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

Welcome. I'm Katy Huberty, IT hardware analyst at Morgan Stanley, and I'm really pleased to welcome Duston Williams, CFO; and Monica Kumar, Senior Vice President of Product and Solutions Marketing at Nutanix. Duston has served as CFO to public and private technology companies for over 20 years. And over the last decade, he has led 3 companies through an IPO, including Nutanix, in 2016. As Head of Product and Solutions Marketing, Monica is responsible for driving the global go-to-market engine. And her experience includes more than 22 years at Oracle, where she was most recently VP of Oracle Cloud Platform Marketing. Before we begin this discussion, I want to point you to Morgan Stanley research disclosure website at www.morganstanley.com/research disclosures. If you have any questions, please reach out to your Morgan Stanley representatives. Duston and Monica, thank you so much for joining us today.

Thank you, Katy.

Very welcome. Thanks for having us.

I want to start out, Duston, by getting your thoughts on the demand environment. Our checks around HCI demand remain incredibly strong. You just guided to March quarter, ACV billings and revenue that is ahead of Street or was ahead of Street last week. Talk about what your view is on how demand will evolve this year, particularly as businesses fully reopen? And then just put some context around how much of that you baked into your guidance?

Sure. Yes. No, we were pleased to deliver not only the Q3 guide, but the Q2 performance that we just announced last week. And to your point, we raised guidance for Q3 and we're really happy with the progress that we're making here. I think on the IT spend in general, I don't think anybody can argue, it's been mixed to some degree, certainly by industry and vertical. Last quarter, we saw financials and health care and SLED performed quite well. And we're seeing some encouraging trends. Also, I think if you looked at the Gartner's recent raise, if you will, on the HCI market in general, so I think that's encouraging. So we're seeing a lot of good signs. I think IT spend is being prioritized around -- more around operational efficiencies. And if you're a company that can help people modernize their infrastructure or make it easier for folks to work from home or help them with their journey to the cloud, I think you're in a pretty good spot, and we can clearly do all 3 of those quite nicely. And we've seen that trend. And over the last couple of quarters, we're seeing a lot of Tier 1 workloads expanding and things like that. So I think once it gets back to more of a true normal environment, whenever that might be, and I think we're really in a good position here to see some pretty good expansion as we go forward. Now it kind of -- it, again, varies by vertical, country and how COVID's going and things like that. But relative to the Q3 guide and how much we baked in there, we still got a reasonably conservative view there. You have to have some bias, I think, to the conservative side, just like we did really for Q1 and Q2. And so that's continuing with our Q3 guidance. But even at that, we had a nice raise. It reflects the -- the ACV billings reflects about 11% to 15% year-over-year growth. So we're starting to see some growth there. So I think overall, not too bad, could be better, but I think we're really well positioned as things come out of the pandemic here.

That's great. And Monica, just from a big picture, how do you think COVID has reshaped the long-term demand curve for HCI? And as you talk to customers, what parts of the Nutanix portfolio is resonating with the customer base as they think about trend that Duston mentioned like work from home or moving to the cloud?

Yes, absolutely. Thanks for that question, Katy. I mean it's no secret to anyone that, whether you call it digital transformation or business transformation, it's been innovated to a whole new level, right, through COVID. And we are seeing people dust up projects that they will put away for the last 5 years to now completely goes in the next 2, 3, 4 months because business continually became a big deal during COVID. For those organizations who are prepared, great. For those who are not, they are now preparing full force in case of another such disaster that may happen. Future work or work from anywhere has been a huge initiative for a lot of our customers. And I think ultimately, it's really about this whole notion of customer and employee engagement and experience through modern apps through cloud and through data. So we are seeing roughly -- those are some of the big buckets of how business priorities are evolving during COVID, right, as Duston said as well. In fact, we conducted something called an Enterprise Cloud Index with a company called Vanson Bourne just a couple of months ago. And we talk to about 3,400 global IT decision makers. And I have some stats here, which I want to read off to you. They've said their primary motive for modifying the IT infrastructure are better delivery on business requirements and improved support for customer and remote workers. In fact, they also said, 86% of the respondents consider hybrid ideal operating model, and 46% of respondents said they increased their hybrid cloud investments as a direct result of the pandemic. Now the fact is, as Duston also alluded to this, organizations are modernizing their infrastructure, embracing more automation, adopting cloud for certain use cases and workloads and ultimately looking to realize those business benefits through the use of hybrid and multi-cloud. So that's where our big focus is. Even according to Gartner Group, 90% of organizations by 2021 will have deployed a multi-cloud or hybrid cloud model for their IT needs. So where am I going with this? Well, now that we know where our customers are at, we also know the power of the Nutanix HCI platform. And essentially, Nutanix hyperconverged infrastructure is the foundation for a hybrid and multi-cloud strategy for many of our customers because it enables this seamless connectivity between private cloud, which is the on-premise environment, and public cloud. Our customers can simply move apps, data and even licenses across any cloud. They can optimize whatever workload they want in which cloud and so they can optimize the cost. And all of this while leveraging the same exact software, consistent set of tools, consistent set of it skill set, consistent set of services and processes. So that's where we are seeing a huge amount of interest in HCI. It's evolving to deliver in this hybrid and multi-cloud platform with the same simplicity, the same ease of use that we are so well-known for and the same flexibility. And I would just add 1 more thing around this. So at HCI, we see a big drag of a lot of our product portfolio with it as customers are looking to hybrid cloud. And I'd name a couple for now. Era, which is a database-as-a-service solution, is seeing a humongous amount of interest, just because, as I said, our customers want to stay connected to their customers and employees and provide them great experiences, and one way to do that is to be data-driven, and assess trends and assess what types of services they need to deliver, how they can deliver better service, et cetera. So Era, we are seeing a big interest in because it really makes our customers' database deployment very fast, easy to access cloud database, multiply them quickly for dev test. It improves time to market tremendously for our customers as well. And of course, we have multiple other portfolio -- products in our portfolio. We have container distribution solution. We have unified storage solutions, which are also seeing a huge amount of interest. Like I said, customers are adopting simplified, unified solutions along with HCI.

That's great. And a good segue to the next question, which is about emerging products just in total, which was very strong last quarter with ACV billings up over 100%, attach rate on a trailing 12-month basis of 37%. Just talk a little bit more about that emerging products category outside of core HCI, what's driving the strength beyond Era, which you mentioned? And also, how is it changing your customer base and deepening your customer relationships?

Absolutely. I think the way I look at it, and I've been in the industry for 27-plus years and going strong. If you build it, they will come doesn't happen. Your solution has to solve problems for the customers. And what we're realizing is that our solution with HCI as the core crown jewel of it with all this other treasure that we have with all of our different products, it's actually helping customers go through the journey to cloud. So all the way from infrastructure modernization to automation and building private clouds to the taking some workloads in public cloud, some on-prem. And ultimate nirvana is building this seamless, unified, hybrid and multi-cloud environment with a single management frame where they can move workloads at any point they want to on any cloud, right? Now along the journey, what we are seeing is as I said, unified storage is huge for us. So files and object storage. That's something our customers are -- we see a huge amount of interest in. I would say, if I were to look at our product portfolio in 4 different buckets, we have our infrastructure services, which is core HCI. We have additional data center services, where there's other storage products, there's disaster recovery as a service, which we are seeing really a strong interest in, of course, during COVID, but even more so now, as we are navigating through this period. Customers are getting more savvy about creating the disaster recovery planning. Then the other bucket is really the World DevOps and database, right, area. And I talked about Era, but DevOps is also becoming a stronger focus for us as a company, and our customers wanted to automate the software delivery platform. So products like Karbon, like Calm, which is an application automation orchestration product, we are seeing interest in that. We have a product called Beam, which is mostly a tool, but it's a fantastic tool to give you visibility into where are you incurring what cost by putting workload, whether it's on-premises, whether it's in AWS, whether it's in some other cloud. And that gives customers then the visibility to know, oh, should I be actually running this workload on AWS? Or should I move it to on-premises or vice versa? And then the fourth category is really desktop services. So we are seeing a big interest again in our VDI solutions. We also have a desktop-as-a-service, a full SaaS product in the cloud, too, if customers want to just do that and not worry about managing the infrastructure themselves. And so in a nutshell, those are -- that's kind of our portfolio. It's really building from the ground up from an infrastructure layer to platform services. That's how I look at it. So as a company, we are vertically extending our stack to add a lot of the different platform services to our portfolio.

That's great. And Duston, just as a follow-up to that, how should we think about emerging products as a percentage of sales today? And then what that might look like over 3 to 5 years.

Sure. As you mentioned, the emerging products, specifically over the last 2 quarters, really performed well, and we're really happy with that. And I think it's a combination of a little bit more product maturity, quite honestly, in some of these products. And also the sales force focus. As we've gone to ACV, a lot of these products have shorter terms, so those now become in favor a little bit more with the sales force. So I think we've clearly seen some of that benefit. I think the last time we talked about it, but we don't disclose this all the time, I think last time we talked, like 15% to 13% to 15% or so, somewhere in that range of new ACV. We haven't disclosed that in a while. But as you might expect, with the performance over the last couple of quarters and 100% year-over-year last quarter, that's gone up significantly relatively from that point a while ago. Relative to -- well, let me just touch there. The new products play 2 roles here. And they -- both roles boost the top line, but they're just incremental to deal size, which is great. But most of these products also have better deal economics. So they're adding to the overall deal economics when we include these new products, which is really nice to see. Now the exact percentage going forward is a little tricky because we're going to start potentially folding some of these products and bundling some of these products into the core offering also. So we'll have to see how that plays out. But overall, they're doing quite well, and we're really pleased with what's going on there.

And I want to come back to this topic again later, but just to touch on it as it relates to the product portfolio. There is an increased focus at Nutanix around profitability and cash flow and the path to getting there. So how do you think about that investment required for a more diverse portfolio, including all of these emerging products, with achieving operating leverage over time? How are you balancing needing to invest in these products and being more efficient at that, so that you can drive operating leverage?

Yes. So I think what you'll probably see on a lot of these new products, some of those will get folded in probably to the fore. And most likely, we'll start going deeper on some of these products to really start driving top line. And Era, we talked quite a bit, but that's a really good example of a product that you'll see us go deeper on. I don't think you'll see a kind of broadening of the portfolio. There's a few things around potentially maybe a 1-click network need some security stuff, native file things, but for the most part, we're going to start driving deeper on a lot of these offerings. So I think we're -- from an engineering perspective, I think we're reasonably happy with how that expense structure is set up for what we're delivering. And certainly, with the progress of the new products over the last couple of quarters, we're pretty pleased there. So again, you won't see us significantly broadening. There'll be definitely some things there, but we're going to go deeper [indiscernible]

Okay. That's great. So the costs are in the model. The expense is in the model, and then it's just a matter of scaling revenue on the products that you decide to go deep on.

Correct.

That's great. So I want to shift to the ACV transition. And Duston, you've really led multiple transitions at the company during a relatively short period of time, from hardware to software, from perpetual to subscription and now from TCV to ACV with the goal of shortening term length. You're now about 6 months into this transition to ACV or annual contract value. Talk about how that's tracking versus your expectations back in August? And what, if anything, has surprised you?

Yes. So this one, yes, you're right, it's been free, and hopefully, no more because they've all had their own interesting aspects to them. But as far as the ACV transition, overall, and again, to your point, we're only 6 months into this transition. So we still have lots of work to do. But so far, things have pretty much been going as we expected. And I think you have to start probably one of the biggest risk areas probably with this was overnight effectively. So at the end of our fiscal year, July 31, overnight to August 1, we completely changed the sales contract. 100%. And any time you do that, there's always -- it's fraught with risk, obviously. And through the first 6 months, I think, from my point of view, because I worried about it a lot, I think that's gone much better than I thought. Now do we have work to do on that still? Yes. Are we still going to tweak things to make it a little bit better? Absolutely. But that piece of the equation has gone better than I thought. And people who focused on ACV is doing what we thought it was going to do. There's more optionality for the reps clearly than with -- they're focusing on ACV and things like that. So that's gone better. The other things that we thought would occur with this transition so far through the 6 months has occurred. We were out of belief that because the reps now are looking at ACV and not TCV, that the deal -- the terms would compress a bit, and terms have compressed. We thought that the deal economics would get better. And overall, the deal economics have also gotten better. And we did this to set up the renewal flow, so those renewals now will happen quicker with shorter terms. And once those renewals happen, that will happen in a much more efficient and effective manner in the market. So all that, and again, a short period of time, 2 months -- 2 quarters. But overall, I think this is pretty much a track to plan with a lot of work to be done and certainly on where a lot of the effort is now and a lot of thinking is on the renewal piece of the equation to make sure that we can transact these renewals very cost effectively and keep their retention rates high. So that's what folks are now focusing on.

And so how should investors impact to the model from this transition?

Yes. So the short term, we've already seen some of that impact. We've seen shorter terms and compressing comp line. Revenue in billings. So that is just a function of term. We knew that was going to happen. That's why we started guiding just in ACV billings because it's not impacted by current. So we've seen term compression. We've seen obviously, a dip in growth with revenue and billings. So that was expected. Now what we're waiting for is the positive aspect of that is the renewal flow. And today, again, our renewals make up roughly 11%, 12% of our total billings. It's a tiny piece. So what we now need to do to benefit of this, obviously, now is getting the renewal flow to have that percentage of our total mix of business, the more low cost, low-touch business, that ultimately, the go-to-market cost structure starts to get into line where it should be over time with the efficient renewal flow.

And I think you've been surprised with the uptake of 1-year deals and maybe some of that is companies focus on cash preservation and maybe taking a little bit less risk here near term. Does that mean that you have a bigger base of renewals as you go into the next fiscal year, such that you could start to see some benefits of more efficiency and operating leverage?

Yes. So any 1-year deal we do this fiscal year, just by math, obviously, gets renewed in FY '22. So the more we're doing now, the more that's going to boost the '22 piece they create. So it all helps. Now top line shrinks, obviously, with 1-year deals. But those will start flowing into FY '22. The more we do, the bigger the renewal piece in '22. Now the renewal setup in general, we'll see some increase in '22. '23 is really a bigger increase of renewals. And then, '24 you see pretty good. So that's kind of what we're waiting for there. Any 1-year deal here makes '22 better by definition, as long as we keep the retention rates high, which we think we can.

That's great. So I guess, stick with Duston here, and maybe Monica, you can chime in as well. Back in December, Nutanix announced that it had hired Rajiv Ramaswami as its new CEO. I'd love to hear from both of you, now that you've worked alongside him for a couple of months, what you're most excited about in terms of what he brings to Nutanix. Duston, do you want to start there? And then maybe, Monica, if you have any thoughts.

Sure, I'll be glad to do that. Yes, I've talked about this before, just to kind of set this up a little bit. Companies go through evolutions and revolutions. And evolutions are periods of extended growth and then something happens and companies go through revolutions where the kind of growth stalls a little bit. And in our case, that's transitions and things. And then companies get to the next evolution stage, which is another period of extended growth. And during those evolutions and revolutions and new evolutions, you need different leadership styles and different leadership style traces. It's just natural because the company is in a different position. And as we get out of this kind of revolutionary period that we're doing now in transitions and things like that, we get to the next evolution period. I think Rajiv is the perfect now leader to come in and help the company get to this next period. He's got a different style and things like that [indiscernible] which is to not say anything different about the past. It's just that it's the new leadership that's needed to take us there. So he has a wonderful -- what I've seen so far, a wonderful balance between focusing on top line growth because we have to have that, but also having a massive discipline on operational efficiencies. And I think that combination in itself will do wonders for the company. And I think ultimately, he's going to make people better, he's going to make processes better and he's going to make the company better. And I think, so far, in the first few months, through his expectations and leadership, I think that's exactly what's going to happen. We're going to have good focus on top line and a massive focus on operational efficiency.

Yes. I'll just add a couple of things to that. The fact that's really super exciting to me is that he is very focused in terms of prioritizing where the company direction should be. So I love the fact that we, as a company -- because we have a lot going for us. And with him coming in, having the experience he has had at scale, understanding what the customers need and then helping us focus on the top 3 or 2 or 1 thing that we're going to do as a company. To me, that's what we need to scale with discipline and with rigor. So I'm super excited about sort of that mindset that he comes with to the company.

Yes. And that point is really important. Duston, you've already brought some operational focus to the -- or efficiency to the company in fiscal '21, lowering OpEx more than 10% over the last couple of quarters year-on-year. Talk about what levers you do have. I know we talked about renewals already, but what other levers do you have to accelerate that path to positive free cash flow and ultimately, breakeven or profitability. And then what's the right time frame that we should think about that, that might be achievable?

Sure. So if you break up, I think, the operational efficiencies into a couple of buckets, and that's really R&D and [indiscernible]. Again, on the R&D side, we may redirect. We'll add some resources here or there. We may redirect. As I say, we'll probably go deeper on things. But you won't see any great change there. We'll continue to obviously worry about efficiencies and things. Where we're going to get the efficiencies and where we should get the efficiencies is around go-to market. And so a couple of things there. First thing we're doing is -- and we've been doing over the last couple of months, let's get the base spending right currently. Forget about renewals, forget about anything else. Is the base spending correct today, and so there's a lot of effort around that. And then you go forward. And so what's the real lever here going forward? It's sales productivity. And sales productivity, we've talked about this, has come down over the last couple of quarters just because of -- well, actually Q2 went up nicely, but prior because of COVID, it came down a little bit. So we have a wonderful opportunity now with sales productivity. It's a great focus within Chris' team, and there's lots of levers. And you mentioned it, the first lever is renewals. But we're not going to go higher field-based quota-carrying reps to go for all the renewals. So there's natural leverage there. We'll get that leverage. And then you add on the emerging products, we've talked about that. That's a natural productivity enhancer. Partnership. We haven't talked about partnerships. We need to get more, and there's, again, a lot of focus here, a bit more reselling, a lot more co-selling help from partners. I think we'll get that. So we have the right talent. We have the right segmentation. New logos have come down over the last couple of quarters. They've covered around 700-plus. We can do a lot better in a non-COVID environment, and we will do better there. So I'm convinced there's more there. And then just existing accounts, we have wonderful large accounts that we can continue to go deeper. And these new products, by the way, they allow us to go deeper into these new accounts. And then simple things like test drive at Google and whatever. So we have a laundry list of things that folks are putting together here from our productivity. So I feel really good about the sales productivity going forward, led with renewals. And again, we just have to get the retention rates right, which we think we will. And then that comes back to your question about free cash flow and operating profit. And a lot of the -- we're getting more and more questions about the Rule of 40 and what happened to the Rule of 40. And we were, I believe, one of the first companies several years ago to kind of bring that out of dormant state that nobody was talking about it, but I love the Rule of 40. I think it's a wonderful discipline tool to go around a company now with the transitions, you couldn't really hold to that stand because of the transactions going on. But I think now going forward, obviously, I have a wonderful partner now with Rajiv to go help drive this, too. So I'd love to get back to focusing on the Rule of 40 to help go run the company efficiently and effectively. And I think we'll do that. '22 is still a transitionary period for that. I think we at least get back on to that grant in '23. And then I think '24 will really be kind of interesting from that Rule of 40. So we're really looking forward to resurrecting that because I think it's great, just [indiscernible] Your point about when is a good time there. That's exactly what we're doing now is we're going through the model. We've spent plenty of time over the last couple of months going through the model. We'll give, I think, a very hopefully deep dive during Investor Day and to build a very credible path not only to positive free cash flow, but to positive operating margin. And I think when you see the renewals and how we've set the renewals up and the costs of new and upsell compared to the cost of renewals and how the business mix shift and how the go-to-market naturally comes into the go-to-market cost structure and actually comes into play over time. [indiscernible] story, it's a story quite honestly that we've been talking about for quite some time that we're now very excited to put on paper and show investors here in the [indiscernible].

Just a follow-up on one of those points, OEM partners. It was something that Rajiv talked about that will be a focus of his. Which OEM partners do you see the most potential leverage? And what are you doing to get more selling capacity out of those partners?

So we've got several partnerships today. And those are -- they're doing okay. We're starting to see more larger type deals that we're teaming up with the server vendor and the SI with our software. So those things have been starting to play out a little bit. I said, what we really like to see is more co-selling, reselling from the partners of the product. And I think it's not too easily to induce that HP would be a likely one there that, hopefully, we could get a little bit more co-selling, cross-selling. How that partnership continues to enhance and it gets, I think, better every day. There's lots of discussions going on there, and we'll see how that plays out. But I think that would be one of the more likely ones that we could actually leverage and get more leverage into the bottom.

Right. I know we're running up on time, but I want to sneak 1 more in for Monica because in addition to expanding or getting more leverage out of the OEM partners, Rajiv talked about needing to simplify the product portfolio and shift to more of a solutions approach to selling. Just talk about what that looks like in practice? And what would be a reasonable time frame to start making those changes?

Yes. The good news is, Katy, we are already on our way in terms of go-to-market in talking about solutions. Now the great news is with Rajiv coming on board, we are actually looking at our product portfolio and truly integrating certain products with each other to create best solutioning from the ground up. And I gave you an example. We talked about our database portfolio. We have end user computing. We have products where you can automate, so there's an automation portfolio of products. There's obviously the core platform that services like DR-as-a-service that we offer, and we are looking at cloud-native services. So I'm a huge proponent of going to market by solutions. Customers don't buy products anymore, they buy solutions. And also, customers don't want vendors anymore. They want partners. The more solutions that we can create, not just from a marketing perspective, but actual ground-up product development and pricing and packaging, it makes it easier for our sellers to go, position them and for our customers who then consume them, because they can then procure them as a single SKU. And that's the pathway going forward, too. I mean, the timing is in the next few months, next few quarters, you're going to hear more and more about us. We'll unveil as we come out with the bundles and solutions, so to speak. But just know that, that work is already in progress. It's not as if we are starting from scratch. The second piece I want to just quickly highlight is, look, we understand customers are on a journey. It's not just one and done. We just don't go in and say, oh, you have a lead, we acquired the customer, out of there now. Our [indiscernible] begins once somebody buys our technology and solutions. We are very invested in customer engagement, the whole experience piece. Subscription and experience are 2 sides of the same coin. Because we are building our subscription business, we have to make sure customers are happy, they are adopting our technology, they're consuming it. That's when the renewals happen. That's when you could get upsized renewals. That's when you upsell and cross-sell. So from a marketing and go-to-market perspective, that's a real big focus for us, go-to-market by solutions. Make sure you're not just focusing on customer acquisition but really customer engagement and retention phases as well. So it's a continuum of how we take it to market, not just through direct, but also through partners that Duston mentioned, too.

That's really helpful color. Thank you both for joining us today. We really look forward to hearing more about these investments and the path to operating leverage at the June 22 Analyst Day. Thank you again. Have a good day, everyone.

Right. Thank you.

Thanks so much.