Nutanix, Inc. (NASDAQ:NTNX) Q2 2023 Earnings Call Transcript

Nutanix, Inc. (NASDAQ:NTNX) Q2 2023 Earnings Call Transcript March 6, 2023

Operator: Hello, and welcome to Nutanix Second Quarter 2023 Earnings Conference Call. I would now like to hand the conference over to your speaker for today, Rich Valera. You may begin, sir.

Richard Valera: Good afternoon, and welcome to today’s conference call to discuss the results of our fiscal second quarter of 2023. Joining me today are Rajiv Ramaswami, Nutanix’s President and CEO; and Rukmini Sivaraman, Nutanix’s CFO. After the market closed today, Nutanix issued a press release announcing financial results for the fiscal second quarter of 2023. If you’d like to read the release, please visit the Press Releases section of our IR website. During today’s call, management will make forward-looking statements, including statements regarding our business plans, strategies, initiatives, vision, objectives and outlook, including our financial guidance as well as our ability to execute thereon successfully and in a timely manner and the benefits and impact thereof on our business, operations and financial results.

Our expectations regarding the resolution of the investigation, its impact on our financial statements, including our financial guidance, our financial performance and targets and use of new or different performance metrics in future periods, expectations regarding profitability, our competitive position and market opportunity, the timing and impact of our current and future business model transitions, the factors driving our growth, macroeconomic, geopolitical and industry trends including global supply chain challenges and the current and anticipated impact of the COVID-19 pandemic and its effects. These forward-looking statements involve risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially and adversely from those anticipated by these statements.

For a detailed description of these and other risks and uncertainties, please refer to our SEC filings, including our annual report on Form 10-K for the fiscal year ended July 31, 2022, and our quarterly report filed on Form 10-Q for the fiscal quarter ended October 31, 2022, as well as our earnings press release issued today. These forward-looking statements apply as of today, and we undertake no obligation to revise these statements after this call. As a result, you should not rely on them as representing our views in the future. Lastly, Nutanix management will be participating in the Morgan Stanley TMT Conference in San Francisco on March 8, and we hope to see you there. And with that, I’ll turn the call over to Rajiv. Rajiv?

Rajiv Ramaswami: Thank you, Rich, and good afternoon, everyone. Against an uncertain macro backdrop, we delivered a solid second quarter with results that came in ahead of our guidance and saw continued strong performance in our renewals business. With respect to the macro backdrop, in our second quarter, we continue to see businesses prioritizing their digital transformation and data center modernization initiative enabled by our platform. However, we have seen some increased inspection of deals by customers, which we believe is likely related to the more uncertain macro backdrop, and this is driving a modest elongation in sales cycles. We consider this dynamic in our outlook for the remainder of the fiscal year. Supply chain constraints with our several partners improved compared with the prior quarter.

I’d like to comment on the investigation mentioned in our press release. We recently discovered that evaluation software from one of our third-party providers was instead being used for interoperability testing, validation and customer proof of concept over a multiyear period. Our Audit Committee commenced an investigation into this matter, which is still ongoing with the assistance of outside counsel. Rukmini will provide more details on the near-term reporting implications of this matter, but I’d like to emphasize that we do not believe it will have a significant impact on the fundamentals of our business and overall prospects. Taking a closer look at the second quarter, we delivered solid top-line growth, including 23% year-over-year ACV billings growth, driven by continued strong performance in our renewals business.

We again demonstrated good expense management, which helped us generate $63 million of free cash flow, continuing our strong recent free cash flow performance. Overall, I’m pleased with our financial performance in the second quarter. Our second quarter results reflect the value our customers are seeing in both our core cloud platform and in adjacent solutions in our portfolio with particular strength in Nutanix cloud management. A good example is our largest new customer win in the quarter, which was with a Federal agency looking to modernize their infrastructure. They replaced their legacy 3-tier environment with Nutanix’s cloud platform, including Nutanix cloud management, to run their business-critical applications, leveraging its simplicity and building automation for Infrastructure as a Service.

They also added Nutanix unified storage to service their unstructured data needs. We see this as a good example of a customer adopting our full stack offering to modernize and automate their IT infrastructure. Another notable win in the quarter was with the bank in the APAC region, who had been running a key business-critical applications in the public cloud on Red Hat’s OpenShift. However, they were having performance issues and were unhappy with the incident response times of their public cloud service providers. So following an evaluation of multiple on-prem and public cloud options, the customer chose to run OpenShift and their critical applications on-prem on the Nutanix cloud platform, including our AHV hypervisors, concluding that it was the alternative that could deliver the best performance and total cost of ownership.

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This deal reinforces our view that cloud is an operating model, not a destination and that our Nutanix cloud platform is ideally suited to enabling the hybrid multi-cloud operating model, increasingly favored by IT professionals. Following the general availability of NC2 on Microsoft Azure late in our first quarter, we saw solid momentum with NC2 in the second quarter. A good example is a win we had with an EMEA headquartered provider of global transportation services, looking to accelerate their migration to the public cloud, reduce their data center footprint and optimize their public cloud spend. Following a rigorous evaluation of alternatives, including native public cloud, this customer chose NC2 on Azure, which they found enabled a roughly 4x faster migration, lower migration costs and significantly lower operating costs.

This win demonstrates how our customers appreciate the ability to rapidly and seamlessly shift their workloads from their private clouds to the largest public cloud provider with the consistent management, governance and data services provided by the Nutanix cloud platform without the time and expense of refactoring their workloads and with lower ongoing operating costs. On the product front, during the second quarter, we delivered meaningful upgrades to our core platform with the release of AOS 6.6, which offers enhanced data services and a number of networking and security-related features, further strengthening its capabilities to support business-critical applications. In closing, I’d like to provide some thoughts on our priorities and outlook.

First, our overarching priority remains delivering sustainable, profitable growth through judicious investment in the business, execution on a growing base of renewals and diligent expense management. Our strong free cash flow, along with solid top-line growth in the second quarter, reflects the progress we made to date towards this objective. While the macro environment remains uncertain, we are encouraged that the strength of our business model underpinned by a growing base of renewals and our ongoing focus on profitability, allow us to raise our fiscal year top-line outlook and reaffirm our free cash flow outlook. I remain confident in our ability to continue to capitalize on the vast opportunity in front of us while continuing to drive sustainable, profitable growth.

And with that, I’ll hand it over to Rukmini Sivaraman. Rukmini?

Rukmini Sivaraman: Thank you, Rajiv. I would first like to note that with respect to the investigation Rajiv mentioned, we are in the process of assessing the financial reporting impact, and it is likely that additional costs would be incurred to address the use cases previously noted. As a result, we have not provided financial information regarding expenses in our second quarter preliminary results or our outlook for the third quarter or full fiscal year 2023. While we are working diligently to address this matter and finalize our financials as soon as possible, we do not expect to be able to file our 10-Q on time or following the 5-day prescribed extension period allowed under 12b-25. Relatedly, we are rescheduling our Investor Day we had intended to hold on April 4, 2023 to summer of 2023 and will provide a specific date once it is confirmed.

With that said, I will now move on to talk through our Q2 results, followed by our outlook for Q3; and then finally, provide an update on our fiscal year ’23 outlook. Q2 ’23 was a solid quarter with results that came in better than our guidance. ACV billings in Q2 was $268 million, higher than our guidance of $245 million to $250 million and representing a year-over-year growth of 23%. The significant majority of that growth came from growth in renewals billings. Revenue in Q2 was $486 million, higher than our guidance of $460 million to $470 million and a year-over-year growth rate of 18%. ARR at the end of Q2 was $1.378 billion, a year-over-year growth of 32%. New logo additions were about 480 in Q2. Contract duration stayed flat quarter-over-quarter at three years as expected.

As described previously, the percentage of orders with future start dates likely due to partner supply chain constraints continue to be a key assumption in our Q2 guidance. This percentage came in lower than it was in Q1 ’23 and below our expectations. Q2 revenue also benefited approximately $11 million from the improvement in percentage of future start dates as more license revenue was recognized in quarter than deferred, slightly more than the $10 million estimate we had provided on our last earnings call. Billings linearity was good, and DSOs were 28 days in Q2. Free cash flow in Q2 was $63 million, implying record free cash flow margin of 13%. A couple of additional notes on Q2: One, we retired the remaining principal amount on our January 2023 convertible notes of approximately $146 million with cash from the balance sheet.

Two, last month, we reached an agreement to settle the outstanding securities class actions litigation, which is subject to documentation, notice to class members and court approval. We recorded a net charge of approximately $38 million for the settlement. This is the amount, inclusive of legal fees and expenses, net of our expected recovery under our D&O insurance. We expect approximately $33 million to be paid and settled in Q3, while the remainder was already paid for legal defense costs in previous quarters. We ended Q2 with cash, cash equivalents and short-term investments of $1.311 billion, down slightly from $1.388 billion in Q1 ’23. Moving on to Q3 outlook. The guidance for Q3 ’23 is as follows: ACV billings of $220 million to $225 million and revenue of $430 million to $440 million.

I’ll now provide some more context around our guidance. First, the top-line guidance for Q3 assumes that supply chain dynamics for our server partners would remain more or less the same compared to Q2 ’23. It also assumes that contract durations would stay approximately flat to slightly down in Q3 ’23 compared to Q2 ’23. Second, the revenue guidance includes approximately $5 million of revenue benefit from the decline in percentage of orders with future start dates over the last few months. Said differently, we expect to recognize more license revenue in Q3 than is deferred, similar to the dynamic we saw in Q2. Over time, as our partner supply chain constraints resolves and our future start date percentages normalize, we would expect this dynamic to normalize as well.

I will now provide an update on our full year 2023 guidance. We have had a solid first half and our renewals business continues to provide a strong foundation for growth and efficiency. Those factors, combined with our continued focus on disciplined expense management, allow us to raise our ACV billings and revenue outlook for the year while reaffirming our prior free cash flow outlook. Our updated guidance for full year fiscal year ’23 is as follows: ACV billings of $905 million to $915 million, year-over-year growth of 20% at the midpoint; revenue guidance of $1.8 billion to $1.81 billion, year-over-year growth of 14% at the midpoint; and free cash flow of $100 million to $125 million. I’ll now provide some additional color on our full year guidance.

First, we are seeing continued new and expansion opportunities for our solutions despite the uncertain macro environment. However, as Rajiv mentioned, we have seen a modest elongation of sales cycles likely due to increased deal inspection. We have considered this dynamic in our updated guidance. We continue to expect that the significant majority of our growth in ACV billings for fiscal year ’23 will come from growth in renewals ACV billings with the uncertainty in the macro environment factored into our expectations for new and expansion ACV billings. A reminder that ACV billings for the full year is not simply the summation of four quarters ACV billings because of deals with less than one year in contract duration. We expect that full year ACV billings is discounted by approximately 5% relative to the sum of ACV billings from the four quarters.

Second, similar to our comments last quarter, the full year guidance assumes that contract durations would decrease slightly compared to fiscal year ’22. The fiscal year ’23 revenue guidance also assumes that the percentage of orders with future start dates would ease slightly in the second half of the fiscal year compared to the first half. Third, the reaffirmed free cash flow guidance of $100 million to $125 million includes the impact of approximately $33 million in net cash outflow expected in Q3 from the previously mentioned litigation settlement. It also includes the impact of approximately $12 million of cash usage in Q3 for nonrecurring tax obligations related to a portion of our employee RSUs vesting this month and other anticipated cash outflows.

These cash outflows were not included in our prior guidance for annual fiscal year ’23 free cash flow. Finally, I’d like to note that we continue to expect to generate at least $300 million of free cash flow in fiscal year 2025. In closing, we are pleased that our Q2 results reflect our continued execution towards our stated objective of sustainable, profitable growth, and we expect to continue that focus. With that, operator, please open the line for questions.

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Q&A Session

Operator: Our first question comes from the line of Pinjalim Bora with JPMorgan.

Pinjalim Bora: Congrats. It seems like a pretty good quarter. I just wanted to go back to the investigation that you were talking about. Could you maybe explain it in a little bit of a leaner what happened exactly? And it sounds like it’s like an underpayment to a vendor. Am I understanding it right? Or what — help us understand a little bit in less legal terms.

Rajiv Ramaswami: Yes. Let me start and Rukmini, you can explain the details here, right? But the one thing — the first thing I want to say is that the fundamentals of our business are unchanged. So this matter doesn’t impact our market opportunity or the demand for our solutions. And we are working diligently to resolve it as quickly as possible, and we are very focused on driving sustainable profitable growth. Now with respect to that specific matter, Rukmini, maybe you can just explain the details behind it and what we’re doing.

Rukmini Sivaraman: Sure. Yes. Pinjalim. So what we discovered was that certain eval software, evaluation software, from one of our third-party providers, so somebody who provides us software, which is intended for evaluation purposes was instead used for validation, interoperable, testing and proof of concept over a multiyear period. So that is a — we discovered that, and as we said on the call, that matter is ongoing. And because of that Pinjalim, we weren’t able to disclose expense information on the call, and we’ve announced that we expect to be unable to file our 10-Q in a timely manner, given that we want to make sure this is resolved first. Now I want to also provide a little bit of color that we are — given this, we still believe that our top-line results, our free cash flow as we reported it, are all unimpacted by this.

And when we look forward to guidance, we are pleased to be able to raise our revenue and ACV billings guide, and we’re comfortable with the $100 million to $125 million of free cash flow guidance for the year after factoring in the potential impact from this third-party software use that we mentioned on the call. And as I noted in my prepared remarks, the free cash flow guidance also includes the impact of the $33 million approximately from the settlement of the litigation and the impact of this $12 million of cash usage in Q3 for nonrecurring tax obligations related to employee RSUs vesting. And these cash outflows were not included in our prior guidance for the full year free cash flow.

Pinjalim Bora: Yes. Understood. And Rajiv, we had — with some of our discussions with some of your partners seem to suggest that the VMware opportunity is taking shape. But I wanted to ask you, one of the discussions kind of highlighted that just the complexity of some very large VMware customers using tens of thousands of VMs, who might be looking at Nutanix as an alternative. It’s just complex to kind of move from one to the other, of course. So I wanted to ask you, what can Nutanix do or what are you doing to kind of make those large companies feel a little bit at you to kind of move those large VMware environments over to Nutanix? And how has those — some of those discussions have been progressing?