Nutanix Inc (NTNX) 2021 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Nutanix Third Quarter Fiscal 2021 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Rich Valera, Vice President of Investor Relations. Please go ahead.

Good afternoon, and welcome to today's conference call to discuss the results of our third quarter of fiscal year 2021. This call is also being broadcast over the web and can be accessed on our Investor Relations website at ir.nutanix.com. Joining me today are Rajiv Ramaswami, Nutanix' President and CEO; and Duston Williams, Nutanix' CFO. After the market closed today, Nutanix issued a press release announcing financial results for its third 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, goals, strategies and outlook, including our financial performance, financial targets and performance metrics, competitive position in future periods, the timing and impact of the current and future business model transitions, the factors driving our growth, macroeconomic and industry trends and the current and anticipated impact of the COVID-19 pandemic. These forward-looking statements involve risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially and adversely from those anticipated by these statements. For a detailed description of these factors, please refer to our SEC filings, including our most recent annual report on Form 10-K for fiscal year 2020 filed with the SEC on September 23, 2020, and our quarterly report on Form 10-Q for the fiscal quarter ended January 31, 2021, filed with the SEC on March 4, 2021, as well as our earnings press release issued today.

These forward-looking statements apply as of today, and we undertake no obligation to revise these statements after this call. As a result, you should not rely on them as representing our views in the future.

Please note, unless otherwise specifically referenced, all financial measures we use on today's call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided, to the extent available, reconciliations of these non-GAAP financial measures to GAAP financial measures on our IR website and in our earnings press release.

Lastly, Nutanix management will be participating in the William Blair Growth Stock Conference on June 1 and the Stifel 2021 Cross Sector Insight Conference on June 9. Nutanix will also be hosting a virtual Investor Day on June 22. A link to register for these can be found in our earnings release issued today. We hope to see many of you at these upcoming events.

And with that, I'll turn the call over to Rajiv. Rajiv?

Thank you, Rich, and good afternoon, everyone. I hope you're all staying safe and healthy. We are closely monitoring the current COVID situation around the globe, particularly in India where we've offered health and support to our local team from health care assistance to fundraising for organizations supporting relief efforts in the country. I'm impressed by the resilience of both our employees and customers around the world, especially in India.

Now I'll move on to our results. Q3 was a strong quarter across the board. We delivered another quarter of improved execution, continued momentum and outperformance on all our guided metrics. Today, I'd like to highlight some of our accomplishments in the quarter and also discuss progress on some of the key priorities I outlined on our last earnings call.

We continue to execute on our transition to an ACV-based revenue model. And as expected, our renewal pipeline is continuing to build. The economics continue to improve due to shorter-duration terms combined with uplift from our emerging products. In addition, we saw good linearity in the quarter as a result of our ongoing operational improvements to our go-to-market engine. And finally, while we typically see a seasonal decline in backlog in the third quarter, we were able to hold it steady, further demonstrating the strength of demand in the quarter. Overall, we are pleased with our execution and can see that the hard work of moving to a subscription model is paying off. Duston will go into more details later on our financial performance.

Last quarter, I shared my observations as the new CEO at Nutanix and outlined our priorities for driving long-term growth, including simplifying components of our product portfolio, deepening our ecosystem partnerships, continuing our shift to subscription and nurturing our talent book. I'd like to give updates on a couple of these priorities today, including our transformation to a subscription business model and deepening our ecosystem partnerships, to provide more impact on how we go to market.

Starting with our transition to a subscription model. Our average contract term continues to decline, coming down from last quarter to 3.3 years, helping drive higher unit economics. We also see a growing base of renewals as an increasingly important driver of top line growth and sales and marketing efficiency. With this transition well underway and with our increased focus on efficiency, we see a clear path to cash flow positivity and operating profit. And we'll go into more detail at our upcoming Investor Day.

Focusing on deepening partnerships to scale, how we go to market as well as creating more opportunities with larger accounts is critical to our long-term success. In April, Lenovo and Nutanix announced a complete as-a-service solution for hosted desktops to enable IT decision-makers to drive in the new remote hybrid workforce model. This new solution, all managed as-a-service with the convenience of a single monthly payment and single point of contact for support, includes Lenovo client devices, Citrix virtual desktops and Lenovo servers powered by Nutanix software. This new aspect of our extended relationship with the #1 seller of PCs in the world is a great example of how we can work with a strategic partner to leverage their capabilities from the data center to the desktop in order to best serve our customers as well as give us meaningful incremental opportunity.

Our partnership with Microsoft also continued to progress. During the quarter, we announced that our Kubernetes solution, Karbon, is now validated with Azure Arc Kubernetes management. With the ease of deploying and managing their certified Kubernetes Clusters on Nutanix HCI with consistent policies and governance across Clusters provided by Azure Arc, our mutual customers now have a smooth and fast path to modern containerized applications in a hybrid cloud environment.

This month, we announced that the Nutanix cloud platform now extends to AWS GovCloud, providing a unified hybrid cloud environment across Nutanix on-premises and bare metal Amazon EC2 instances running on AWS GovCloud. U.S. public sector organizations looking for strengthened security offered by AWS GovCloud can now accelerate their adoption and leverage a single platform and management interface across their private and public clouds.

Next, I'll talk about the momentum in our core software as well as our emerging solutions during the quarter. In Q3, we continue to acquire new customers, while our existing customers expanded their engagements with us. We saw continued strength in our core solutions, reflected by a healthy year-over-year increase in our win rates against both our largest competitor and 3-tier infrastructure solutions.

We also saw continued strength in emerging products with our attach rate on a rolling 4-quarter basis increasing to 39%, up from 37% last quarter. We are seeing more examples of customers using our complete cloud software platform together with emerging solutions to meet all of their business needs. An example of this was with a government entity in the Asia Pacific region that chose our cloud platform software as well as our network security solutions to develop a secure private cloud, supporting their mission-critical systems, including security, Exchange and SQL database workloads.

Our database management solution, Era, continues to be an important differentiator for us and had good momentum during the quarter. A financial services company headquartered in Europe selected Era and other emerging solutions on top of our cloud platform to help expand their infrastructure at scale to support their banking customers' requirements for performance, growth and financial service-level agreements. This customer will use our database management solution to deploy, optimize and manage SQL databases across multiple hybrid clouds, helping to drastically simplify and standardize their overall database operations.

We also saw increased adoption of Clusters during the quarter. With the use cases, including data center consolidation, virtual desktops, disaster recovery and the ability to burst to the cloud for additional capacity. In one case, a Fortune 500 North American financial services company selected Nutanix in a multimillion-dollar deal to replace their 3-tier architecture and run their VDI workloads and is using Clusters to burst into AWS on-demand for disaster recovery in their multi-cloud environment.

Next, I'd like to touch on efficiency, which is an important part of our path to profitability. We have increased our go-to-market productivity, including more efficient digital marketing spend, increased leverage of our channel partners and optimized headcount in geographies based on market opportunity. In connection with these efforts, we recently decreased our global headcount by 2.5% from within the sales and marketing functions as we continue to refine our go-to-market model. We expect this action to yield approximately $50 million in annual savings.

Finally, I'd like to highlight some industry awards that Nutanix received during the quarter, which demonstrate our customers' enthusiasm for our products and support. We were recognized by Gartner as a Peer Insights Customers' Choice vendor for our emerging solutions for distributed file systems and object storage. In addition, our core software was recognized by TrustRadius as a top-rated product in the HCI, server virtualization, software-defined storage and virtual desktop infrastructure categories. Also, we recently won the NorthFace Scoreboard Service Award for achieving excellence in customer service. All of these awards are based on customer feedback.

In summary, I'm very pleased with our execution across the board in the third quarter. I look forward to sharing more information at our upcoming Investor Day on June 22. We plan to go into more detail about our mission to delight customers with a simple, open, hybrid and multi-cloud software platform with fixed data services to build, run and manage any application. We will also provide insights on our strategy, solution portfolio, go-to-market and midterm financial outlook.

In the meantime, I will hand it over to Duston Williams. Duston?

Thank you, Rajiv. Q3 was another quarter of consistent execution. In Q3, we exceeded all guidance vector, and the expected benefits of our subscription transition and our ACV-first focus continued to play out as planned. Our average contract term length compressed as expected, declining to 3.3 years versus 3.4 years in Q2 '21. Term compression is highly correlated to better deal economics, and we were very pleased with the improvement in deal economics during the quarter.

Other key components of our subscription transition and our ACV-first focus include retention rates and increased attach rates for our emerging products, which typically have shorter average contract term lengths. Both of these metrics performed well in the quarter. And as average contract term lengths do begin to stabilize, we expect reported year-over-year revenue growth to move closer to ACV billings growth over time.

Now I'll move on to some specific Q3 financial highlights. In Q3, we had record ACV billings. ACV billings were $160 million, reflecting 18% growth year-over-year, above our guidance range of $150 million to $155 million. Run rate ACV as of the end of Q3 was $1.45 billion, growing 25% year-over-year compared to our guidance for growth in the mid-20% range.

Revenue was $345 million, growing 8% from Q3 '20. Our non-GAAP gross margin in Q3 was 81.7% versus our guidance of 81%. Operating expenses were $361 million versus our guidance of $365 million to $370 million. We continue to benefit from overall spending reductions, including go-to-market efficiencies.

Our non-GAAP net loss was $86 million for the quarter or a loss of $0.41 per share. We were pleased that our backlog position remained flat in Q3 versus Q2 despite Q3 typically being a seasonally slower quarter in which we usually experience some usage of backlog.

In Q3, we experienced a solid year-over-year and quarter-over-quarter increase in our pipeline. This pipeline growth occurred with significantly less demand generation spending versus our spend in Q3 '20. Q3 represented our third consecutive quarter of good linearity. DSOs in Q3 were 37 days, down from 44 days in Q2 '21 and down significantly from 67 days in Q3 '20.

Our free cash flow for Q3 was once again aided by good linearity, coming in at a negative $71 million, $15 million better than consensus. We closed the quarter with cash and short-term investments of $1.25 billion, down slightly from $1.29 billion in Q2 '21.

Now turning to our Q4 '21 guidance. The guidance for Q4 is as follows: ACV billings to be between $170 million and $175 million, representing year-over-year growth of 21% to 25%; gross margin of approximately 81.5% to 82%; operating expenses between $380 million and $385 million; and weighted average shares outstanding of approximately 212 million.

Based on the Q4 '21 ACV billings guidance, we expect run rate ACV to grow in the low to mid-20% range year-over-year. Additionally, based on our Q4 '21 ACV billings guidance, we expect ACV billings for FY '21 to approximate $590 million to $595 million, up from $505 million in FY '20, reflecting year-over-year growth of 17% to 18%.

As a reminder, for our reported quarterly ACV billings, we annualize any deal that is less than 1 year in term length. Therefore, the total fiscal year ACV billings are not derived from the simple addition of the 4 fiscal quarters. Our yearly ACV billings calculations eliminate any duplication that happens with the renewal of a deal that occurs within the period and is less than 1 year in duration. We do not believe we'll see the material change in average contract term lengths in Q4. Based on our ACV billings guidance, the implied revenue for Q4 should reflect double-digit year-over-year growth.

Our operating expense guidance includes approximately $15 million in severance costs related to the previously mentioned limited workforce reductions that took place in Q4. We expect some improvement in our free cash flow performance in Q4 versus Q3.

And finally, to help with your modeling, we continue to include in our earnings presentation located on our IR website our historical trends for ACV billings, run rate ACV, billings term length and a bridge on how to model and convert our current and future ACV billings guidance to total billings. We will continue to include this level of detail through the end of FY '21.

With that, operator, could you please open the call up for questions?

(Operator Instructions) Your first question comes from Matt Hedberg with RBC Capital Markets.

Congrats on the strong ACV results. I wanted to ask about Clusters. You guys talked about in your script, it sounds like it's doing better. I'm wondering if you could provide a bit more detail on some adoption trends there. And how is it helping, I guess, both with an up-sell perspective but also future-proofing existing customer spend? Is that kind of how they think about Clusters in terms of extending the Nutanix stack in the cloud?

Yes, Matt. Happy to answer that. It's Rajiv here. It's still fairly early days, first of all, for Clusters since we did the GA for AWS. But we're quite encouraged by what we are seeing from a taxing perspective. If we look at the use cases today, there are existing use cases that customers are using Clusters. For example, disaster recovery for mediated funds. We talked about a large financial services customer doing that today. The advantage there, of course, is that it's somewhat elastic where you can actually run your VDI workloads or any other workloads on-prem but use the cloud as you need for disaster recovery. And that's a very cost-effective, very effective use case for Clusters.

We're also seeing other use cases for driving data center consolidation. You want to get out of a data center and migrate to the cloud, but this is the easiest way to lift and shift workloads for existing applications without needing to re-architect them. We are starting to also see organizations use this for dev test and burst capacity for seasonal demands.

Now to the latter part of your question there, Matt, I think there's an equally important factor of future-proofing. So our customers vary across the spectrum in terms of cloud adoption. Some of them are, of course, using cloud already today. Others are thinking about it as a part to the future. And for those customers who are actually looking at this as part of their future journey, having this capability today gives them a lot more confidence in choosing Nutanix as a platform.

Now the last piece is our multi-cloud road map. So we -- as you know, we've talked about working with Azure on Clusters, and we do expect that to be available for early access later this year. And we're closely partnering with Microsoft on that project.

That's great, Rajiv. And then maybe one for Duston. Obviously, strong ACV results. ACV billings were up this quarter, and you're calling for another acceleration in Q4. I assume a lot of it is based off your pipeline and also the fact the backlog didn't decrease. But I guess, what else gives you confidence in that kind of acceleration, which is certainly noticeable here?

Yes. No, we're pleased to give you that guidance, which, as I said, is about 21%, 25% year-over-year growth on the ACV billings. Q4 typically is a stronger quarter for us, so you see some of that. Clearly, the pipeline and the work that has gone on with the pipeline management and the discipline in the pipeline is a big deal from that perspective. Conversion rates are doing okay and things like that. The product is doing well in the marketplace, emerging products continuing to do their thing.

We've seen some early indications with the channel starting to do a little bit more of the lift themselves with deals. So I think it's a combination of those things. But again, Q4 is always a little bit better but with the backdrop of a lot of good things going on behind the scenes.

Our next question comes from James Fish with Piper Sandler.

Guys, congrats on the acceleration again. Kind of going off of Matt's question there, the demand environment does appear to be favorable now as the business is inflecting from our vantage point. I guess how are you feeling about the sales capacity and productivity? And what are you looking to do to ensure the first set of renewals really go as well over the next 12 to 18 months?

Yes. So maybe I can start, and Duston, you can chime in there. So we continue to focus very much in terms of our sales productivity. We've talked about how Chris has driven a lot of discipline in terms of pipeline management and much more predictable pipeline conversion with the sales team. We are also building out, of course, leveraging the partner ecosystem more now. We are bringing on more solution-oriented selling. And then the emerging products on top of that also improved our productivity. And at the same time, again, encompassing these terms help our overall ASP uplift as well.

Now when it comes to the second part, renewals, of your question, Jim, so we have been focused very much on building out the engine for being ready for all the renewals coming in. So we are building out the renewals team now to focus on the low-cost renewal mechanism. We are putting in all the tooling necessary, so that we get full visibility into where customers are in their adoption and consumption cycles. And we've also created the clarity around who is responsible across the sales organization and the customer success teams for driving this whole process from the time of sale through the time of renewal. So all in all, we feel pretty good about the upcoming stream of renewals here.

That's very helpful, Rajiv. And just keeping on the sales and marketing, obviously, the announcement about the headcount reduction. Just any further details here? Was it more kind of middle management layer or any of the reps themselves? Or how do we think about that reduction element?

Yes. I mean I think there was -- it wasn't -- I mean, it wasn't exclusively in sales and marketing. But it was based more around where we saw, for example, excess coverage that we didn't need that many people for in specific market regions, elimination of certain functions, creating, again, a room to go build out our renewals engine, right, separate from the team that's doing new ACV. So it was fairly distributed across the spectrum. And of course, whenever possible, we try to not impact quota-carrying reps but look at the nonquota-carrying reps in terms of this process. So it is highly distributed, not specific to one particular area.

Our next question comes from Pinjalim Bora with JPMorgan.

Congrats on the quarter, seems like a pretty good one. Rajiv, I want to double click on the emerging products. We have been hearing a constant drumbeat about Era being a differentiation in the market and kind of pulling the core platform in some cases. Maybe I think you kind of alluded in it in the last quarter. Where is this -- what's the maturity of the thinking at this point in time to sell Era as a stand-alone solution to kind of act as a beachhead? And the other part to that is, at this point in time, what kind of an ACV uplift are you seeing from Era and maybe Files?

Yes. Good questions there. So on Era, clearly, Era is a database management offering, right? It allows our customers to streamline how they install databases, provision databases and then life cycle of those databases and manage all the day-to-day operations that they need to do on the databases. And we make use of the underlying Nutanix platform to do some of these functions very efficiently. So that is the connection and tied today to the underlying platform. So what we see is a twofold go to market around Era. Obviously, within our installed base of Nutanix customers, we can go in there and up-sell them on Era on top of our platform. But also, Era has been a way for us to get into new accounts where they don't have any previous Nutanix footprint by focusing on the value proposition of Era, which is differentiated and allowing us to pull in our core platform as well.

So it works both ways. So I would say there's a very good product market fit at this point. It is an area that we are investing more in. And our vision, of course, over time, is to grow Era into a multi-platform, multi-cloud offering. Not just tied to -- only to a Nutanix platform and increase the range of database engines that we will support in the offering.

I'll let Duston comment on the specific ACV uplift that we're seeing from Era and Flow and Files, et cetera. Duston?

Sure. Yes, let me talk a little bit more in the broader bucket as far as just the emerging products, which Flow and Era and the likes are in there. And as you heard, the 80% year-over-year increase in ACV for those products, 39% attach rate. And from an uplift perspective, I think the best way to look at it that we look at it also is just plain deal economics. And there's 2 ways to get better deal economics. Term compression, obviously, shorter terms have higher deal economics but then just better like-for-like pricing on a 3-year to a 3-year deal.

And when we look at deal economics, without Era, Flow and the likes in that emerging bucket and with those products, we're seeing a significant uplift in the overall deal economics. And the Era is front and center as far as the uplift that we're getting there. And I think we'll shed a little bit of light, because there's been questions a little bit, uplift, are we getting from a 5-year to a 3-year and a 3-year to a 1-year deal and how are emerging products helping deal economics. So I think we'll try to shed a little bit of light on that at Investor Day and give you some insight, I think, for the first time now.

I see. Understood. Duston, one for you. I was wondering on -- I mean, at this point in time, you already have motions to go back to your life of device customers and get them to convert to term, maybe on renewals. But how has those conversations been? Those customers -- are those customers weighing more towards like a 3-year deal than a 1-year deal? And what portion of the ACV growth is coming from that motion at this point?

Yes, not a ton. Naturally, as you said, when a support renewal is up for renewal -- life of device support renewals up, for renewal, it's a natural time to have that discussion as far as merging over into a subscription-based transaction. So those go on naturally. Our guys are all over that. And so that's a natural occurrence from that perspective.

And with the shift to ACV base comp, it's got a higher likelihood that those deals, which we pegged as 5 years for a life of device, gets more tilted to a 3 or maybe even shorter deal. Because most likely, they have better deal economics, better higher ACV and the reps want to get more money, more commission dollars with that downtick in terms.

So again, it's a natural occurrence. A lot of our support renewals that come up for renewals just merge, and they don't renew. They'll merge into a new subscription transaction. So that's ongoing. And the great news there is that we've got a big pool of that, as you well know. And so that's an ongoing effort over the next several years that we'll continue to tap from that perspective.

Understood. I'm sure we'll hear more about that at the Analyst Day, but congrats on the quarter.

Our next question comes from Jason Ader with William Blair.

My first question, I guess, for Rajiv, there's this narrative that COVID has accelerated the shift to cloud. And I'm just wondering how you think that's impacted demand in the on-prem space generally, and then how has it impacted demand specifically for Nutanix.

Yes. I mean I think at the top level, if you look at the COVID impact, a lot more customers talk about how to get their employees working remotely pretty effectively. And that certainly had a stimulus effect in terms of virtual desktop deployments and scaling those deployments. And we -- that's a sweet spot, the use case for us. So we certainly benefited from that.

They're also starting to use -- see the use of cloud. Now cloud migration, certainly, I think as customers look at cloud, more and more customers are looking at making use of the public cloud. And we have certainly seen that being a driver for some of our deployments as well, like we've talked about here with some of the examples we provided. Like the financial services customer who's actually doing -- meaning doing both, right: doing VDI to support their remote workforce, but also using the cloud for disaster recovery in a very cost-effective way. So we're certainly seeing more and more of these use cases of hybrid cloud emerge as we go forward.

So I think, in general, when we look at COVID, I think it's accelerated customers' digital transformation, which means they're focused also on going more and more digital, driving application work. And that generally means they're also modernizing infrastructure where it makes sense.

So that helps us. The drive to hybrid cloud is going to be a helping factor for us as well. And then this remote work is here to stay. It's going to be hybrid workflows. As we all come back into the offices, it will likely be people working part of the time in the office and part of the time remotely. So it will continue. So those drivers, in general, I think, are helping us.

Got you. And you haven't seen any kind of significant shift from customers or opportunities where they've just said, you know what, we're done with on-prem data centers. We want to go -- we want to go cloud-native and we just don't need you guys anymore. You haven't really seen that type of a phenomenon?

Well, we haven't quite seen that. As you can see, our business continues to grow healthily. We are seeing good demand, and we are seeing, in fact, an uptick in demand here. So no, I think we're not seeing that yet. But we are seeing more and more customers talking about wanting to be in this multi-cloud world, right? They're going to decide what they want to go put in terms of their applications. Some applications will continue to run on-prem. Some will be in the public cloud. Some will be in the Edge. And these are newer applications as well. So we are starting to see more of that hybrid trend emerge.

Our next question comes from Jack Andrews with Needham.

Rajiv, given your focus on partnerships, I was wondering if you could just maybe discuss how -- maybe the -- I guess, the amount of awareness and maturity your channel ecosystem has for your line of emerging products relative to their awareness and your core HCI offerings. Is the channel fully up to speed in terms of just all the capabilities that you've introduced to the market? Or is there still an education process happening there?

I think it's very much the latter. There is still an education process. Most of our channel partners are very much selling our core offering, our core HCI. That's what they're most familiar with. These newer products such as Era and Files and Flow and so forth are relatively new to our partners. And only now are they building up their capabilities to be able to sell that. I think the initial product market fit for some of these products was driven very much by us. And now we are at the point where they're actually scaling these products that we have product market fit on. And this is where the partners come in, and they play a very significant role. So we are certainly investing in building up the capabilities and enabling them to transact and build up their competencies in these emerging products. And I think there is a future opportunity for leveraging the partners there as well.

Great. And then a quick one for Duston. You'd mentioned that you're not expecting any material changes to contract term lengths here in the fiscal 4Q. Any comments in terms of how you're thinking about it beyond this and moving into next fiscal year?

Yes. I think, again, we'll see some potential gradual declines. I think what we see in the pipeline, there's not a whole lot of movement in those terms. Now when it converts to actual deals, we'll see how that plays out. But I think, again, I've said for a while now, and we'll have to see here over the next couple of years, but what I've said previously is probably 2.8 to 3.0, somewhere around there, years, but that's over a period of time.

And it's pretty much -- now things can change, but it's pretty much played out so far as we have expected. We thought it would be a gradual decline because you've got plus or minus 80% of the existing customer base already has a set term, so you need to change that and whatever. So again, I think it's ultimately somewhere between that 2.8 and 3, and I think that occurs over some period of time, and we're at 3.3 today. And we'll see how that -- see how it goes over the next year or 2.

Our next question comes from Wamsi Mohan with Bank of America.

Congrats on those solid ACV results and guide. Rajiv, there clearly has been a lot of change or -- at your largest competitor, both in terms of leadership, ownership, et cetera. Do you anticipate any significant competitive changes there as it pertains to Nutanix, especially with respect to either channel or pricing? And I have a follow-up.

Yes. Look, I think, obviously, competition is good for the customer. I feel pretty good about our position in the market, independent of what's happening at any of our competitors. We are very focused, right? We are focused on executing on our HCI platform, building out the emerging products on top of that and extending that to multiple clouds. And we're very focused on our customers and delivering the best outcomes to our customers. And look, if we do that right, I think the rest will fall in place.

Now it is worth noting that we are still the one provider that provides the most choice in the market, right, allowing our customers to take the hardware, the hypervisors, the container and cloud platforms, along with our software. And we remain very focused in terms of executing on that mission. And also continuing to build and leverage partners where I see even more opportunity for us.

Okay, Rajiv. And Duston, the $50 million in annual savings, is that on a gross or net basis? And is there some that's getting reinvested somewhere else? Or is all of that to flow down the P&L?

Yes, most of it flows into the P&L. There may be some minor reinvesting, but most of it all flows. And probably 2/3 of that is in operating expense, and the rest is in COGS, with some of our services and things like that. But vast majority, though, will flow through.

Our next question comes from Katy Huberty with Morgan Stanley.

My congrats on the quarter, too. I want to start with a question for Duston. Can you just give some context around the better-than-seasonal third quarter backlog? Is that a function of an internal strategy to just run at higher backlog levels and improved visibility? Or was that a bit of a surprise and a signal of strengthening demand that you weren't able to ship at the end of the quarter?

Yes. Sure, Katy. I mean you always hope for a higher backlog, to your point there. But pipeline has been strong. You saw the comments that you were pleased with the quarter-over-quarter increase in pipe, the year-over-year increase in pipe. So I think you definitely see something going on from a demand perspective there. And then again, you have to layer that on with the backdrop of some pretty good execution also within the pipeline management and deal management and deal closure and things like that.

So now I think it's certainly a combination of both. And a good indicator also is linearity, which we talked about. Quite honestly, linearity surprised me a little bit in the quarter, being as good as it was. It's just typically not like that in Q3 coming off a big Q2. So I think it's a combination of mostly positive things at play there.

Great. And then just as a follow-up, maybe Rajiv can comment here. Today, what percentage of the business is driven by OEM partners? And how does that compare to a year ago? And then which OEMs are you seeing the fastest growth with? And I just asked that in the context that, clearly, part of your strategic change is to build out that partner ecosystem.

Yes. I'll comment on the second one. And then Duston, you can comment on the size of the business with these OEMs. So I would say HP clearly is the one that's been growing the fastest for us overall in terms of the OEM relationship for us. Clearly, Dell continues. And I would say Dell is more fulfillment as we partner together and our customers want to land our solution and Dell hardware -- Dell supports that. So I would say HP, Lenovo, to the extent that they're in markets where they are strong, continues to be -- from a server perspective, also continues to be a very good partner for us. So I would probably say those are the 2 big ones.

Duston, you want to comment on the sizing?

Yes. I don't have a whole lot to add because we stopped giving that stat a while ago. And because it just got complicated because most, if not all, the Dell business that's rolled over to the XC Core, which has kind of meet the channel with our software running on their service, which continues to do quite well, but it's outside of that OEM bucket there.

Our next question comes from Rod Hall with Goldman Sachs.

I wanted to start with kind of this question on supply. I know you're selling software, not servers, but then your customers have to install it on a server. So I'm just curious whether you think that there's any risk as you look out the next quarter or 2, given all the supply shortages we keep hearing about, that people want to buy your software, but then they can't find servers to install it on. And then I have a follow-up.

Yes. I mean, Rod, I think there's clearly a global challenge of chips out there. And I think the one thing that I would say about software sales is not all our software necessarily goes on new servers all the time, right? I mean it's -- people are doing more virtualization, and they might deploy it even on existing ones. In some cases, where all staff they've already procured. So we haven't quite seen supply shortages being a driver or impacting us at this point at all.

Okay. That's great, Rajiv. And then my follow-up, I just wanted to come back to this point on contract term. I think some people look at a stabilization and maybe they worry that we're stabilizing a little higher level. I'm just curious -- I mean, Duston, you said that's tracking what you guys would have expected. I'm assuming this is just kind of puts and takes around mix on terms. And I think -- any other color you could dig into to help us understand why that 3.3 remain stable in Q4 in the guide and how we ought to maybe see that trajectory after does it probably ticks down after that? Or how is that kind of playing out? That would be great.

Yes. As you know, it's not an exact science to predict exactly what the term is going to be in any given quarter. It could go down 1/10 here or there or whatever. I wouldn't be surprised about that. My comment is here, but it's just -- I just don't see a material quarter-over-quarter change. That's a little bit different in Q1 when Fed pops up, and they have a lot of 1-year deals. So take that out of the equation.

But I just don't see any rapid decline in terms. And again, I -- we'll see how it plays out over the next couple of years, 2.8, 3.0, somewhere in that range. I think as we have more time and reps have more discussions with customers, they're naturally going to try to move them from 5 to 3 or shorter. So I think that occurs naturally over time. But I -- it's not my assumption that we stay here at 3.3, and we don't move any further. I just don't think it's a rapid decline.

But we shouldn't think that maybe there's any slowing down on renewals or anything like that, that would cause that to stabilize. It's nothing like that.

No, no, no. No. We'll give you a very good feel, a more loud and clear on the renewal front, and you can get more visibility and all that. So you're going to -- you'll see a good dose of that on June 22.

Our next question comes from Simon Leopold with Raymond James.

This is Victor Chiu in for Simon. I wanted to drill a little more into the cloud portfolio. Hybrid cloud is kind of a generic term that encompasses a number of different approaches and solutions. So can you maybe speak about Nutanix' competitive proposition compared to more integrated cloud platforms/software-defined data center solutions like VMware cloud and Azure Stack? And maybe help us understand what are the most vital factors that enterprises consider when deciding which particular hybrid cloud approach to adopt.

Yes. I think the key question there, by the way, is, first of all, I mean, people operate -- our customers are operating, of course, with an on-prem data center but with one or more public clouds as well. Now if you are looking at a particular public cloud provider, all the public cloud providers are also embracing hybrid strategies now, AWS GovCloud, Azure Arc. And so the -- so if a customer is locked to 1 public cloud, then they can also look at that particular public cloud's hybrid solution.

But more often than not, and we'll show you some more data at Investor Day, right, survey shows that customers are interested in more than 1 public cloud. So they're using multiple public clouds, and they're on-prem. And now when you start looking at this environment, they're -- the value that we provide with our cloud solutions is we provide 1 platform, 1 set of tooling, 1 set of management interfaces, 1 license, right, that a customer can use to deploy and manage their workload on whichever cloud they want, all right? Whether it's today, it's, of course, on-prem, Edge or data center and also moving to -- in AWS and tomorrow, once we get our Azure Arc, we have Azure, and over time, hopefully, we'll have more.

And so that unique -- think of this as a multi-cloud platform that our customers can actually get. And so to some extent, VMware has something similar as well, right? The approach that we have is slightly different. Today, we essentially say customers, you have your own whatever public cloud accounts you have, you can just deploy. Buy the software from us, that same license, you don't get value, use it. You use it whatever you want. If you want to deploy that in the public cloud of your choice, we enable you to do that, and you can go out and deploy it. You can manage it all with 1 solution.

And we also do a lot more work in terms of handling all the data services in terms of our heritage team, in terms of how we manage and store data. So we do that particularly well as well.

So our value proposition fundamentally is to be able to provide this platform that cuts across multiple clouds, essentially made these clouds invisible, right, hide the underlying complexities of each of the cloud silos and provide this consistent platform for customers to go run their business as well.

Our next question comes from Erik Suppiger with JMP Securities.

On the Lenovo partnership, can you talk about what the competitive dynamics are there? Are there any other providers that are working with Lenovo and if they have as tight of an integration as you do? And then, secondly, just curious with AHV. It's kind of settled in at 52%. It's been in the 50% range for a while. Is that something that's going to change at any point down the road? Or is this probably where it settles in for a while?

Good questions. So Lenovo launched this offering just with us for now, right? I'm sure they may have other partners that they're bringing onboard over time. But the -- this particular announcement, which was fairly unique for Lenovo, it's called a 2-scale offering, it is everything delivered as a subscription. So that means the hardware, the PCs, the servers, the Citrix media and the Nutanix software all put together delivered as-a-subscription offering, as-a-service offering to their customers.

And so this is an example where they work with us as a first partner to go deliver this complete end-to-end as-a-service subscription offering, combining hardware and software, to address this customer use case of their end-to-end solution, right, enabling their end users as well as to be able to consume remote desktops. So we are the first solution there.

Now to your question on AHV, we expect continued growth and adoption of AHV over time. It's been a gradual continuing upshift for customers. Look at the value of AHV, it's getting better and better every day to where AHV can today handle all the mission-critical workloads that customers want. And so customers look at this as an opportunity for them to save quite a bit of cost and, over time, continue to migrate more and more of their workloads to AHV.

For example, I mean, one of the large deals that we announced with this Asia Pacific mission-critical deployment was on AHV, right? It makes you -- made use of one -- make network security solution that's built in essentially now as part of AHV. And so people are very comfortable with it as a mainstream hypervisor that can run all workloads. So we do expect more and more. It will be a gradual uptick in terms of the deployment of AHV.

Is there any catalyst that would drive that higher?

Potentially, as cloud, for example, all our cloud -- hybrid cloud solutions in AWS and also in Azure are based on AHV. And to the extent that the customers actually start using more and more of that, that will drive AHV. As customers look at renewals of their existing software from other vendors and they look at this as potential cost savings, that could accelerate it as well.

Our final question comes from Nehal Chokshi with Northland Capital Markets.

Let's see. So has there been a change in the way you're building up the ACV guidance this quarter relative to prior 3 quarters? Because in prior 3 quarters, you've been able to beat your own guidance by a healthy margin in the past. So just wondering if there's been a change in the way that you're building up this ACV guidance.

Same methodology. Yes, Nehal, same methodology.

Okay. Great. And then when you talk about an uplift from emerging products, does this just mean the driver of the ACV billings acceleration? Or are you also seeing year-over-year increase in ACV core? And is that what you mean by like-for-like pricing, actually?

Yes, the latter. Yes, it's actually better deal economics.

Got you. Good. Great. And could you -- I know this is somewhat difficult, but could you tell us what percent of AC billings was actually renewals in the quarter?

We have not given that on an ACV basis, but highly likely, you'll see a fair amount of detail, again, at Investor Day on that.

Okay. Great. Congrats on a strong quarter, and I think what I think is fantastic guidance. Congratulations.

There are no further questions at this time. This concludes today's conference call. Thank you for participating. You may now disconnect.