Nutanix, Inc. (NTNX) Earnings Call Transcript & Summary

Good morning, everyone. I'm Jason Ader. Welcome to our virtual fireside chat with Nutanix CFO, Duston Williams; and VP, Product Marketing, Greg Smith. Duston, Greg, thanks for being with us today.

Sure. Thanks, Jason.

Thanks for getting us up at 6:40 and doing this.

My pleasure. So before we begin, I'm required to inform you that a complete list of research disclosures or potential conflicts of interest is detailed on our website at williamblair.com. Also, there should be a question box on the webcast for those listening or watching. So please submit any questions you have during the fireside chat rather than after it so we can queue up those without any delay. With that out of the way, let's dive into questions.

So Duston, it's been a whirlwind couple of years for Nutanix. How has the company evolved, both from a technology and business model perspective? And how do you think the company is positioned for the future?

Yes. Let me take some of that. And Greg, probably pitch in on some of the product stuff. But yes, a whirlwind, I guess, is an okay definition there. A lot happened in the last year, but everything that we've always done for the company is thinking a few years in advance. And the last year, quite honestly, was no different as far as the investments that we made and are making new products-wise, focused on building up the stack and getting the product fulfilled and more sticky and things like that. On the business model side of the equation, the whole subscription thing and what we've done over the last, really, 1.5 years with subscription has been an interesting transition, I think. If you had asked us 1.5 years ago if we would be at 84% subscription billings last quarter, I would have thought that, that would have been a big stretch, honestly. So the good news there is that, that's gone faster. The bad news, if you will, is it has impacted some results. And maybe we didn't do a perfect job of really helping people work through that in advance in all the moving parts. I think we've got a pretty good hold of that now, and I think the best is yet to come. And I'm sure we'll get into that and probably some follow-up questions here on the model. But all the hard work we're doing, why are we doing it and effectively, but what folks should be asking is, "Okay, I understand that, but what's the ROI, right? Why are you doing this? What's the return? How does the return develop? And when does the return happen?" So I'm sure we'll get into some of that, and we can elaborate. But maybe, Greg, do you maybe want to take how the product has evolved?

Yes. The portfolio has evolved pretty meaningfully as well over the last 2, 3 years. So we began the company, Nutanix, of course, as a pioneer in hyper-converged infrastructure, and that's a market in which we still lead. We have built upon that foundation to provide an entire portfolio of services and full-cloud stack, as Duston alluded to. And what it allows our customers to do is really modernized their IT, modernize their data center to provide a cloud-like experience within their own IT infrastructure. And most recently, what we're doing is using that foundation, using that cloud stack to help our customers build a hybrid cloud architecture to meld what they're doing in their own data center and their consumption of public cloud services. And going forward, we will actually provide all of our services to run both on-prem in that private data center as well as in the third-party public cloud of the customers themselves. And the ultimate goal is to give our customers the freedom to choose, the freedom to choose the right cloud, public or private, for every workload, and the freedom to migrate or lift and shift workloads between clouds. We think that's sort of a -- the ultimate goal for organizations today.

Okay. Great. And a follow-up on that, Greg. In some circles, I think there's a perception that the cloud is a secular headwind for you, guys. In a recent interview, though, Dheeraj talked about the killer app for HCI being -- as a bridge to the public cloud and an enabler of lift and shift. Can you explain what he means by this? And why the cloud may not be the headwind for Nutanix that some think it is?

Yes. Let me hit the second part of the question first, if I could, because it's a common misperception. It's a little bit counterintuitive. Even traditionally, where our sales have been on-premises in the data center, not in a public cloud, the public cloud has actually been a benefit to the business. And the reason why is the public cloud has demonstrated to the entire IT organization and, more informally, the consumers of IT organization, that there is a better way, a more advanced way to deliver IT services. So it's been a very disruptive force, and it's really compelled a lot of data center managers, CIOs, to adopt new architectures, new approaches in their data center, to be more cloud-like. And that's been an emphasis for change. If it were not for public cloud, you probably wouldn't see the pressure to modernize data center IT. Now going forward, we've built a full-cloud stack, meaning we provide all of the IT resources to run any application in the data center. That means storage, virtualization, networking and security, automation. That's the full-cloud stack. So think of Nutanix as software that lays down on any bare metal server in the data center, provides everything you need to run any application. That same software can only run on a bare metal server in the data center, but very soon, we'll be able to run the same software on bare metal instances in the public cloud, like AWS. So our customers can run Nutanix software in their data center and take the exact same license and run it in AWS. And when they have the same environment in their data centers as they do in public cloud, then they get the freedom to keep applications and data mobile between these 2 environments. We're going to pay off the lift and shift. So any application that customers are running in their data center, even if it's not reengineered or refactored, they'll be able to move into the public cloud of their choice. So that's the ultimate lift and shift. That's the nirvana of hybrid clouds, and that's where we're working toward very aggressively.

I think, Jason, that in that interview, Dheeraj basis is very analogous to what VMware and virtualization did to bare metal servers years ago, that there was no change to the apps, no change to the operating system. And if we can provide that same thing for lift and shift to the public cloud, that killer app, if you will, the HCI could take place.

Yes. In fact, more specifically, what we've done with HCI and our stack is consolidate the data center, consolidate those silos of operations within the data center. Now the next step in the journey is to consolidate clouds, to basically make clouds invisible so our customers can focus on the applications and services that their business needs and take the cloud of their choice but preserve their common experience.

Are there any disadvantages to having the Nutanix stack kind of underneath the application in the public cloud? Are you going to be able to still tap into the native cloud services of the various public clouds?

Absolutely. In fact, the way we've done it, as opposed to some others, is we use the native cloud constructs. So when Nutanix software is deployed in, say, AWS, it sits in that customer's virtual private cloud, or VPC, that uses native AWS networking and gets direct line-of-sight access to the entire portfolio of AWS services. So customers can have the ability to move applications into, whether it be AWS or Azure or the future Google, and move those applications between public clouds or back on-prem. But when they're in the public cloud, they get access to all the services. There's really no trade-off in that respect.

And this is launching this year, this capability?

Yes. What I've been describing is an approach we call Nutanix Clusters, and it's basically the ability to run our entire cloud stack, all of the services I mentioned, really, the entire portfolio in AWS to start. In just a few weeks, we will announce general availability. We've already announced that -- actually, the product last calendar year. So we'll start with AWS. We'll quickly follow with support for Azure, and then we'll continue to support other clouds as well.

Okay, great. Duston, from your perspective, what were the big takeaways from Q1?

The big takeaways was we executed, I think, pretty nicely in a very, very tough environment. And again, when we gave guidance, I think people questioned us a bit, well, "Why would you take guidance down for APAC specifically?" And we were saying, "Hey, it's a demand issue. It's not a supply issue." The question is there, but things turned out the way they did. And at the time, we said we also didn't adjust the Americas and EMEA guidance, our guidance for those 2 regions, because we just didn't know anything, and they were clearly impacted. But collectively, the team played it out nicely. There's a lot of things that moved out of the quarter. There's a lot of things that moved into the quarter. Actually, deals moved in, moved out, moved in, moved out, the same deals. So there was a lot of things going on within the quarter, especially right when things started getting tough from an uncertainty perspective. But I think, ultimately, the product took over because some of the things that helped us with the quarter -- a lot of solutions couldn't do is like we get calls that say, "Geez, I needed some help. Can we get this done in a week?" And we said, "Of course. Yes, just tell us what you need, and we'll do that." So ultimately, it was good execution. But I think the product really ended up shining quite nicely in a tough environment, too.

Okay, great. You talked on the call about -- on the earnings call about starting to have line of sight to a renewal cycle. Can you talk about what the timing is here and why you think it's so important to the business?

Oh, yes. I think it's more than important. I think it's huge. It's absolutely huge for the business. And yes, it's just -- we had a tiny bit in Q3. And quite honestly, most of that renewal of, call it, $5 million of nonsupport renewal in Q3 wasn't even associated with our move to subscription 1.5 years ago because we were selling -- upsell software Pro and Ultimate before we made the official transfer over to subscription. So a lot of that renewal came from those type of products or some of our cloud stuff that had shorter terms. But that was the first piece. And where we have average terms or 4 years is going to take a while, but we do have 1-year term, 2-year terms, 3-year terms. So those will mature, obviously, earlier than the average. But why is it important? It's just like why it's massively important to any subscription company is because that's what's going to, ultimately, garner us leverage going forward because those transactions will come at a very high-efficiency factor. When I talk about efficiency factor, if we transact new and upsell business at x, it should be x minus 80%, x minus 90%, something along those lines. So these dollars, the renewal dollars, will get -- that's where leverage comes from. It's the renewal base. And the average subscription company probably is 50% -- 40%, 50% of their base of that stuff. And again, for us, it's all been tough. Right from the beginning, we haven't had any renewals, except for some support renewals. It's all been tough new business, and it's all been upsell business which is not as hard and not as expensive, but still it's a tough business. So what we'll have going forward, that mix between new upsell and renewals, there will be a shift. And by definition, the renewal sliver will turn into a pretty big chunk of the business as we look over the next 4 or 5 years. And I think the intriguing thing, again, if people want to do the work and all the numbers are there basically to do the work. Go model out FY '23 and see and pick a growth rate. You pick whatever you want, 10%, 20%, 30%, or whatever you want to pick, and see what our renewals could be as a percent of that total, even in FY '23, and then when you look at the efficiency factor of those and things like that. So I think it's -- as I was saying yesterday to some folks, I think it's probably the most exciting thing going forward for the business, quite honestly. And all the hard work has been done. And now the focus is on the renewals and how do we get those to be a very efficient transaction. Chris Kaddaras is already setting up a small work structure to handle those that will be kind of teamed with the sales -- as a sales rep, PSE, and then a separate group that will help with these. So yes, massively exciting, and then that will also get facilitated as we transition over to ACV comp here in the near future.

That was my next question, so good segue. You talked about aligning the sales comp to ACV and incentivizing the sales force to reduce contract duration. First, can you explain to everyone the difference between TCV and ACV? Some people may not be super familiar with that terminology. And then also -- and secondly, can you explain why that ACV metric is becoming so important?

Yes. Yes. And this is another really, I think, important event for the company here. So TCV, again, it's just -- if we do a 3-year deal that's $3 million of license over the duration of the 3 years. That's the total contract value, $3 million. And then simply, the annual contract value, just divided by the terms, so $3 million divided by 3, $1 million of ACV. And then ACV times 3 is $3 million. So it's as simple as that. But there's a couple of things going on now with ACV comp. I think the first thing to really think about -- and if I was a Nutanix rep, which, thankfully I'm not because I wouldn't do very well. But if I was a Nutanix sales rep, I would be out there every day trying to -- what they get incentivized to do today to maximize TCV. And also I would care about is give me a 5-year deal, I'll discount it as much as I can, but I want maximum TCV. So their interest today and the company's interest of a nice discount deal is not really aligned. So when we go to ACV, everybody is going to be aligned because now the rep should only care about maximizing ACV. And if that happens to come with a 5-year deal, great. If that happens to come with a 3-year deal, great. If that happens to come with a 1 year deal, great. But by definition, I think discounting comes in line, and that gives some of these terms might decrease and whatever. But you mean, ultimately, decreasing terms for the company is probably the best thing that could happen. Yes, and TCV comes down and all that stuff, but what happens when terms come down, 2 important things: discounting comes down because we know we discount a 5-year deal x percent more than a 3-year deal. So just on that shift, it's just a 5 -- just assume it's 5%, that's a 30% uplift on that transaction going from a -- over the equivalent 5-year period, going from a 5-year to a 3-year. So there's huge benefit to the company there. And of course, the shorter the terms, the quicker the renewal comes into play to get to a more efficient renewal. And then the other thing that ACV comp sets up is when the renewal does come, and our reps haven't really -- we haven't had any renewals anyway, but just like any subscription company now that when that renewal comes, the compensation associated with that renewal will be obviously a fraction of what it was on the original transaction. So massively exciting. Terms will come down, there's no doubt about that. In conjunction with that, when we give guidance for FY '21, some of the macro still holds, and we're comfortable doing that. We will focus on ACV guide because terms do come down, TCV will do what it will do. But again, we'll focus on ACV, watch ACV growing. And again, with some term declines, discounting comes down. And actually, ACV growth -- actually, ironically, you think it has nothing to do with terms one way or another because they're ambivalent -- ACV is ambivalent to terms. But actually, decreasing terms actually increases ACV growth because the discounts decrease. There's a lot there to talk about, and you -- I could go on for hours about that. But on the surface, it's a pretty exciting thing. I think we're -- on the call, we said we need to be an ACV, a TCV hybrid, or full ACV. We still have some things to work through -- I'm -- and hopefully, that it will be a clean ACV cut over.

August 1?

What's that?

August 1.

August 1? Yes. Yes.

Okay. And I guess some investors might ask, given your cash position and the fact that you've been a TCV company, and you've collected cash upfront and you're burning right now, isn't it a bit counterintuitive to push for a shorter-term duration?

It's the right thing to do for the company. The ROI is massive, right? It's almost like, why wouldn't you do that? We'll go get the base cash burn down. We're doing a good job on expenses. We can talk about that if you want. But I don't know, worst case, you put a little money on the balance sheet to fund this effort, but it's the absolute right thing for the company. I mean it sets it up so nice, discounting comes down, the renewal rates start quicker. Obviously, the convert market is wide open. So I'm not concerned about that because it's so overwhelming, and the ROI is so overwhelming. It's like, why wouldn't you? And I think -- now we need to think through some things and make sure we completely understand how the terms will -- until we've modeled it out. And again, for term decreases also, if you look at it, when we put this matrix together, new business is 25% -- 20%, 25% of our business. That piece of the business would be subject to that -- a customer is not a customer, and so there's probably more downward pressure on new terms, about new business terms. But an existing customer, I don't see a massive rapid change there because if a customer goes from 5 years to 3 years but also has to happen there as the discounts have to go down. So I think that's probably a slower migration on that piece, maybe the new business a little bit. But some enterprises just continue to demand 5 years, and we'll continue to do those deals.

Okay. Well, let's talk about the cost-cutting initiatives and how you're focused on trying to get the burn rate lower.

Yes. So we got a pretty good -- I think early on effort, again, I think we were worrying about the macro, I think, probably before most folks. And we already had some plans in place to really -- to put some clamps on spending. And I think we've done a pretty good job with that. Now we've been helped out by no travel and things like that. But we've, I think, taken a nice view there, and it's a $375 million to $400 million for expenses for the next several quarters there. But I think what's -- with everything that's gone on with COVID-19, what it has done is made us think differently about the business and how can we get demand gen more efficient. Maybe we don't need to do what we were doing before, or maybe we don't need to do all these events in person, or maybe we don't need to do all these travels. So I think there'll be a lot of rethinking as far as the expense architecture goes, if you will. And then, quite honestly, we've been void of a worldwide sales leader for, call it, 1.5 years or so. And Chris is now fully engaged in there. And I'll tell you, the discussions that he's having with his folks and the executive team, probably a discussion I haven't heard in the company since I've been here, and I've been here for over 6 years. It's now -- it's like, no, guys, you have enough resources, right? We've built up a lot of resources. Let's go figure out how to get some things more productive, maybe we'll tweak some resources here, maybe tweak some resources there. But I'm pretty excited just about the change of thought process there. It's not -- well, let's just throw some more bodies out and get some more growth. He's really thinking through that. So I'm pretty encouraged on that front. We haven't been hiring many folks. They've been spotty here and there. Even some of the attrition, we're letting it trip. But I think the combination of what we've done upfront with a few things there, very limited hiring, and then how do we do things differently, and then how do we get more efficient with what we have, I think, is a pretty good combination that I'm feeling pretty good about it actually.

Okay, great. I want to bring Greg in here along on competition. I think it's pretty clear who your main competitor is. It's kind of a 2-horse race in HCI. But one of the things that, I guess, I think about over the next 5-plus years is maybe your real competitors are not the guys that we thought, but are AWS and Microsoft because there's a choice for a customer, right, in terms of where he wants to place his workload. So if -- first of all, do you agree with that? And second of all, how do you compete against massive organizations and marketing muscle like those players?

Yes. The framework is correct that, in the data center, if we're competing in the hyper-converged infrastructure market, the HCI market, or sort of the larger private cloud market, the competition is VMware, and it has become a 2-horse race. However, the higher order decision that customers were making is they have to decide where I'm going to invest in IT. Am I going to continue to invest in my private IT by data center? Or am I going to continue to shift workloads and data into public clouds? So we've actually been an indirect beneficiary, as I mentioned, for the public cloud spend because we provide a cloud-like experience in the data center. But going forward, all of our customers are working toward a hybrid cloud architecture, that they're not going to abandon their data center, they're not going to give up the ability to run workloads in an environment in which they control. But they also want to avail themselves a public cloud services, whether it be AWS, Azure, Google Cloud or other. So everyone's working toward and marching toward this hybrid cloud environment. But to pay that off, you need to meld the 2 environments together, private and public. Because too often today, the decision -- even if I have resources available to me in the public cloud, AWS and my own data center, the decision to place a workload, the decision to manage data, is a binary one. I have to decide upfront. Is this workload going to run now and forever in AWS? Because once I place a workload in a particular cloud environment, public or private, it is really difficult, time-consuming and expensive to extract it. And to change my mind -- to put it in any different -- to go either from public and pull it back and repatriate back onto on-prem or vice versa. So what people want, what they insist upon in this hybrid cloud is the ability to make workloads and applications mobile, right, to do that lift and shift. So that if I wake up on a particular day and for the business' sake, I want to run workload A in a private cloud, whether it be for better economics, better run time economics, security SLAs or what have you. If I do that on Monday, but I wake up Tuesday, and I want to run it in AWS. And Wednesday, I changed my mind yet again, and I want to shift it to Azure. So that is what our customers tell us that they are looking for is that freedom, that flexibility, and that's what we're trying to do. And the way to do it is to provide the same experience, the same capabilities, the same software stack that runs on a bare metal server in the data center or an AWS or an Azure. And regardless of which cloud I get a in a single console, I can see and manage and monitor all my applications and data from that console. And from that single point, I have the ability to move or lift or shift applications between clouds, to optimize economics, control and performance. So very soon, we will be able to do exactly that, provide the entire cloud stack in not only private clouds but public clouds. So that is the vision right there. And again, it's about -- we've been very successful in building the HCI market, consolidating teams, consolidating licenses, consolidating IT resources in the data center, basically making things simpler. What's happened with the advent of public cloud and this rapid adoption is we've had to sprawl. Typically, even when customers use AWS, they have a separate team advantages. They have a separate management workflows. We'd like to consolidate that, and we think we're on the right path to do that.

And relative to VMware was, I think, a similar vision as you guys do. They have this really deep partnership with AWS. They have some very deep partnerships or building partnerships with Microsoft and Google. Do you guys need to create similar types of partnerships there so you can really leverage the -- I guess, the branding of some of those big players?

Yes. I won't discount the possibility of having the sort of go-to-market partnerships. But right now, the approach we've taken is, it's not necessary for the business in that the way we've architected the software to run in AWS, for example, we're using open APIs. So we're able to do it in a very seamless fashion. So the way we're going to go to market with this is continue to help our customers modernize their data center, but let them know that the licenses that they buy, when they buy a Nutanix software license, and they can run it in the data center, but they can just as easily run it in an AWS. That's not possible with our competitors. That's not possible. Basically it used -- only Nutanix will allow you to pick up your licenses, move them to the public cloud and, at the same time, be able to use whatever AWS credits and accounts that you already have. So we're making it seamless. Other companies have taken different approaches where they separately bundle AWS services, along with their software, and they manage it for you. And so you have a pseudo-managed service in the public cloud while you have a do-it-yourself on-prem. And that complicates things from an operational standpoint in terms of how I manage the infrastructure and even how I manage applications between these 2 environments. So we were very happy with the approach that we've taken, and that is, one, cloud-agnostic. We're not walking ourselves into a single cloud. And having to go to market that gives us the ability to do it ourselves with our existing channel partners and down the road, if we so choose, to partner with a public cloud vendor.

Okay. I've got 2 questions from the audience, and then we'll wrap up. I know we're going over here. First one for you, Duston, and second one for you, Greg. First one is, the stock is still attractive, why aren't insiders buying the stock down here? And then second is, given your position at the base layer of the stack, do you feel like things like monitoring tools, et cetera, could make sense to what more security could make sense to add to the stack?

Yes. So I can't speak to other folks, obviously, as far as why folks aren't buying stock. But I think, every quarter, I add to the stock that I own through vested RSU shares. The company sells some for the taxes. But I've been accumulating those residual shares, and I've not been selling those for a while. And so I don't know, when I add net shares, maybe 25,000 a quarter of owned shares from my perspective. And I agree, that's -- the stock is at a pretty low point, especially if you want to do the work, look to 1 year, 2, 3 years out, there's no doubt -- I mean there is like no doubt if you want to do the work because the renewals are going to happen. They will happen. And maybe they come in at 95%, maybe they come in whatever retention rate is. If that's going to happen, we're going to transact them at a low rate. And by the way, that's not -- that's another reason why we have this debenture out in 2023, that's due today as a 0 coupon. But that's fine, I'm not in a rush to do anything there. We'll do something 12, 18 months in advance of that maturity date. But it's not like I want to go out and rush just because everybody else is doing that today from a convert, because preferred market is so strong. I'm not anxious to do that transaction, to refinance that piece just because a, we don't have to, and at a $25 stock price, I'm not anxious to do that.

Greg?

Yes, touched on 2 important aspects. And one was monitoring, and the other is security. So for monitoring, we've continued to build the instrumentation into the stack to give people the ability to monitor different levels of their infrastructure, whether it be application performance, storage, characterization and so forth. One example is we bought a company, I think, about 3 years ago, by the name of Minjar and then created a product called Epoch, which gave us some really deep monitoring capabilities per application, looking at actually performance attribution -- attributes per application or per workload. We are actually building that technology into our management console, into Prism and Prism Pro. So we continue to enhance what we have. So monitoring is really important, particularly as you consolidate IT resources, you have to provide the operator visibility across all the different layers of the stack. From a security perspective, we are not a security company, okay? We don't have -- we don't explicitly sell security products. What we do, however, is build security into every product and into the policies of those products. The most explicit way that we do that is with our Flow product, which is part of our AHV virtualization layer. And what Flow does is provide micro segmentation, which is a fancy way of saying that we're able to provide firewall services, data controls for each and every application individually. So we do that. We build that in a policy. So when customers today use and consume the full Nutanix stack, they can not only provision an application in an environment, but they can tailor a security policy just for that workload. And the beautiful thing about attaching security, making security as part of the stack, attaching security to that individual workload is that when I move that workload, when I lift and shift that application, either to a different part of my data center or to a public cloud, the policy goes with it. So I can protect my application, okay, I can protect who talks to application and when, and I can do that regardless of location. So we're building security into the stack. We're building security into the experience and into the policies, but not by selling explicit security products.

Okay, understood. All right. We have to wrap it there. But Duston and Greg, thanks a lot for joining us. Thanks, everybody, on the line for being with us as well. And stay safe, stay healthy. We look forward to seeing you guys in person soon.

Thanks, Jason.

Thank you, Jason. Appreciate it.