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

Hello, everybody. My name is George Wang. I'm the analyst covering Nutanix for the Barclays. So with me today is Rukmini, the CFO for Nutanix. She has been with Nutanix for 5 years, but recently became CFO 6 months ago. So really appreciate you taking some time out.

So maybe to start with, can you just briefly talk about the value prop of HCI in this environment?

Yes. Great to be here. Thank you, George, for hosting us. So HCI, as you know, stands for hyperconverged infrastructure. It's a category that Nutanix pioneered, and we're now the leading vendor in that space. And what that is, is traditionally, legacy architectures in a data center have sort of what we call 3 tiers, which is storage, compute and networking. And what we pioneered was this architecture which, when it's hyperconverged, allows more flexibility. But importantly, from a customer perspective, has really high ROI, much lower total cost of ownership, or TCO, and the payback is -- happens in a matter of 9 months, right? So it's really quick to pay back and much more efficient and much more high performance also, while giving customers flexibility. So it's something that we now have about -- we're projecting for this year about $1.8 billion in revenue. So this is now a scale company. Our overall market is about $5 billion to $6 billion, with the potential to do a lot more as we displace more of the 3 tiers. So this is a large and growing market.

Got you. So as the calendar year turns, as we head into 2023, so maybe you can talk about kind of the top priorities you guys are working on right now.

Yes. So for us, the overarching theme that we've adopted for me is driving towards sustainable, profitable growth. And all of those 3 words are important in that. So we've been a high-growth company. We intend to continue to grow nicely. Also for us been increasingly important to make sure that growth is sustainable and profitable. And so what that means for us, as we enter the new calendar year, is, one, we want to continue to make sure our renewals engine. So we're a software company selling term licenses. And so our renewals stream continues to grow over time. And so renewals provides not just visibility and predictability, but it also is a contributor to our growth in the near term and to leverage and efficiency. So one priority is making sure that we continue to execute on our renewals, and we have gross retention rates of over 90%. So we want to continue to do that. Second priority is continuing to focus on new and expansion business, which is important to us. And then thirdly, is continuing our operating discipline on spend. We had our first quarter in the October quarter, first quarter of non-GAAP operating profit in the history of the company. And it's an important milestone, one we intend to continue to build on. So those are the 3 sort of priorities: continue renewals execution; new and expansion business; and continued leverage to the bottom line.

Got you. So last week, you guys just had earnings. So -- and it's encouraging to see all the metrics came on top of guided metrics. So maybe you can talk about the kind of drivers causing the stellar performance in the last quarter.

Yes. So the first one I would say, just going back to the theme we just talked about, right? Our renewals business did really well in the October quarter. And we saw a significant majority of our growth in ACV billings, which was 27% year-over-year, actually came from those renewals billings. So that -- and then across geos and verticals, we generally saw good performance across the board. There wasn't any one region that was an outlier one way or the other. And then on the bottom line, continued expense management. And as I said, the first ever quarter of non-GAAP operating profit was -- just came from us continuing to be disciplined, some timing of hiring and then we also have benefited a little bit, just not a huge amount, about $2 million benefit from FX with the dollar strengthening.

Got you. So I guess, in the past, you guys had some issues with supply chains. So going forward, can you talk about kind of easing supply chains? And what do you think of the effect from kind of backhaul conversion playing into a higher upside going forward?

Yes. So as I said, we are a software company. And so this is something that is one step removed from us. But what we saw is because we are an infrastructure software company, there was this relation between the software -- our software and the underlying servers on which it runs. So we've been talking to our server partners and our customers were the ones seeing this firsthand. What we saw in the October quarter is that those sort of supply chain constraints that they were experiencing seem to have improved somewhat. The way it shows up in our business is we look at the percentage of our orders that come in with future start dates as a way to say, okay, the customers have the servers, they need to run our software. And so that percentage came down in the October quarter compared to the July quarter, which was in the right direction. What we are assuming for this quarter, the January quarter, is that it stays more or less the same compared to the October quarter. And that's because things don't seem to be getting worse, but they also are not getting better in a hurry. We believe this will be more of a gradual improvement, not a flip the switch type of event. That's what we assume for this quarter's guidance. And then for the full year, our year ends on July 31, we've assumed that the second half of our fiscal year, things will start to ease, ease modestly though, again, not a flip the switch but more of a turning off the knob.

Got it. So maybe we can double-click on profitability and kind of FCF. One of the biggest takeaways from the earnings last week was you guys raised full year of income and FCF. Just especially right now in this environment, more software investors are focused on bottom line profitability. So maybe you can talk about the driver behind the kind of renewal, much lower cost kind of going forward and some of the other levers you guys are doing on the sales and marketing side.

Yes. Yes, definitely. So we reported $46 million of free cash flow in the quarter in October. And for the full year, we've guided about $100 million to $125 million of free cash flow. And we've also said that in fiscal '25, we expect to generate at least $300 million of free cash flow. And so for us, renewals, as you pointed out, George, has been an important element of leverage, right? So as I said, renewals not only provide visibility and are helping with our billings growth, as that base grows, it also can be transacted at a much lower dollar cost of acquisition, right, per renewal dollar, almost 80% lower cost of acquisition, which helps us with the bottom line. So one of the things we've seen from our research, as we made the transition to being a subscription-based software company, we talked to other companies who have been on this journey and, one, we believe that most of these software companies at scale that are subscription software companies have 70% to 80% of their billings actually coming from renewals. We are significantly lower than that level. So as our mix of renewals grows, we expect the efficiency of our overall business to also grow, leading to both free cash flow generation and operating margin expansion.

I think that's going to segue into the kind of macro buffer you guys putting in the guidance. And what are you seeing in terms of the deal pipeline in this macro environment? I think the elephant in the room is that you guys mentioned some anecdotal evidence of deal push out but now kind of material. So maybe you can talk about customer engagements. And are you seeing any clients kind of sweating the assets, so to speak, right now?

Yes. So a few things. Demand remains good for us. And as I said, our TCO value proposition is very strong. And so you could argue that in an environment like this, when people are more focused on cost, the value proposition of being able to produce our TCO and get a return quickly is enticing. I will not say that we are immune to a recession, I don't believe we are, but one of the things we factored into our full year guidance is that a significant majority of our growth in ACV billings for the year will come from renewals billings. And we believe that renewals, given our 90-plus percent gross retention rates, is more resilient in an environment like this than new and expansion business might be. And the other part of the question was our folks sweating their assets. Again, we don't rely sell the actual boxes in the hardware, right? We're sort of a software company. And so for us, renewals are purely when the term license comes due, right? And so if we had sold a 3-year license to a customer 3 years ago, then it's due, and we're going to go back and work on that renewal. So yes, that provides some resilience. And then you mentioned backlog earlier. We did exit fiscal year '22 with a record level of backlog. And so as we go through the year, we expect to use some of that backlog, which provides another layer of sort of resiliency to -- and conservation in our forecast overall. And the last thing I'll talk about is I think you alluded to, where we mentioned in our earnings call last week, that anecdotally, we are seeing our sellers on the field tell us that there's increased [ steel inspection ]. So the reason is anecdotal is that when we look at our October quarter, we actually didn't see sales cycle times lengthen as we looked at the data. But we're hearing this from our sellers saying, oh, things [indiscernible] inspection and more approvals to go through before a purchase order is provided to us. So it's possible that it might lead to delays down the road, but it's something, of course, we continue to watch closely.

Got it. So you mentioned your renewal business has been outperforming. And I guess with this backdrop, you have better visibility as this base for renewal is getting bigger going forward. I think right now, like based on the guidance, you don't need to rely on the expansion and new deals as much as maybe other companies. So maybe we can stay on the topic that you can kind of briefly talk about unpack, kind of how you see this dynamic playing out in terms of NAND new ACV versus kind of expansion and kind a new ACV.

Yes. I think the analogy we give our teams, right, is sort of this bucket, right? And we have -- the bucket is filled with a certain amount of water. So we want to make sure there's no leaks in the bucket, right? So renewals is performing really well, and we're continuing to sort of make sure that, that book of business stays. It's also really important, though, to continue to fill the bucket, right? So sort of the NRR, whether it's expansion with existing customers or new logos coming in to fill the bucket even more. So you're absolutely right. That renewals for us as a base does provide a really good foundation. It's a significant majority of the composition of the growth for this fiscal year. However, I think the market's big. We believe our opportunity is big. And so we are absolutely asking our field sellers, right, who are the ones that are primarily focused on both new logos and expansions to go and capitalize on that opportunity. And for us, expansion is really, I would call, 3 main vectors, right? So if we -- often our initial transaction in a land-and-expand model might be a one use case or one workload that a customer chooses to buy. And then the expansion vectors are threefold. One is doing more of the same workload, right? So that's a relatively easy expansion opportunity, where they see the TCO, they see the value and they say, "I want more of this." Second way might be to add an additional workload. So they might, for example, use us for a virtual desktop infrastructure, but then they add -- they use us to run databases or some other mission-critical application. The third vector expansion, of course, is buying more of our portfolio, right? We might have sold our core platform to the customer in the first 2 instances. But then they say, "I see that you have cloud management or unified storage or your database's service offering. I want to expand into those, right?" So that -- those are sort of the 3 vectors that our sellers are focused on, on existing customer expansion.

Thank you. So for the HCI space, the way I see is a 2-horse race between you and your biggest competitor, which is getting bought by a larger player. So maybe you could unpack some of the benefits you are seeing, whether from a customer standpoint or from kind of the talent kind of engineers. Maybe they see Nutanix as a place of comfort in terms of this period of disruption?

Yes. So you're referring to sort of Broadcom's announcement that they're acquiring VMware. And so what we've seen post that announcement is an increased level of engagement from prospects and customers on understanding what it might mean for them and how we can help them through this process. And that's the lens through which we've approached this, which is to say we are -- as you said, this market is largely between us and them. And so we have an NPS -- a Net Promoter Score of 90, very sticky product. We talked about gross retention rates. Our net retention rates are in the 120s. And so how can we help folks who are thinking about what this acquisition might mean for them. Now what I will also say, though, right, is that the transaction hasn't closed yet. I believe they're going through antitrust approvals and so on. So we'll see how that all plays out and what their strategy is going to be after that. But we are singularly focused on making sure our customers understand that value proposition. And that, with this increased engagement where -- we're doing everything we can, right, to capitalize on those. The other thing I'd say is that, especially with the larger customers, these sales cycles can take time. They can take 9 months, maybe even 12 months. So in our fiscal year '23 outlook, we haven't really baked into any -- baked any kind of upside from this potential transaction. In the medium term, could it -- could there be some tailwinds from it? Possibly. But again, remains to be seen when the transaction closes and then what their approach is after that.

Got it. Maybe you could unpack kind of the large Tier 1 customers, traditional kind of VMware customers versus kind of SMB kind of on the small side, I see kind of upside for both as you guys here increase from sort of Tier 1 customers as they worry about kind of future pathways. So maybe you can unpack some of that.

Yes. I think that's definitely our intent. Because I think some of these doors are open to us now that weren't always open to us. And look, this might also turn out to be sort of a win-win, right, where Broadcom shareholders benefit and so do VMware shareholders, right? Because I think there's enough to go around. You also asked about talent. And to address that question, I think we've hired some good people from VMware. Our CEO is formerly from VMware and we have our Head of Americas sales from VMware. So we have definitely been able to attract some really good talent out of there as well.

Maybe we can shift to product, kind of solution-oriented setting for a little bit. You used to sell kind of 15, 20 different scales. Now it is compressed to 4 or 5 scales. So it's mostly they're a kind of bundled deals. That's the trend where the industry is going. So maybe you can give more color in terms of more bundled sales and kind of bigger size deals kind of as a result?

Yes. So I think you're referring to, in earlier this year, we kind of announced a simplified portfolio, as you point out, with -- also simplifying our packaging and metering and pricing. And we did that, one, for the obvious reason of just making it easier for not just customers but also our sellers to take our solutions to market. And so that certainly helped. Increasingly, we're seeing a bigger proportion of our transactions each quarter be transacted with the new portfolio. So we've kept both in place in the transition period. So we have our portfolio and the new one, of course, encouraging people to switch to the new one. So there's nice increasing adoption of that over the quarters. And I think that -- we are seeing that when folks are using the new portfolio, that there's some evidence of increased tax rates, right, people are engaging and buying with the broader portfolio. And so it's simplified selling for our sellers because I think for them, one of the things we're also focused on as a vector for growth is increasing our productivity of sales reps. We've made some good improvements in that over the last couple of years, but we're not where we'd like to be. So we think there's room for improvement there. And this is one of a few things we are driving to get them to be more productive, right? Simplifying the way they sell so they can do more, right, do more transactions, do more with any given customer and so on.

So you just mentioned this land and expand. So I wanted to go back to that and you also mentioned kind of increased attach rate. So maybe you can unpack further just in terms of the attach rate for the cloud manager on top of the bread and butter kind of HCI cloud infrastructure.

Yes. So NCI, or Nutanix Cloud Infrastructure, is sort of the core platform, right? And what cloud manager does is help people kind of provision things, manage, governance, all of that on top of the core infrastructure. So it is the most logical, if you will, adjacent attach motion for our sellers. And what we found is with this simplified portfolio solutions that we launched earlier this year, we've seen that particular one, increased adoption of that, right, because it's a natural extension of what we sell already. And the other thing, I think, to call out about the cloud manager is that as our own vision has evolved from where we started this conversation around the hyperconverged infrastructure to being a hybrid and multi-cloud platform company is that cloud manager can allow our customers to manage their workloads and their infrastructure software in on-premises, but really also increasingly in the public cloud, right, whether that be AWS or Azure or anybody else. So it's a very seamless way for folks to manage a hybrid and multi-cloud environment.

So that's a good segue into the channel kind of partner program you guys have, which is highly differentiated. You guys also provide more incentives through this LED programs. So maybe you can unpack kind of channel partners. How is that going in terms of the progress?

Yes. So this is another area where we've talked about work and opportunity that we have, right, to go and do more. So one of the recent announcements we made around this was enhanced incentives for our channel partners to bring in more new logos, people that we haven't transacted with before, and also giving them incentives and enablement to transact autonomously, right, independent of us, which again provides leverage to our sellers, right, to go and do more and increase productivity overall for a company -- for Nutanix. So that's what we've been -- we're trying to get our sellers to focus on. It encompass a lot of enablement for them, right, so that we are driving. So this is another area where if you think about our sales and our productivity initiatives, one is the portfolio that we talked about. Two is all of the channel work that we're doing to make the channel more autonomous. And then the third thing I'd say is just making sure that our sellers are enabled, right, to tell and articulate kind of the value proposition. Everything from the core hyperconverged infrastructure value proposition, all the way to why we should -- why folks would choose us in a hybrid and multi-cloud environment, right, which is a fulsome kind of value proposition.

Got you. So maybe we can kind of double click on this Azure partnership with NC2, which has just reached the general availability starting from October. It seems on the go-to-market side, it's more involved versus the partnership with Amazon. So maybe you can compare and contrast of the latest Azure partnership and the kind of related marketplace offering you guys are doing on the go-to-market side.

Yes. Yes, we were very happy to announce the general availability of our Nutanix Cloud Clusters, our NC2 product on Azure. We have had the AWS product which runs on AWS bare metal for a couple of years now. And as you point out, the Azure partnership is one that we're excited about. It's early days. The product has just become generally available. But I think the value proposition is strong. We've also had -- our solution is now available for purchase through the Azure Marketplace, as you alluded to, which is exciting for us. And we talked about 1 customer actually on our earnings call, which is using this NC2 product on Azure for disaster recovery, for expansion -- flexible capacity expansion, where they're able to use their workloads, run their workloads, both on-premises and seamlessly extend it to the cloud when needed by using our platform.

Got you. Maybe you can talk about kind of Azure service. Most people don't realize they can get Azure service through Nutanix, whether that's through the GreenLake or through the service provider channel. So maybe you can unpack some of the kind of Azure service offerings from Nutanix.

Yes, that's a great point. And this is another area where I would say it's growing. We're seeing more interest. It's still a small portion, but an opportunity for us. And on the call last week, we actually talked about our largest new logo transaction for the quarter came through a service provider route for us. And this is, again, with the sell through, right, so they're selling it. And this new logo was a publishing and education company based in EMEA, and this opportunity came to us through this service provider, right? And similarly, on HPE GreenLake, Lenovo TruScale is another offering where, again, they are providing you can use their offering and use Nutanix through that as a service, whether it's GreenLake or Lenovo TruScale.

Excellent. So maybe next topic, it's highly topical is the Kubernetes for enterprise.

Yes.

You guys actually highlighted that kind of in the last few months. Customers can get a native Kubernetes, obviously, in Nutanix through the carbon, but also through different channel partners, whether that's Google Anthos, Amazon. Maybe you can unpack kind of the sort of various offerings for the enterprise kind of at scale from Kubernetes.

Yes. So we announced some enhancements to our platform to support Kubernetes-based applications in the enterprise. And as you said, we've already supported a variety of those platforms. We did add support for -- Kubernetes support on the AWS platform specifically. We've already had Red Hat OpenShift. We've had Google Anthos, Azure Arc and so on. And so we'll -- this is something in addition to our own Kubernetes engine, right? So this is an area that we realize is of continuing importance right out of the market.

Got you. Maybe we can shift it to kind of customer. Maybe you can give more color in terms of the recent customer adds, which is very strong, and also kind of G2K penetration as you continue to focus on larger size accounts, which increases the deal size.

Yes. So we have about half of the G2K customers, so call it, 1,000 plus or minus. And I would say that even within the 1,000 of the G2Ks that we do have, there are share of wallet, it's still relatively small. I mean there's room for expansion even within those 1,000 customers, not to mention the 1,000 that we don't have today as logos, right? So that's definitely an opportunity that we're going after. And you alluded to this earlier, George, with the possibility of this Broadcom, VMware acquisition, some of those doors are open now for us for increased engagement. Now there is also a whole market sort of below that Global 2000, right, which you can call it large mid-market or small enterprise, whatever you want to call it, that's also a sweet spot for us. We have about 23,000 customers today, logos, right? And so a lot of them are in that category, and it's an area we'll continue to focus on. And I'd say that I think for us, it is important that we -- yes, we acquire new logos. But in the recent quarters, we've continued to focus on the quality of the logo, right, and not just the number or quantity of the logo. So we've seen, in general, a trend of nice ACV improvements over time. So we want to make sure that the logos we acquired are quality, and this whole going back to land and expand. Even if it's a smaller transaction upfront, we know that once we prove our benefits within the customer that they're likely to expand and buy more.

So a few KPIs in software. Obviously, the gross retention and net dollar retention, both metrics are kind of [ pre-stellar ] for Nutanix. You guys posting 90s gross retention and NRR around 125%. So maybe you can talk about kind of competitive advantage, keeping up with those key metrics within software.

Right. Yes. As you said, so our gross retention rates are in the 90-plus percent range and then NRR, both are dollar based, for the fiscal year that ended in July was 125%, as you said. And so for us, look, we believe in our simplicity of the product, the value proposition and really extraordinary customer service, right? And so that goes to the GRR metrics, and we're often in mission-critical workloads, right? So it's not easy to sort of rip and replace something like that. On the NRR side, I think we talked about the vectors of expansion that I talked about earlier, right? So one is selling more in the same workload. Two is new workloads. And then three is selling more of the portfolio, right, to those workloads. So those 3 vectors of expansion are what our sellers are largely focused on to drive that NRR number. The other thing I would say is we have evolved to being a subscription company. So one of the things that we -- our sellers are becoming more and more familiar with, right, is just how you think about this bucket I talked about, right, which is an analogy that our sales reps use around. How do you make sure the water stays in the bucket? There are no leaks, so meaning that your GRR is strong and then adding more water, right, to the top of the bucket. And the benefits of annualized, whether it's ARR or ACV, how do you maximize that annualized value because once you have that and you combine it with really strong GRR, then that's now -- you have the renewals and the constant renewal and expansion, renewal expansion motion, right? That's quite valuable for a subscription.

So we have just a couple of minutes left. Last couple of topics. And obviously, the sales force, the productivity has been improving and you guys are looking to add maybe incrementally more sales reps. So maybe you can talk about kind of recent initiatives, kind of progress you are seeing on the sales force productivity kind of after segmentation recently.

Yes. So our sales team is in a good place. We've talked about hiring a few more folks. We are not quite at the capacity we'd like to be, we're slightly below. So we will expect to add a few more sellers over the course of this fiscal year and end with, hopefully, our [ required ] capacity by the end of the year. We talked about productivity. There are several initiatives that we are driving. We talked about channel efficiencies. We talked about some of the portfolio enhancements that we've made. Lot of enablement. We had our sales kick off in person for most folks coming back after the COVID years. And it was -- there was great momentum. And I think from the sellers to go out and continue to kind of drive home this idea that we're taking our strength in the core hyperconverged market and extending it into a hybrid multi-cloud world, right? And what differentiates us in that world.

So we just have 1 minute left. Do we have any questions from the audience? If not, we can just wrap this up. Thank you.

Okay. Thank you. Thank you, George.