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

Good afternoon. Thanks for joining us today. I'm Jack Andrews. I cover the data analytics and infrastructure software space at Needham, and we're very pleased to have Nutanix with us. Today, we have Duston Williams, CFO; as well as Greg Smith, who is VP of Product Marketing. So welcome and thanks for taking the time to join us today.

Maybe just starting off at a high level, just Nutanix has been through a number of changes. So could you just talk about speaking here today, what is the catalyst for one to become a customer of Nutanix? We all know that traditional infrastructure has been very complex. So is there a specific pain point these days that's really driving customers to your solution? Is it more of a frog boiling in water analogy where things just ratchet up over time? What's really driving -- what gets people excited about becoming a new customer of Nutanix these days?

Yes. Thank you, Jack. I can take this. Customers come to Nutanix when they need their IT infrastructure to drive better business outcomes. And by that, I mean, they need to lower their operational costs. And they typically do that by removing complexity, moving complexity in how they design the private cloud environment, how they operate it, how they scale and how they troubleshoot. They also need greater IT agility. They need to be able to provision new IT environments faster so that they can get applications and services to market faster, and then, of course, run them at a lower cost. They also need to react to unpredictable business conditions. So they need to be able to scale out capacity on demand and do it without any downtime. So they look to IT and the infrastructure to get to market faster and reduce cost. I think going forward, cloud strategy plays a big role. I mean, clearly, we see big decisions being made on the part of all organizations of where they invest their IT dollars. And what is top of mind for companies as they look at their public and private cloud investment mix and where they decide to run applications, whether they run them and deliver them via their own private cloud or in a third-party public cloud, they want those investments to be liquid. They want to make sure that when they invest in a technology or vendor, they are not locked in. Can they move those investments? Can they move those software licenses between their own IT sites as well as can they move them to third-party public clouds so those assets don't get stranded? So those are the dynamics that we see with our customer bases and what they are prioritizing.

Right. No, I appreciate that. And then just could you touch on maybe the broader market opportunity and just how you see it these days? It certainly seems like this has gone from evangelical to a mainstream concept now. A lot of other IT vendors have introduced, for example, their own hyperconverged products. But are any of these things really credible out there? I mean, it seems like -- should we think of you as basically become a -- is this a duopoly between yourself and VMware, just how are you thinking about your core HCI market environment these days?

Yes, I can address that one as well. So first of all, hyperconverged infrastructure or HCI is absolutely mainstream today. It's almost required as companies need to modernize their IT infrastructure to be more cloud like. Gartner, for example, forecast that adoption of HCI will increase from 40% to 80% in large enterprises in the next 3 to 4 years, and we see that reflected in our business as well. In fact, Nutanix now counts among our customers, nearly half of the Global 2000. So we're seeing companies of all sizes, particularly large-size organization, really feel the need to bring their infrastructure into the modern era and they are using hyperconvergence to do exactly that. And they are using HCI to deliver nearly every type of application. So we see it from the low-scale applications into the most demanding databases and now using it to deliver cloud-native applications, so those that are containerized and using Kubernetes orchestration. From the competition and the competitive dynamic that you mentioned, one thing that is clear is our Core markets, including HCI, this is a software market, meaning customers expect that they get the flexibility and the freedom that it comes with being a software solution. So they want software. They want the velocity of new features and capabilities that come with software. They want the flexibility to run the software on the hardware of their choice. And so we know that in the HCI market and in the private cloud market, it's really become a 2-horse race, and that's Nutanix and VMware. And what we've been told by the leading industry analyst is that from our Core product, HCI, we're leading that market. We are the market share leader in HCI software. And that's a result of our -- the velocity of a road map as well as bringing customer to light and having a Net Promoter Score, now 5 years running, over 90. Going forward, in order to stay on top and take advantage of the software form factor, customers are now asking for 2 things. They're asking to make sure that they can run that software solution, for us, the entire Nutanix stack, across multiple clouds. Can they run -- they want to be able to run it in their private cloud, but they also want to be able to run it in their choice of third-party public cloud. And of course, they want more and more services. They want not just infrastructure services, not just storage and compute and virtualization, but they want more application layer help. So they want more orchestration and automation so that they can provision applications with 1 click. They can provide services in an open marketplace for their internal customers. So we think it's software. We think it's multi-cloud, and we think that it's become a full stack sort of demand that we're seeing in the market.

Right. No, I appreciate that overview. I want to touch on just sort of timely topic these days, which is just related to COVID-19. When you think about the past 9 months in your business, can you just talk about what changes that happened are maybe permanent going forward? And maybe what changes that have happened are really just temporary in nature and you think are going to go back to sort of the old normal, whether it's from sales or product perspective?

Yes. I can take maybe the front end of that. I think what doesn't change, as we've talked about is customers have the need to move faster. They need to be more cloud-like. They need IT to really empower business that help them get new services to market, revenue-generating applications to market faster. In terms of our business, and how it's changed is the initial engagement that we have with customers, of course, is more virtual, and that's put pressure on the organization to make sure that our sales teams are more efficient. And how can we leverage -- how can marketing particularly accelerate that sales cycle? How can we bring customers through that buying journey faster without a lot of on-site, human-to-human contact. So one thing that we've done is to make sure that our customers can evaluate our products in a very low friction way and they can do it on demand, so without needing an on-site, rigorous evaluation or software. So we put everything in the cloud. And we've made the evaluation of software very easy with something we call 'Test Drive' that's running in a third-party public cloud that's on-demand and customers and prospects can do a full evaluation of all of our capabilities without sort of heavyweight evaluation process in their own environment. Now that's the initial acquisition, adoption/expansion. We also want to increase adoption/expansion. So we want to do that again through various means with marketing. We've shifted -- we're pretty much all virtual now, and that's had a great benefit, not only lowering our cost, reducing travel for the teams, but by making easier for prospects and customers they are able to spend more time with us. They're able to take the time, learn more technologies, learn more about our products and capabilities and ultimately consume more of the content that we're putting out. And so that's been a positive for our business is that not only are we more efficient, we hope that our customers -- we're making our customers' lives more efficient throughout the evaluation process, and then, of course, how they embrace and get the value of Nutanix software.

I think one of the -- your question is what did it cause that won't continue. And I think one of the things, we've got a wonderful end user compute solution in total. But we saw that initially in Q3 go up to high 20%, mid-high 20%, of total bookings. Normally, that runs 18% to 22%. We've seen that come down now into the high end of that range, but we didn't think it would continue up at that level. It was lucky that we had a solution that could be implemented quickly and seamlessly and all that, but that won't continue at that level. I think the good things of COVID that really -- and Greg mentioned most of them, it forced us to do things either that we didn't think was possible or we were comfortable doing it the way we were doing it, and the virtual events that Greg talked about. Who would have thought that you could have done our .NEXT event 100% virtual, have the attendance that we had and have the feedback that we had and building a pipeline and things like that. We didn't think that was possible. We didn't think it was possible to go add, although it's come down because of the COVID situation, 700 new customers without any in-person contact. So what we have to do going forward is the goodness that's happened, how do we continue to make sure that goodness continues and we don't go back to our old ways. We can't, as a company, go back to spending 100% of the travel that we spent in the past because we don't have to. We know we don't have to. We don't have to have all the events in person. There will be a hybrid, but we know we don't have to do that. So from a spend perspective, there will definitely be things that we will do different because we were forced to do it different and now we know that it works.

Right. No, that makes a lot of sense. I appreciate your commentary around that. Just to put a fine point on it, though. If we think about remote working persisting in some form or fashion over the long term for some of your customers, how should we think about how that impacts demand for your offerings?

Greg, do you want to take that?

Yes, happy to. I think in terms of demand for our products, we see more adoption for a lot of the, what we call, portfolio of products. So the hyperconverged infrastructure sort of lays the foundation for that infrastructure to deliver all types of applications and to manage data. And we see companies increasingly build on that foundation to consume additional capabilities and services that Nutanix is offering. So for example, they are -- customers are relying us to manage not only the data for their applications but also file and user data through our Nutanix files project -- product as well as object-based data. They're also looking to us to provide additional automation. They get more value out of their Nutanix investments. So we see increasing consumption, more value that's coming out of their use of the Nutanix stack over time.

Got it. No, that makes sense. Shifting gears a little bit. You've certainly had some significant news recently. You have a brand-new CEO. And so I just want to see if you could talk about what -- just share with investors, what is he bringing to Nutanix? How should we think about any -- what his priorities might be and any notable changes to your company, broadly speaking? I guess the second part of the question is, what's it like without Dheeraj now?

Yes. Yes, it's a good question. You've got 2 leaders that are not unexpectedly quite different in styles and things like that. And that really shouldn't surprise anybody because we had a founder, CEO, that built the company from scratch and those -- that type of environment usually requires different leadership styles and traits and now we're kind of at the next phase of growth that requires a little bit different leadership styles and traits, and I always think that as a great article. He since aged a little bit. He's long since retired, but a great professor at USC, Larry Greiner, had this Harvard business Review article, 'Evolution and Revolution as Organizations Grow.' And the thesis there was is that you go through a prolonged state of somewhat steady growth and kind of what worked at that period continues to work until you come to a revolution and of slower growth and whatever. And you could argue a lot of our transition was that period of revolution where we had some slower growth for whatever reason, and then you kind of regroup and you have a different kind of game plan to get you to the next evolution, a period that's a longer period of sustained growth and then there's another revolution, et cetera. But there's always leadership styles that are different and game plans that are different within those phases. So we've got 2 different leaders. And in my month of -- with Rajiv, he's been obviously massively engaged in the business. He's met a ton of people. I don't know how he's done as much as he's done, quite honestly, in a month. He is very focused on a few different things that shouldn't surprise you because we've talked about them in the past, around completion of the business model, and that's a generic term but buried within there is the go-to-market efficiencies. How do we get more efficient with the go-to-market spend? And I'd tell you that's a massive effort. There's already been a lot of work done there. He is laser-focused on that piece of the equation, and so I think you'll see some goodness happening there. Because in my mind, the go-to-market leverage, there is 2 pieces of go-to-market leverage. There is the piece that's going to happen, "It's a lot of work naturally through the renewal stream." As more renewals come in, you're going to transact those at lower cost, a bigger percent of the business, you're going to get leverage. But the harder work is how to forget that, how do you get leverage regardless of that? And what do you do differently within the go-to-market cost structure to do that differently? So that's a major focus of the business. And within that piece, obviously, you have the renewals, which is how do we end up transacting those and consumption and all that stuff. So huge effort there, product rationalization, product portfolio rationalization. We've talked about in the past, these aren't surprises here. What do we do differently there? Do we make bigger bets on some products? Do we not make any bets on other products? There's a lot of discussions going on there. Some more around partnerships, how do we get more leverage on partnership. There's a long list that, actually, we're all, as a team, working on these as we speak. And the -- ultimately, the accumulation of this effort will be some type of -- I put in quotes again, "Investor Day type view of the business," which we've been wanting to do for a while. Obviously, COVID came along, the CEO transitioned. We need to give Rajiv a period in the saddle before he's comfortable. But that's what I'm excited about is to get that type of presentation in the investment community, because I think it's going to be a pretty powerful view of life as far as the business, the products, the business model, going forward.

Right. No, thanks for that. And that's something that we would definitely look forward to because that kind of leads into my next question, which is, based on our investor conversations, I feel like Nutanix has been a difficult story for a lot of people over the last couple of years, just given all the transitions you've been through. There was the hardware to software perpetual to subscription. Now you've embarked on the TCV to ACV, plus you also have this architectural shift as well, moving from on-premise to hybrid and SaaS. So I guess, maybe just focusing on the most recent transition, TCV to ACV. Could you just remind everyone what the benefits are? Why are you doing this? And what are sort of the near-term milestones we should be thinking about as you are on this journey?

Yes. So you are right, I mean, there's no dodging that, that point that has been tough for investors to model the business to get the hands around the business. And it's been a frustrating point, obviously, in my part, because a lot of these transitions -- now these transitions have been always for the longer-term good of the business. I mean, we could have ignored a lot of these, but I think we've now got the set up with a powerful combination of a -- which I'll get into in a second, a great business model. Now combined maybe with a little bit more focus on efficiencies and go-to-market efficiencies and product rationalization and the combination of those 2 things that I think ultimately will be a very powerful combination. But specifically on the ACV piece, why did we change the focus from TCV to ACV? We were convinced it was the right thing for the business. It was the right thing for customers and ultimately garner more efficiency and leverage for the business. And our -- just as a reminder, again, our premise when we went into this shift, from ACV to TCV (sic) [TCV to ACV] and it started firstly, which you had to do with the sales comp model, it was a day 1 change, August 1, we started comping on ACV versus TCV. But our whole premise there was when we did that, we would now have total alignment with the sales force and the company's objectives that we would both now be focusing on maximizing HCV, which means minimizing discounts. Before, we all wanted maximization of TCV, but the company wanted lower discounting and those 2 were counterintuitive. Because a sales rep would want highest ACV, and in fact cause more discounting, so be it, so I could get more TCV. Now we are 100% in line. We also thought that when that occurred, terms would decompress. And in Q1, terms compressed. And when terms compressed, we believed that the business would get more efficient as measured in our internal measurement of ACV per Core. And ACV per Core increased in Q1. So terms compressed, discounting went down, ACV per Core increased and then what happens when renewals -- when terms compressed, the renewals happened quicker. So instead of a 5-year deal, now we've compressed them a little bit more now last quarter's 3.5-year deals, and we did a significant amount of 1 -- year deals. So now with those shorter-term deals, we did $20 more million in Q1 than we thought of 1-year deals. Now those deals are up for renewal in FY '22 at a high-efficiency factor. So now we have the kind of the model flowing, the renewals flowing, a bigger mix of renewals, better efficiency, et cetera. So that's why we did this and more optionality for the customer, too. Because now the customer can -- they want a 1-year term, our sales rep will be more than happy to do a 1-year term. If they still want to do 5-year terms, that's what they really want to do, then the customer -- it is fine, we will do 5-year deals. So there's optionality for the customer. It's good for the reps because now the reps have a lot more option on how to make quota because they can go in all sorts of direction. And the last thing that we assumed in this transition was there would be higher emphasis on new products. And why? Because new products have shorter terms. And in a TCV environment, shorter terms were not in favor of the rep. Now shorter terms, which have higher ACV per Core actually leads the rep to higher order attainment. So now those new products, which are more 1-year deals than other products become in favor, too. So that is kind of in a nutshell why we were excited about the potential of this transition, and after 1 quarter anyway -- now we'll have to see how Q2 plays out. But after 1 quarter, that initial premise played out as we thought.

Right. No, I really appreciate that detailed explanation. So just to put a fine point on it, so besides building the renewal base in an efficient manner, and getting better, call it, unit-deal economics, the last piece I want to drill in on a moment, so the new products -- so it's strictly -- should we expect -- because you had a very strong new product attachment, I believe, in the most recent quarter. Do you expect that to be something that -- given the dynamics you described that this transition should help unlock selling your whole host of new SaaS-based products this should help gain them -- get traction on these products moving forward then?

I do. I do. And I think we've gotten some pretty good traction in a period of time. I think, again, from a sales comp perspective, they come back into favor quite a bit. And it might not, obviously, be probably a straight line, but yes, I think there will be continued focusing because it's not only that it's good for the rep but they are good products. Right? They solve problems. They are really good. I think what we've recently done with Era and some of the new customers that we've captured and the repeat business that we're starting to see after a quarter or even 2 quarters of deployment of these products, the products solve problems. So now we've got a good product, you've got reps focusing on it. Now we can never lose, obviously, sight of the Core, because that's what pays the bills today. But I think it's a great combination that I think can only help the new products.

Right. No, that's great. And I know that there's been some -- you solved some very technical -- very difficult technical challenges that some people felt that you couldn't do. So that's -- it's great to see that they will be hopefully going to get some real traction moving forward. So shifting gears a little bit, as part of this transition, you did raise some convertible debt with being capital. So I just wanted to ask just how is that relationship going, given that Bain has 2 seats on your Board now? And how do you feel about your balance sheet these days?

I feel great about the balance sheet. It's quite hard not to feel great about the balance sheet. But again, the balance sheet -- again, why we put that money on -- raise that money, was more around comfort, in my mind, around the ACV transition and let terms do what terms do. And if terms can press a little bit more than we think, we've got plenty of cash. So that was a big comfort level there. It wasn't to go put a bunch of money on the books and go spend a ton more OpEx. That's what it was not. It was meant to go -- let us go run the business, let us go focus on ACV and let that play out. Your question about Bain, how that's gone? I -- no, it's been, what, since August, and we've had some reasonably good quarters, so -- but they've been very engaged in the business. They're willing to help with most anything. They've spent a fair amount of time with Chris Kaddaras and his team. What I've personally asked their help for is once we kind of get to this rollout, if you will, of some type of Investor Day, whenever that may be, is some help in thinking around positioning of that and how can we do that in the most succinct manner possible. The content is there, but again, just help some thinking around that. So they are -- they got a wonderful, obviously, knowledge base. They've got a big team. And again, they've been very engaged, very helpful. They will offer different views and perspective on the Board, which I think is great also. So I think overall, I don't know how we couldn't be pleased with what we've experienced at least since August. And you will have to ask them if they feel the same in reverse here, but they have been very engageable and I think very helpful so far.

Right. No, that's great to hear. And so I guess maybe just maybe to guide us over in advance of a Financial Analyst Day at some point down the road, could you maybe just provide a high-level framework in terms of just, as renewals become a bigger portion of your business over time, just directionally, how should we think about the potential operating leverage gains that should come from that?

Yes. It's hard to talk about that without details. We have a wonderful presentation already put together here. But again, you should think of it in 3 buckets we have talked about. The cost, the S&M cost per dollar of revenue for new business. So how much do we have to point at that, how much of that needs to kind of estimate it, but pretty good? How many S&M dollars per dollar of revenue for upsell? And how many S&M dollars do we need to point at the renewal piece? And they are substantially different as you might expect. High on the new business, a lot less on the upsell and significantly less on the renewal piece. And so as that mix changes, and we know, by definition, the renewal piece. And you have to look at -- this is one of the metrics you have to look at it really on a TCV basis, because that's how the P&L is run and leverage is run off TCV. Today, on a TCV basis, those renewals are very small piece. But we know as we get into FY '22, that increases are reasonably high. And then in '23, you've got another big pot, so by definition, you've got a bigger percent of the business that's getting a cost factor that's a fraction of new and certainly seemingly less than upsell. So you just get natural leverage there. So that will happen over time. The thing that we need to focus on in the interim is making sure the consumption of the product happens, because if a customer is going to consume the product, highly likely they are going to love the product, and if they love the product, they are going to renew. If they don't consume it, they're not going to love the product and they're probably not going to renew. So that's what's focusing on now. And then just the whole renewal team and how do we do renewals efficiently and things like that. So that's a big focus. But in the interim, I think you've asked what's the different focus that Rajiv has brought or whatever. I wouldn't underestimate, and we'll have to see how this plays out, I wouldn't underestimate the potential ignoring the renewal flow, the potential for go-to-market spend leverage even before those renewals might happen. So again, there's 2 pieces. Again, there's just plain efficiency. What do we do better? What do we do smarter and then the efficiency that's garnered from the renewal flow? So that's -- we'll see how it plays over time.

Sure. No, that makes lot of sense. Appreciate that commentary. So that leads me back to sort of a couple of go-to-market related questions. I mean, one is, could you update us in terms of the progress with your self-service channel, you've got sort of a 0 touch model, how much of your sales are -- could perhaps go through that channel over time? How should we be thinking about that as a potential source of efficiency or is it too early?

Greg, do you want to touch on that a little bit? I can add as needed.

Yes. Happy to. Yes. So as you know, we have a very strong channel ecosystem. We rely on our channel partners, not only to bring us new prospective customers but make our existing customers successful. So we've invested considerably in helping our partners. Most recently, we've improved the deal registration program, we call it, Performance+ Deal Registration. So it helps our partners register deals and give them better incentives faster. So that's been a success. We have also accelerated our deal flow through distribution, and we've done that by automating a lot of the resources that partners need to size their Nutanix environments to quote and to support the deal. And then we back this up with a lot of partner certifications that not only cover sort of the sales and technical skill sets but also the delivery and the customer success skill sets. So we really invested with the -- in our partners. They've told us that they want more autonomy. They told us that they want the tools. And so over the last 6 to 12 months, our channel team, sales and marketing, have really invested in those to make them successful. And so we're happy with where we're at and we're happy looking into calendar '21 as well.

That's great. And then just to put a fine point on it, is there any sort of update you can provide with HP? Looked like you got off to a pretty good initial start with the relationship there. How should we think about some larger partners like HP, in particular, moving forward?

Yes.

Yes, go ahead, Duston.

Yes. No, HP, we're, what, 3, 4 quarters, in the 4 quarters into it right now, I guess, now. And it's gone great. A lot of traction. It's done really 2 things so far. One thing is that we've had an existing customer base that, in some cases, might have a higher preference for HP service. So we've seen some business shift over from the NX appliance to HP, just because that's what their infrastructure environment runs on and that's what they're comfortable with. And then we've seen a fair amount of new customers being generated from the HP product line, too. I think what we love to see even more is a little bit more leverage with the relationship, which I think we're working on and we will see how that plays out. But so far, it's worked nicely. And again, the big thing is it's given customers optionality, too. It's not only for existing deals but new deals that somebody that's got a complete HP infrastructure that loves their servers, loves our software. It's a perfect match from that perspective.

Right. Okay. I appreciate the update. I want to incorporate an investor question in the mix here, which is sort of gets back to one of my earlier questions. The question basically says, we can model growth rates for HCI just based on some of the, call it, the analyst market share reports. How should we be thinking about modeling for some of your newer SaaS products, like Era, Files and Frame? Is there sort of a corollary to think about industry dynamics, I guess, around some of these new SaaS products?

Greg, probably more -- makes sense for you to answer.

I will leave the modeling question -- the part of the question to Duston, of course. In terms of the new products, and we mentioned some of them, so Era for database-as-a-service, Calm for application lifecycle management, Files for providing file based storage, Objects for object based storage and so forth. So the best way to think about these is these are -- our HTI is really the digital infrastructure that we provide customers. It is the infrastructure service. It allows them to be more cloud-like. As they progress in their modernization and their cloud strategies, they want more platform services. They want more automation and more orchestration, and so those services are part doing that, and they run on top of our stack. Now one thing that we've done very successfully over the past 18 months is rather than burden our channel partners, our customers with warning all these different product names and understanding how we go to market with each individual product, we've taken a very strong solution-selling approach. So instead of pitching products, our sales teams are now being very successful in talking to customers about their business problems, and of course, their IT problems. Talking about where they could benefit from automating their infrastructure? What their database strategy is? What database engines are they moving toward, and how can we help streamline that? What is their larger data management and storage challenges and how they can collapse all the different silos of data that they have sprawled throughout their IT environment? So we're having higher-level discussions with our customers and that helps from a solution selling standpoint, which helps drive demand for all these individual products. Another outcome of that is it engages us with different personas, different buyers within enterprise IT. So traditionally, we would sell our HCI solution to data center managers, maybe virtualization teams, but now we're talking to database administrators. We're talking to the line of business, who own the databases that are powering the applications. We're talking to the security teams. As we talk about flow, and we're building in micro segmentation into the Nutanix environment. So we're enabling our sales teams to take a very solutions-driven approach to the go-to-market. That's making it easier for our customers to understand Nutanix. It's making them easier to embrace our technologies and we're benefiting because we're talking to a lot more people in the accounts and that helps us expand our business in all size accounts.

Right. No, that's really helpful. We're just bumping up on time here. So I just wanted to ask one last question quickly. I know you're roughly halfway through your fiscal year, but we're in a new -- brand-new calendar year, I should say. So maybe what's the most important or the hardest thing that you're looking to get accomplished over the next, call it, 12 to 18 months?

Hey, Duston, you are on mute.

12 to 18 months is a long time. But I think right now, it's kind of those objectives that Rajiv has put out there, that the executive team is working diligently towards here. It's completion of the business model. It's the product portfolio rationalization. It's leverage from partners. There's lots of meat there that -- call that, the initial phase is 6 months, but some of those phase out over FY '23, as far as specific targets that we have put in place. So there's lots of -- I make it sound simple, but there's lots of sub-efforts around those things that some you will see immediate benefits, some will be rolled out over a period of years, a couple of years anyway. But the ultimate goal of committing to a specific time frame for free cash flow positive and committing to a specific time for operating profit, positive operating profit. So that's what we're working towards kind of at a high level over the next, certainly short term and then over the next couple of years.

Sure. Got it. Well, I think we are out of time. So I'm going to leave it there, but thank you both for joining us, and we look forward to learning more details about some of the -- all the work you're doing behind the scenes.

Great. Yes. Thanks so much.

Yes, take care.

Thank you.