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

All right. Thanks, everybody, for being here. I'm Jason Ader with William Blair, and happy to have the folks from Nutanix here with us. Rukmini Sivaraman, is that right? Chief Financial Officer; and Rich Valera from IR. So before we begin, I'm required to inform you that a complete list of research disclosures or potential conflicts of interest available on our website at williamblair.com. With that out of the way, thank you for being here with us for our fireside chat. I'm going to go through some questions and then feel free to ask away towards the end here.

Rukmini, maybe to start out for investors less familiar with Nutanix. Can you give us a quick overview of the history of the company and how your portfolio has evolved over the last several years?

Yes. Thank you for having us. Jason, it's good to be here. So Nutanix is a cloud infrastructure software company. We have -- we created and pioneered the category called Hyperconverged Infrastructure. And the genesis of it was, if you think of a traditional data center, you sort of would have a 3-tier architecture, which was storage compute networking and then a hypervisor on top of that. And our idea, our genesis came from hyperconverging those which really simplify the operations of the data center, resulted in significantly better total cost of ownership, increased ROI, simplicity and more, right -- and so this category has now grown Gartner and IDC estimated to be in the $5 billion to $6 billion range, and we are one of the 2 leaders in the market, right? And so that's sort of how we started. More recently, in the last few years, we've evolved our vision to also consider how our customer is thinking about cloud right, and public cloud and how that plays into how people think about their IT infrastructure. And we believe that the future is hybrid and multi-cloud, meaning that there will be some folks who sort of stay purely in the public cloud, but for the majority that there will be a hybrid-cloud world, meaning that people would run workloads On-prem and in the Cloud and that they will often use multiple cloud vendors to do so. And so our vision has evolved now to encompass that where we have a role in really creating a single pane of glass, which is I know is an overused word, for our customers to manage their infrastructure in a simple way. We've also evolved our business model. We started out as being an appliance company with I'm sure you remember this, Jason. And we moved to being purely a software company, which is always our IP and gross margins went from the low 60s to now the low 80s. So we've now completed that transition to being a software company. And we've also undertaken this journey to become more of a subscription company, which sells term licenses. And today, that's all we sell. We sell only term licenses. So in that sense, that part of the journey is complete. And now we are in a place where we're seeing a significant volume of renewals come up from the term licenses we've sold, which we expect will add predictability and leverage to our operating model going forward. Let me pause there, Jason.

Great. And you -- congratulations. I know that you've been recently appointed -- promoted to CFO. Maybe just a brief bio on yourself and what your strategic priorities are, now that you've been promoted to CFO?

Thank you. Thank you. Yes, I've been at Nutanix for 5 years in different roles in finance and strategy and so on. And I'm sort of honored to take on the responsibility of being the CFO. Before Nutanix, I spent almost 8 years at Goldman Sachs as a banker. So have a lot of experience working with software and subscription companies during that time, doing mergers and acquisitions, IPOs and so on. And before that, I'm an engineer. So I actually went to business school up here in Evanston, and so it's nice to be back in the area. And in terms of strategic priority is we -- our CEO, Rajiv joined us about a little over 18 months ago now. And he has been really focused on this idea of profitable growth. And for us, both of those words are equally important, the profitable piece and the growth piece. And so that remains at the center of all my strategic priorities as well. So we are really focused on continuing to grow because we see a big opportunity ahead of us, but we're also focused on getting to sustainable free cash flow generation and operating profitability. And I think, Jason, in your most recent note, you have noted that we have had significant operating leverage. We went from negative 20% gross in opening margins last fiscal year and this fiscal year, our guide is negative 9%. So we've seen significant leverage, and it's something that we'll continue to focus on to get to operating profit and free cash flow. So those are growth but profitable growth, really the center of, call it, my priorities.

Okay. Great. And can you talk through the 2 big headwinds you saw in Q3 and when you think these issues will start to get better?

Yes. So we announced our Q3 earnings towards the end of May. And what we said was we beat all of our guidance metrics on Q3. However, we did see some -- the 2 headwinds that you are referring to towards the tail end of Q3 and which also affected our guidance for Q4. The 2 were -- the first one was supply chain related, which we have been -- really haven't seen the impact of that until recently, until late in Q3, which I'll talk about a little more. And the second one and a smaller factor was we saw some increased attrition in our sales rep population, which led us to enter in Q4 with a smaller sales rep headcount than we would have liked. But the first piece, the supply chain was the majority. And I think the way that impacts us is because we are an infrastructure software provider, we only provide the software to our customers. But our customers often time their purchase of our software with server, right, commodity servers, hardware that they procure from our hardware partners. And so what we saw happen in that time period late in Q3 and into Q4, is that an increased number of our orders were coming in with future start dates because of the delays that people were seeing in the supply chain. And so that started to impact us and that's what led to the majority of the downward guide for Q4. Now that's a macro issue. I think a lot of folks are talking about it. And for us, we are one step removed from it. At the same time, we've sort of seen our customers be impacted by that. So that was the majority of the delta that we saw, and we're doing everything we can to mitigate that and obviously working closely with our partners. And then a smaller component was this rep headcount, which -- we're actively looking to get back to our target headcount as well.

And do you think that's also kind of just a macro issue in terms of the turnover in Silicon Valley and other places where people are just leaving jobs to go to other jobs?

Yes. I think -- I feel like that a lot has been written about the great resignation and just across The Valley and tech, as you talked about. And so we have seen actually improvement in attrition for the few quarters leading up to that quarter, and we saw an uptick in Q2. So we do think it's part of the broader environment. We're also very focused on making sure we're compensating our people fairly that there's -- the comp programs are aligned and all the things that we should be doing anyway, right, to make sure that we're retaining those key folks.

And how much of the turnover do you think is a function of new head of sales? I mean, relatively new CEO just at the executive levels, there's been a fair amount of change at Nutanix over the last, let's say, 2 years. Do you think that has factored into the rep situation?

You -- so Dom Delfino, our new CRO, has been with us about 6 months, and he actually has been really well received by the sales team because he understands our business. He hit the ground running. So I don't think it's sort of a direct result of that, right, because he's generally been well received by the team, Jason. So I think it's more of the factor of the market and what's going on more broadly than any sort of change, for example, even our -- how we approach the go-to-market, if anything, Dom has sort of try to move those things further along, than not. So.

Yes. I guess what I'm getting at is just sometimes there's disruption when somebody new comes in and like the old guy is like -- or the old [ gal ] is kind of like, this isn't my guy. You know what I mean?

Yes. There's probably some of that, but we don't think that's a big driver, given how Dom has approached his entry into Nutanix.

All right. And then switching gears to just your product portfolio. Maybe it would be helpful to provide folks with a high-level overview of your 5 product Buckets, and how they kind of all fit together?

Yes. So we have oriented this, and we sort of relaunched a simplified portfolio in February of this year. And so there is our Nutanix Cloud Infrastructure, which is the core platform that I talked about, the Hyperconverged Infrastructure platform, which is the core business, if you will, that we have our Nutanix Cloud Management, which is all of the management layer that goes above managing this infrastructure and that's a really nice attach motion because, of course, if you're buying the core infrastructure, you want the cloud management to go with that as well. We have our Nutanix Database Solutions or NDB, which is a -- it's a database management solution that works across all clouds, all database offerings, open source and [ not ] relational and non-relational, which is an exciting new solution for us. And then we have an adjacency in Nutanix Unified Storage, which is -- because we have sort of a data-centric company, the Unified Storage piece is a nice adjacency for us as well. And the fifth one is End User Computing, which is all of the virtual desktop infrastructure and so on, which was a big application for us as a company. Rich, do you want to talk about the NC2 platform?

Yes. So NC2 is Nutanix Cloud Clusters. It's the sort of the new name for it, and that's actually part of our core infrastructure offering and what that enables you to do is to take a workload without refactoring it and run it in the public cloud very seamlessly, still on our stack, essentially running on a bare metal offering of that particular public cloud provider. Today, we have that up and running in GA and AWS. We've talked about having being in private preview with Azure, looking forward to getting that up and running soon. But we've seen our customers adopting this for a variety of different types of use cases from sort of disaster recovery to seasonal flexing into the cloud to very quickly getting a footprint in a new geo. We had a case -- this quarter of a customer establishing a presence in Asia like within 2 weeks by flexing into the cloud. So we're seeing a lot of our customers, even if they're not buying it to use it today or buying it sort of future-proof their current stack just saying, "I want to have that flexibility to move into the public cloud. So if I buy the Nutanix core offering, I know that I'll be able to do that seamlessly and probably to multiple -- cloud providers with a single unified control plane in the future. And so it's really been an important part of sort of evolving the portfolio towards this hybrid multi-cloud in that vision that Rukmini referred to earlier.

And do you -- the Cloud Infrastructure and Cloud Management, I'm assuming that's like the 90% of the revenue. Is there -- do you have any way to quantify either the NDB, the unified stores end user computing. Where does Nutanix Cloud Clusters go?

It goes in the core.

It's in the core. That same core.

Yes. Because in the beauty of that and come to your question on sort of the [ relative size ], Jason. But the beauty of NC2, right, is that it's the same portable license, right? So the customer gets 1 license that they can then either use On-prem in their data center or use clusters to run it on the public cloud or even across public cloud is [indiscernible] seamlessly. So portable licensing is really an important element of that, which makes it desirable for the future proofing that Rich talked about. So we don't disclose the mix, Jason, but I think the majority is core NCI -- in NCI.

Okay. And then one of the questions, I think that's sort of maybe rose to the floor a little bit during the last earnings call, which I think has been probably the main bare argument I've gotten on Nutanix for the last 5 years has been that you guys are over-indexed to On-prem spending. You just talked a little bit about cloud clusters as an example of what you guys are trying to do to address the cloud more. But really, how do you respond to that? How do you help people think about Nutanix over the next 5 to 10 years, if the bulk of your business is still focused on On-prem data centers, even though it's private cloud, even though it's automation, a lot of cool stuff that you guys have brought to the bare, frankly, you brought a lot of the public cloud principles to the enterprise. But if more customers have just decided that their journey to the cloud is one that's ongoing. And so it's just going to be more and more money spent on cloud versus On-prem. How do you guys fair in that kind of world?

Yes. And I think you said it quite well, right, when you think about just sort of we have always thought of cloud as an operating model rather than a sort of a destination, right? And so that's the principle with which even our On-prem infrastructure was built, which is to sort of say the flexibility, right, the ease of you was all that brought to the on-prem data center. Our view on cloud is that there will be a proportion of folks who are going to run all of their workloads in the public cloud, right? And so that's one category. There's also a category of folks who are still using this 3-tier legacy infrastructure that I talked about that are taking their sort of first steps into modernizing their data center. And they do it by adopting our Nutanix Cloud Infrastructure platform often or they may say, "I know I'm going to run some things in the cloud in the future, maybe not tomorrow, but maybe a year down the road. And -- but they want to start by modernizing with the Nutanix Cloud Infrastructure. And in both of those cases, I mean, the first one is our bread and butter. That's how we -- that's how the business grew and it's still a significant portion of our go-to-market. But the second piece where people are saying, "I now want to go to the cloud, maybe I want to own some workloads in the cloud and Nutanix can help me get there". So we see a lot of that where folks will say, I know that if I run my application on the Nutanix Cloud Infrastructure platform, and if I say I want to move that same workload to the cloud a year from now, 2 years from now, there's no refactoring required. I don't have to rewrite the whole application, which would be the case, by the way, if they're going to have to move it to the public cloud without Nutanix, right? And that's a lot of -- it's expensive. It takes time, it takes resources to go do that. So we have customer selling that is not only "do I love your solution for today, I cannot see it being my sort of gateway to the cloud". There's also folks who say, "You know what, there's some workload", I think there's one example we talked about in our earnings call earlier, but a big retailer said, "I want -- I have my -- all of my workloads on On-prem, but I have burst capacity in the cloud" or they say they have disaster recovery in the cloud. And all of those require the seamless movement between On-prem and cloud, which we're best equipped to do, right? Because we're agnostic about which cloud you're running on, even if you have multiple public clouds, and we see customers coming to us with that. Now if you think about the category that I sort of set aside at the beginning, which is the folks who are saying, "Hey, I'm a startup, I'm going to write all of my apps natively in the public cloud". Then for them, today, we have our Nutanix Database Solution, right, which really helps all apps run on databases. And so we have that solution that they can use. And often, we find that as an entry way for the core platform or often what those folks realize as they scale out is that the cloud becomes really expensive as you scale beyond a certain point. And so we've also seen repatriation, if you will, where folks are saying, well, maybe the cloud is not the right place for all the workloads and I need a more hybrid approach. So that's sort of how I would break down the different categories, Jason, and how we are applicable in each of those.

So basically, what you're saying is you see a hybrid world for quite a long time in that? Customers will just have a mix of public cloud and private cloud, effectively?

That's right. And we've done a proprietary survey that we commissioned with over 1,700 IT professionals, and that's what -- over 80% of them said they see hybrid multi-cloud, where it's hybrid, but it's also multiple clouds as their sort of ideal operating model going forward.

Do we have any questions from the audience? Well, we're -- moving on here. Okay. Just feel free if you have anything. I wanted to ask about the transition of the [ ECD ] model. You talked about it up front. Where are we in that transition? And how important will renewals be for your top line growth going forward?

It's really important. And what I said earlier, right, where we went from selling sort of these life of device licenses to the more term license-based model. That transition is done in that we only sell term licenses today, right. So we have some professional services as most companies do, but really everything else, our software term licenses that we sell to our customers. And the beauty of that is that you know when they're coming due for the renewal. And we've said publicly that our target for gross retention rates is north of 90%. And so what that allows us to do is have -- for the top line, it does 2 things that you have visibility and predictability. So we know when those renewals are coming and can go and transact on them in a timely way at those high renewal rates. And we've seen that play out really nicely actually in the last year, year-plus, where the renewals team has really been a good engine that's humming well. It also has an impact on leverage for the business because we're able to transact the incremental renewal dollar at a much more efficient rate compared to a new ACV dollar. So it also goes back to this theme of profitable growth, where it's fueling the growth, but it's also helping us get to sustainable operating profit and free cash flow -- so it's a really important number, is the short answer.

And let's talk about that because you had put out targets on free cash flow and profitability. I think it was end of fiscal '23 for free cash flow and then shortly thereafter.

It's actually first half of fiscal '23 for free cash flow and end of fiscal '23 for operating profit, yes.

And so with the guide down that you guys just gave, are those still -- are those targets still realistic? And then maybe what are the biggest levers that you have to use right now to maybe get you there?

Right. So what we said on the earnings call is that we are not in a position to reaffirm those targets we put out in June of last year at Investor Day last year. Because of the challenges we saw in guiding to Q4. And what we are in the process of doing now is doing all of our planning for fiscal year '23. And so as we come out of that planning and as we get to our Q4 earnings call, which will be in the end of August, we expect to be able to provide a lot more color on what fiscal '23 will look like, but also on the fiscal '25 goals, which we had put out. As you'll recall, we had said we would generate $300 million to $500 million of free cash flow in '25. And so we expect to come out and give some color on that number as well. So we did not reaffirm that. What I do want to emphasize, though, and we said this on the call, right, is that the principles behind what we laid out at that Investor Day last year still remain. That's still how we're running our business. As we plan for fiscal '23, we're still prioritizing sustainable free cash flow generation and operating margin. And we felt it was prudent to do that work, see how Q4 plays out before we're able to come out and talk more about the specifics of those.

Okay. Great. And then I guess one thing that has happened on new development is Broadcom's acquisition or planned acquisition of VMware. Do you think that's going to have an impact on you guys at all, given that they're your primary competitor?

Yes. No, it's interesting. We've been following that news, right? Is it -- and I think there was an article today about how they're doing integration meetings and so on. So I would say, look, publicly what's been said is that Broadcom has come out and said that they expect to add about $8.5 billion of EBITDA from this acquisition in 3 years. Today, VMware's EBITDA is about $4.5 billion, right, plus or minus. So that's a big growth in EBITDA, right? And you can -- I think folks can imagine sort of what that means from an expense standpoint. They've also -- I think Broadcom has also not been shy about saying in the past that they really intend to focus on really the top, call it, [ 1,000, 1,500 ] customers that we bring. And so I think that leaves for us an opportunity to be there for customers and prospects when they're looking for an alternative or when they decide that it's -- they need a solution that is easy to use, that's data-centric, that saves them a lot of TCO and has phenomenal customer centricity, our NPS scores are 90. And is -- as you said, really only one of 2 alternatives in the market and one has just been announced that they're going to be acquired by Broadcom, right? So we intend to embrace our existing customers and make sure that we're there for prospects when they need us.

And have you seen any difference in VMware's behavior since the spin-off from Dell? Has anything changed from a competitive standpoint once they spun off from Dell?

I think the ownership structure there is still the ownership structure, right, in terms of Michael Dell's ownership and so on. So I know they have said that they're now -- after that spin-off having a independent company and so on. But it's -- we remain focused on what we do well.

So no -- it was no -- okay. I got you.

Rich, would you add anything?

I'd just say we track our win rates pretty consistently against both our largest competitor and others, and they have been pretty consistently improving kind of in a year-on-year basis, but nothing dramatic. I mean, if anything, I think we're maybe doing a little better at the margin, but nothing dramatic since that's happened.

Okay. Good. And well, I guess, we'll a year from now on this stage, we'll find out if the Broadcom situation changes anything. All right. In the last couple of minutes, any questions? No? Yes, go ahead.

[indiscernible] you have some data usage from beyond storage [indiscernible].

I think the question was Pure Storage, I think, reported their results. And the question was, does that have a -- is this something we drawn between the On-prem dynamics on Pure versus what we do and this impact on supply chain that they saw versus not? Did I frame that somewhat correctly? Okay. Thank you. Thanks for the question. So I would say, I think, again, we're one step removed from the supply chain because we don't directly -- we're not directly providing the hardware, our server partners are. That said, we're staying close to both our customers and what they're hearing and with our server partners, right, because we want to make sure that we're doing everything we can to help them manage this in the best possible way. I believe Pure Storage as sort of an appliance vendor kind of manages their own supply chain, right? And so they have just a lot more control, visibility, all of that, that goes into it. So there's one fundamental sort of difference between them and us. And then on On-prem piece, I think, look, I think they've talked about just what they're seeing and how they think about On-premises cloud and everything else, right? So I think that sort of speaks for ourselves. I think, for us, you're right, we're not sort of purely a storage vendor, flash-based is still a big portion of our business as well, right, in terms of the deployments that we're putting our core infrastructure into. And so that's how I sort of characterized both of your points. Anything you would add, Rich?

No, I think that's fair. I think they manage their own supply chain. It's probably the margin a little simpler than ours because we -- ours is a converged appliance and they, at Pure, have done a really good job of managing it. So -- yes.

Okay. Maybe just to wrap up here. Rukmini, Rich, what do you think is the most underappreciated aspect of the Nutanix story?

I'll go first and Rich, you can agree or not with me. I think it's this -- it's the leverage and the growth that the renewals brings us, Jason, because I think this is a dynamic in the business and now is the time that we're seeing the sort of renewals base continue to grow. It's going to be a big factor in our growth, and it's going to be a significant factor in our operating leverage and free cash flow generation. And it's at a GRR of 90-plus percent. It's fairly a derisked lever, right, that we have in our business going forward.

Rich?

Yes. I would echo Rukmini's comment there. I think on the -- really the fact that we're a subscription model, we're 90% plus subscription -- and that transition is pretty much done, so there was a lot of heavy lifting went into it, but it's done and now we're going to get the benefit of the renewals, and we're still at the early stages of that. So that's kind of, I think, the main takeaway.

Great. Well, thank you both for being here. Thanks, everybody, for attending, joining and have a good rest of the day.

Thank you.

Thanks, everyone.