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

Welcome, everyone. I'm Katy Huberty, IT hardware analyst at Morgan Stanley. And I'm really pleased to host this discussion with Nutanix CEO, Rajiv Ramaswami. Rajiv joined Nutanix in December of last year from VMware, where he served as COO of Products and Cloud Services. During his first year at Nutanix, he has prioritized productivity and already shown significant operating leverage. Before we begin, I want to point you to Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Rajiv, thank you so much for spending the time with us today.

Katy, thank you for having me on the call today. Great to be with you all.

Likewise. So just to start the discussion, for those investors that are maybe newer to the Nutanix story, can you talk about the solutions that Nutanix brings to market and what are some of the customer problems that you're solving?

Absolutely. Let me start with what we do. We are a multi-cloud software platform company. And what we do is we provide a platform on which customers can run all their applications, modern as well as traditional applications, wherever they'd like to run them on, on the cloud of their choice. Now if you step back up in terms of the vision itself, right, our customers are all operating in a multi-cloud world. I know Morgan Stanley has done a lot of research on this, and you've got your report out in terms of where customers are running their applications and they're running them everywhere. And that includes more than one public cloud as well as their on-prem data centers and managed service providers. And our goal is to provide a platform to make that simple. In fact, our vision as a company is we need to make these different clouds invisible, so that customers can really just focus on getting their business outcomes. And if you look at what we do specifically to enable that, our history here was around bringing together different silos in the data center and making it a lot simpler for customers, right? Instead of having separate compute, storage, network silos with separate hardware, separate teams running them, with hyperconverged infrastructure, which we pioneered, we brought all of that together and managed that using simple software, so that we could dramatically simplify and provide TCO benefits to our customers. Now we are extending that same philosophy across the cloud. Every cloud is a different silo. And what we are providing is a common platform that our customers can use to run their workloads, applications across any of those clouds. The platform itself is simple. We think of ourselves as like providing consumer-like simplicity into the enterprise. It's open in the sense that while we have a full software stack, customers can mix and match, choose, very flexible in terms of licensing terms. We have subscription, 100% at this point pretty much, and customers choose the duration that they want to buy from us. And once they buy from us, they can use it anywhere, choice of hardware, on-prem, choice of public cloud going forward. And our Net Promoter Score is really high. Now to the last piece in terms of what problems can we solve for the customer, ultimately, we help the customers transform themselves digitally. We help them modernize their infrastructure. We help them operate across multiple public clouds, and we help them support their remote workers.

That's great. Perfect setup for the discussion. Rajiv, when you think about that long-term vision that you just laid out, how would you compare the product portfolio today versus where you think it needs to be in 3 years? And what are some of the biggest TAM expansion opportunities that are in front of you?

Yes. First of all, when we look at our fundamental portfolio, the way investors should think of our portfolio is along these vectors going forward. Hybrid cloud infrastructure, which is a suite of product software, but everything we talk about here is software, that enables our customers to build a cloud, right? Build a cloud-like operating environment, wherever they want, whether it be on-prem or inside of a public cloud. So that's HCI, hybrid cloud infrastructure. Hybrid cloud management provides them the tooling needed to operate the cloud, whether it be the operations capabilities, whether it's the automation capabilities. So that's our fundamental stack. Now above that is unified storage, which is the ability to manage all kinds of unstructured storage, files, objects, all of that put together. And then we have a very specific targeted solutions further up the stack, one of the things that's most exciting for us is database-as-a-service, right, which again resides on top of the infrastructure stack. Now if you look at the TAM and the market opportunities for us, with this portfolio, we talked about in 2025 being able to address a $60 billion TAM opportunity. So we're not really limited by the market here. HCI is sort of our core hybrid cloud platform itself, even on-prem continues to grow and displays existing 3-tier architectures. So that's bread and butter for us that's historically what we've been doing and that business itself will continue to grow. Going forward, we expand that into the cloud as a natural extension of the product portfolio itself. We are starting to do things like build in more security into our platform. We are -- these emerging products that we talk about here include networking, include automation and include governance, unified store rates. And of course, the one that I'm most excited about is the biggest TAM expansion opportunity is database-as-a-service, because that opens up a whole big new TAM for us. So take -- put all of these things together, we're looking at a $60 billion-plus TAM that we can address. So we're not really limited by market opportunity. I think it's about how fast we can go and capture that.

Now an investor concern or question that I'm sure you recognize from your VMware days is that as more workloads shift to the public cloud, it may shrink the opportunity for on-premise or hybrid cloud software and infrastructure. How have your customer conversations shifted over the past year, as it relates to their plans of moving workloads to the public cloud and the importance of this hybrid cloud strategy to their overall business?

Yes. It's interesting, Katy, because if you're -- in fact, this cloud conversation has been going on for quite a while. And if you look at it, 3, 4 years ago, there was a big movement to say everything should go to the public cloud. And I would say now the conversation is a lot more nuanced than that, which is what is the best cloud for me to operate in my application? And that answer can vary depending on the application. So our customers that we talk to are now much more nuanced in they're thinking about, I want to run my applications. I want a cloud-like operating model, where managing the infrastructure is simple. I just don't want to deal with all the complexities, but I want to be able to have choice and flexibility where I run my workload. I'm going to use the best cloud for that. In some cases, that may be AWS, some cases it may be Azure. In some cases it may be other cloud providers, but it could also be on-prem. It could be in the edge locations, right? And the governing items there are around what's the cost of doing so. Can I afford to be locked into any particular cloud or do I want flexibility and portability across these cloud environments? What about data governance and data privacy and data locality requirements? Security? And then last is, how do I manage my traditional applications alongside my new applications? And what does it take for me to actually get my traditional applications to run in a cloud-like environment? And what is the level of effort required to port it if I need to? So all of these become factors in the discussion now. And so what I see with customers now is more and more of the discussion we're having is, yes, it's not on-prem only or public cloud only, it's how can we enable them to operate across all of these environments. And I'll give you some good examples of what we're seeing now, right? We're seeing -- in our case, customers wanting to use the public cloud for sure, right, with every customer, that's a factor. Now the question is how do we do that? And we see use cases where -- I would say, probably 3 kinds of use cases, right? The first is, okay, cloud migration. I want to go exit a data center and move to the cloud. The second is, well, I have seasonal capacity demand where I think I'm better served by using the cloud for that. The third is disaster recovery. Well, I'm running my workloads on-prem, but if there's a problem, I don't want to have another data center, I can go to cover that from the cloud. These are real use cases that we are seeing now with customers as they look at how to run across these multiple cloud environments.

Now Rajiv, we're coming up on your 1-year anniversary in a couple of weeks at Nutanix. Talk to us about some of the biggest changes that you've made since joining the company? And what, if anything, about the opportunity or how the business is run at Nutanix has surprised you in your first year?

Yes. I think we outlined a number of priorities in terms of what we were driving towards at our Investor Day, and I'll recap some of them. First one is, of course, as you know, we've been going from being a perpetual or life-of-device software company to a subscription software company. And getting through that transition, getting successfully to the other side, we're making great progress and that's a top focus for us. And the key aspect of that, of course, is renewals. As we've gone into the subscription business, our business is almost all subscription at this point. And we are starting to see this big avalanche of renewals starting to come in, because as you know, our average term length sits around 3 years. And as you can imagine, all the new stuff that we've sold over the last 3 years is coming up for renewal, and we are starting to prosecute that as we go forward. And renewals, of course, drive a lot of leverage for us, because with the high NPS, Net Promoter Score, that we have and the high retention rates that we have, renewals can be prosecuted in a very cost-efficient manner, giving you a lot of bottom line leverage while capturing top line growth. So completing our subscription journey is one. The second really is the product portfolio, as we talked about here just in the last few minutes around orienting the product portfolio around solutions and simplifying the portfolio along the lines of what we talked about and taking it to market as a multi-cloud portfolio. So we're making great progress on that front. This portfolio that I outlined with this is what we're going to market with. We've started piloting that already this last quarter. We'll be taking that globally going forward. And it simplifies the way we take things to market, right? Instead of taking things to market before as point products, now we're taking things to market in the form of solutions around how do you build a cloud, how do you operate a cloud, how do you store your stuff, how do you run databases and how do you support your remote workers. So these are solutions that are directly tied to the use cases that customers have. So that was the second thing. And the third thing was relying on partners and doing more with partners. And over the past year, we made great progress with our OEM partners, which is HP, Lenovo, in particular, continue to expand on our relationship with them. With our cloud partners, AWS and Azure SB, get our AWS offering to scale now and bring the Azure offering to market. With ecosystem partners including a deal that we did with Red Hat, which is starting to bear great fruition now in terms of our preferred partnership with Red Hat as well as a preferred partnership with Citrix. And the last but not the least, I think, especially for you, investors is the financial model. So one of the things that I'm committed to here is to have disciplined execution and more -- bring more predictability. So we provided some mid- to long-term guidance in terms of our financial model. We said our ACV billings will grow at 25% per year for the next -- through fiscal '25 for us. We will get to a sustained free cash flow breakeven by the end of calendar year '22. And we will be operating income positive on a non-GAAP basis the following year. And we are driving towards that model. And as part of the model, of course, we are being very disciplined about our expense line, for example, while making sure that the renewables business is coming through. We put a renewals machine in place to go handle that piece of it, while our sellers are largely focused on new business. And so driving that financial model and executing on the financial model is the top priority as well for us. So those are the 4 priorities.

Now that's a long and important list of priorities. Is there anything incremental that we should expect you to focus on over the next 12 months?

Yes. I think -- look, I mean, this is a long list of things and, as you said, that we have to get done. And my focus right now is just delivering very much on what we said we're going to do over the next year. Just put our heads down. Let's go make everything that we said happened. We just outlined these this June. So now the organization inside the company is very aligned to making this happen, while, of course, continuing to delight our customers. Because at the end of the day, all of this happens because we have a great set of customers, 20,000 plus customers who love doing stuff with us, right? The Net Promoter Score is over 90% and that's something that we very much want to preserve as we move forward.

And as you've said, an important part of execution is transitioning to more of a solution selling strategy and also leveraging partnerships. Talk about some of the go-to-market strategy shifts or changes that you announced at the .NEXT Conference and also that you talked about on this last earnings call.

Sure. Look, I think when we look at .NEXT, we talked about a partnership with Citrix. And just before that, we had announced a partnership with Red Hat. And then of course HP and let me talk about each of those in a bit. So with Red Hat, this is about building a complete stack, including our infrastructure stack combined with Red Hat stack, which includes their Linux OS as well as all their OpenShift container portfolio. And together, our customers can now build a full stack for -- that can run both their existing virtual machine applications on our platform and modern containerized applications on our platform. We are already starting to see that take traction in the marketplace with joint customer wins. With Citrix, we have -- we've had a long relationship with them. Almost -- probably 5,000 customers together today already. And we've cemented that relationship with a formal agreement, where we will work together from a product road map, joint support and go-to-market as well. And again, the opportunity for us is Citrix has a huge installed base of customers, 300,000 plus customers. And again, to the extent that we can go together and provide a complete solution to enable them to operate in a distributed workforce environment is good for both companies. So we're doing that. HP and Lenovo, we continue to expand our relationships with them in terms of both go-to-market efforts as well as them taking more of our product portfolio to market. And so we've continued that journey as well over the last year. So that's sort of some of the big things that we talked about at .NEXT.

And then as it relates to Salesforce execution, you recently hired a new Chief Revenue Officer. Can you talk about what stood out in Dominick during the hiring process and what you think he brings to the table as it relates to scaling the sales model and continuing to execute?

Indeed, Katy. So first of all, I think our previous CRO, Chris has done a great job of driving operational discipline within our sales team. And as you know, we've been able to predict our quarters and beat and race for the last 4, 5 quarters here. And we certainly want to continue that discipline and Dom, of course, brings strong operational discipline to the table as well. We expect to continue that process. Now if you look at Dom's background, one of the things, of course, is that he knows his domain really well. He used to run worldwide data center sales, including storage, compute and -- I mean, storage and networking, and cloud management, right, at VMware in his past life. He's got operational experience at scale. He used to run Americas, the sales organization for VMware, pretty large multi-billion dollar business, for VMware. He's also got the enterprise DNA having worked with larger enterprise customers quite a bit and brings a lot of enterprise connections to the table. And the last piece of it is that he is also a technical guy and an evangelist and spokesperson. He can be in front of customers, he can motivate our sellers, he can work very well across boundaries within the company as well, all the way from customers to the sales team to our product teams. So I expect him to be coming in and hitting the ground running. He's going to start literally in about 10 days from now, and I'm excited to have him on board.

Great. Let's talk about the competitive landscape a bit. What's surprising is given such a large TAM, this is really a 2-horse race between Nutanix and the Dell VMware stock. As everybody knows, Dell just completed the spin of VMware. Have you seen any material change in your win rates or competitive positioning as those companies certainly still have a commercial agreement, but have effectively separated? And just more broadly, anything new that you're seeing on the competitive front?

Yes. I haven't really seen any difference or change in the competitive landscape yet, Katy. It's -- for the most part, we see the same kind of dynamics in the field as we saw before. And of course, I will say that when we look at our competition, it's a broader landscape, right? So our public cloud folks are both competitors and partners, right, in the same -- in a way, -- we partner with them to help move our customers to the public cloud. But if they don't go to the public cloud on our platform, then we lose the workload, right? So in that sense, it's a competition with the public cloud providers for us, but it's mutually beneficial competition as well here for both sides. Now in terms of our own differentiation as we look at this picture, fundamentally, our differentiation is around 4 areas, right? The first is we're good at managing data. We know how to operate on data that's our history and legacy, and we do that really, really well. Second is the simplicity of our offerings. One of the things we pride ourselves on is it's easy for folks to use our product. Doesn't require sophisticated huge IT teams, right? I mean if you're a school district with 1 IT admin, you can bring and put our product in and really go to sleep, right, in some ways, and it operates well. And at the same time, we have the capability to scale and handle the needs of Fortune 50 or Fortune 10 type enterprises as well. So the simplicity of our product and the design focus on simplicity is a key virtue. The flexibility and choice that we provide to our customers, we don't try to create any kind of lock-in. Customers are free to mix and match and use what portions of our stack, pick the choice of hardware, choice of cloud, choice of hypervisor, choice of the container stack and, of course, choice of licensing terms and duration with us, right? And so we provide that kind of a flexibility. And as you know, the last but not the least for us is our obsession with the customer, and that translates into them giving us a Net Promoter Score of 90. So we are focused on continuing to make sure that these continue to remain differentiators for us as we execute in this highly competitive multi-cloud world that we're in.

And one of your priorities is driving sales force productivity, driving a more recurring renewals based business. And that kicked off in August of last year when the business started shifting from TCV to ACV. So total value versus annual value of contracts. How has this changed the sales process and the sales cycle for Nutanix?

Yes. I think the -- this is one of the biggest evolutions that we have gone through, Katy, as you can imagine, right. Moving from a life of device to a subscription company and what that means. And the bulk of it is behind us at this point in the sense that, that transition from total contract value to annual contract value, this has had a fundamental change in behavior for our sellers, right? Because we are not focused on having long-term contracts with our customers. In fact, we get better economics when we have shorter duration contracts where we can charge higher prices. And then the customer is happy with the product, and then we renew it after that and the renewals can be done at much lower cost. So with our go-to-market, what we have done is we've now focused our sellers on ACV and maximizing the annual contract value, so that the way they retire their quota is by selling more of the portfolio, but for shorter duration versus selling less and getting bigger deals by extending the duration, which is not a good thing for us, right? So it's driven the right behavior in the sellers. The second thing we've done is we focused our sellers now on mostly new and expansion, right new and upsell, with the building a separate customer success and renewals team to handle the renewals. Because renewals, again, once we have good adoption and consumption, our gross retention rate is above 90%, and the renewals can be prosecuted with -- at a much lower cost point, right, much more efficiently. And that then provides leverage on our bottom line. So that's a big go-to-market change that we've driven over the last couple of years here, and it's well established. The most of the transition is behind us. Now we are focused on -- okay, now we've got this machine in place. Now let's focus on continued productivity increases for our sellers, right? Let's make sure we can get them more productive. And part of that, of course, is simplifying the product offering itself, right? Rather than having a whole bunch of products, we are now going to market in the form of solutions. We are getting more leverage through some of our strategic partners, more so than we had in the past. So all that helps as well.

Given that the renewal cycle is a really important driver of operating leverage, talk about what the mix of renewals is within billings today and where you see that sort of exiting fiscal '22 and maybe 3 years from today?

Yes. So in fiscal '21, which finished last July, renewals were about 12% of our billings. Now we expect that to roughly double to 25% in our fiscal '23, and to reach about 40% by fiscal '25. So that's the growth in renewals. And again, all of that is coming in with good leverage on the bottom line.

Okay. So you're hitting critical scale in renewals over the next couple of years and that's a key driver of operating margin improvement.

Indeed.

Now in the near term, sort of next couple of years, at the Analyst Day, you talked about a much more stable base of operating expenses versus pretty extreme growth if you look historically.

Yes.

How does that tie into what we're seeing in the labor market in terms of higher levels of turnover, your ability to replace people that leave the company, the wage inflation that we're hearing about? Does any of that dynamic change your near- to medium-term goals around driving productivity and operating leverage?

Yes. I think, Katy, we factored in a lot of that. I mean clearly, attrition or, let's call it, job migration has kicked up across the industry overall over the last year as we've all seen that, and we are not in a different place. In general, I would say we continue to hire aggressively. We continue to focus on retaining our talent aggressively as well. We've added net right, to -- in terms of heads to the company, we continue to add. In fact, when -- when we look at the sellers, again, we continue to add reps, net increase in reps in Q1. We hope to continue adding reps here as we go forward as well. And we manage that fairly closely. Now so far, we haven't -- while there's a lot of talk about inflation and so forth, one of the great benefits of distributed work for us is that we can go get talent from anywhere in the world, especially for R&D. And to some extent, that helped offset this notion of like, okay, there's more competitiveness in the market. And yes, as you know, we have a big presence, for example, in India and Eastern Europe and even within the U.S. we are flexible in terms of locating our people anywhere. So when it comes to R&D, I think we've been able to offset a lot of that quite effectively so far. Now when it comes to sales reps, I think sales reps are largely driven by commission and quota and how we can help them. One of the focuses for us is like how do we get more of our sellers to go meet their quota? How do we enable them to be productive? How do we enable them to be successful? And that's what we're doing. And while we're continuing to groom and also hire from the outside. So, so far, I think we are managing quite well through this inflationary environment that we're in.

And when we think about the shift to subscription and a focus on annual contract value, arguably, that should make it easier for your salespeople to bring on new customers, because they're really only having to commit to a year and then can scale their use of Nutanix over time. But when we look at new customer adds of 550 in the October quarter, that was lower than the run rate in the prior quarter. So talk to us about how this pandemic has impacted your ability to go out and reach new logos and whether you see an acceleration as economies reopen and people return to the office and you can have more in-person interactions with potential new customers?

Yes. I mean there's no doubt, Katy. As we went into the pandemic, we were living off social capital that had been built up, right? And we've been kind of eating away into that and building relationships, especially on a customer-facing node is harder, right? If you're a new customer, to go do that completely remotely. But our sellers have been adapting. We've, of course, been helping with trying to give them tools, digital tools to help. For example, customers do proof of concepts completely remotely without having to go into their data centers. But all that said and done, there is no substitute for direct face-to-face engagement. And I think from that perspective, things can only get better as we come out of COVID and people are able to have more face-to-face interactions. The other thing, I think, from a new logo perspective that we have also focused on is getting higher deals upfront also and making sure that the quality of the new logos in terms of opportunity for not just immediate opportunity, but also how much can we grow with these accounts over time is important, right? Because if you look at our sales process, it's -- yes, you land, but then a lot of it is how much do you upsell after that and upselling across more on the same use case, driving more use cases to the platform and attaching more of our product portfolio, right? All of these 3 drive upsell. And we want to focus on landing accounts where we can continue to go drive more upsell and expansion in terms of the account. So we've gradually been ticking up the landing average contract value, right, at new customer. And that's to some extent, the certain reduction in the new customer adds, right? Over the last quarter, you saw a little bit of that. Not dramatically so, but we're still adding close to we did 560 or so in this last quarter, we'll continue. And I'm hopeful that, that thing -- and we expect that, that should go up this quarter. And we'll continue to go drive that forward, especially as we come out of COVID.

We're just about out of time, but I want to ask you one last question, which is, as you think about the remainder of this fiscal year, what would you say are the biggest upside or downside risks to your outlook?

Yes. I think we're -- look, we feel pretty good about where we are in the product portfolio. Now we don't control the macro. I mean, if something happens with the new form of virus that costs us everything to shut down again. I mean, those kind of things we don't control. But in terms of what we can see and control, I would say, first, the macro spending environment as of now is actually quite good, right? People are coming out of COVID, and they're looking at reaccelerating their digital transformation efforts, their modernization efforts, their cloud efforts, all of which I think we're in and it helps, right? So from that perspective, I do think that creates some tailwinds for us. The product portfolio is well positioned. The competitive dynamics are, I would say, reasonably stable, right? And we haven't seen some major changes there. And I would say, overall, as a company, we are now very focused on execution. And so I think -- and that's, by the way, what gave us the confidence to give annual guidance at this point going forward, which we started doing this quarter, right? And so we feel good about the guidance we gave you all, and we are very focused on executing on what we said we'll do.

That's a perfect place to end it. Thank you, Rajiv, for your time today. Thank you to everyone who joined us. We very much look forward to watching your continued success at Nutanix.

Thank you, Katy. Thank you for having us.