Nutanix, Inc. Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for joining us, and welcome to the Nutanix Q1 Fiscal Year 2021 Earnings Conference Call. Now I'd like to turn the call over to your speaker today, Ms. Tonya. Please proceed.

Good afternoon, and welcome to today's conference call to discuss the results of our first quarter of fiscal 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 Dheeraj Pandey, Nutanix' CEO; and Duston Williams, Nutanix' CFO. After the market closed today, Nutanix issued a press release announcing financial results for its first 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 plans, strategies, and outlooks, including our financial performance, use of 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 timing and impact of our announced CEO transition plan; 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 23, 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 to 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 meetings with investors at the Crédit Suisse 24th Annual Technology Conference on December 1, the Wells Fargo TMT Summit on December 2, the Raymond James Technology Conference on December 7 and the Needham Growth Conference on January 11. We hope to connect with many of you there. And with that, I'll turn the call over to Dheeraj. Dheeraj?

Thank you, Tonya, and good afternoon, everyone. The first quarter was very strong, setting us up well for the rest of the fiscal year. While Duston will provide more details on the financials, I can say we exceeded expectations across all key metrics. Our ACV billings were 14% above the midpoint of our guidance and consensus. Additionally, Q1 marked our highest ACV bookings quarter ever, even amidst the pandemic. We also achieved strong gross margins, earnings per share, and free cash flow performance. We are pleased with our continued progress and proud to reflect on how much we have accomplished over the past three years. Our vision for a hybrid and multi-cloud future, built on our leading hyperconverged infrastructure, combined with a strategic shift to a cloud-like subscription model, is proving successful. While there is still work ahead, the most challenging tasks are behind us, and I feel proud and grateful for what we have achieved together thus far. Several factors contributed to our strong Q1 performance. Firstly, our ACV-based sales compensation strategy had a positive impact on our business. During Q1, our average contract term shortened, resulting in lower overall discounting and an increase in new product sales, driving significant run rate ACV growth of 29% year-over-year at a scale of $1.3 billion. We also experienced solid uptake of our new products alongside growth in our core software. Over the last four quarters, our new product attach rate in Q1 was 35%, an increase of 7 percentage points from a year earlier. New ACV for new products rose by 87% year-over-year and 27% quarter-over-quarter. Within our newer products, we saw particularly strong momentum in our data center solutions, Files and Flow, as well as DevOps and database-as-a-service solutions, Calm and Era. Importantly, many new product deals also involved additional licenses for our core software, affirming our belief that demand for our new products drives demand for our core software, which underpins our hybrid cloud infrastructure. Demand for our solutions was consistent across all regions and various verticals, including federal, which performed well as anticipated, in part due to the seasonal nature of the U.S. government's fiscal year-end. The federal sector also had a number of one-year contract deals, contributing to the reduction in average contract durations during the quarter, a point Duston will elaborate on. As always, our customer journeys are the best way to illustrate our quarterly success. One notable victory was with one of the largest and oldest financial services firms globally, which provides investment management, servicing, and administration. This existing customer, having spent over $20 million lifetime, invested an additional $1.7 million in ACV to expand their private cloud. Another similar success came from one of Japan's largest power companies, which has invested upwards of $15 million lifetime in digitizing their desktops and files with our software stack, spending an additional $1.8 million in ACV in Q1. Our strong results were bolstered by our go-to-market momentum in the cloud sector, especially with the successful introduction of our ACV sales compensation plan, alongside effective sales enablement and training regarding ACV benefits. Moreover, our sales teams excelled at enhancing the sales process by building a robust pipeline even amid COVID-19, collaborating closely with partners, and adopting a multi-product and multi-workload sales strategy. The channel continues to play a critical role in evolving our customer journey. Accordingly, we launched a simplified channel program to deliver greater profitability and an accelerated roadmap for partners to transition to a cloud business model. Furthermore, we made significant enhancements to Nutanix University, our educational platform, which now offers more certifications across new skill levels in technology tracks to boost the adoption of Nutanix software and overall technology consumption. Participation in this program quadrupled over the past year, reaching over 38,000 learners and counting. Our on-prem partnerships with companies like HPE, Dell, and Lenovo remain vital for providing our customers with flexibility and choice. In fact, we recorded our best quarter with HPE to date in terms of new ACV and significant new customer acquisitions. A prime example of a new customer we secured this quarter is a large European furniture retailer that opted for our core software, the database-as-a-service solution Era, and the automation software Calm. We are set to implement a fully automated distributed cloud solution that will significantly reduce IT implementation time from weeks to days, without requiring IT staff on-site, which is especially critical during the pandemic. Speaking of the pandemic's effects on digital transformation, it has expedited our advancements. Over the past several quarters, we have evolved into a markedly digital marketing organization. Initiatives such as test drives, self-service offerings, and proactive engagement have proven successful in generating distinctive top-of-the-funnel engagement, shortening sales cycles and achieving the highest conversion rates across our marketing programs. We also continue to host global virtual events, and in Q1, we held our largest event ever, both virtual and in-person, in our company’s history. Our entirely virtual .next-gen event attracted record attendance from customers and partners and is expected to generate substantial pipeline growth at a significantly reduced cost compared to in-person events. I'd like to highlight how we are transitioning from being a pioneer in on-prem hyperconverged infrastructure to being a true hybrid cloud infrastructure provider. During the quarter, we announced the general availability of clusters, our hyperconverged infrastructure on AWS. Additionally, we forged a significant partnership with Microsoft to make our product portfolio available on Azure. This collaboration significantly enhances our company strategy, allowing us to deliver solutions that offer smooth application, data, and license mobility along with a unified management experience across all clouds. This positions us as a leading infrastructure software company with a bring-your-own-license model to assist our customers on their hybrid computing journey. As we've previously mentioned, Nutanix clusters on AWS introduce new advantages, extending the simplicity and user-friendliness of our software to the public cloud. This is a crucial step toward realizing our vision of making computing seamless anywhere by providing a unified fabric across various clouds, whether public or private. An example of our new customer in the APJ region that acquired clusters on AWS during this quarter is a financial services institution that selected Nutanix to support their growing testing and development needs for client services. Nutanix clusters on AWS offer them the flexibility and seamless migration to any required cloud. We continue to innovate both our core platform and new products, which included new capabilities for our core software platform and the launch of our Kubernetes-based Platform-as-a-Service solution, alongside significant updates to our database-as-a-service solution, Era. As subscription business models emphasize the importance of consumption and renewals, our product reliability and exceptional customer service remain key factors driving our customer loyalty and repeat business. For the seventh consecutive year, we received the NorthFace ScoreBoard award from CRMI, recognizing our commitment to customer service. Furthermore, our sustained excellence in achieving this award for more than five years has led to us receiving the NorthFace Summit Class award, a rare distinction. Finally, as we reflect on our performance relative to future opportunities, let me briefly address our expanding addressable markets. Gartner forecasts that by 2025, 80% of organizations will be utilizing hyperconverged solutions, up from 40% in 2020. We are encouraged by the steady IT spending despite the pandemic as companies focus on modernization through private and public clouds, hands-free automation, and remote work and business continuity projects. This trend was confirmed by our recent Enterprise Cloud Index, which surveyed 3,400 IT professionals worldwide, with 46% indicating they increased their hybrid investments due to the pandemic. Global IT teams are planning significant infrastructure alterations and anticipate hybrid cloud deployments to rise by 37 percentage points over the next five years. In summary, these trends offer a robust tailwind for the migration to both private and public cloud solutions. Now, I will turn it over to Duston.

Thank you, Dheeraj. Going into the quarter, we provided guidance that took into consideration both an uncertain macro environment and our transition to an ACV-based sales compensation model. We clearly outperformed our expectations and are very pleased with the strong start to the fiscal year. As we enter FY '21, our overall thesis for the business going forward is centered on the following: our industry-leading product set that seamlessly enables on-prem, off-prem, and the convergence of both remains the best and most elegant solution in the marketplace. Next, new products will continue to drive the growth of our core HCI offering by further extending our solution to address new opportunities that were previously out of reach with our core solution alone. Optionality truly matters to our customers and prospects, and offering subscription options with variable terms and their corresponding flexibility will continue to add significant optionality, which in turn leads to additional ACV growth. Our ACV-first focus will ultimately strengthen our business model via term compression leading to lower discounting, better deal economics, accelerated ACV growth, and more efficient renewals. Finally, we expect our go-to-market execution will continue to show improvement, and this, combined with a market-leading solution, ultimately becomes a very powerful combination for ACV growth going forward. The business thesis set forth above clearly played out in Q1. During the quarter, our core product continued to perform very well with new customer ACV bookings representing 23% of total ACV bookings. We also added about 680 net new customers in the quarter, despite the ongoing macro uncertainties related to COVID. Linearity was also very good during Q1. We generated a record amount of new pipeline, and we also added a substantial amount of ACV backlog compared to typical usage of backlog in previous Q1s. As you may recall, during our Q4 earnings call, it was our belief that our ACV-based sales comp would put a renewed focus on new product sales, and not surprisingly, new products performed very well in Q1. As Dheeraj noted, we had a record quarter of new ACV related to our new products with Calm, Era, Files, Flow, and Objects, all delivering record ACV quarters. New products also played a role in improving our deal economics during the quarter. Furthermore, the benefit of subscription optionality clearly came into play during the quarter with more customers opting for the budget flexibility of 1-year deals. Our outperformance on 1-year deals in Q1 has added an incremental $20 million to $25 million to the renewals pool, that will come up in Q1 FY '22, which is over and above our previous plan. We expect these renewals to be more predictable and transacted at significantly less cost compared to our new and upsell business, which will drive leverage in our model. As we look ahead, we are very optimistic about the setup for the balance of the fiscal year. In Q1, we experienced lower discounting that resulted in better deal economics, as well as some term compression, all as we expected. The specifics around the actual Q1 term compression also mirrored our previously communicated expectations, specifically that our new ACV-based sales comp plan with compressed terms saw a shift from 5-year deals to more 3-year and 1-year deals. And when terms did compress, existing customers did not experience any significant term compression, while new customers potentially saw larger amounts of term compression. In Q1, the average contract term decreased to 3.5 years compared to 3.8 years in Q4 '20, which was somewhat lower than our expectations. Federal completed several large 1-year deals, which contributed to the average decrease. Since our federal business is usually a much smaller percentage of our total business in Q2 versus Q1, we do not expect the federal business to have the same level of impact on average term in Q2. While we do not plan to disclose this level of detail every quarter, the average contract term of existing customers, excluding renewals, decreased by one-tenth of a year, while the average contract term of new customers declined by six-tenths of a year. Lastly, our go-to-market is showing consistent execution as evidenced by our top-line outperformance over the last few quarters. Although we only have one quarter under our belt in FY '21, we are very encouraged by our progress to date. Now, I'll move on to some specific Q1 financial highlights. ACV billings were $138 million, reflecting 10% growth year-over-year, well above our guidance range of $118 million to $121 million. Run rate ACV as of the end of Q1 was $1.29 billion, growing 29% year-over-year compared to our guidance of at least 20% growth. Revenue, which as expected, was impacted by decreased average term length, was $313 million, down 1% year-over-year. Our non-GAAP gross margin in Q1 was 81.9% versus our guidance of 81%. Operating expenses were $341 million, down 12% year-over-year and versus our guidance of $350 million to $360 million. End-user computing, as a percent of the total business was flat versus Q4 '20 as the spike in demand we saw at the beginning of COVID moderated. During the quarter, we completed our previously announced $125 million stock buyback. We purchased 5.175 million shares at an average price of $24.15 per share. As a reminder, the stock buyback was executed with the intention of offsetting the additional dilution that we will incur related to the PIK, or paid-in-kind interest feature on the Bain convertible notes. Our non-GAAP net loss was $89 million for the quarter, or a loss of $0.44 per share. Our free cash flow for Q1, which was aided by very good linearity, was negative $16 million. This performance was significantly better than our internal expectations. We closed the quarter with cash and short-term investments of $1.32 billion versus $720 million in Q4 '20. The Q1 cash total includes $750 million from the Bain convertible note, less expenses and the $125 million stock buyback. DSOs in Q1 were 54 days versus 68 days in Q4 '20, also driven by good linearity. Now turning to our Q2 '21 guidance. ACV billings are projected to be between $145 million and $148 million, representing year-over-year growth of 4% to 6%. Gross margin is anticipated to be approximately 81.5%. Operating expenses are expected to be between $360 million and $370 million, representing a year-over-year decline of 7% to 9%. Weighted average shares outstanding is projected to be approximately 202 million. Now, a few modeling assumptions. Our guidance for Q2 includes a slightly negative COVID impact, as we continue to be cautious in light of the second and third waves of COVID that could create additional macro uncertainty. On a bookings basis, the implied year-over-year growth rate of our Q2 '21 ACV is expected to be substantially higher as we consumed backlog in Q2 '20. As a reminder, similar to what we experienced over the last two years, we would expect Q3 to exhibit sequential seasonality, suggesting a slight decrease in ACV billings in Q3 versus Q2. Based on the Q2 '21 ACV billings guidance, we would expect the run rate ACV to continue its strong growth trend and grow approximately 25% year-over-year. We are projecting a slight decrease in term length in Q2 compared to 3.5 years in Q1. From a free cash flow perspective, we are not currently expecting Q2 linearity to mirror that of Q1, therefore, we expect our cash usage to increase in Q2. Regardless of the exact amount of cash usage in Q2, we expect free cash flow for the first half of FY '21 to exceed our internal plan set forth at the beginning of the fiscal year. While we maintain our focus on go-to-market efficiencies and continue to benefit from lower travel costs, we anticipate fiscal '21 operating expenses to be flat to slightly higher than last year as we continue to grow and invest in the business. And finally, as we did last quarter to help with your modeling, included in our earnings presentation located on our IR website, are historical trends for ACV billings, run rate ACV, billings term length and a bridge for how to model and convert our current and future ACV billings guidance to total billings. With that, I'd like to pass it back to Dheeraj for additional remarks before we take questions. Thank you.

Thanks, Duston. I want to close this quarter's earnings call with a thank you to everyone who has participated in the journey to get where we are now. We're extremely encouraged by the progress in the last 3 years of our business model transformation. While we still have work to do, these results demonstrate the power of the subscription thesis. Our Board continues to make progress on the CEO search. We look forward to updating you when we have meaningful news. Personally, it has been a journey of a lifetime to serve our customers and partners, working alongside our employees, whom we call 'mutants.' With a future-proof business model, a customer base that fundamentally values reliability, and a technology portfolio that has such strong product-market fit, our best is yet to come. This is the decade to watch for a company that's so value simple, secure, and seamless. Now we'll open it up for questions.

Your first question will come from Jason Ader of William Blair.

My question is on the ACV transition. And it seems like maybe there were a little bit of surprises, but if you could just talk about, broadly speaking, what surprised you? What didn't surprise you? And why you did better than you expected?

Yes, I'll respond to that, and Dheeraj can chime in as well. Jason, I would say there were very few surprises, if any at all. We had a perspective and expectations heading into Q1, and for the most part, everything unfolded as we anticipated. We expected a decline in terms, particularly among new customers, while existing customers would see a lesser decrease. This was expected to result in improved deal economics, which indeed happened. We recognized that optionality was important, not just for our customers but also for our sales representatives, who now have more tools to help them meet their quotas. I can't think of anything else significant. Yes, terms were slightly lower than we anticipated, but that's not an exact science. Overall, very few unexpected outcomes arose. Also, from a sales compensation standpoint, I believe the ACV performed better than we had hoped, and everyone seems to be unified around that. As I mentioned, optionality matters, and the benefits were evident for the quarter and provide a positive outlook for Q2.

And the demand environment was better than you expected?

Well, based on the record pipeline, we were pretty pleased, especially in this environment. Obviously, it's not perfect, and the economy is not running at full capacity, which has had an impact. Overall, I think we were quite pleased from that perspective as well.

Yes. I would like to add to that, Jason and Duston, that much like our experience with the federal sector from 2011 to 2015, the federal business with ACV has truly embraced this approach. We anticipated that operations and maintenance would be advantageous for us because many cyclical spenders prefer to keep their expenditures and budgeting discreet. It has turned out to be an excellent quarter for the federal sector, partly due to the one-year deals that Duston mentioned. Another positive surprise has been how well our sales team has embraced this, as it makes them more competitive compared to selling three, five, or seven-year contracts.

Your next question comes from the line of Ittai Kidron of Oppenheimer.

A couple of questions from me. First of all, from a sales capacity. How do you guys think about the evolution of the capacity going forward, just given that renewal activity is now going to be done on an annual basis instead of a multiyear basis? So more time from a sales capacity standpoint would be dedicated to renewals than new business. How do you think about the evolution of capacity? Does that mean you need to hire aggressively again on that front in order to create more new customer capacity?

So, I am sure. Go ahead, Dheeraj.

Yes. So, I think the field reps are all focused on land and expand, which is all new ACV-focused. Now they will get a ding if we didn't get the renewal. But all in all, we expect them to be really focused on land and expand. All of their customer success team, which is all on the inside, on the phone that's really doing adopt and renew and that's how they are going to be comped as well.

Yes. What I would add is that the main idea behind the shift to ACV is leverage. All renewals will not require aggressive hiring, as that will primarily be managed by a separate team that we need to build up. Renewals will not lead to an increase in sales rep numbers. This is where subscription businesses gain leverage. We just haven't seen the renewals come in yet. You observed the effect of the increase in one-year deals this quarter. We added $20 million to $25 million to the pool in Q1 '21 to '22, and that won't need new reps to pursue it. So that's the basis for the ACV shift.

Got it. Okay. And maybe as a follow-up, just then on that topic, clearly, you've done very well in cutting the contract term quite aggressively in the quarter. I guess it was just a little bit of outperformance there. But does this help you make you perhaps think differently about where is your long-term steady state from a term standpoint? Or the pace by which you can get there?

Not dramatically. Federal played a role in some of the term compression in Q1. They won't be the same percent of the business in Q2. So, there are some offsetting factors there. We've got this view of kind of low 3-year average somewhere at the end of the fiscal year. We'll see how that plays out. I think the more that our sales reps get used to this model and maybe to start to be the more customers get used to this model, with the optionality and things like that. Maybe we see a little bit bigger, but 1 quarter is too early to give a real opinionated view, especially because how federal kind of played into this a little bit. But certainly, we're encouraged by what we've seen in the first quarter anyway.

And there's going to be opposing forces as well. The large enterprises, places like Japan, they're probably still going to be longer term. Some of our very large customers are still longer term. And then you look at federal and commercial on the other side, that will go shorter term. So I think it's going to be a healthy yin-yang between these two.

Your next question will come from the line of Alex Kurtz of KeyBanc.

I had a question, but I want to start with a clarification. Duston, on the contract duration target that three you just threw out, was at the end of fiscal '22 you were targeting?

I was mentioning low again, we've got one quarter, but I was referencing there, kind of in the low 3s at the end of fiscal '21.

And do you think there's a chance that given what you saw with the wonder opportunities that this thing could dip below 3 at some point in fiscal '22 or too early to tell?

It's too early to determine, but as Dheeraj mentioned, some of our long-time customers still prefer to stick with 5-year contracts. Therefore, while one quarter is insufficient to gauge the situation, we are optimistic that what we anticipated largely came to fruition. However, let's wait for another quarter to provide a more informed assessment.

I just want to say that we'll be able to go and tweak this, depending on how much cash we need to collect as well based on simple sales incentives and such as part of sales compensation. So we're not overly worried. We feel like now we have a great architecture in place. And we can go and tweak how we want it.

I appreciate that, Dheeraj. Regarding your successor for the CEO role, there have been numerous discussions with investors about the ideal profile, capabilities, and experience. Since you're a bit into this process, could you share your vision for the person who would take over your role? What qualities and skills would you like to see in that individual? I know you mentioned this last quarter, so if you could provide more details, I think that would be very helpful.

Yes. I think the big piece is, how do you balance the short-term and the long-term because you can't overdo one or the other, you have to be strategy-focused, being able to look around the corner because computing is an industry that's changing so fast that you can't take your eyes off the strategy ball. Basically, someone who can embrace process, people, technology, and product. I think we've gotten some great candidates in the pipeline. And we definitely would like the relevance of the infrastructure to be there. There's a lot of people out there with the business software space. We're looking at quite a few people in infrastructure as well. And I think, all in all, somebody who has a 3- to 5-year view and a vision would be very, very important, especially for our sales engineers, our developers, our system reliability engineers. There's a lot of engineering in the company in various different departments that also need to look up to somebody for a strategy in the public cloud landscape that's out in front of us.

Your next question will come from the line of Jack Andrews of Needham.

Congratulations on the strong start to the new fiscal year. Could you provide more detail on the success of your new products? You've mentioned several products that are performing well, but can you specify the types of use cases? Are they primarily related to DevOps or something else? Additionally, are you seeing continued success? Have you made any changes to sales incentives for new products, or do you attribute the increase in the attach rate of these new products to the shift towards ACV?

Duston, do you want me to take that? Or should you take it?

I'll let you take the use cases, Dheeraj.

Okay. Cool. Yes. So first of all, we saw really good unit economics, as Duston said, because of short mid-term lenses. So we're not taking money out of one pocket and putting it together. We are very, very mindful of that. New products have to fend for themselves and they have to pull through the core. So a lot of what we watch for is no financial engineering of money moving from core business to new products. All in all, we saw some great traction in database-as-a-service. Again, amazing economics with large databases, Oracle, SQL, SAP, Ethics, and healthcare. We're seeing a ton of large database workloads, and we've made them so simple that database administrators are loving this new architecture, and the fact that they can drag and drop it from one cloud to another. The other one is around unstructured data files and objects with the special containers. We're doing a really good job around that DevOps use case. Finally, desktop-as-a-service. I think there's a lot of work we've done, not just for Citrix and VMware Horizon but also around our own brokers. So all in all, I think databases, unstructured data, and desktop-as-a-service, there are some great use cases around that. Duston?

Regarding the sales comp aspect, it is generally distributed. However, I believe the shift to ACV has significantly contributed to this. It's important to note that a $100,000 one-year deal for a new product is equivalent to a $500,000 five-year deal. This change provides more flexibility, not just for our customers but also for our sales representatives, who can utilize these various tools to meet quotas with shorter terms. This approach has proven effective. While there are minor variations, it has performed well across all regions, all of which exceeded their quotas, which is encouraging. This illustrates the benefits of having such flexibility.

Your next question will come from the line of James Fish of Piper Sandler.

Just want to drill down on the change for ACV-based compensation. Can you give further color as to what you're seeing from reps? And whether this caused any additional churn to normal as your employee count and your sales and marketing team was actually down sequentially?

Yes. I mean, churn in general within the sales organization hasn't changed much from what it has been over the last several quarters. Now there might have been some more selective and maybe some forced churn, the focus maybe on a little bit more software selling and things like that. But overall, the churn rates aren't significantly different. Now what Kris, coders, and team have done, though, in the field is they've certainly shifted to incremental leverage, how do we get more productivity out of the same reps? There has been some realignment with resources amongst regions and things like that. So, the real focus right now is that we have a reasonable number of reps. How do you get them even more productive, certainly from an ACV perspective and things like that? So that's the main focus right now. We won't add a significant number of reps this fiscal year.

Your next question will come from the line of Matt Hedberg of RBC.

It's Dan Bergstrom for Matt Hedberg. So Dheeraj, you mentioned clusters in the prepared remarks. Just curious around early use cases for early adopters there? Are customers looking for that, the elasticity on demand bursting, mobility across clouds or optionality around the operating model? Just any thoughts around early adoption or what you're hearing from customers?

Absolutely. Yes, I just want to have everybody probably also draw from the whole movement of virtualization 15 years ago. A lot of the enterprises are moving from Unix servers to Intel x86. And virtualization had to find a great use case, and that was test and dev. And then it became VDI at 5 years. Citrix was one of the biggest workloads for VMware, apart from testing then in 2008 and '09. So for us, I think we are again very use case-focused when it comes to clusters. A very important piece of the puzzle is around very high I/O intensive workloads, low latency workloads, test and dev, virtual desktops and also lift and shift. I think there's a big disaster recovery sort of initiative coming within large enterprises as well. The best part about clusters is 'bring your own license' and 'bring your own contract' of AWS, which will be the same for Azure as well. So we expect that many of these early use cases surrounding large databases, test and dev, as you saw from one of the wins I talked about and finally, a lift and shift to the cloud.

Great. And then maybe for Duston, on the expense side. You provided some color around guidance for the quarter, for the year. From here, should we think about maybe remaining prudent on the expenses for now? But would there be a potential to maybe accelerate investment into accelerated growth? Should we start to see that on the top line further out?

Duston, are you there?

I'm so sorry. Yes, just in the near to midterm, hopefully, from a top line perspective, we're going to get most of that through leverage, increased rep productivity. So you won't see some great hiring surge to get incremental ACV growth. We should be able to get reasonable amounts of incremental ACV growth with most of the resources we have currently. We may need to continue hiring here and there as we need to realign resources and to make sure we are taking care of customers with products and support and things like that. So that's kind of the view here over the near to midterm.

Your next question will come from Katy Huberty of Morgan Stanley.

Just coming off the strong October quarter ACV performance. Why would ACV billings growth decelerate in January, especially given what you said about the record pipeline levels, the fact that you didn't eat into backlog like you typically do in the first quarter and the successful next conference? Just some color as to why the outlook is a bit more conservative than the performance you just put in? Then I have a follow-up.

Yes, we have not taken an aggressive stance with our Q2 outlook due to concerns about the ongoing COVID situation and the potential for further shutdowns. This uncertainty has influenced our billings. We did see a 10% year-over-year growth in ACV billings for Q1 and have guided for 4% to 6% growth moving forward. However, if you examine it on a bookings basis, which we are no longer disclosing, that 4% to 6% growth could be doubled, at least, when comparing bookings. There is significant growth when viewed from a bookings perspective, especially since in Q2 of last year we utilized some backlog, which was somewhat atypical. Therefore, on a bookings basis, the outlook is more promising. Nonetheless, we remain cautious about how aggressive we will be as we approach the next quarter.

Yes, just to add to Duston’s point, you know, we had one quarter where we understood ACV and the ACV-first strategy, but we get into the second one, and we understand that it would be a coincidence. The third one would be a pattern. So I think the next two quarters are going to be really important for us to learn about this ACV-first strategy.

Okay. And then just lastly, Duston, how do you think about from here, the timeline to breakeven free cash flow? What has to happen to build confidence in that becoming a more imminent goal?

Well, we need to get terms kind of compressed to where they're going to even out. And I don't know if that's three years, maybe a little bit above, maybe a little bit below. But we have to have that happen first. Because right now, we've got two offsetting factors: how fast will terms come down, so that takes out, obviously, billings and revenue. And then on the flip side, regardless of terms, how fast can we accelerate the ACV growth to kind of offset that. But we need some stabilization in the terms first to have a good view. Now we think that's probably the first half, maybe of FY '22. And then I think the combination of some more productivity and the prudent expense growth, products, all that stuff, it steps up quite well after that point. But again, we need some stabilization, and that's why I have always been of the view that, the quicker we get through the term compression, quite honestly, the better.

Your next question comes from the line of Wamsi Mohan of Bank of America.

Yes. Can you tell us if the renewal activity changed much during the quarter? And how we should think about renewal billings as a percent of total billings in fiscal '21? Is 15% sort of in the ballpark there? And I have a follow-up.

Yes. We haven't given specifics on that, but the good news is we've given you now quite a bit of data to go start modeling that on your own. You now have Q4 and Q1, ACV as a percent of ACV by term length. So, you know now, obviously, Q1 1-year deals will swap in four quarters. You've got the 3-year, the 5-year, and things like that. So, we've disclosed quite a bit to do some pretty simple modeling from that perspective. On a TCV basis, over the last 12 months, it has been roughly 10% or below renewals and things like that. And that will start to kick up. Again, we've already added $20 million, $25 million to Q1 '22, just based on what happened here in this quarter. And that will continue to accelerate. You'll see some more in '22. And then, again, we've discussed this in FY '23, you've got a pretty significant tranche of 3-year deals that start to kick in now from the initial push to subscription a few years ago.

Okay. And can you maybe help us think about the strength between Enterprise and SMB? And especially given the vaccine news now, how are you thinking about sort of a recovery in SMB and maybe even just tell us like where your SMB exposure is?

Do you want to take that, Dheeraj?

Yes. I mean, obviously, it's early. It's probably going to take another three quarters for administering the vaccine itself. And we have a fairly international business. There are quarters in which we do about 45%, 50% of our business outside the U.S. And when you talk about SMB, a lot of the mid-market outside the U.S., we consider as SMB. Even the enterprise outside the U.S., we look at that as commercial. So, I think given the fact that we have customers in about 150 countries, we are taking a view that it will probably take two to three quarters for real administration of the vaccine itself. In the meanwhile, we are focused on new products, new workloads and whatever you can get from new customers. I think we've done a fairly good job, and we are changing a lot of our practices like digital prospecting. What can we do to reinvent ourselves, transform ourselves so that when the pent-up demand opens up, we have an amazing digital business? So, we're doing everything we can right now to really open up for the SMB as they feel safer.

Your next question will come from the line of Aaron Rakers of Wells Fargo.

Congrats on the quarter. Thinking about just the modeling variables. I'm curious if you could talk a little bit about how we should think about ACV to billings ratio? And how you think about billings to revenue? I'm just curious because we did see some compression on those ratios in the quarter. I mean, how do we think about those going forward? And I have a follow-up.

Sure. Again, Aaron, we've given you, I think, all the tools to go do that as far as working with ACV and TCV and doing where you think terms are going to come down. So all that is pretty easily doable with the tools that we've given you there. Again, with a tenth of a decline or two-tenths or whatever it might be, Q1 to Q2, you're not going to see massive movement. I don't think anyway, we'll see how the quarter plays out in those ratios. On the bill to revenue ratio in general, not talking about the total billings, total revenue, that's probably a little easier to talk about. With the term compression, you've got slower total revenue and total billings growth, but you still got a fair amount coming off the balance sheet at a little bit higher rate. So, that's why you saw the bill to revenue come down this quarter. And I think probably going forward for a bit, it's probably 1.1 to 1.15, somewhere around there on that ratio. But again, the good news is you've got a lot of tools there to go. You can go pick where you think terms are going to be and you can back into ACV and then total billings and all that stuff. So, it's a pretty good exercise.

That's very helpful. And then as a quick follow-up. You mentioned in the transcript about AWS and Microsoft and the engagement there. I'm just curious, can you go a little bit deeper in terms of the go-to-market engagement with those cloud providers?

Yes. So, the good thing is that bringing your own contract is very helpful for a consumption point of view. Both AWS and Azure sellers get paid on consumption. HCI is a killer workload to really get rapid consumption of everything that they sold and committed. They don't get paid on commits; they get paid on consumption. So, we're really working hand-in-hand at Microsoft. We've built Nutanix ready nodes, and those things burn the credits so that they don't lose them at the end of 3 years, which is what happens if you don't use the cloud credits. For the sellers, it just means that they have better, faster consumption. That's how they get paid because consumption is revenue recognition for the cloud players. So, we're really working hand-in-hand with both cloud players and their sellers and doing webinars and a lot of joint prospecting. Honestly, there's a lot that they are also understanding and learning from the enterprise because the enterprise has a lot of mundane workloads, legacy workloads. I was talking to one of the customers the other day. And they are like the Windows machine does not reboot in the public cloud. It does not boot up in the public cloud because they have legacy devices and things of that nature. So there's a ton of that lift and shift that will come up, and we hope not to take three years to redesign the operating system or redesign the applications before this can all come together.

Your next question will come from the line of Simon Leipold of Raymond James.

First one, I just wanted to maybe set context. You talked about the strong growth rates of new products and you've rattled off some of what contributes to that, but I'm not sure I got the baseline of what percent of ACV roughly is coming from new products? And how should we see that evolve over time?

Yes. We broke that out for a few quarters or a couple of points at 15% or so of new ACV is coming from new products. We've got, obviously, a goal in '21 to accelerate that further. I don't think there's any reason why it shouldn't. We're off to a good start. Again, we've got all the tools to go focus on these products. We've got a continued acceleration as a percent of new ACV built into the plan.

Great. And then as a follow-up, and maybe somewhat related. But when we see the duration trend, one of the aspects you mentioned in your prepared remarks was the high federal contribution. And I guess my understanding is some agencies are restricted to 1-year term deals. So that has to play something in the mix. Could you maybe help us understand how much the federal contribution influenced the average duration and how we should think about sort of what's normal in quarters that don't have the big federal contribution? I hope that makes sense.

Yes, that makes sense. We don't have a normal situation yet since we only have one quarter to consider. The federal contribution depends on how we look at it, whether it's renewals or other factors. You could view it as around one-tenth of a year, or maybe close to two-tenths, but we’ll stick with one-tenth for now. The federal portion will decrease as a percentage of total business in Q2, as it typically does from Q1. Additionally, as our sales team and customer understanding improve, we anticipate a continued downward trend. This is why we expect a slight decrease in Q2. I would be surprised if it were more than that. However, we don’t have a clear normal yet. Give us another quarter, and we can provide a more informed perspective. I would be surprised if there were any significant changes. The new customer mix and existing customer contributions play a role, and we expect new customer contributions to decline more quickly, similar to what we observed in Q1. On a positive note, we added 680 new logos, and in terms of ACV, new business actually increased compared to Q4. It was better than Q3 and Q4, so we saw some encouraging signs regarding new customer ACV as a percentage of the total, showing a slight quarter-over-quarter increase. That's just an additional thought, but that's the overall view.

And with that last question, that's all the time we have left for today. This concludes today's earnings call. Thank you very much for your participation, and you may now disconnect.