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

Perfect. Welcome, everybody. Happy to have everybody here. We're delighted to have Nutanix with us here today. Again, for anyone in the audience, I'm Meta Marshall. I cover networking and enterprise storage and a little bit of everything this week. And so happy to have you guys here. For any important disclosures, the morganstanley.com/disclosures or check with your sales representative. So Rajiv, and Rukmini. I totally screwed that up. Yes, Rukmini, long week, but we're getting there. Pleased to have you guys here, CEO and SVP of People and Ops. Delighted to have you guys here today.

Likewise, glad to be here.

Glad to be here.

All right. So you guys printed a very solid fiscal Q2 last week with ACV billings growing 37% and showing a lot of operating discipline. The core business performed really well, but there we have some ancillary contributors to the upside from some pull-forward of renewals and slower-than-expected hiring. Can you just refresh us on kind of the core underlying trends that led to some of the strength in the quarter and what some of those upsides were?

Yes, sure. And I'll talk about the trends, and you can cover the financials. And so from a trend perspective, the fundamental demand environment continues to be favorable. Companies are all going digital. They're looking to modernize their infrastructure as a result of that. They're looking to use cloud and they're looking to continue to work in a hybrid workforce environment. And the public cloud platform that we provide is quietly aimed at delivering all of those capabilities. So the fundamental demand environment continues to be good. We have been executing against the goals that we set out for ourselves, and we laid out during our Investor Day. And so clearly, this quarter, we had a strong quarter. We exceeded guide on everything we beat, and then we also had good guidance going in. So Rukmini you can talk about the specifics.

Yes. So we -- as Rajiv said, like we exceeded our own guidance and consensus across all metrics in Q2. We saw our overall ACV billings growth 37%, as you said, Meta. And I say, I think one was just the overall demand environment. So all those continue to be really strong. We also saw an outperformance in our renewals business, which I think we view as really important to our overall story and our path towards free cash flow -- permanently free cash flow positive and operating margin profitability. So renewals is really starting to hit its stride. And I think that we saw that play out really nicely in the quarter as well.

Got it. Rajiv, there may be some concern going into the quarter, but there were just -- there would be some impact from kind of underlying supply chain issues from your hardware partners. What do you think kind of helped that not be an issue for you guys in the quarter?

Yes. One of the things about the cloud platform that we sell is that it runs on a whole range of hardware. Customers have many, many choices. They can go to the server vendor of their choice. They can also go to the public cloud and use public cloud hardware. So that provides them a lot of flexibility. And it's that reason -- that flexibility is the primary reason why we have not been as impacted by the supply chain issues as, of course, hardware vendors had. And so we've been able to manage that well. We've been able to provide that flexibility to our customers, and they made full use of it.

Got it. Rukmini, you've been working towards this ACV model versus TCV with shorter renewals, offering a chance for more operating leverage. You noted on the call last week, the duration of contracts continues to come down as a result. Can you just level set where we are in this transition and the ongoing impact of that transition to the model?

Yes. No, it's an important point. So when we started our subscription transformation, those average contract term length for us is over 4 years. In the most recent quarter that we reported, it was 3.1 years. And in the year ago quarter, it was 3.4, right? So the compression continues. And where I think that shows up and it's important to sort of understand this, right, when you talk about ACV billings of 37%, our revenue grew 19%. And a lot of that delta is because of that term compression. Now the term compression by the way, is by design, right? It's something that, as you said, we made the transition from TCV, total contract value, to annual contract value because doing so allows us to garner better unit economics. But also with the renewals being a much bigger part of our business, that lowers the term length as well. And importantly, renewals are transacted at a much lower cost, 80% lower than new and upsell, which allows us to also just overall build leverage into the cost model.

Got it. And just refreshing on where you think you can get that term down to.

Yes. Yes. So that was part of your question. So I think what we've said in the long term is that we'll get to about 2.8 to 3 years in that area. So we're not far from there, but we'll probably continue to see some term compression, certainly to the end of this year and maybe into next year. But for a year or 18 months out, that starts to level out and make the comparisons just much simpler on a revenue basis, which it already is on ACV but it took revenue and ACV to converge.

Got it. Perfect. Rajiv, the theme we've heard from nearly every enterprise vendor this quarter is that kind of moving past catch-up spend was the theme of a lot of 2021. And people are really now looking at architectural changes or their cloud strategy. Just how are you seeing that in your customer interactions? And then how does that kind of help advance Nutanix?

Yes. I mean, no doubt, right? I mean during the pandemic, people were focused on just keeping the lights on and running their businesses. And now that we are getting past it, they're really starting to look at their strategic initiatives and continue to make headway and progress against those, whether -- and that includes digitization, that includes using clouds. And we talk about cloud being an operating model. It's not just about a destination, this public cloud or that public cloud. But companies are figuring out how to build modern applications, how and where to run their applications. And they want to run them on an infrastructure that is agile, that is the cloud. And that's why we say cloud is an operating model versus just a particular destination, and they want to run them everywhere. And so that -- and that's a key focus area for them, right, as they go look at these applications and data. That's the lifeblood. And therefore, for us, we see the same trends, and we see demand being quite robust.

I mean does that lead to -- like do you think that they know where the end destination is yet? Or they want a flexible solution like you so -- that they can refine that approach over time?

Yes. We did an enterprise cloud study recently where we polled about 1,700 enterprise customers and asked them for this exact same question. And they all said -- [ 83% ] of them said they're going to be operating across multiple clouds, including on-prem. So on-prem data centers plus more than one cloud, and they would like to have a solution that allows them to make use of all of those in as simple a way as possible. And so I think the reality is applications are going to be everywhere. They're going to be running in the public cloud, in data centers, in edges and remote locations everywhere. And they all need to be managed in a cloud-like environment.

Got it. Okay. Perfect. Another upside surprise last week that we saw in addition to the ACV billings beat was just the free cash flow generation. Positive for the first time through this business model transition. Can you just remind investors of targets here and what the biggest levers towards achieving those are?

Yes. So we were really happy with that free cash flow performance, right, first time in 3 years that we've been free cash flow positive. So the big lever there is really, I think, renewals, right, because we laid this out at our Investor Day in June last year, where we said that renewal is becoming a bigger mix of our business. It's going to drive significant operating leverage in the market, right? So that's a big driver. What we've said in terms of goals, we said that in the first half of fiscal '23, which is the second calendar half of this year, we will be free cash flow positive and that for the full year fiscal '23, our free cash flow margin will be between 3% and 8%. And so just given how the first half of our fiscal year has played out, we are -- we see us being very much on track for that.

Got it. Even as -- so you can achieve that even with some of the catch-up in hiring that you would expect to do.

Correct. That's all sort of baked into that, Meta. And the other thing I'd add is that it's always with free cash flow, things like working capital now that go in there as well, but we feel good about that number even with some of the other assumptions about hiring.

Got it. Another area that investors have kind of dived into is this repackaging and repricing of some of the noncore offerings. Just can you go into the thought process of what drove that decision? And then the help that -- or the benefit that you're seeing in kind of the sales cycle transition there?

Sure, Meta. So we used to go to market with 15 different products, 15-plus different products. Each of them had their own pricing schemes, their own metering schemes and trying to go to market individually. Now, that, as you can imagine, is quite complex. It's complex for our customers to absorb and consume those products. It's complex for our sellers to sell as well. So over the last year, we've had a project to really align these into solutions that tie up nicely with customer use cases. And so what we did with the portfolio is to say, okay, if a company wants to go build a cloud, here's the Nutanix cloud infrastructure platform that allows them to go build a cloud wherever they may want to run their apps. Then once they have a cloud, they want to be able to manage the cloud. And so we have the Nutanix cloud management. which allows them to monitor, operate, self-govern and automate. Then we have Nutanix Files Storage, which allows them to store all their data, unstructured data, files, objects, what may be. And then we have Nutanix database services, which allows them to manage all their databases and, finally, end user computing for their remote workers, distributed workforce. So now we have our portfolio very much aligned to how consumers want to consume it. And what this means is twofold, right? Our goal, by the way, was not to either increase price or decrease prices. It was to make it easier. It was to make it easier for companies to adopt our solutions and for us to sell. And also, this allows us to actually sell more of our portfolio quicker, right? Instead of just selling our core platform, now we can sell our core platform plus all the management required together. So we've completed that now in terms of launching it into the market at this point. It's available globally, and we will be transitioning to this new portfolio over a period of time. For now, we will keep both going. And the feedback so far has been very good, both from our customers who've been using it and as well as our sellers.

Got it. Do you have targeted attach rates that you think of for some of these noncore products? Or just how do you think about their contribution to growth in the longer term?

Yes. I think clearly, we have a base with the core product, which is the Nutanix cloud platform. And then over time, I think the benefit is a lot of the other parts of the portfolio can be attached to the sale. And increasingly, I think that's a huge opportunity. So we think those other products have a smaller base than the core. And so their growth rate is going to be much more accretive, right, accretive to our overall growth rate. So we said that our overall growth rate, we're going to be driving 25% ACV growth for the next 3 years. And I would expect the newer components of the portfolio to grow faster than that and be accretive to that level.

Got it. Now I kind of want to dive into go-to-market. You announced on the call some wins with Red Hat. You're seeing some traction with these selling partnerships. Is there a specific customer type or a segment of the market that they tend to work best with?

Yes, I think it depends largely on the kind of partnership. We have several of them in play. So if you look at -- starting at the bottom -- let's start with Red Hat because you asked about Red Hat. So with Red Hat, our partnership with around 2 vectors really. One is the entire Nutanix infrastructure SaaS solution is now fully certified as part of the Red Hat ecosystem. So that means, for example, all applications using Red Hat Linux are now certified to work on our platform. And so that's an easy win, and that means more workloads can land on our platform immediately. The other is, of course, the longer strategic play here is Red Hat's OpenShift platform plus our infrastructure platform together provide a complete stack for companies to run modernized -- modernize and run their modern applications wherever. So that leads us to great collaboration at the field level, at the account level where we sell together. And so we're seeing the benefits of that already in the marketplace with wins. So that's Red Hat. Similarly, if you look at Citrix, that's another ecosystem partner for us, where Citrix is virtual desktop. We are a great hosting platform for their virtual desktops. And we've been working together for a long time, and we'll continue that relationship. Then you look at some of the other ones, OEM partners like HP, Lenovo. These are partners where we go our software with their hardware together in the marketplace. In some cases, they are reselling our software as part of their solutions, like HPE with GreenLake and Lenovo overall. So that's the OEM relationship. And then we have an emerging set of partnerships with the cloud -- public cloud providers, notably Azure, where we are just about to roll out their solution. And again, we will have joint go-to-market engagements with them as well.

Does that appeal to a particular customer type? Or where do you get the greatest leverage out of that?

Yes. I think it's -- it actually appeals across a very broad base of customers because, largely speaking, our products are very horizontal, and so are theirs. All our partners actually sell everywhere. Now so depending on the customer profile, right -- so if it's OpenShift, for example, with Red Hat, those are very specifically customers who are looking to modernize and build container-based applications and manage them. So that's a subset of customers out there. And so for that customer base, we can go in there and be very targeted. Azure, for example, will be joint customers of ours who want to expand their footprint into Azure. So it's not necessarily tied to, hey, a large versus small or any particular vertical, but it's based on just where we have intersection at our customers.

Got it. Okay. Perfect. I want to circle back to kind of the pull-forward element that we saw last week. There was obviously a lot of questions about renewal versus incremental ACV and the impact of what caused maybe some of the increased or pull-forward renewals. I know you guys aren't going to give details around renewal versus incremental. But can you just lay out kind of the elements of that, what impact co-terming might have had in that?

Sure. Yes. No, I think it's a good question. So when we think of renewals in any given quarter, right, we -- the way we look at it, we start the quarter, we say, okay, how much is available to renew, or ATR, in that quarter. And then we look at how much of that is going to come in. And it's normal to have a portion of that be late, a good chunk of it be on time and some of them be early, right? Like this is not just for us, I think, as an industry standard biz. It's bound to happen, just given how people transact. So we did expect some mix of that. What we did see was that we saw more earlies than we expected. And I would say, I think there are a couple of things that drove that, right? So one, we said there was about $10 million that would have shown up in this quarter that was transacted in Q2. Now I want to be very clear how we define, your word, pull-forward, Meta, because it shows up in ACV billings because customers might transact early and pay for it early. So it's in the ACV billings number but revenue is recognized in the quarter in which the renewal is due, right? So in that sense, there was really no pull-forward of revenue but it was more for ACV billings. So to go back to your question on what might be causing that, so one is just the nature of how things transact. We go out to our customers several months in advance because you want to be proactive about these. And sometimes, their sort of paperwork might go faster than we hoped, which might cause the timing differences. The other piece is co-terming, which you brought up as well. And that happens when we -- let's say, we've sold a customer something 3 years ago, and it's coming up for renewal. But in the intervening time, we've sold them a lot of other things as well, which is fairly normal for us, by the way. We're sort of doing things in between as well. And so the customer might say, well, we have all these now, these all these various outstanding renewal dates, can we converge them, can you help us sort of streamline them to be 1 or 2 dates versus so many out there. And that's a good thing for the customer. If it simplifies things for them, it's actually good for us because ultimately, our goal is we want our customers to stay with us, right, and renew and grow really, right? So we've done some of those as well. That was also a factor in the Q2 ACV billings outperformance. The last thing I would say is we spend a lot of time, a lot of focus on making sure the economics of these renewals remain good, regardless of late, early, co-terming, on time, right, because that's really important because we want to make sure that we're protecting the value of what we're selling.

Only one thing I'd add to that, if you don't mind, is the third factor in terms of these early renewals would be just natural budget cycle for customers. They may have budget during a particular quarter that they may decide to transact.

Yes. No, I mean I think I may have asked you guys on the call or the callback about does this -- is this negotiation on the part of your customers, and you guys were pretty clear that it wasn't kind of a negotiating tactic for discounting.

No, no.

And neither did we have any sales incentive either, right, or reps to kind of pull anything forward. So this is -- the intention always has been, right, is to sort of have it be a natural process and not sort of -- so try to sway things one or the other or give the customer any sort of leverage, right, for us to go and do that.

Okay. Perfect. Yes. No, that was helpful for me to have resolution on the call. I'm just addressing that. With some of the changes around the sales compensation model, just has that really changed -- I just wanted to get a sense of how that's changed kind of the reaction of your sales reps and if there's been any change in mindset or any change in kind of how they're approaching a sales cycle?

Yes. I mean maybe I'll take a crack at it, you can add. So last year, we moved the sales force -- the entire sales force from being compensated on total contract value to be compensated on annual contract value. That, of course, led to a fundamental behavioral shift, which is what we wanted to drive, which is don't focus on returning your quota by extending the duration and providing bigger discounts. That's not healthy for subscription business. What we want them to focus on is, okay, you go since you're going to be comped on ACV, focus on extracting the maximum economic value from selling shorter-term contracts. And shorter-term contracts are just fine because as long as the customer adopts, we can renew them later and the renewals are very cost-effective, and so it's driving the right behavior. And so that was a significant behavior shifted for us. And fundamentally, this led to better economics for us, higher dollars per unit sale, and that continues. So that -- we haven't changed that this year. That was a successful transition we did last year, and that's continuing this year.

Yes. Okay. Perfect.

Anything that you want to add?

The only thing I'd add is that I think we shared it at Investor Day, right, we said that when you go from a 5-year to a 3-year deal and then from 3-year to 1-year, the economics improve by about 40% between those, right? And that thesis has continued to play out really nicely.

Got it. Maybe circling back to kind of competitive environment. Obviously, there's kind of been some major changes with your competitor. And just, clearly, you guys have a strong value proposition, but it always helps to have disruption with competitors. And so just what are you seeing there? And then what kind of opportunities is that creating for you guys?

Yes. I think in this space, HCI, hyperconverged, we are a pure-play company. We are entirely -- our entire business is focused on this. And to some extent, we are a market-maker in the sense that many of our competitors, I would put them into 2 categories. One class of competitors, typically, they're trying to balance selling HCI with also selling traditional storage, traditional storage typically at higher margins, higher revenue. So there's always a balancing act in terms of how much you push HCI compared to your traditional storage. The other class of competitors would be where they're not focused on this particular thing as a go-to-market initiative, but they're more just focused on a broader set of priorities and selling this as just one element in their portfolio of broad solutions. And so when you look at both of those, then we have a clear distinct focus on the market on just leading with and only leading with what we do, which is HCI. And so that allows us to -- and with our improved execution overall at this point in terms of the focus we have on both new upsell as well as renewals, I think we are now -- you can see that reflected in our growth rates and our top line growth compared to what we see from others in the market.

Got it. I mean how does the competitive landscape change once you start getting into these noncore offerings and maybe competing against different set of competitors than traditionally?

Yes. If you look at -- it depends on the specific aspects of the portfolio. So if you look at Nutanix cloud management and Nutanix unified storage, those are largely sold as an attach to our core for us. So where we have a core platform that we sell, we will typically try to attach those. Now the Nutanix database service is an entity of its own in the sense that there's a huge value proposition. There's a stand-alone value proposition associated with it that is independent of the rest of the portfolio. And so there, again, I think we have a specialized selling engine that we're building. We are focusing on database admins. And our value proposition there is quite strong because we support a range of databases. Customers can pick and choose the database they want. We provide a unified automation platform for them to manage and simplify the operations of these databases. And we also, going forward, will have a multi-cloud version where they can run their databases on the clouds that they want. And so that's different from competitors who are either just single database engine providers that have some management around it, right, or cloud-based solution providers, again, that are very prescriptive in what they do. So we're giving customers a lot of choice and freedom while, at the same time, providing a unified platform for them to manage their database. So that's -- so on that end of the portfolio, that's a very specific go-to-market.

Perfect. You guys mentioned that with your OpEx kind of coming in a little bit lighter, the last quarter, that hiring had remained an issue. I don't think that, that's unique to anybody out here. Where are you making progress meeting those targets? And how do you expect those changes to show traction throughout the year?

Yes. So I'd say, overall, right, in Q2, our overall company net head count grew, right, quarter-over-quarter, which was good, and we expect to sort of continue that momentum. I would say when we think of -- and I think the challenges in hiring that I think everybody is facing, as you said, is not limited to any one sort of role or team necessarily, right? Like it's not -- tech talent has always been hard here, right, here and just around the world, in the Valley and elsewhere but so is go-to-market now, right? And so what we are trying to do, and we've seen success with this, right, is for the folks who understand our value proposition, right, this is a company that creator category, is a leader in our market, has phenomenal customer focus, it's highly innovative. It's coming -- it's emerging from our subscription journey with a lot of leverage is still out there for us to gain when proof points along the way to show it. People get it, right? And they say, okay, this is actually a great time to join the company because it's -- there's a lot of upside from here to that. People -- who do we sort of compete with, I'd say there are some of the bigger players like Google, for example, but then there's also these pre-IPO companies. And so for us, it's about -- what seems to resonates with people is when folks sort of get the thesis but also we're big enough to matter. We have 20,000 customers. We have a good market fit, but we're small enough, people have an impact, right? So that message resonates with folks. And so that's -- and I don't think this will be a switch in any way either, right? It's not like it's going to like flip. But gradually, we're starting to just sort of -- I feel like attrition has somewhat stabilized for us actually in the couple of quarters. So that helps as well, right? And we're able to retain and it just becomes -- you're trying to add folks versus trying to fill the hole as well.

Yes. The frozen capital markets lines to age you as well.

Yes.

Perfect. Maybe last question that we're ending with for everybody is just Russia-Ukraine impact. Anything worth noting there either in terms of customer engineer kind of exposure?

Yes. Our business in Russia and Belarus and Ukraine together is very, very small, well less than 1% of our total sales. We don't have any employees there. We have a few contractors in Russia, and we are doing our best to take care of them. And of course, we are -- in terms of handling customers over there, we are very much compliant with all the sanctions that are in place in terms of either what we can do with them or cannot do with them. So overall, it's a very small, negligible impact for us, for the company.

Okay. Perfect. Well, thank you so much for being here today, and this was a great discussion. So...

Thank you for having us, Meta. Great to be here. Thank you.

Thank you for having us. Thanks.