Editor's note: An initial version of this article misstated Nutanix's total addressable market figures, now corrected. The Fool regrets the error.
Shares of Nutanix (NTNX 0.67%) touched a two-year high this week after the company hosted its Investor Day conference on Tuesday.
After the company went through a years-long transition to a subscription software-as-a-service (SaaS) model, the fruits of those efforts are finally coming to bear. Wall Street cheered as the company outlined profitability targets, showing it would turn profitable sooner than expected. The stock rose 7.1% on Tuesday, and several analysts lifted their price targets on the stock following the conference.
Among the highlights of the Investor Day presentation were:
- 25% annual contract-value (ACV) billings growth expected through fiscal 2025, an acceleration from current levels.
- 20% annual revenue growth through FY 2025, also an acceleration.
- Nutanix expects to reach positive cash flow by calendar 2022 and a positive operating profit by calendar 2023.
- The company projects that its total addressable market will expand from $39 billion in 2020 to $61 billion by 2025.
Those are all impressive numbers that show the company is building scale faster than expected. For the first three quarters of its current fiscal year, ACV billings grew by just 12.6%, but management sees the key growth metric accelerating due to an increase in sales reps, higher sales-rep productivity, increasing renewals, and new products like Era and Files.
Revenue, meanwhile, has grown mostly by single-digit percentages, as the shift to the subscription model has presented headwinds because of recognition rules. However, that's now fading away as the subscription transition is nearly complete.
With the transition behind it, the company can now enjoy the same kind of benefits as other SaaS companies, as high gross margins generally make the SaaS model profitable at scale. That's part of the reason why the company expects to reach profitability in the coming years. In its forecast, it also called for just 7% annual growth in expenses through FY 2023 and expects sales and marketing expenses to decrease from 79% of revenue in fiscal 2020 to just 43%-47% in fiscal 2025.
Tonya Chin, Nutanix's chief communications officer and senior VP of corporate marketing and investor relations, explained that costs are coming down because of the benefit of contract renewals, which are 80% cheaper for the company than landing new customers. With those renewals, Nutanix now has a base of high-margin renewable revenue, and those renewals free up its sales force to pursue new customers.
A tipping point
Nutanix has always excelled at pleasing its customers. It has a net promoter score of 93, meaning almost all of its customers would encourage a friend to buy a product, and its renewal rate is above 90%. Additionally, the company is considered the leader in hyperconverged infrastructure (HCI) by both Gartner and Forrester.
However, the stock's performance has been rocky over its history as Nutanix has been in a transition for almost all of its history. It first moved from hardware to software, and then from software to a cloud-based subscription model, an evolution that has made its financial results noisy. More recently, it switched from reporting total contract value billings to annual contract value billings in order to better align its performance metrics with a sales model that encouraged more renewals and upselling, rather than incentivizing longer contracts.
Those changes seem to be finally paying off, as Nutanix's long-term guidance and the chorus of cheers from Wall Street indicate. The stock has always traded at a substantial discount to most SaaS stocks, in part because revenue growth was slow and it was not approaching profitability. Currently, the company trades at a price-to-sales ratio (P/S) of 6, while many SaaS companies have a P/S at 20 or higher.
The company didn't get too specific on how profitable it could be, calling for $150 million-$350 million in operating profit by 2025. But in its last quarter, its adjusted gross margin was 81.7%, leaving considerable room for leverage if the company can slash sales and marketing expenses by nearly half as it intends to do.
If Nutanix's cost savings flow to the bottom line and its growth rate remains strong, investors could be richly rewarded down the road.