Earnings Call Transcript
Everpure, Inc. (P)
Earnings Call Transcript - PSTG Q3 2022
Operator, Operator
Good day, ladies and gentlemen. Thank you for standing by, and welcome to the Pure Storage Third Quarter Fiscal Year 2022 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, there will be a question-and-answer session. As a reminder, this call is being recorded. I’d now like to introduce your host for today’s conference call, Mr. Sanjot Khurana. Mr. Khurana, please go ahead.
Sanjot Khurana, Vice President of Investor Relations
Thank you, and good afternoon. Welcome to the Pure Storage third quarter fiscal 2022 earnings conference call. My name is Sanjot Khurana, Vice President of Investor Relations at Pure Storage. Joining me today are our CEO Charlie Giancarlo, our CFO Kevan Krysler, and our CTO Rob Lee. Before we begin, I would like to remind you that during this call, management will make some forward-looking statements, which are subject to various risks and uncertainties. These include statements regarding the COVID-19 pandemic and related disruptions, our growth and sales prospects, competitive industry and technology trends, our strategy and its advantages, our current and future product offerings and our business and operations. Any forward-looking statements that we make are based on facts and assumptions as of today, and we undertake no obligation to update them. Our actual results may differ materially from the results forecasted, and reported results should not be considered as an indication of future performance. A discussion of some of the risks and uncertainties relating to our business is contained in our filings with the SEC, and we refer you to these public filings. During this call, we will discuss non-GAAP measures in talking about the company’s performance, and reconciliations to the most directly comparable GAAP measures are provided in our earnings press release and slides. Additionally, when we refer to the sales in our prepared remarks, we mean total bookings excluding cancelable orders. This call is being broadcast live on the Pure Storage Investor Relations website and is being recorded for playback purposes. An archive of the webcast will be available on the IR website and is the property of Pure Storage. With that, I’ll turn the call over to our CEO, Charlie Giancarlo.
Charlie Giancarlo, CEO
Welcome everyone. As American families and many of you get ready for Thanksgiving, all of us at Pure extend to you our thanks for joining us today to discuss another terrific quarter. We are very pleased with our Q3 results, which demonstrate what can be achieved when great innovation and enthusiastic customer focus work together. Our Q3 revenue was up 37% year-over-year with double-digit quarter-over-quarter growth across all product lines and across both US and the international markets. We are also pleased with our strong profitability trend continuing through this fiscal year. With a sustained and steady growth across all key regions, products, and customer segments, Pure continues to take share in this large and growing market. Our strategy to deliver a modern data experience to our customers and partners continues to lead the industry with new firsts almost every quarter as we deliver on all aspects of the modern data experience. Modernizing data infrastructure, operation, and application, this quarter we announced the latest additions to our product portfolio that brings storage and applications even closer together. Pure Fusion, our new software-defined multi-cloud self-service storage environment, is a major advance that will allow customers to better manage their data in a multi-cloud environment while enabling developers to deploy sophisticated data storage services on demand. We also announced Portworx Data Services, which will further allow those self-same developers to quickly deploy production-grade data services on Kubernetes. Together with advances in our Pure1 digital experience, Pure is enabling a cloud operating model for enterprises everywhere, and engagement has been strong. Our next announcement on December 8 will push infrastructure modernization even further and extend the breadth of our FlashArray platform. Today, all of Pure’s capabilities are available as a service. We continue to see strong growth across Evergreen, Pure as a service, and Portworx, which together represent a third of our revenues. Gartner has once again validated Pure’s leadership in both of their Storage Magic Quadrants, recognizing our execution and vision in primary storage and in the rapidly growing file and object market for unstructured data. Given our speed and breadth of innovation, it should not be a surprise that more and more customers are purchasing the full Pure portfolio. This quarter, the Commonwealth of Massachusetts chose a full Pure as a service solution with FlashArray and FlashDeck for block performance and capacity. FlashBlade for unified fast file and object. And our Portworx suite to containerize and modernize applications. The Commonwealth of Massachusetts said that what put Pure ahead of the competition was our ability to provide them with what they describe as a data plane as a service offering that can work with any data type, provide ransomware protection and rapid recovery, and scale seamlessly, all delivered through an SLA for transparency, reliability, and cost-effectiveness. One of their first use cases will be to modernize an application for Massachusetts law enforcement, using Pure and Portworx. They will provide fast distributed access to criminal record information with no degradation, even under heavy load, increasing the safety of their law enforcement personnel and the public. Pure continues to see strong adoption in the public sector; state and local governments and agencies have long been a strong segment for Pure. I am pleased that we are seeing steady progress and traction with US federal and international governmental agencies. For instance, we now have deployments in all three branches of the US federal government and three branches of the US Department of Defense. Enterprise and commercial markets continued to experience strong growth. Pure is proud to deliver our modern data experience to now more than 50% of Fortune 500 companies and almost 50% of Fortune's Global 500 list companies, which speaks to the universal appeal of our portfolio. I will now turn briefly to two topics very much in the news and on investors’ minds. Our global customers and prospects are beginning to appreciate the power and green advantage of Pure. By power, I am not referring to IOPS or throughput, and by green, I am not referring to our evergreen subscription. Simply speaking, Pure’s products use dramatically less energy and create far less waste than competitive offerings. We take this expanded scope and responsibility very seriously and look forward to publishing our first environmental, social, and governance report early next calendar year. When customers learn how much our solutions reduce energy, space, and waste in their environmental footprint, Pure becomes a true partner in helping them achieve their ESG objectives. Supply chains are on everyone's mind, and no company is immune to this disruption. As we have reported in the past, Pure has built a very robust supply chain based on strong, open, and trusted relationships with our partners. Our strategy incorporates manufacturing and operations in multiple sites and on multiple continents to enable flexibility, resilience, and global responsiveness. This past quarter, global semiconductor availability was more challenging than last quarter, and we expect this environment to continue into next year. However, our operations team and the strong partnerships we've built with our suppliers have continued to work well, minimizing impacts to our customers and our business. Knowing that our products are helping people all over the world is incredibly motivating to our team. I am proud of how well Pure employees have innovated, executed, and delivered our modern data experience to customers, despite the continuing COVID environment and the many other challenges they may individually face. I'd like to give a special shout-out and congratulations to our new Chief Revenue Officer, Dan FitzSimons, who in his six years at Pure has risen to every challenge we've thrown at him, most recently leading our America's business to increasing excellence. Dan's elevation is indicative of the deep leadership and bench strength we have across the company. Given the effectiveness of our team, the quality of our products, and the strength of our customer and partner relationships, the future remains bright for Pure. Kevan, over to you.
Kevan Krysler, CFO
Thank you, Charlie, and good afternoon. We are very pleased with the continued robust demand across our entire portfolio, as well as our execution delivering both strong revenue growth and operating profit during the quarter. The high demand we saw this quarter was balanced across our portfolio, key geographies, and market segments. It was evidenced by our sales growth of an incredibly strong 41%, excluding cancelable orders. Our sales growth this quarter also includes sales of FlashArray//C to one of the top 10 hyperscalers. Our supply chain team and suppliers continue to execute, minimizing disruptions for our customers, despite an increasingly supply-constrained environment that is dynamic. We are also pleased with the continued progress of our subscription business as subscription services revenue grew approximately 38% year-over-year. Subscription ARR, or annual recurring revenue, was $788 million at the end of Q3, growing at 30% compared to last year. Subscription ARR includes the annualized value of all active subscription contracts as of the last day of the quarter, plus annualized on-demand revenue. Remaining performance obligations, or RPO, which includes our committed and non-cancelable future revenue, was over $1.2 billion, growing at 27%. We saw an improvement in new customer acquisition with 345 new customers representing 12% year-over-year growth. New customer acquisitions were balanced across geography, market segments, and our solutions portfolio. Our total customer count has exceeded 9,500 customers, which includes over 50% of Fortune 500 companies. Now turning to additional specific financial results for the quarter. Total revenue grew 37% to approximately $563 million. Revenue in the United States grew 35%, and international revenue grew 42% compared to last year. With the strong demand this quarter, including the sale of FlashArray//C to one of the top 10 hyperscalers products, revenue was very strong, growing approximately 37%. Non-GAAP total gross margins were 68.5% this quarter. The decline in non-GAAP total gross margins, both sequentially and compared to last year, is driven by non-GAAP product gross margins, which were 66.7% in Q3. Our sales of FlashArray//C to one of the top 10 hyperscalers this quarter and, to a lesser extent, increasing supply chain costs were the primary drivers we saw impacting product gross margins this quarter. Non-GAAP subscription services margins continued to trend favorably at 72.1% this quarter. We achieved nearly $70 million of non-GAAP operating profit and 12.3% of non-GAAP operating margin this quarter. Increasing revenue growth, sales efficiency, and the effects of the COVID environment contributed to our increasing profitability. We estimate that the effects of the COVID environment are approximately two points of benefit to our operating margin this quarter. These reduced expenses generally relate to significantly reduced travel, physical marketing events, and slower-than-planned hiring. We ended the quarter with over $1.36 billion in cash and approximately 4,000 employees. Cash flow from operations of $127 million was again very strong this quarter, and capital expenditures were $25.7 million during the quarter. We returned approximately $56 million of capital to repurchase slightly over 2.3 million shares. At the end of the quarter, we have approximately $70 million remaining from our $200 million share repurchase program. Now turning to Q4 guidance, we expect strong demand in Q4, with estimated revenue to be approximately $630 million, growing 25%. We also expect continued healthy profitability, with non-GAAP operating profit estimated to be approximately $90 million in Q4, representing approximately 14% non-GAAP operating margin. For the full fiscal year, given the strong performance of our business in Q3 and outlook for Q4, we are also raising our annual guidance. We now expect that our revenue for FY 2022 will be $2.1 billion, growing approximately 25%. Non-GAAP operating profit is estimated to be approximately $206 million, representing approximately 10% non-GAAP operating margin. In closing, our highly differentiated and innovative portfolio and services are why our customers are choosing Pure. I want to thank our entire Pure team and channel partners for continuing to deliver terrific results while navigating a dynamic environment. With that, I will turn it over to the operator so we can get to your questions.
Operator, Operator
Our first question is from Jason Ader from William Blair.
Jason Ader, Analyst
I didn't know if you wanted me to do a dance or something.
Charlie Giancarlo, CEO
Yeah.
Jason Ader, Analyst
Okay. So, I guess my main question is, can you rank what the main factors are driving your outperformance? I mean, obviously, this is a bit of a weird year, given that the comps are pretty easy, but you guys seem to be executing really well. So maybe just macro execution, new products, and then maybe competitor weakness, because we know that some of your competitors are struggling with supply, and I don't know if you think that's factoring in as well to your performance?
Charlie Giancarlo, CEO
Yeah. Jason, thank you for the question. First of all, I'd say that we had a hard time describing this quarter only in the sense that everything went very, very well this past quarter. So calling any one thing out really seemed to only diminish everything else that was going very well. So, as I mentioned, very balanced across new products to be a lot longer, the longer balanced and strong growth across from our sales force, so very balanced among the sales force in pretty general terms. Obviously, as you point out, the comps are easier, but even if you were to compare two-year comps, the coming together of the investments that we've been making over the enterprise, the investments we've made in broadening out our product line to be much to major enterprises. The fact that we did invest in enterprise, during the COVID environment, all of these have really contributed to our strength and the fact that we've continued to advance the technology contributed to our strength. And the fact that we’ve continued to advance the technology to the extent that, even as we pointed out, hyperscalers looking to utilize us in their infrastructure, of course, that will be lumpy business, which we saw this quarter, that added to this quarter. But, again, it's very promising for us in terms of we think all these investments will continue to pay dividends as we go forward. So does that make sense?
Jason Ader, Analyst
Yeah, that's great. And then that's perfect. And Kevan, is there any early look at fiscal 2023 and how we should be thinking about both top line and the operating margin? Obviously, you've got some serious outperformance this year that you just mentioned 2 points coming from kind of COVID related benefits. Could you provide some broad strokes on fiscal 2023 for us?
Kevan Krysler, CFO
Yeah, Jason. And again, when we think about it from a demand lens, it continues to be robust. As we think about Q4, I wouldn't see a significant change in demand as we look beyond Q4. Now, with that being said, it's probably a bit early to get specific views, as you mentioned for next year. I would like to see how the remainder of this year plays out with our guide that is reflecting continued strength in Q4. A couple of call-outs when we think about next year: Look, these terrific growth rates that Charlie mentioned, for all of the various reasons, are also aided by the COVID environment, so we do need to take that into account. And then obviously, the hyperscalers opportunity that's being reflected in this quarter is a consideration as well when we think about next year. But hopefully that's helpful, Jason.
Operator, Operator
Your next question comes from the line of Aaron Rakers with Wells Fargo.
Aaron Rakers, Analyst
Yeah. Thanks for taking the question. I guess, I kind of want to build off that last point. Can you help us understand how meaningful that cloud opportunity was this last quarter? I think last quarter you talked about an eight-figure deal. Did that all impact this last quarter? Is there any expectation of a follow-on for cloud opportunities? And you may be in that same vein; can you talk about, I think recently announced a relationship or a deal with Microsoft Azure for EDA? Was that the cloud relationship, or is that something separate from your opportunities? And I have a follow-up.
Charlie Giancarlo, CEO
Right, okay Aaron, so first of all, no, the EDA announcement was separate from the top 10 hyperscaler. Obviously, if we felt we could have announced it, we certainly would have. But the customer wants to keep this confidential, so we certainly respect that. On the hyperscaler, but the EDA one is one that – yes, we work very closely with Microsoft to develop it where customers want to have very high-speed performance on EDA workloads that it's not necessarily restricted, or we don't believe that the architecture is restricted to EDA workloads, but we think that it's something that's going to scale well for us. So we're looking forward to that, but the hyperscaler was different. I'll let Kevin respond with how we've given you some insight into how the hyperscale affected the quarter.
Kevan Krysler, CFO
Yeah, I mean, it’s not that different than how we were talking about it last quarter as part of our guidance. But if you think about it with the quarter being completed, if we were to exclude the hyperscaler opportunity that came through this quarter, our year-over-year growth would more likely be in the high 20s. That's a good way to be thinking about it.
Aaron Rakers, Analyst
Okay. And that's helpful. And just so I understand, there's nothing embedded in this quarter from a hyperscale top 10 win. We announced the win last quarter, but we booked it and fulfilled it this quarter. So this – that is in Q3.
Charlie Giancarlo, CEO
Yeah.
Aaron Rakers, Analyst
And then as the quick follow-up, I'm just curious on gross margin. I know you talked about the hyperscale deal impacting gross margin, but product gross margin, cost headwinds and stuff, do we think that those start to abate? Do you feel comfortable still that that 70% plus gross margin that you outlined at the Analyst Day is achievable, and how should we think about that in the next couple of quarters? Thank you.
Charlie Giancarlo, CEO
Yeah. That sounds great. In that gross margin, I think on the 70% was more akin to the subscription, our subscription business. But hey, when we think about it from a product gross margin or total perspective, we look the largest driver really this quarter was the hyperscale opportunity. It did have some headwinds; obviously, with the increasing component costs that we saw in the quarter, but that would be a much lower driver, if you will, in terms of what we saw in the sequential and year-over-year drop in the product gross margins. And hey, when I think about looking into Q4, I do expect our product gross margins to normalize back to what we typically see in the high 60s, that's a good way to think about it. And that's even obviously considering the cost increases that we're contemplating.
Operator, Operator
Your next question comes from the line of Simon Leopold with Raymond James.
Simon Leopold, Analyst
Thanks. Appreciate you guys taking the question. I wanted to get a sense of where you are in terms of the contribution from software product revenue within the mix, so I know Pure Fusion is new, but how has Portworx been performing?
Charlie Giancarlo, CEO
Well, Simon, as you probably know, especially with new products as they develop, it's not practical to break them out. New products tend to go through their own cycles, which can be uneven, and focusing too much on the new products can skew the overall revenue picture. However, I will point out that last quarter we provided some insights on Portworx and Pure as a Service, which are seeing year-over-year growth in the three-digit percentage range.
Kevan Krysler, CFO
Yes, that's correct, Simon. We are providing solutions through our software, and this is evident in the gross margins we’re experiencing both on subscription and annual recurring revenue year-over-year. I'm pleased with how the software is performing as we evaluate our growth figures.
Simon Leopold, Analyst
Thanks. So just as a follow-up, I wanted to see if maybe you could unpack a bit about the use case for this hyperscaler and what I'm really trying to get at in this question is an understanding of if this is a repeatable opportunity, a repeatable opportunity, either with this customer or other customers. I'm looking for an undertaking we should think of this as a new to make it grow for…
Charlie Giancarlo, CEO
You're right. Thanks, Simon. So I mean, I think also Erin might have referred to this earlier on, and Kevan Krysler: Right. Thanks, Simon. I think also Aaron might have referred to this early on. I – and we didn't respond to it specifically. So I just want to start off by saying that with this particular hyperscaler, we do believe it's repeatable. There’s no reason for us not to believe that it's repeatable and conversations continue. But let me let Rob weigh in on the general use case. Yeah. So as far as the use case, this is part of their production environment. It's an environment that they're using to essentially do analysis and an understanding of how to better deliver the hyperscaler service. So it is part of the production environment. I think as far as repeatability and understanding, it’s just the broad applicability of the use case. I think what's notable is the overall size and capacities that we're talking about here, the performance requirement. And the fact that this is a very sophisticated customer who has evaluated all the options available to them. Obviously, cost was a part of the equation. And so obviously with a disk, they pretty quickly came to the conclusion that FlashArray//C was really the only option that was going to solve the balance of their needs, performance, price, footprint, and so forth. And I think it's also worth noting that the overall footprint savings was a key part of winning the initial deal. But we're now also undergoing work with this same customer to quantify the environmental savings and benefits that we're delivering to them with a FlashArray//C solution as part of their ESG analysis. The nice thing is that these are all benefits that we're able to deliver to each and every one of our customers.
Operator, Operator
Your next question comes from the line of Rod Hall with Goldman Sachs.
Rod Hall, Analyst
Hey. Thanks for taking my question. I just want a quick clarification that this campaign from probably this year seems to indicate that there could be an extra week in fiscal Q4 but I might be wrong; but I just wanted to double-check.
Charlie Giancarlo, CEO
For Q4, we have an additional week in our fiscal year, which impacts both revenue and operating expenses equally. I see this as a slight challenge for our profitability, likely around $14 million to $15 million on both the revenue and operating expense sides, due to this extra week.
Rod Hall, Analyst
Got you. Very helpful. And then I have a follow-up. So I just want to double-check on this chartered fee; the hyperscale roadmap. Now, the hyperscale digital model is obviously but I just had one thing: Do you feel more potential hyperscale customer traction about going forward? Are we having more accommodation for the players or anyone who is actually might be evaluating assets? Any color on that roadmap there would be very helpful.
Charlie Giancarlo, CEO
We strongly believe that as flash technology continues to decline compared to magnetic disk, there will eventually be a point where all players, including hyperscalers, begin to transition from disk to flash. It's just a matter of time and their specific use cases before this occurs. We have the best technology in the industry and are in discussions with several parties. However, it's premature to make predictions because large environments can be unpredictable; they tend to be significant when they arrive, but the wait for them can be long. That said, we are having discussions, and we believe it will soon be commonplace to use flash in the hyperscale environment.
Rod Hall, Analyst
Thank you, Charlie. And I think I saw revenues are finally assuming any revenues in fiscal Q4 from that hyperscale?
Charlie Giancarlo, CEO
We are not expecting revenues from that particular hyperscale in Q4. We shifted all at that point. Well, I'm sorry. Okay. There's some residual revenue for it in Q4, but for the most part, no.
Operator, Operator
Your next question comes from the line of Steve Enders with KeyBanc.
Steve Enders, Analyst
Okay. Great. Thanks for taking the question. I just want to talk a little bit more on the guide; pretty strong revenue that you're expecting to see there. But just wondering kind of what's built into the assumptions within that guide, and how should we be thinking about kind of how the macro environment has played out over the past 90 days that’s leading to the guide here?
Charlie Giancarlo, CEO
Well, let me start, and then I'll let Kevin go into it. It's based on what we see in the market today in the performance that we had in Q3. We're certainly not – we're not contemplating any major changes to the current direction of the world economy. So the expectation is generally more of the same in terms of macroeconomic forces. We're expecting COVID to continue probably if you've been watching the news and watching the figures. It's having a seasonal effect, so seasonally it will get a bit worse, but we're not expecting that to have a major change to our expectations about how business will perform this coming quarter. What we see is the strong demand and we believe that strong demand is based on fundamentals - fundamental demand; we don't think it's - we don't think that at least for our market there’s a lot of speculative demand out there, and our lead times have stayed relatively low; our customers know that, so they can order when they need it, not when not to gain the system.
Kevan Krysler, CFO
Yeah, and Steve, I probably wouldn't have much more to add on that. I think as we've got good visibility in terms of how we're looking at Q4 to Charlie's point, demand still is robust in terms of what we're looking at. No real change in the trajectory understanding that there's a little bit more in terms of what we're seeing on a wave of COVID on the European front. But again, I don't think those will be meaningful drivers as we think about Q4.
Steve Enders, Analyst
Okay great, that's helpful. And then just on the hiring environment, it seems like it might have been a little bit behind plan in the quarter. But is there kind of anything to call out there in terms of where the biggest challenges are and when you kind of see that beginning to reverse?
Charlie Giancarlo, CEO
Yeah, I would say that the being a bit behind in hiring is across the board; there's no one function that stands out. To put some context on it, we're seeing somewhat slightly higher attrition than average years, certainly a lot more than last year. Last year was very low by comparison to an average year. This year is a bit higher, I would say that recruiting, interestingly, is the quality - the quality of resumes that one can bring on for interviews now; a lot of blocks that we need to fill. But we’re confident we’ll be able to catch up?
Kevan Krysler, CFO
Yeah. And I would just add on to that that we are seeing a nice pick-up in terms of hiring cadence, thanks to our talent acquisition team, doing a nice job on that front. And that's been contemplated obviously in the Q4 guide as you'll see a pick-up in OpEx sequentially. And that's not only the additional week but also contemplates the pick-up in pace that we're seeing in hiring talent as well.
Operator, Operator
Your next question comes from the line of Wamsi Mohan with Bank of America.
Unidentified Analyst, Analyst
Hi. Thank you for taking my question. This is John on behalf of Wamsi. My first question. So you've mentioned about the supply chain constraint headwind face the quarter. I was just wondering if you could maybe quantify the impact from a hospital revenue standpoint…
Charlie Giancarlo, CEO
Yes.
Unidentified Analyst, Analyst
…as I just wanted to confirm the guide reflects the supply chain uncertainty. Thanks.
Charlie Giancarlo, CEO
Yeah. Maybe what I'll do is talk just more tactically in terms of the impact for the quarter and then maybe have Charlie just talk about it more from a holistic standpoint. Because I think the operations team and our engineering team as well as our suppliers continue to do a terrific job. And look, when I look at it for the quarter, obviously, you saw a drop in product gross margins both sequentially and year-over-year. As I mentioned, a smaller piece of that is really due to the component cost increases that we saw during the quarter. That was moderated slightly by the fact that our ASPs are still quite stable and were quite competitive in the marketplace. So with that, I'll turn it over to Charlie to give some more holistic macro comments.
Kevan Krysler, CFO
On the macro side, yeah, we see all costs associated with the supply chain. So all costs associated with the supply chain, so component transformation and logistics costs all have increased on an annual basis we think on the order of approximately 10%. So that's a significant cost increase in what is traditionally a deflationary market for technology products. So quite significant. Our expectation at this point is that while supply chains will remain tight, we're expecting to not see the same kind of increases in costs going into next year. Now it is, as Kevin said, a very dynamic market. On a quarter-by-quarter basis, things can change dramatically because both supply and demand are a little bit difficult to predict, and that causes swings in pricing. So, as Kevin mentioned, it's a very dynamic market, and it's hard to get a complete story, or it's hard to have complete confidence in exactly where it will go.
Unidentified Analyst, Analyst
Great. Got it. Thank you. And as a quick follow-up, I was just wondering how the broader IT spending environment is tracking, particularly in storage? And if you have any trends that you would call out? Thank you.
Charlie Giancarlo, CEO
Yeah. On the enterprise side, it's been quite robust. So we think quite good, a lot of demand, a lot more data processing are taking place and upgrading. So we've seen it quite strong commercially. The wall has recovering slowly. I would say that in general, that's probably still down from where it might have been without COVID. And we're looking forward to continue a recovery there. But I would think overall the demand for enterprise storage actually has been quite good.
Unidentified Analyst, Analyst
Got it. Thank you.
Operator, Operator
Your next question comes from the line of Tim Long with Barclays.
Tim Long, Analyst
Thank you. Charlie, could you share some insights, or Kevin if you'd like to add anything? The margin performance this quarter has been impressive. I'm curious about our leverage strategy over the next year or two, considering the many changes ahead with the benefits potentially offset by a return to work. Also, I'd like to revisit the hyperscale and FlashArray//C situation; it seems the pricing has led to a significantly lower gross margin for that segment. How is that pricing determined? Is it intended to align closely with disk pricing, or will the approach differ for all hyperscale deals? Additionally, could the initial margins be lower but improve with repeat business? Please discuss the pricing dynamics and potential changes. Thank you.
Charlie Giancarlo, CEO
I don’t want to look too far ahead to next year, and we will have a clearer perspective during our Q4 earnings call and projections for next year. What I can say is that we plan to still be operating under COVID rules at least through Q1 and probably most of Q2. As we move into the summer, we anticipate that customers will begin to be more receptive to visits, which will lead to increased travel and normal expense categories, including in-person meetings for some activities. We expect about half a year of a return to greater investment. Therefore, you will likely notice a gradual increase in those additional expenses. At the same time, as you may have observed, even during COVID, our overall performance remained stable. We have been enhancing our productivity, particularly in our sales and marketing departments, and we are optimistic that our engineering team will see similar improvements over time. Consequently, we expect to gain more leverage consistently going forward, driven by increased productivity within the organization, primarily due to scale.
Kevan Krysler, CFO
I’ll add a bit more on that before we move to the hyperscaler topic. When we consider the entire fiscal year with our guidance for Q4, which indicates about a 10% non-GAAP operating margin, we believe that two to three percentage points of that will come from certain COVID-related factors, such as reduced travel and fewer physical events for marketing and hiring. We're experiencing a positive trend in hiring, and we anticipate this momentum will persist. Looking ahead to next year, while it's still too early to provide specific details, I expect to see continued leverage as we exclude the COVID-related tailwinds. We have a solid plan for how we view this moving forward.
Charlie Giancarlo, CEO
Right on fee, I’ll go back to that. On fee, we expect that a large portion of C sales to this hyperscaler, but also potentially others, will be replacing if not replacing, usually it goes into new builds. But the new builds would be for them to look at flash rather than disk, and so they'll be comparing the price to their existing disk design. As such, the early wins will probably be lower margin, but will improve over time, both as flash costs improve, but frankly, as they gain more experience with Pure as a provider.
Operator, Operator
Your last question comes from the line of Karl Ackerman with Cowen.
Karl Ackerman, Analyst
Yes. Thank you. Good afternoon, gentlemen. Kevin, I have two questions, please. The first one for Kevin: Mostly upside this quarter came from product revenue. That's quite impressive given the ongoing supply chain constraints you’ve mentioned. I'm curious whether the upper revised outlook for January is also driven primarily by product revenue, particularly given your planned expansion of your FlashArray platform that you highlighted in your prepared remarks. If you could comment on that would be helpful?
Charlie Giancarlo, CEO
Yeah. And I guess my view on this, and I'll let Charlie and Rob add some commentary as well, is that, yeah, absolutely. We've gotten great momentum fueled by high demand across our portfolio, which translates to the growth rates you're seeing in product revenue. But obviously, we're also seeing good traction with our subscription business, 30% growth in our subscription ARR. Obviously, that's going to have a lag before that works its way to the P&L. But this comes back to how balanced the demand and strength is that we're seeing across the board, whether that's specific to our subscription business or whether that's specific to sales of our solution. So, that's really the storyline here: the balanced strength that we're seeing across the board. Charlie or Rob, any other points you'd add on that front?
Kevan Krysler, CFO
I think that answers that. Kevin, I think what you're seeing is strong demand for our products regardless of strong demand for our products, regardless of capital and/or subscription base. Of course, we always want to allow the customer to buy in the way in which they want to provide or want to buy rather. But we're expecting – I would say we're expecting this quarter and this Q4 to be balanced as well. So we are seeing, just to be clear, we're seeing good growth in terms of service, and obviously the way that works from given that’s ratable, that starts off slow. So you don't see it quite as readily. But again, I expect it to be balanced going into this quarter.
Karl Ackerman, Analyst
That's helpful. Thank you. I guess as my follow-up, do you want to touch on margins a little bit? It seems that the entire upside in your revenue outlook for January is falling directly to operating income, which is quite impressive. Now that is quite impressive and now operating margins are in line with your long-term outlook. On one hand, it seems you're benefiting from volume leverage and the other release offsetting these rising input costs through pricing actions. So in that vein, could you discuss the ability to perhaps further pass on rising input costs as they happen? And secondarily, how you see margins improving or may improve as subscription revenue becomes a larger piece of revenue next year? Thank you.
Charlie Giancarlo, CEO
Yeah. Well, as we've said in the past, we don't specifically – we don't price on a cost-plus basis. We price based on competition in the market. One of the unique things about this market is that nearly every new opportunity, even in an existing customer is newly negotiated with competitors. As such, we're responding primarily to the pricing of our competitors rather than, let's say, a standardized discount for that customer. Many of our competitors do operate on a cost-plus basis. As a result, with the rising costs that exist in the market, that finds its way into the price negotiation. Because of that, we do expect that for the most part, ASPs and costs we expect to remain relatively stable margins. It'll vary based on mix; obviously, the hyperscaler deal. But for the most part, we think it'll stay relatively stable regardless of costs. Now part of the mix as well is in fact, as you point out, the subscription offerings. We expect long-term that those subscription offerings, because they will have higher value, will be providing more services in the subscription offerings than we do in the straightforward capital sale. As such, we expect those margins to be significantly over time to be above our reported standard margins.
Kevan Krysler, CFO
Yeah, and just to be clear, Karl, our view on the subscription margins really hasn't changed since our Analyst Day, our communication and expectations on that. To Charlie's point, with the growth of Portworx, and then as we scale our Pure as-a-Service offering with cloud block store, that clearly is going to give us some tailwinds as we think about it longer-term for subscription gross margins. Shorter term, to your point – yeah, we are very much pleased with what we're seeing in terms of increased profitability even considering the tailwind from COVID. So we like what we're seeing, and we'll definitely still trade and prioritize growth, but we very much believe that we can drive that growth and increase the operating leverage as well.
Operator, Operator
This concludes the question-and-answer session. At this time, I'll turn the call back over to Charlie Giancarlo for closing remarks.
Charlie Giancarlo, CEO
Thank you, operator. Pure has been preparing for this next phase of our growth for several years, building breadth in our product line, developing operational excellence in our functions, industry partnerships and vendor relationships, and most importantly, building trust and excitement with our customers. I want to thank our investors and our employees for their trust and their patience. I'm grateful for all the effort and creativity of our Pure team. As I sit down to my own family's meal on Thursday, I'll certainly offer gratitude and thanks for everyone past and present that has made Pure what it is today. Thank you all for your attention and your questions, and I wish you all a happy Thanksgiving.
Operator, Operator
This concludes today's conference call. You may now disconnect.