Shares of Nutanix (NTNX 1.68%) were plunging on Thursday after the cloud-based hyperconvergence specialist offered underwhelming guidance in its second-quarter earnings report.
The stock finished the day down nearly 30% even as the company beat estimates in the quarter. As Nutanix continues to transition from hardware to a software subscription model, overall revenue inched up 3.4% to $346.8 million, topping analyst expectations at $341.9 million. While gross margin improved as the company moves to the subscription model, it also spent heavily on sales and marketing in the period to push its new subscription-based offerings. As a result, its adjusted loss per share widened from $0.23 to $0.60, but that was still better than estimates at a loss of $0.69 share.
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The guidance effect
What seemed to throw investors off was the company's third-quarter guidance, which called for software and support revenue of $300 million-$320 million, down from $338.2 million in the second quarter. It also slashed its full-year guidance in revenue, calling for $1.6 billion-$1.67 billion, down from a prior range of $1.65 billion-$1.75 billion.
CEO Dheeraj Pandey explained the guidance, saying: "The change in our fiscal 2020 TCV guidance is driven by two factors -- first, a much faster than expected shift to subscription, coupled with a more cautious view on business activities in the greater APJ region due to the anticipated impact of the coronavirus."
The faster-than-expected shift to subscriptions is a good thing for Nutanix as the company aims to have 100% of its billings come from subscriptions within the next three years. Billings from subscriptions jumped from 73% to 79% sequentially, showing the company making rapid progress toward that goal, ahead of its own forecast.
However, the effect of shifting to the subscription model on financial reporting is that revenue that would be recorded at the time of sale gets drawn out over the length of a contract, temporarily muting revenue growth. The company's headline numbers also look worse because it is still shifting away from hardware and one-time software sales, meaning it's rapidly losing sales in those categories.
Subscription revenue in the quarter jumped to $267 million, representing 77% of total revenue, showing the company is executing on its primary goal of building a subscription-based business. Sales of non-portable software and hardware fell sharply in the quarter, down from $169.5 million to $67.7 million. Nutanix's revenue growth should begin to accelerate as non-portable software and hardware becomes a smaller part of its business.
Still, investors seem weary, as the tech stock also fell a year when the company slashed its full-year revenue guidance. That time the reason was that the company underestimated its sales force needs. This time around, with the transition to subscription model happening faster than expected and the coronavirus affecting the broader tech industry, there seems to be less reason to be concerned.
Positive signs
Despite the guidance cut and the stock plunge, CEO Dheeraj Pandey remained optimistic about the long-term growth of the company, touting the embrace of the subscription model by Nutanix's biggest customers, its partnership with Hewlett Packard Enterprise, and an increase in the attach rate, or the percentages of customers buying products outside the company's core hyperconvergence infrastructure offering, from 21% to 31%. That's also a sign that its marketing efforts are paying off. Growth in the attach rate should help support long-term revenue growth, as it means contracts are getting more valuable.
Marketing costs rose 43% in the quarter to $304.9 million, making up 88% of total revenue. Investors should expect that percentage to moderate over time as the company moves closer to a full subscription model.
For now, investors should expect Nutanix's results to be choppy, especially with the uncertainty from the coronavirus. While it's no doubt frustrating for investors to see another post-earnings crash, Nutanix is still executing on its long-term goals.
Editor's note: This article has been corrected to state that subscription revenue in the quarter jumped to $267 million.
