Nutanix, Inc. (NASDAQ: NTNX) Q2 2021 earnings call dated Feb. 24, 2021
Tonya Chin — Investor Relations
Rajiv Ramaswami — President and Chief Executive Officer
Duston Williams — Chief Financial Officer
Dan Bergstrom — RBC Capital Markets — Analyst
Katy Huberty — Morgan Stanley — Analyst
Jason Ader — William Blair — Analyst
Jack Andrews — Needham — Analyst
Alex Kurtz — KeyBanc Capital Markets — Analyst
James Fish — Piper Sandler — Analyst
Nehal Chokshi — Northland Capital — Analyst
Rod Hall — Goldman Sachs — Analyst
Wamsi Mohan — Bank of America Merrill Lynch — Analyst
Ladies and gentlemen, thank you for standing by, and welcome to the Nutanix Second Quarter Fiscal 2021 Earnings Conference Call. [Operator Instructions] After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to your speaker today, speaker Tonya Chin. Thank you, please go ahead.
Tonya Chin — Investor Relations
I apologize, we’re having some difficulties on our end. Just give us a second. Good afternoon and welcome to today’s conference call to discuss the results of our second quarter of fiscal year 2021. This call is also being broadcast over the web and can be accessed on our Investor Relations website at ir.nutanix.com.
Joining me today are, Rajiv Ramaswami, Nutanix’s CEO and Duston Williams, Nutanix’s CFO. After the market closed today Nutanix issued a press release announcing financial results for the second quarter of fiscal year 2021. 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 plan, goal, strategy and outlook, including our financial performance, financial targets and performance metrics and competitive position in future periods. The timing and impact of our current and future business model transition, the factors driving our growth, the success and impact of our CEO transition, macroeconomic and industry trends and the current and anticipated impact of the COVID-19 pandemic. 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 factors, please refer to our SEC filings, including our most recent annual report on Form 10-K for fiscal 2020 filed with the SEC on September 23rd, 2020, as well as our earnings press release issued today. These forward-looking statements apply as of today and we undertake no obligation to update these statements after this call. As a result, you should not rely on them as representing our views in the future.
Please note, unless otherwise specifically referenced, all financial measures we use on today’s call are expressed on a non-GAAP basis, and have been adjusted to exclude certain charges. We have provided, to the extent available, reconciliations of these non-GAAP financial measures to GAAP financial measures on our IR website and in our earnings press release.
Lastly, Nutanix management will host virtual meeting with investors at the Morgan Stanley Technology Conference on March 2nd. We hope to connect with many of you there.
And with that, I’ll turn the call over to Rajiv. Rajiv?
Rajiv Ramaswami — President and Chief Executive Officer
Thank you, Tonya. And good afternoon everyone. Q2 was a strong quarter across the board. We exceeded guidance across all metrics, saw ACV growth, spend less than expected on operating expenses; gained momentum in our renewal vendor [Phonetic]; and continue to make progress on our transition to subscription.
Before I get into more details, I’ll begin by talking about how I spent my time since joining Nutanix in December and provide my initial observations on the business and our priorities going forward. In addition to some introductory meetings with shareholders, I met with many of our major constituents; including customers, partners and employees just coming on Board in December. The observations mean from these meetings has provided me with a good perspective that switch to bonds and priorities for our future. These observations include, the deep value that our customers get from the simplicity of our software; the importance that our channel partners play in growing our business at scale; the significant opportunity ahead of us with strategic alliances that will help us penetrate bigger accounts; and the quality and engagement of our talented employee base, who are critical to the execution [Indecipherable].
Feedback from these key constituents and collaboration with my engaged leadership team has enabled us to clarify several core priority areas to drive long-term growth. All of these priorities are part of the natural evolution for a company at scale. First, we will drive more simplification of our portfolio and how we take our solutions to market, including our products and packaging for the benefit of our customers. Second, we will focus on deepening our partnership to provide more impact and how we go to market, as well as create more opportunities within larger accounts.
Third, we will continue our transformation of our business model to subscription with a significant focus on renewals and our path to cash flow possibility. And fourth, we will continue to nurture and grow our talent pool, as well as to ensure that our employee base has a diversity of talent, thoughts and experiences, create a better workplace environment and business outcomes.
Now let me provide a little bit more detail on these conversations, observations and priorities. I’ve had many encouraging and informative conversations with customers, including our Advisory Board. When it comes to our product portfolio customers love our simplicity, I think our solutions and support are exceptional and appreciate the end-to-end nature of our portfolio. They’ve also told me that Nutanix is a critical component of their business transformation plans. On the constructive side some have expressed that they would like us to make it easier for them to adopt and consumer software by delivering more solutions that bring our portfolio together and to simplify our pricing and packaging. We have built the feedback into our key priorities for our go-to-market strategy.
During the quarter, I had the pleasure of presenting at a well attended Global Partner Event, where I met several key partners. They see the value that selling Nutanix software and solutions can bring to their business as they have customers on their multi-cloud journey. Last quarter, we launched our Elevate Partner Program, which focuses on partner competencies to training to increase the quality of partners working with us and partner enabled, including improving the de-registration process to increase volume. With this focus we have seen a 12% year-over-year expansion in the number of partners, who transacted with us during the quarter. As well as an increase in partner led deals. Engage and efficient channel partners will be a critical component of ensuring that we have the leverage needed to grow and scale our business through our subscription transformation.
Our partnerships with HPE, Lenovo and other server OEMs remained strong. Our customers recognize tremendous value in having freedom of choice. In their selection of hardware with these partners and in a broader ecosystem. Allowing us to address the increasingly complex needs of large enterprises. For example we were selected by a leading financial services company headquartered in EMEA to modernize their data center and to provide virtual desktop to more than 90,000 users. This multi-million dollar one-year subscription deal was with our core software are AHV hypervisor and our Files solution.
We partner with HPE, Citrix and Azure one of our global systems integrator partners. To provide the total solution required for their use cases. I’ve been encouraged by the value that our customers see from our software, the variety of workloads they’re deploying on our platform and our traction with our Global 2000 customer base. We now count 950 Global 2000 companies as our customers, after adding about 20 in the quarter. We continue to progress with our public cloud partnerships and integrations with both Azure and AWS and are exploring how to maximize these relationship to help our customers on their journey to multi-cloud. Our partnership with Azure is still in its early days, but we are excited about its [Indecipherable]. We will focus on deepening our integrations and relationships in this area.
Finally, I’ve had the pleasure of speaking with many employees at all levels. I’ve been delighted to see that there is strong talent in this company and I’m highly impressed with that passion, it’s no surprise to me that Nutanix was named in both the Fortune Best Workplaces in the Bay Area 2021 and a Great Place to work in India during the quarter. I already mentioned that an area of opportunity for us is to advance our efforts to diversify our talented employee base. In addition, we will increase our focus on ESG and related disclosures.
Now let me talk about the market opportunity in front of us, as well as provide more color on the momentum and execution we saw during the quarter. During the quarter industrial analysts highlighted the market potential for Hyper-converged Infrastructure or HCI, and it’s path to multi-cloud. IDC released reports concluding that HCI can create a consistent experience across all platforms, well around premises or in the club. How multi-cloud strategies are now the enterprise [Indecipherable]. And how a large majority of IT managers plan to migrate or repatriate workloads from public cloud to an on-premises for ease of management.
In addition Gartner raised its forecast for HCI systems during the quarter to $8.1 million, a five-year CAGAR of 15% from 2019 through 2024. They noticed that organizations are expanding their HCI systems footprint on a wider set of enterprise workflows. With emphasis on a new set of software capabilities such as orchestration in a multi-cloud world.
Now let me provide some highlights of our performance this quarter. We delivered record ACV billings growth of 14% year-over-year with included notable strength coming from emerging products. Our opex was less than expected and we will continue a disciplined approach to managing our opex going forward. Our thesis of the benefits to a shift term licenses continues to playoff with better deal economics and reduced average tumbling, driving shorter renewal cycles. As we have said getting this right will be critical to our success. Both and growing the topline and in reducing our operating costs. A year into the pandemic, we continue to see various industries and verticals impacted differently, while some industries faced headwinds there are a number that have the resources to focus on innovation and transformation with IT as their enabler.
To that end we saw strength in demand from the financial services, healthcare and state and local government sectors in the quarter. Our emerging products, particularly our database management solutions era and our file storage solutions Files had a strong quarter. Emerging product ACV was up over 100% year-over-year and we had a 37% attach rates to deals on a rolling four-quarter basis. We are encouraged by the fact that nearly half of the Fortune 100 have adopted our emerging products.
Our Era solutions is showing great momentum and market fit, and I see this as a competitive differentiator for us going forward. We’ve seen repeat purchases from large enterprises, who are early adopters. This quarter a US-based financial services company purchased Era and our core software in a multi-million dollar deal. They are using Era to provide a single database management platform to enable their app developers to publish a new environment, clone and refresh multiple Tier 1 workloads and now have the ability to replicate and recover large databases in a fraction of the time that their current solution fits.
Era has become a competitive differentiator for us in the telco, finance, retail and manufacturing sectors in particular. And we now count three of the top 10 Global 2000 customers at Era customers. We saw growing interest in our clusters of AWS solution, since its launch last quarter. One customer example this quarter, if a pension services company in EMEA, an existing customer who is building on their Nutanix Hyperconverged Infrastructure software as they continue their journey to multi-cloud. They were looking to increase the mobility of their applications and workloads across multiple clouds, as well as to have options for bursting and clusters hit the requirement. Ultimately, they selected the Nutanix Solutions so that they could get a single solution to consistently manage their private, hybrid and multi-cloud environment.
We remain focused on go-to-market sales productivity and execution. They are pleased with our progress so far, this is a reflection in part on Chris Kaddaras leadership. During this quarter, Chris was promoted to Chief Revenue Officer, after leading the global sales organization for the last year. We’re also seeing material progress in demand gen productivity across the board. Including our virtual events and overall digital marketing performance, all at significantly lower cost. We also continue to see benefit from our debt side, which has seen an increasing number of trials over the past year. And has proved to increase conversion rates, when compared to sales where test drive isn’t used. We are encouraged by our momentum and we will continue to focus on overall go-to market efficiency.
We continue to innovate our storage offerings with the recent release of new features enabling our customers to simplify data management and effectively manage costs, moving IT teams even closer to true hybrid and multi-cloud operating models. The new capabilities, include cloud tiering for object storage; hybrid cloud file storage and simplified disaster recovery for both objects and files. Recently, we also announced new features in our cloud platform to help protect customers against ransomware attacks, which are becoming even more common as a result of increased remote work. These new capabilities all natively built into the Nutanix stack, add to Nutanix’s rich data services for network security, files and objects storage and business continuity to help enterprises prevent, detect and recover against ransomware attacks across multiple cloud environments. We are pleased with the external recognition, we continue to receive for our solutions and our market share.
In Q2, we were recognized by Gartner as a leader in their Magic Quadrant for Hyperconverged Infrastructure for the fourth year in a row. And we’re positioned best and execution when compared to all vendors in the report. Also Gartner released its software market share numbers for Hyperconverged Infrastructure, and Nutanix was once again ranked number one in market share for HCI. And saw our market share increase year-over-year. In addition an IDC’s new software-only view of the market, the software defined infrastructure factor, Nutanix is the leading vendor in the space. This new view is not influenced by hardware sales.
Let me conclude by reiterating how excited I am to be leading Nutanix into its next phase of growth and execution. We remain focused on our vision of making cloud invisible and freeing customers to focus on their business outcomes and our North Star continues to be our customer. We believe our mission of delighting customers with a simple, open, hybrid and multi-cloud software platform with which data services to build, run and manage any application will help us achieve transmission. Our [Indecipherable] in a significant experience, designing software that is easy to use and in our expertise in key areas for the journey to multi-cloud, including storage and data services.
I have confidence and our continued momentum going into the second half of the year. Balanced with cautious optimism about the global macroeconomic environment. I very much look forward to sharing more details with all of you at our Investor Day on June 22nd.
I’d now like to turn it over to Duston for more details of our financial performance. Duston?
Duston Williams — Chief Financial Officer
Thank you, Rajiv. Our sales team executed quite well in Q2 amidst an uncertain macro environment and our ongoing ACV transition. Comparable to the quarter before, last quarter we provided guidance that took into consideration the uncertain macro environment we are operating in. And clearly, we outperformed our expectations for the quarter, while at the same time adding to our backlog.
As we look forward, our thesis for the business continues to be proven out that in ACV first focus will gradually compress term lengths, leading to better deal economics and a shorter time to more efficient low cost renewals. As the mix of our low cost renewals increases as a percent of our total business, we believe it will eventually add significant leverage to our go-to-market cost structure.
We are also seeing the result of our ACV based sales compensation plan putting a renewed focus on sales of emerging products, which typically have shorter term lengths. I have previously shared that we expect the term lengths would compress slightly in Q2. Our Q2 average term length was 3.4 decreasing by 0.1 and down slightly from 3.5 years in Q1. We are also pleased with the overall deal economics in Q2. We build a record amount of subscription renewals during the quarter and while the sample size is still relatively small, and we are still early in the process we are encouraged by the retention rates that we are currently see. We continue to sign an increasing number of one-year deals. These deals will add to the pool of low cost renewals available to renew in FY ’22.
As we previously noted, we had an outstanding quarter related to our emerging products with most of those individual products generating record ACV. Emerging products continue to play an important role in improving our deal economics during the quarter. So in summary, based on our strong execution in Q2, our thesis for the business continue to play out as expected, as we move into the second half of our fiscal year, we remain very encouraged with our progress to-date.
Now, I’ll move on to some specific — our Q2 financial highlights. In Q2, we had record new ACV, renewal ACV and total ACV. ACV billings were $159 million, reflecting 14% growth year-over-year, significantly above our guidance range of $145 million to $148 million. Run rate ACV as of the end of Q1 was $1.38 billion, growing 28% year-over-year, compared to our guidance of approximately 25% growth. Revenue was $346 million, essentially flat from Q2 ’20, driven by a 0.5 year decrease in average term length versus Q2 ’20.
Our non-GAAP gross margin in Q2 rose to 82.7% versus our guidance of 81.5%. Operating expenses were $354 million, down 11% year-over-year and less than our guidance of $360 million to $370 million. We continue to benefit from overall spending reductions including go-to-market efficiencies.
Our non-GAAP net loss was $74 million for the quarter or a loss of $0.37 per share. We also saw a good year-over-year increase in our pipeline in the quarter, as well as continued improvement and overall pipeline quality. Our linearity in Q2 was outstanding, resulting in one of our most linear quarters ever.
Our free cash flow for Q2 was aided by good linearity coming in at negative $28 million, this performance was significantly better than our expectations. DSOs in Q2 were 45-days down from 54-days in Q1 ’21 also driven by good linearity. And we closed the quarter with cash and short-term investments of $1.29 billion, down slightly from $1.32 billion in Q1 ’21.
Now turning to our Q3 ’21 guidance. The guidance for Q3 is as follows: ACV billings to be between $150 million and $155 million, representing year-over-year growth of 11% to 15%. Gross margin of approximately 81%, operating expenses between $365 million and $370 million, representing a year-over-year decline of 5% to 6%. Weighted average shares outstanding of approximately $207 million.
Now few modeling assumptions. Our guidance for Q3 continues to have a small conservative bias based on the ongoing uncertain macro environment. As we communicated last quarter and similar to the seasonality we have experienced over the last two years, our Q3 guidance anticipate a slight seasonal decrease in ACV billings in Q3 versus Q2. While at the same time reflecting year-over-year growth of 11% to 15% and a raise of 5% to 8% from the current street estimates, based on the Q3 ’21 ACV billings guidance we expect run rate ACV to continue its strong growth trend and grow in the mid-20% range year-over-year. We believe we are now to the point in our transition that we will not see dramatic quarter-over-quarter change in term lengths, returns fluctuating by 0.1 or so per quarter going forward.
As term length begins to stabilize, we expect reported year-over-year revenue growth to move closer to ACV billings growth over time. We also expect our operating expenses for fiscal ’21 to now come in upwards of $50 million less than what we spent in the prior fiscal year. From a free cash flow perspective linearity in Q3 is typically not nearly as strong as we experienced in Q2 and therefore, we expect our cash uses to increase in Q3.
Our Q3 cash usage will most likely approach the current street consensus numbers for Q3. We are pleased with our overall cash management efforts, especially in the light of compressing terms and continue to exceed our internal plan set forth at the beginning of the fiscal year.
And finally to help with your modeling, we continue to include in our earnings presentation located on our IR website, our historical trends for ACV billings, run rate ACV, billings term length and a bridge on how to model and convert our current and future ACV billings guidance to total billings. We will continue to include this level of detail through the end of FY ’21.
With that, operator, could you please open up the call for questions. Thank you.
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