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

All right. Perfect. Welcome, everybody. I'm going to read a very short disclosure, and then we'll get into questions. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. For those of you who don't know me, I'm Meta Marshall. I cover kind of the enterprise networking and storage group here at Morgan Stanley. We're delighted to have Rukmini Sivaraman, CFO of Nutanix.

I have a whole list of very long-term questions, but just given kind of earnings earlier this week, I just wanted to give you an opportunity to kind of start out with kind of just explaining what's going on with the Audit Committee investigation?

Thank you, Meta. First of all, it's great to be here. Thank you for hosting us. It's great to see you all. Thank you for coming. So I will start with this, we disclosed on our earnings call that we had discovered some improper use of third-party valuation software that we were using instead of evaluation purposes for validation, proof of concept, et cetera. We -- management discovered this during the quarter, and so we are doing all the right things to get this addressed and working closely with just the right expert advisers to make sure that this is done in a timely manner, but also in a complete manner. And so we hope to sort of share more about it once it's resolved here. And I will say, as a result of that, we are not going to be able to file our Q on time. But again, the intent is to resolve this completely and as soon as we possibly can. I will also emphasize, I think this is important that we don't believe that this has any significant impact on the fundamentals of our business and the overall prospects of the company. And we were really happy actually -- and I know we'll talk more about this. We're really happy to be able to raise our topline guidance for the year for this fiscal year and also reaffirm our long-term free cash flow outlook for fiscal year '25 or $300 million plus of free cash flow.

Got it. Perfect. So maybe just let's take a step back. Nutanix has been on this multiyear journey towards ACV and refining expansions of the product portfolio, helping bring kind of the operating and cash flow leverage you just spoke about. Just where do you feel like you are on this kind of transformation journey? And are you out of kind of the transformation phase and on to the selling phase?

Yes. Thank you. I actually think you -- I think you characterized it quite well, Meta, in that we do think that the transformation phase is behind us, and I'll clarify what I mean by that and beyond into the scaling phase. So 90-plus percent of our business is subscription software that we sell. Our gross margins are in the low 80s percentage, which is a significant improvement from where we were several years ago, and the small remaining portion is professional services. So when you look at that profile, that is very much like any -- most of the subscription software companies and what we're selling to our customers. Our sellers have been sort of incentivized on annualized contract value, ACV model, as you alluded to, for several years now. And so that portion of this journey, I would say that as you characterized this, the transformation phase is done. We are in a scaling phase, and for us, what that means is that we are now starting to see the benefits of that business model evolution. So renewals as an example, right? So because we are now -- we've been selling term licenses, we are seeing an increasing waterfall of renewals that are coming up in the next several years. And that helps us, I think, on at least 2 fronts, right? One is in terms of growth. We've talked about how we expect for this year, for example, the significant majority of our growth in billings is expected to come from growth in renewals billings. And that, I would say, is a lower-risk topline growth than new and expansion, especially in this environment. We talked about that. So in terms of growth, it's a driver for growth and somewhat lower risk growth. And the second piece that the renewal growth helps us with is on efficiency and leverage. And so as you can imagine, it takes -- it's much more efficient for us to transact $1 of renewals, which is $1 of new and expansion, and so that helped us as well. And when you layer all of that along with the significant opportunity for new and expansion, that's sort of the point that we are at, right, in terms of what's to come from this evolution on both growth and efficiency.

Got it. We talked about -- you just mentioned macro is obviously kind of more challenging for new business. You're seeing great renewals business, but we're also seeing kind of a rationalization of cloud spend, which is kind of making people reevaluate their on-premise data centers or just kind of what their hybrid footprint is going to be going forward. That would seem to be a great setup for an HCI company. So just what are those conversations like with customers? And is it creating kind of the inroads into customers as they go through these kind of cloud rationalization journeys?

Yes, it absolutely is an opportunity for us, right? Because we have been a leader in, what you refer to HCI, hyper converged infrastructure, which is a great stepping stone, I would say, for an operating model that is a cloud operating model regardless of whether your underlying workload is running in sort of a public cloud and hyperscaler environment or whether it's on-prem, right? So for us, we've always believed that cloud is an operating model and not a destination. And so I know we'll talk some more later on, I think, about just how different ways and when people think about this. But to your question on rationalization today, right, especially in this environment, we are seeing that, and I think for us, we are there to help customers with making sure that their total cost of ownership and ROI is the most it can be in the environment they're in. If that means moving some workforce around, then we believe we're the best platform for that because we make those movements whether it's between private and public clouds or whether that is in between public cloud, not just easier to do, right? So it saves them effort, but it also saves them costs, right? So there's a time and a cost element that we can make things easier for them to make those transitions.

I mean do you feel like -- obviously, we're seeing the cloud rationalization, and -- but I don't think everybody is clear on has that changed kind of the end state? And then I guess, I'm just kind of asking, do you think customers have started thinking about the end state? Or we're still in the I just need to rationalize spend right now?

Yes. And I think they're actually -- as you can imagine, people that are in different parts of that done, right? So I think there are some folks who are very much in the throes of a game and cloud rationalization mode right now in a more reactive way, which is okay. We're there to go help those customers, but there are also folks who are thinking about this in a more kind of strategic longer-term way, which is not so much about near-term cost rationalization, but more about strategically, what do I want my environment to be, right, in the medium term, in the long term. Do I want it to be hybrid? Depending on what the workload is and what I'm going to need from it. Do I want it to be multiple public clouds, right, or somewhere in the middle? And we're having both those conversations. And on the strategic side, I think maybe where you were going, Meta, right, is if the customer is more saying, look, there's near-term things that are happening, we'll go figure that out. But when I think more strategically about just what my operating model should be, one of the reasons I think we can differentiate ourselves is, we're able to help them future-proof it because there might be some CIOs who say today, I'm not ready to make some kind of a significant change, but I know I'm going to want to do that in a year or 2 years' time, and Nutanix can help them really future-proof that because we can help them now from a very practical PCO perspective, but we can also help them go on that journey in the future, right? So there is definitely -- that's a leading indicator for, I think, for them to say, well, why would I choose you, right? And I think we are uniquely positioned because we are on-prem. We can work across cloud, public cloud and some of the other folks in the space have reasons, right, to be in one or the other.

Got it. I mean maybe just kind of refreshing back to earnings on Monday. It seems like a long time ago now. Just on kind of the macro impacts that you're seeing, I think you kind of described them across both the renewal business and the new business. But maybe just kind of refreshing, kind of where you're seeing it? Is it just longer sales cycles? Is there hesitancy to try out new products? Just where are you kind of seeing that within your portfolio?

Yes. So our renewables business has held up really nicely, right? Our GRR, which is gross retention rates, we've talked about that being 90-plus percent, which continues to be the case and just comes back to, I think, what I talked about earlier in terms of just being more predictable, but also just these are deployments. We're off and running mission-critical workloads for people. So it's going to not be easy for them to not renew, right? So that's good. So I think renewals continue to be healthy and strong. As we've talked about the new and expansion side is where we had baked in some caution into our expectations. And what we saw that was probably new in this earnings from 2 days ago as opposed to the previous quarter, but previously, we're anecdotally heard about more deal inspections, things like that. In the January quarter, we actually did see some modest elongation of sales cycles -- and just to define it for folks what we mean by sales cycles, we looked at all the transactions that happen in any given quarter, and when were those opportunities created, right? So how long did it go from opportunity creation to close? And those are modest elongations. I wouldn't characterize them as drastic in any way, but we did see it across both kind of new logos that we were trying to win and with existing customers, but this is all purely on the expansion side. So even with all that, I don't think that's unusual, Meta. I'm hearing that from a lot of other companies in the space. And I would say, look, as someone who does approve a lot of our spend, we are asking those questions, right? Like do we -- and so I think that's absolutely appropriate for the environment. So we baked some of that into our outlook for the rest of the year, but even factoring that in, we were happy to be able to raise the topline guidance.

Yes. I mean, I think, obviously, we've spent a lot of time to talk about rationalization and macro and all these things, but you did kind of beat the quarter on the topline, and we're able to raise. And so where are you seeing that kind of greatest source of upside?

Yes. So I think what we continue to see is kind of the fundamental value proposition, right? Like for us, in our market, we have -- and even before kind of any of the near-term discussions, I think a lot of people are having around TCO and ROI, that has been our value proposition from the get-go. And so naturally, as I think folks can imagine in an environment like this that resonates with people, right? Like so if someone's going to go say, hey, need to go transact with Nutanix, we have a very strong proposition around TCO and ROI and benefit. So I think that value proposition is resonating with people, which is great, right? And I think when we talk about expansion, people are also seeing that play out for them, right? So when existing customers come back and buy more from us, it's because we have the proof points and I have to imagine taking those to their decision makers to say, look, look at all the benefits we've already obtained, and this is why we're going to expand with this with Nutanix as a vendor.

Another big opportunity investors have been pretty excited about for you guys is just the consolidation that's taking place within the space or acquisition that's taking place within the space. Just how do you position yourselves best to take advantage of that opportunity either through targeted initiatives through hiring of salespeople? What are all the different ways that you're kind of putting yourself in the best position to take advantage of that?

Yes, it's a great question. And so this acquisition that I think you are referring to in the market of one of our competitors has been announced, right? There is yet to be -- to close. And so for us, what this has meant is, it's an opportunity just given some of the uncertainty surrounding that provider to say, here is our value proposition, here's why we are the right partner for our prospects and customers. And so we have been doing everything in our control to capitalize on that opportunity. What do I mean by that, right? And this is a company that is not new to us, right? We have competed against them for a while, and so in that sense, our sellers absolutely know how to go work those opportunities. But it has opened some doors for us, right, that were previously not quite as open because of what's going on with them, right? So what we have done is, we've created sort of campaigns, folks that maybe don't know about us as much sort of create that awareness, but also armed our sellers with tools around how can we make it easy for people to migrate if that's what they're thinking about, right? And so there's a lot of that, that has gone on as well. And I would say, I think from the people side, you brought up that talent piece as well, Meta. We will continue to be opportunistic, and we have hired some great people in the market from this particular competitor, but I think just more generally, we'll be opportunistic. We are not planning to increase our sales rep capacity dramatically by any means, but we'll be opportunistic for great talent out there, we'll absolutely want to get them in.

Got it. Yes, because I think the biggest question that I have sometimes and I know I've asked you this before is, you could spend a lot of effort kind of going after what is a very big installed base of customers. And so just how do you find what's the most effective way to say, Hey, I'm just going to introduce myself and see if I kind of get a bite on that to, okay, these are what are the most actionable targets.

Totally agree. Like we have to be smart about where we're spending our time, right? So I think you're absolutely right. I will also say that I think some of those -- some customers of this particular vendor, I think, you're referring to, Meta, have also -- we understand have signed renewals, right, with them to sort of buy themselves some time to go and understand what their options are. And so I think, for us, we are thinking about which segments of the market we want to spend our time on. Like I said, there are some areas where doors were not open to us, but they are open now, and we fully intend to capitalize on that. And then there are places where we've always been in a motion, where we're used to competing with other vendors, and we'll let that continue. And we are picking our spots in some ways in a way the customer said, look, I've signed a renewal with them for 3 years. So we -- of course, we'll stay in touch, but we may not amp up that effort until, call it, 18 months, 2 years from now.

Okay. Perfect. You've had a number of changes to your salesforce over kind of the past year or so. There's been turnover, changes at the Chief Revenue Officer, Arief in addition to kind of supply chain disruption. So just how have you been able to manage to deliver like largely to plan over the last year with a lot of disruption underneath the surface?

Yes. So I think some of those, I would say, like for example, you mentioned our CRO. He has actually been with the company for 6 years, right? So he wasn't new to the role, suddenly he was promoted into the role, but is really sort of well-known inside the company and himself was very familiar with the strategy and the initiatives that are in place, right? So in that sense, it was an easier transition benefit was somebody that was hired from the outside. So that I think is going well. He's got its leadership team in place and so on. I think overall, I would just -- I do give -- I think our teams have done an incredible job of executing in an environment that has been fluid, right? From a macro perspective, which I think a lot of folks are facing and navigating, but to your point, some of the partner supply chain issues, which are one step removed from us and we don't directly control, but this is where I think we have talked about how one of our core value proposition is choice. How do we give our customers as much choice as we can to help them navigate this in a seamless way, right? So we have -- I think we've simply sort of focused on things that we can control and driven to those, Meta, and then also capitalize on just what is the strength of our platform, right? Like I talked about before in terms of value proposition, helping companies digitally transform future-proofing them, TCO, ROI, all of those things to me are evergreen value proposition, right, that our teams continue to drive. And lastly, look, I think not to belabor this, but it does -- the renewals, the base has provided us with a nice foundation, right? That is relatively resilient even in these -- because the supply chain things or the macro less impactful to that piece.

Got it. I think sometimes one of the things that I struggle with is, yes, you have this leverage coming from your business model from moving from TCV to ACV. But if I were a sales rep, I would say, well, that just means I'm getting paid less on kind of this renewal business, and I was getting paid on kind of a bigger transaction upfront. And so what do I misunderstand about that in terms of how a salesperson is kind of incentivized the same, but differently than they were before?

Yes. So I think when we made this switch, this is now more than 2 years ago, right? This is the third year that our sellers are being incentivized on annualized contract value. We absolutely took into account all the points that you're rightfully making because if I am a seller, how do I make money? And how can I still make as much or just feel like I can win, right, in the sales comp model. And so when we thought about that, we did a lot of actually work just going to other companies who have made this evolution, benchmarking and so on to say, how do we make this small work for our sellers? And so today, they are largely incentivized on new and expansion business, right? And they also have a small incentive to focus on renewals. Why? Because renewals can be a great point or a point in time to go and have an expansion discussion. That is a natural touch point with the customer. So I would say, at this point, will we continue to kind of tweak our sales comp model and incentive model? Of course, we will. That's just normal and all companies do that. But I think they are now at a place where we are -- they understand why this annualized model, right, while balancing kind of all the other things that a customer might want to do. If the customer may still say, I want a 5-year transaction or a 3-year transaction because of how they are choosing to spend their dollars and their budgets, and we've tried to make it clear to our sellers like what are the levers that they have, right, to one make this work for the customer, but also to make it work for them from an incentive standpoint.

Got it. When we started, you talked about kind of the free cash flow targets that you guys have had and being able to maintain those, particularly in light of kind of the current Audit Committee investigation. Just where is that leverage coming from? And just given the uncertainty around the Audit Committee investigation, just what kind of gives you continued comfort in being able to achieve those?

Yes. So I think the leverage overall, if I take sort of a step back on the macro free cash flow number that we provided fiscal year '25 at $300 million plus, and then we said, $100 million to $125 million for this fiscal year. And you're right, Meta it does factor in that number, a potential impact from this review that's ongoing. And we haven't quantified it, but I think we feel comfortable that, that number works even with that impact. It also includes, I think, just for the full picture, right, 2 kind of $45 million of what I would characterized as nonrecurring cash outflows that we expect in this quarter, right? So when you normalize that $100 million to $125 million for this $45 million on top of that and then like I said, this potential impact, right, that gives you a sense of just what you should expect on a normalized basis.

Got it. You saw some supply chain challenges from server availability over the last year. I guess, understanding -- just trying to understand is that customer server preference? Like given that you work on kind of any server, I think the question that we got was just, what was reason for kind of that? Why don't we just swap for something else? And then -- or is there kind of a path to market that comes through those server vendors that we don't appreciate?

Got it. Yes. I should first start by saying that this is -- for those that may not be as familiar, right, so this concept of the server availability refers to our partners, right? So we don't sell hardware, as I mentioned earlier, right? But because we are an infrastructure software company, our software does run on underlying servers that our partners provide. And what we saw starting about 2 quarters ago was that because of the supply chain challenges that they were having and this effect only the new and expansion portion of our business, not the renewal piece which we've talked about, our customers were having challenges with getting -- with procuring some of those servers to run our software on them. And so as Meta pointed out, like we do provide a wide variety of choice for customers and because we run -- we provide the software, and we wanted to be able to run on almost any platform. And a couple of things were happening, right? One is that almost all of those vendors were seeing some degree of disruption from supply chain back then. I do think it has improved since then, and we've talked about that and how that's impacting us as well, which is good news. I think the more those resolve, the better it is. And secondly, there are some customers who want to stick to a certain platform for whatever reason, right? So our sellers are going to make it clear to them that they can use any other silver partner who have more availability or less. But in some cases, the customer may choose to stick to one or the other for whatever reason, whether they have a relationship or the way their systems are configured. And so in those instances, they did choose to say, look, I'm going to -- I want to buy Nutanix software, but my server is not coming until 3 months out, 4 months out in some cases, which, of course, we want that business. So we would collect the bookings from them. It just meant that our revenue recognition for that doesn't -- can't begin until the actual license is activated. And so that was the dynamic that we've talked about in our earnings in terms of how that flows through the P&L. And I do think this is something that will resolve itself, right, over time, and we've already seen improvements in the last couple of quarters.

Are there partnerships that are kind of important for you as you go to market?

Absolutely. So I think we have talked about just our strategic partnerships as being really an important lever for us as we go to market. So some -- I'll talk about a few. So if you think about Citrix and Red Hat, important partnerships for us as we go to market with -- jointly with them. The Azure partnership is another important one I would highlight. We -- in October, we announced the general availability of our cloud clusters product in partnership with Azure. And so that's relatively new to the market and going well because it's in the Azure marketplace. People can use marketplace credits to use our product. And then I would say, I think these -- the partners we talked about from my server perspective, right, are also important because in many cases, we are sort of selling the customer jointly in those instances.

Got it. I want to leave a chance for questions. Are there any questions from the audience? All right. Perfect. I have plenty more. All right. So another dynamic over the past couple of quarters has kind of been this early renewal phenomenon that's maybe made modeling a little bit of a challenge or just kind of figuring out what growth rates are. Do you feel like we're getting to a more normalized place here where we know -- like you've refined kind of in your forecasting how you think about those renewal time lines or how should we think about kind of this early renewal phenomenon going forward?

Yes. No, it's a good question, Meta. And I would say, like when you think about renewals -- and this is a more generalized view, right, of subscription software companies, not necessarily just us is, these renewals we know when they are coming due. We've talked about available to renew is what we call it. So at the beginning of the quarter, we know what renewals are available to renew and that are coming due in that quarter. Practically speaking, there are a few things that go in, right? Our renewals teams will sometimes go and start that conversation with the customer up to 6 months in advance. And we see that also, by the way, from vendors who sell through us because you don't want to wait to the last minute to go do that. And some of these like federal customers, for example, have pretty long approval cycles and so on. So you want to get ahead of it, but that also means that sometimes there's just, what I would characterize as, normal fluctuations in when those transactions close. We also do what we call core terming, which is, again, as somebody who we also purchased, right, subscription from other vendors, we can say that you'd like to have all the licenses we quoted term to a single day because you bought -- people buy a lot from us to write different products and different solutions. So those are all, I would characterize normal variations, Meta, and those will continue. But I would say, there -- at this point, we are trying to get our teams to make sure there's not any kind of unusual movements. So these are all, I think, normal levels of variability from quarter-to-quarter, which is I think as expected. And I think overall, we're happy with the levels that I don't know what team is executing to.

Maybe just to sneak in one last one. You're entering into a cash generative period. There's a lot of things you can do with your platform. Just how do you consider kind of yourselves doing M&A as a part of that strategy?

Yes. Look, I think we will be open to it as we are just earning the right. I think in my mind to be able to do that because we've been very, very clear about sustainable and profitable growth as being our are true north, and we're very happy with the record free cash flow margins we had in Q2. So we will be opportunistic, and we'll be thoughtful. I think when you think about valuations in the market, I think public markets have seen obviously a level of valuation change, but I don't know if the public private markets necessarily. We'll see how that plays out. So we'll be thoughtful about any potential acquisitions that we consider as we go forward here.

Great. Well, Rukmini, thanks so much for being here with us today.

Thank you. Thanks for having us.