Nutanix, Inc. (NTNX) Q1 2021 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Nutanix Q1 Fiscal Year 2021 Earnings Conference Call. [Operator Instructions]. Now I'd like to hand the conference over to your speaker today, Ms. Tonya. Please go ahead.

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 in 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. Q1 was a very good quarter, positioning us well for the rest of fiscal. While Duston will go into more details on the financials, the headline is that we outperformed across all our key metrics. ACV billings were 14% ahead of the midpoint of our guidance and consensus. And notably, Q1 was our best ACV bookings quarter ever, the pandemic notwithstanding. In addition, we delivered strong gross margins, EPS and free cash flow performance. We are delighted with our continued progress, and it is great to look back on our journey over the last 3 years and see how far w ehave come, our product thesis of a hybrid and multi-cloud future built on top of our industry-leading hyperconverged infrastructure, the HCI of last decade, combined with an ambitious transition to a cloud-like subscription business model, is bearing fruit. Well, there's more to do. So, the hardest work is behind us, and I'm proud and grateful for what we have collectively accomplished to date. There were a number of factors that contributed to our Q1 performance. First, our ACV-based sales compensation strategy delivered positive benefits to our business. In Q1, our average contract term shortened. And as a result of the shift, we saw lower overall discounting and we sold more new products, all while driving significant run rate ACV growth of 29% year-over-year at a $1.3 billion scale. Next, as I mentioned, we saw strong adoption of our new products on top of growth in our core software. On a rolling 4-quarter basis, our new product attach rate during Q1 was 35%, up 7 percentage points from a year ago. In fact, new ACV for new products grew 87% year-over-year and 27% quarter-over-quarter. Within our newer products, we saw particularly good momentum with our data center solutions, Files and Flow, as well as DevOps and database-as-a-service solutions, our Calm and Era. Notably, a significant number of new product deals also included more licenses for our core software, proving our thesis that as we drive demand for our new products, we also drive demand for our core software, which is the foundation for our hybrid cloud infrastructure, the new HCI of this decade. Demand for our solutions was consistent across all our geographies and many verticals, including federal, which had a good quarter as expected, owing to the seasonality of the U.S. government's fiscal year-end. The Fed sector also had a number of 1-year contract duration deals contributing to the reduction of average contract durations in the quarter, which Duston will address in more detail. As always, our customer journeys are the best ways to speak of the quarter. A customer win during the quarter that combined many of the themes I've discussed was with one of the largest and oldest financial services firms in the world providing investment management, servicing and administration. This existing customer, which has spent more than $20 million in lifetime spent another $1.7 million in ACV to expand their private cloud. We also had a very similar story with one of the largest power companies in Japan, which has spent upwards of $15 million lifetime digitizing their desktops and filers with our software stack, spending another $1.8 million in ACV in Q1. Our strong results were also driven by our go-to-market momentum in the area of cloud. Specifically, the successful launch of our ACV sales compensation plan, together with effective sales enablement and training around ACV benefits. In addition, our sales teams have done an excellent job of improving the quality of the sales process by building a robust pipeline even during COVID-19, working closely with partners and adopting a multi-product and multi-workload sale approach. The channel continues to play an extremely important role in how we help evolve our customer journey. To that end, we announced a simplified channel program to deliver even more profitability and an accelerated road map to help partners embrace the cloud business model. Additionally, we made meaningful improvements to Nutanix University, our education arm. The program now provides more certifications across new skill levels in technolog fracks to increase the stickiness of Nutanix software and overall consumption of our technology. We quadrupled participation in this program in the past year with over 38,000 learners and counting. Our on-prem partnerships with HPE, Dell, Lenovo and others continue to be an important part of our strategy for offering freedom of choice to our customers. In fact, we had our best quarter-to-date with HPE in new ACV as well as meaningful new customer acquisition. A great example of a new customer we gained during this quarter is a large European furniture retailer who selected our core software, database-as-a-service solution, Era and automation software, Calm. We plan to implement a fully automated distributed cloud solution that will reduce IT implementation time from weeks to days with no IT staff on site, especially as they navigate the pandemic. Speaking on the pandemic and digital transformation, it has helped accelerate. For the past several quarters, we have become a meaningfully digital marketing organization. Test drive, 0 touch self-service or prospects continues to provide distinctive top of the funnel engagement and has been shown to shorten sales cycles while delivering the highest conversion rate of all of our marketing programs. We also continue to hold virtual events globally. And in Q1, we held the largest event ever, virtual in person in our company's history. Our 100% virtual.next-gen had record attendance of over [indiscernible] customers and partners. And is on track to deliver strong pipeline generation in the quarter at a significantly lower cost than in person events. Let me also share with you how we are morphing from being a pioneer in on-prem hyperconverged infrastructure to being an authentic hybrid cloud infrastructure, the new HCI company. During the quarter, we announced the general availability of clusters, our HCI on AWS. We also announced a significant partnership with Microsoft to bring our product portfolio on to Azure. This partnership substantially evolves our company's strategy, enabling us to provide solutions that will deliver seamless application, data and license mobility, including a singular experience in management across all clouds. This is a major competitive advantage as we become the foremost infrastructure software company with a bring your own license approach to help our customers in the hybrid computing journey. As we've stated in the past, the availability of Nutanix clusters on AWS also offers new benefits, including extending the simplicity and ease of use of our software to the public cloud. This represents a significant step forward in realizing our vision to make computing invisible anywhere by delivering a unified fabric across multiple clouds, public or private. A financial services institution in the APJ region is an example of a new customer who purchased clusters on AWS during the quarter in a 1-year contract. They selected Nutanix to help support their growing test and dev needs for services to their clients, and Nutanix cluster in AWS provides them with the flexibility and frictionless migration to any cloud they require. We continue to innovate both our core platform and new products in the quarter. This includes new capabilities to our core software platform as well as the launch of our Kubernetes-based PaaS solution, platform-as-a-service, and significant updates to our database-as-a-service solution, Era. As subscription business models continue to underscore the need for consumption and renewals, our product reliability and outstanding customer service continue to be a big driver of our loyalty and repeat business. For the seventh year in a row, we were awarded the NorthFace ScoreBoard award from CRMI in recognition of our customer centricity. And because of our sustained excellence for having won this award for more than 5 years, we also confirmed the NorthFace Summit Class award, which is a rare honor. Finally, as we think about our performance relative to our future opportunity, I'd like to talk briefly about our addressable markets and how they continue to grow and evolve. Gartner predicts that by 2025, 80% of organizations will be using hyperconverged solutions, doubling from 40% in 2020. We've been encouraged to see that IT spending has held up despite the pandemic as companies prioritize modernization with private public clouds, hands-free automation and remote work and business continuity projects. This is validated by the results for out third annual Enterprise Cloud Index, which we launched last week. Across 3,400 IT professionals around the world, 46% of respondents said they increased their hybrid investments as a result of the pandemic. Global IT teams are planning substantial infrastructure changes and collectively see hybrid cloud deployments, increasing 37 percentage points over the next 5 years. In short, these trends provide a powerful tailwind in the lift and shift to cloud, both private and public. With that, let me hand it over to Duston. 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 in a shorter time to more efficient renewals. And 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 a 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 and we would see a shift from 5-year deals to more 3-year and 1-year deals. And when terms did compress, existing customers would not experience any significant term compression, while new customers would potentially see larger amounts of term compression. In Q1, 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, average contract term of existing customers, ex-renewals, decreased by one-tenth of a year, while 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 with 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 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. And 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 to be between $145 million and $148 million, representing year-over-year growth of 4% to 6%. Gross margin of approximately 81.5%. Operating expenses between $360 million and $370 million, representing year-over-year decline of 7% to 9%. Weighted average shares outstanding of 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 the 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 have experienced over the last two years, we would expect Q3 to exhibit sequential seasonality, which suggests a slight decrease in ACV billings in Q3 versus Q2. And based on the Q2 '21 ACV billings guidance, we would expect 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, and therefore, we expect our cash usage to increase in Q2. Regardless of the exact amount of cash usage in Q2, we would 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 we continue to benefit from lower travel costs, as we have previously communicated, 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, our historical trends for ACV billings, run rate ACV, billings term length and a bridge 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 with 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 mutants, as we call our employees. With a future-proof business model, a customer base that fundamentally values reliability and a technology portfolio that has such a 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.

[Operator Instructions]. Your first question will come from the line of 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 take a shot, and Dheeraj, feel free to jump in here, too. Jason, I would say there was very few, if any, real surprises. I think we had a -- which we talked about, we had an opinion and view going into Q1. And pretty much all those views played out as planned. We thought terms would decrease. We thought they decreased more in new customers, less on existing customers. We thought that, that would lead to higher deal economics. Deal economics improved. Optionality, we knew mattered. And it mattered not only for our customers, but for our sales reps because they have more tools now to offer as they go attack their quotas. So I can't really think of anything. Yes, it was maybe 1/10 lower or so in the terms than we expected, but that's not an exact science anyway. So there was just very little surprises that we hadn't thought through, quite honestly. And I think the ACV from -- certainly from a sales comp, I think, played out better than probably we anticipated. And I think everybody has kind of rallied around that. And optionality, again, matters. And you saw what it delivered for a quarter and a good guide for Q2.

And the demand environment was better than you expected?

Well, based on record pipeline, we were pretty pleased with -- especially in this environment. Obviously, it's not perfect. And the economy is not humming at full 100%, they impacted here. Yes, I think we were pretty pleased overall from that perspective, too.

Yes. And I think the only thing I'll add to that, Jason and Duston is how -- very much like federal was for us early on in 2011 through 2015, I think the federal business with ACV has really embraced this. And we kind of knew it when we were going into it that O&M is going to be our friend because a lot of cyclical spenders, operations and maintenance, where to keep it under the radar in terms of spend and budgeting. So it turned out to be a great quarter for federal. Part of it is upon the 1-year deals that Duston talked about. Maybe the other pleasant surprise has been how our salespeople embraced it to really think that this makes them a lot more competitive than selling 3-, 5-, 7-year deals.

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 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 -- 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. No, what I'd add to that, Ittai, is that the whole thesis around this -- one of the main premise here around the move to ACV is leverage, right? And that's the exact point, all the renewal will not take aggressive hiring, right? Because that's going to be handled predominantly by a separate team. Now we have to go build up that separate team. But all these renewals will not be one-for-one sales rep adds. So that's where pretty much any subscription business gets a lot of their leverage. We just haven't had the renewals flow in yet. And you saw the impact from just the acceleration of 1-year deals in the quarter. We've added $20 million, $25 million to the pool in Q1 '21 -- '22. And that's not going to require new reps to go attack that. So that's the premise of the ACV move.

Got it. Okay. And maybe as a follow-up, maybe 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's 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 from what we've seen from the first quarter anyway.

And there's going to be opposing forces as well. The large enterprises kind of 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?

Well, I was mentioning low -- again, we've got 1 quarter, but what 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 tell, but we've got -- as Dheeraj said, you've got some older school customers that still will hang and cling to 5-year deals, too. So I think, again, 1 quarter, it's just too early to tell, but we're encouraged of everything that kind of we thought was going to happen pretty much happened. But give us another quarter and we'll give another, I think, a better opinion.

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 well 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 the way we want it.

I appreciate that, Dheeraj. The question to you about the person to replace you over the -- when that decision happened, there's been a lot of discussions with investors about what the right profile would look like and capabilities and experience. And now that you're a little bit into this process, maybe you could share your vision about the person that would take over your role as CEO? And what you would like to see that person bring to the table? I know you touched on it last quarter, if you could expand, 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, be 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. So 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 and 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 good start to the new fiscal year. I wanted to see if you could drill down a bit more on the new product strength that you're experiencing. You mentioned a number of products that you're seeing success with, but could you drill down on the specific types of use cases? Are they mainly DevOp-related or something else? And the related question is, are you seeing the success? Have you changed any sales incentives around new products? Or is -- do you credit the shift to ACV is helping to drive this new product attach rate?

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 lens. 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 [indiscernible] watch for is no financial engineering of money moving from core business to new products. I think, all in all, we saw some great traction in database-as-a-service. Again, amazing economics with large databases, Oracle, Sequel, SAP, Ethic and health care. We're seeing a ton of large database workloads, and we've made them so simple that DB is 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. And 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, some great use cases around that. Duston?

And then just -- yes, just on the sales comp part, for the most part, it is something spread around. But for the most part, I believe it was the help -- it was certainly helped by the move to ACV because you got to remember, now $100,000 1-year deal for a new product is the same as it was the same as a $500,000 deal that they had to go try to do on a 5-year basis. So there's clearly more optionality, I said, not only on our customers' perspective, but with the sales reps to go use these different tools from an ACV perspective and go drive additional quota retirement with smaller terms. And I will say this played well. There's obvious little things here and there, but it played well in all regions. I mean, all regions were above quota. Which we love to see, obviously. So that kind of gives you a little bit of feel of the power of optionality to.

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 cause any additional churn to normal as your employee count and your sales and marketing down -- actually was down sequentially?

I'm sorry, Jim, on the last part of the question, was what again?

Just your sales and marketing and total employee count was down sequentially. So I'm just wondering, on the change to ACV-based compensation, can you give us further color as to what you're seeing from reps? And if it caused additional churn in the quarter than normal?

Yes. I mean, churn in general within the sales organization isn't much different 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's been some realignment with resources amongst regions and things like that. So that -- the real focus right now is that we have a reasonable lot 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 amount of reps this fiscal year.

Your next question will come from 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 case 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 And so for us, I think we are, again, very use case focused when it comes to clusters. It's 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 the large enterprises as well. And the best part about clusters is bring your own license, bring your own contract of AWS and will be the same for Azure as well. So we expect that many of these early use cases around 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 lot of incremental ACV growth with most of the resources we have currently now we need to continue higher here and there or whatever. But I wouldn't clearly put it as a surge of anything like that. I mean, we've got a fair amount of resources spread throughout the regions as it is here now. So at some point, there's some things that we've just benefited from, clearly, and everybody else has, obviously, no travel, right? So at some point, some travel will come back online. But even when -- whatever things -- whatever normal is in the future, we won't spend -- hopefully, we won't spend nearly as much travel as we had in the past just because everybody's learned how to do things differently. So first and foremost, it's leverage, rep productivity and then selective hiring as we need realignment of resources as we need and to make sure, obviously, we're 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 the line of 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. Again, we mentioned that we haven't gotten real aggressive with the Q2 outlook. We're concerned what's happening. Obviously, things are going in the wrong direction from a COVID perspective and shutdowns in second and third phases, so that's clearly encompassed in our billings. Obviously, to your point, we grew ACV billings 10% in Q1 year-over-year. We've guided 4% to 6%. Now again, though, if you look at it on a bookings basis, which we're not disclosing anymore, but that 4% to 6% growth rate is probably 2x, at least 2x there on a comparative bookings basis. So there's some pretty good growth when you look at it on a bookings base because, again, in Q2 '20, we brought -- actually used some backlog, which was a little unusual from that perspective. So I think the combination of -- on a bookings, it's quite a bit better. And again, we're a little -- again, we've got something baked in there from a COVID perspective to a certain degree.

Yes, just to add to...

Just to that point -- I was just going to say, are you seeing anything in the month of November that would cause you to want to be more conservative on the outlook? Or is it just the news headlines and the potential for rollback of economic closings?

Yes. News. News headlines. It's not much different than our prior approach. I just think at this point, I think, to get very aggressive just doesn't make sense in this environment.

Sorry, Deeraj, I didn't mean to cut you off.

No, sorry. I was just saying that, look, we've had 1 quarter where we understand ACV and the ACV-first strategy, but we get a second one. We understand that it would be a coincident. The third one would be a pattern. So I think next 2 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 time line to breakeven free cash flow? What has to happen to build confidence and in that becoming a more near-term 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 year, 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 is 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 as 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 stepped up quite well after that point. But again, we need some stabilization and that's why I've 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's 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 talked about this in FY '23, you've got a pretty big 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. We have -- 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 of 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 actually 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 -- see 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 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 bid, 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 -- bring your own contract is very helpful for a consumption point of view. I mean both AWS and Azure sellers get paid on consumption. And HCI is a killer workload to really get rapid consumption of everything that they sold and commit. They don't get paid on commits. They get paid on consumption. So, we're really working hand-in-hand at Microsoft. We've actually built Nutanix ready nodes, and those things will be burning the sort of -- it does a great job for customers as well as for the sellers. It burns 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. And 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. And 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 to actually not have to take 3 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. And we've got, obviously, 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. So 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, it makes perfect sense. I'm not sure we have a normal yet with 1 quarter, obviously. But federal probably, it depends how you exactly look at it with renewals or ex-renewals or whatever. But 1/10, maybe you could get it to almost 2/10 of a year, but let's call it closer maybe to a 1/10. So that federal will obviously come down as a percent of the total business here in Q2, which it always does from Q1. And then do we get more knowledge with our sales force and more knowledge with the customer base going forward that you get some continued downward trend. That's why we assume it's a slight decrease in Q2. I'd be surprised if it was a little more than -- it will be more than that. But again, I just -- there's no normal yet. Give us another quarter, we'll give you another opinion, as I said earlier. But again, I'd be surprised if there was any drastic movement. And again, it comes back to the new customer mix in the existing customer mix and new will go down faster, most likely, just like we saw in Q1. And just on the new business, by the way, 680 new logos. But on a percent of ACV, new business was actually up from Q4. So it was better than Q3, it was better than Q4. In -- I'm sorry, in Q1. So we saw some encouraging signs, anyway, as far as new customer ACV as a percent of total, going up a little bit quarter-over-quarter, too. So that's just a side note there. But that's kind of the 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.