components of Results of Operations Revenue
Revenue Third Quarter of Fiscal Change First Three Quarters of Fiscal Change 2021 2022 $ % 2021 2022 $ % (dollars in thousands, unaudited) Product revenue $ 274,470 $ 374,913 $ 100,443 37 % $ 793,718 $ 949,736 $ 156,018 20 % Subscription services revenue 136,149 187,827 51,678 38 % 387,743 522,542 134,799 35 % Total revenue $ 410,619 $ 562,740 $ 152,121 37 % $ 1,181,461 $ 1,472,278 $ 290,817 25 %
Total revenue accelerated during the third quarter of fiscal 2022 driven from both enterprise and commercial customers across our entire product and solutions portfolio and key geographies. Total revenue increased by $152.1 million, or 37%, during the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021 and increased by $290.8 million, or 25%, during the first three quarters of fiscal 2022 compared to the first three quarters of fiscal 2021. The increase in subscription services revenue during these periods was largely driven by increases in sales of both our Evergreen Storage subscription services, and our unified subscription that includes Pure as-a-Service and Cloud Block Store. The increase in product revenue during these periods was driven by increased sales from our entire portfolio of FlashArray and FlashBlade products, including sales of FlashArray//C to a large hyperscaler customer, and repeat sales to existing customers.
Third Quarter of Fiscal First Three Quarters of Fiscal 2021 2022 2021 2022 Beginning balance $ 724,751 $ 909,814 $ 697,288 $ 843,697 Additions 180,285 208,542 467,454 611,006 Recognition of deferred revenue (142,272) (168,606) (401,978) (504,953) Ending balance $ 762,764 $ 949,750 $ 762,764 $ 949,750
Revenue recognized during the third quarter of fiscal 2021 and 2022 from deferred revenue at the beginning of each respective period was $121.9 million and $163.2 million. Revenue recognized during the first three quarters of fiscal 2021 and 2022 from deferred revenue at the beginning of each respective period was $285.0 million and $356.2 million. Remaining Performance Obligations
Cost of Revenue and Gross Margin Third Quarter of Fiscal Change First Three Quarters of Fiscal Change 2021 2022 $ % 2021 2022 $ % (dollars in thousands, unaudited) Product cost of revenue $ 85,634 $ 128,087 $ 42,453 50 % $ 237,664 $ 305,388 $ 67,724 28 % Stock-based compensation 1,027 1,634 607 59 % 3,013 4,547 1,534 51 % Total product cost of revenue $ 86,661 $ 129,721 $ 43,060 50 % $ 240,677 $ 309,935 $ 69,258 29 % % of Product revenue 32 % 35 % 30 % 33 % Subscription services cost of revenue $ 43,559 $ 52,672 $ 9,113 21 % $ 121,756 $ 150,560 $ 28,804 24 % Stock-based compensation 3,883 5,555 1,672 43 % 10,961 15,098 4,137 38 % Total subscription services cost of revenue $ 47,442 $ 58,227 $ 10,785 23 % $ 132,717 $ 165,658 $ 32,941 25 % % of Subscription services revenue 35 % 31 % 34 % 32 % Total cost of revenue $ 134,103 $ 187,948 $ 53,845 40 % $ 373,394 $ 475,593 $ 102,199 27 % % of Total revenue 33 % 33 % 32 % 32 % Product gross margin 68 % 65 % 70 % 67 % Subscription services gross margin 65 % 69 % 66 % 68 % Total gross margin 67 % 67 % 68 % 68 %
Cost of revenue increased by $53.8 million, or 40%, during the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021, and increased by $102.2 million, or 27% during the first three quarters of fiscal 2022 compared to the first three quarters of fiscal 2021. The increase in product cost of revenue during these periods was primarily attributable to higher component costs due to supply chain shortages, and an increase in the amortization of acquired intangible assets. The increase in subscription services cost of revenue during these periods was primarily attributable to higher costs in our customer support organization.
Operating Expenses Research and Development Third Quarter of Fiscal Change First Three Quarters of Fiscal Change 2021 2022 $ % 2021 2022 $ % (dollars in thousands, unaudited) Research and development $ 93,761 $ 111,011 $ 17,250 18 % $ 262,309 $ 316,953 $ 54,644 21 % Stock-based compensation 29,220 36,797 7,577 26 % 87,770 102,343 14,573 17 % Total expenses $ 122,981 $ 147,808 $ 24,827 20 % $ 350,079 $ 419,296 $ 69,217 20 % % of Total revenue 30 % 26 % 30 % 28 %
Research and development expense increased by $24.8 million, or 20%, during the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021, as we continue to innovate and develop technologies to both enhance and expand our solution portfolio. The increase was primarily driven by a $18.8 million increase in employee compensation and related costs, which included a $7.6 million increase in stock-based compensation expense, a $2.1 million increase in outside services expenses, and a $2.3 million increase in depreciation expense from property and equipment due, in part, to revising our estimated useful lives of test equipment, and certain computer equipment and software during the first quarter of fiscal 2021.
Sales and Marketing Third Quarter of Fiscal Change First Three Quarters of Fiscal Change 2021 2022 $ % 2021 2022 $ % (dollars in thousands, unaudited) Sales and marketing $ 157,384 $ 174,021 $ 16,637 11 % $ 469,131 $ 512,737 $ 43,606 9 % Stock-based compensation 14,898 19,151 4,253 29 % 48,018 54,317 6,299 13 % Total expenses $ 172,282 $ 193,172 $ 20,890 12 % $ 517,149 $ 567,054 $ 49,905 10 % % of Total revenue 42 % 34 % 44 % 39 %
Sales and marketing expense increased by $20.9 million, or 12%, during the third quarter of fiscal 2022 compared to the third quarter of fiscal 2021, primarily due to a $15.6 million increase in employee compensation and related costs, which included a $9.5 million increase in sales commission expense, as we continue to invest in certain areas within sales and marketing, a $3.4 million increase in marketing and travel spend due to the continued gradual reduction in COVID-19 restrictions, and a $1.1 million increase in outside services expense. Sales and marketing expense increased by $49.9 million, or 10%, during the first three quarters of fiscal 2022 compared to the first three quarters of fiscal 2021, primarily due to a $43.2 million increase in employee compensation and related costs, which included a $15.4 million increase in sales commission expense, as we continue to invest in certain areas within sales and marketing, and a $7.2 million increase in marketing and travel spend due to the continued gradual reduction in COVID-19 restrictions, partially offset by a $2.8 million decrease in outside services expense.
unaudited) General and administrative $ 35,886 $ 39,027 $ 3,141 9 % $ 102,070 $ 107,042 $ 4,972 5 % Stock-based compensation 10,581 12,863 2,282 22 % 29,993 31,458 1,465 5 % . . .
Dec 07, 2021
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