Q3 2023 Nutanix Inc Earnings Call
Thank you for standing by and welcome to the mechanics Q3, 2023 earnings conference call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session.
To ask a question at that time, Please press star one on your telephone.
As a reminder, today's call is being recorded.
Now I'll turn the conference host Mr. Rich Valera mechanics V. P of Investor Relations. Please go ahead Sir.
Okay.
Good afternoon, and welcome to today's conference call to discuss the results of our third quarter of 2023.
Joining me today are Rajiv ramaswami mechanics, as president and CEO .
Unique around them.
Yes.
After the market closed today.
Dennis issued a press release announcing financial results for its fiscal third quarter 2023.
I'd like to read the release please visit.
Press releases section of our IR website.
<unk> filed our 10-Q for our second quarter of fiscal 2023, which is available on yet.
These website.
During today's call management will make forward looking statements, including statements regarding our business plans strategies initiatives progression objectives.
Objectives and outlook, including our financial guidance as well as our ability to execute successfully.
Timely manner.
Benefits and the impact thereof on our business operations.
The results are.
Implement recommendations and remedial measures.
But the investigation or.
Our expectations and estimates from the resolution of the third party software usage pattern that was the subject of the investigation, including an estimated impact on our financial statements and guidance.
The performance targets.
<unk> metrics in future periods.
Patients regarding profitability okay.
Our competitive positioning and market opportunity the timing impact of our current and future business model transitions and.
Factors driving our growth.
Macroeconomic geopolitical and industry trends, including global supply chain challenges.
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.
Aided by these statements.
For more detailed description of these and other risks and uncertainties. Please refer to our SEC filings, including our annual report on Form 10-K.
For the year ended July 31, 2022, and our quarterly reports on Form 10-Q.
Fiscal quarters ended October 31, 2022, and January 31, 2023, as well as our earnings press release issued today.
Forward looking statements apply as of today, 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 except for revenue are expressed on a non-GAAP basis.
When 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, mechanics will be holding its 2023 Investor day in New York City on September 26, Please see our earnings press release for registration information.
<unk> will also be appearing at the NASDAQ Investor Conference in London on June 13.
Thank you Scott are you there.
With that I'll turn the call over to Rajiv.
Keith.
Thank you rich and good afternoon, everyone.
Against an uncertain macro backdrop.
We delivered a solid third quarter.
But we felt that came in ahead of our guidance.
And saw continued strong performance in our renewables business.
With respect to the macro backdrop.
In our third quarter, we continued to see businesses prioritizing their digital transformation and data center modernization initiatives.
With a strong focus on total cost of ownership, which plays to the strength of our platform.
However.
We also continue to see some increased inspection of deals by customers.
Which we believe is related to the more uncertain macro backdrop.
This is driving a modest elongation in sales cycles.
We've considered this dynamic.
Our outlook for the reminder of the fiscal year.
Supply chain constraints with our seller partners.
Year to have normalized at this point.
And now having minimal impact on our business.
In conjunction with the release of our fiscal third quarter earnings Tonight.
We also announced the conclusion of the audit Committee investigation related to third party software usage and the subsequent filing of our 10-Q for our fiscal second quarter.
As a result of this process, we identified a material weakness in our internal control over financial reporting.
And are working on remedial measures to address the identified weakness and help prevent this from happening again.
We have also helped the responsible employees accountable.
This matter had no material impact on our historical financials, and we believe it will have minimal impact going forward.
While rukmini will provide more details.
We're pleased the investigation has been completed.
Taking a closer look at the third quarter, we delivered solid topline growth.
Including 17% year over year ACB billings growth.
Driven by continued strong performance of our renewables business.
Our ongoing focus on expense management helped us generate $42 million.
Our free cash flow continuing.
Continuing our strong year to date free cash flow performance.
Overall, I'm pleased with our financial performance in the third quarter.
Our third quarter results reflect the value new and existing customers in both our core cloud platform.
And our solutions based portfolio.
As they look to modernize while carefully managing their costs.
A good example of this is our largest deal in the quarter with a fortune 500 semiconductor provider.
That we're looking to accelerate digital transformation.
This customer decided to deploy their containerized manufacturing applications on Red Hat's open check all of our <unk> cloud platform to optimize the infrastructure resources.
And operationalize, the private cloud environment and the numerous manufacturing facilities around the world.
They expect this will meaningfully reduce their costs, but also enabling enhanced agility and deploying new products and responding to changing market demands.
We see this win as a testament to the performance scalability and total cost of ownership benefits delivered by our platform.
And our ability to expand our footprint within some of the world's largest companies.
Another notable win in the quarter was with a leading payment solutions provider in the EMEA region, who is looking to improve that total cost of ownership by modernizing their infrastructure and implementing a multi cloud architecture operating across several countries.
They chose <unk> cloud platform.
Clothing mechanics cloud management to run their business critical applications, leveraging its simplicity and built in automation for infrastructure as a service.
They also adopted metallics database service for managing and deploying their databases throughout their organization and <unk>.
The Chinese unified storage to service their unstructured data needs.
By adopting the full notes Alex that this customer anticipate lowering that annual operating cost by 45%.
We're also seeing customers take advantage of the capabilities of cloud clusters or NTT.
We're rapidly and efficiently optimize that workload distribution across on Prem and public clouds.
An example in the third quarter with a government agency in the EMEA region that we're looking to ship a variety of on Prem workloads running on mechanics truck platform to public cloud.
Keeping with a government cloud first mandate.
They initially chose to shift workloads to azure using in situ.
For what they thought would be a contingency plan for workload migration.
However.
Given the speed and simplicity afforded by <unk> two four quickly transitioning workloads.
Refractory <unk>.
As well as the cost effectiveness they found running workloads on <unk> on Azure.
They decided to make etsy to their primary solution for public cloud migration.
This win demonstrates how our customers appreciate the ability to rapidly and seamlessly shift their workloads from the private cloud for the largest public cloud providers.
With the consistent management.
Governments and data services provided by the new tactics cloud platform.
Without the time and expense of re factoring that workload and with lower ongoing operating costs.
Moving on.
In early May we held our first in person Dot next user conference.
It almost four years.
And saw strong attendance and engagement from our customers and partners.
In conjunction with Cognex, we met several important product related innovation announcements, reflecting our continued investment in the <unk>.
Hybrid multi cloud platform.
First we announced new data services, including data services for Kubernetes.
Which will bring the full power of <unk> enterprise class storage snapshots and disaster recovery to comment in these applications.
We introduced multi cloud snapshot technology.
Which will deliver cross cloud data mobility by enabling snapshots directly to cloud native storage, starting with AWS. This S. Three object storage service.
We also announced the new accounting center.
<unk> delivered management solution that will enable a truly universal cloud operating model.
By providing a single console for visibility monitoring and management across public clouds on Prem hosted our edge environments.
Finally.
We introduced project Beacon.
Our vision for hybrid multi cloud platform as a service.
A multiyear effort to deliver data centric platform as a service offerings natively.
On mechanics.
Our native public clouds.
With the goal of decoupling, the application and data from the underlying infrastructure.
Project Beacon aimed to enable developers to build applications once.
And run them anyway.
In closing.
While the macro environment remains uncertain we.
We are encouraged that the compelling value proposition of our cloud platform.
And the strength of our business model.
Nevertheless to raise our fiscal year top line outlook.
And bottom line outlook.
We remain focused on delivering innovation for our customers now and in the future.
While continuing to drive sustainable profitable growth.
And with that I'll hand, it over to Rukmini severed Aman.
<unk>.
Thank you Rajeev.
Before I discuss our financial results and outlook.
I'd like to first provide a summary of the audit Committee completed review of our third party software usage and the resulting implications.
Upon completion of the investigation.
This committee found that evaluation software.
Two of our third party providers was used in a non compliant manner for interoperability testing validation customer proof of concept training and customer support over a multiyear period.
In addition, the audit committee concluded that certain employees engaged intentional misconduct to conceive us of evaluation software with respect to one of our third party providers in violation of our code of business conduct and ethics and other policies.
We have terminated employment for certain employees, who were found to be primarily responsible for the intentional misconduct.
Sure. The investigation, we identified a material weakness in our internal control over financial reporting.
In particular, we determined that our control did not effectively provide the information and communication necessary.
<unk> non compliant use of third party software.
To address this material weakness, we are implementing our will implement several remedial measures including.
Enhanced internal processes enhanced training and continued communication regarding the importance of integrity and raising concerns in a timely manner.
We have accounted for the estimated financial impact of this issue by recording Cumulated estimated expenses of $11 million as of Q2, 2003, which represents the estimable amount of future payments.
For past Noncompliant usage of software from these two vendors accrued over a multiyear period.
We have accordingly also corrected prior period financials stone in the 10-Q filed earlier today.
We expect the incremental ongoing annual impact to operating expenses of this third party software usage to be approximately in the low single digit millions of dollars.
You can find additional information, including a complete Q2 'twenty three results.
Information about the estimated financial impact and remedial measures related to the third party software review in our 10-Q quarterly report for Q2 2003 that we filed earlier today with the SEC.
We are pleased that this investigation has been completed.
I will now provide commentary on our Q3 23 results followed by the outlook for Q4 23, and the full year 2023.
Q3 was a good quarter during which we beat all guided metrics.
ACD billings in Q3 was $240 million.
Higher than our guidance of $220 million to $225 million and representing a year over year growth of 17%.
Revenue in Q3 was $449 million.
Higher than our guidance of $430 million to $440 million.
And a year over year growth of 11%.
<unk> at the end of Q3 was 1.467 billion.
Our year over year growth of 32%.
New logo addition, what about 430 in Q3.
Average contract duration in Q3 was three years flat quarter over quarter as expected.
As described previously the percentage of orders with future stock date likely due to spot our supply chain constraints continue to be an assumption in our Q3 guidance.
Q3 revenue benefited approximately $5 million from the reduction in percentage of future start dates overtime as more license revenue was recognized in quarter Dan was deferred.
In line with the $5 million estimate we had provided on our last earnings call.
As supply chain challenges faced by our server partners appear to have normalized we expect its impact on our business to normalize as well.
As a result going forward, we will not continue to provide this quantification of revenue impact from orders with future start dates.
non-GAAP gross margin in Q3 was 84%.
non-GAAP operating expenses in Q3 were $369 million.
non-GAAP operating margin in Q3 was 2%, including the impact of about $10 million in nonrecurring tax obligations.
Related to a portion of our employee artist deals that vested in Q3.
And approximately $9 million of nonrecurring legal and advisory expenses, both of which related to the third party software to view and the delay in our 10-Q filing for Q2.
Excluding these one time items non-GAAP operating margin in Q3 would have been approximately 6%.
non-GAAP net income in Q3 was $12 million.
Our EPS of four cents per share based on fully diluted weighted average shares outstanding of approximately 282 million shares.
Billings linearity was good and Dsos were 28 days in Q3.
Free cash flow in Q3 was $42 million.
Implying free cash flow margin of 9%.
A few additional notes on Q3 free cash flow.
One the approximately $31 million payment for the settlement of the previously outstanding Securities Class Action litigation, which is the amount and so whatever legal fees and expenses.
Net of our expected recovery under our D&O insurance is now expected to be paid and settled in Q4, rather than in Q3 as previously expected.
And timing is due to routine process.
Sure.
$42 million of free cash flow in Q3 includes the impact of approximately $10 million of cash usage in Q3 for non recurring tax obligations related to a portion of our employee I'll just use that vested in March as expected and mentioned on our last earnings call and caused by the delay.
In our Q2 10-Q filing.
The delay in our Q2 10-Q filing also meant that we paused our ESP program delaying an estimated $20 million of net cash outflow related to ESP, which would normally occur in Q3 to Q4.
And for free cash flow in Q3 was also impacted by approximately $6 million of payment for nonrecurring legal and advisory expenses related to the third party software with you.
We ended Q3 with cash cash equivalents and short term investments of 1.358 billion.
Up slightly from 131 $1 billion in Q2 'twenty two.
Moving on to Q4 the guidance for Q4 fiscal 'twenty three is as follows.
The billings of $240 million to $250 million.
Revenue of $470 million to $418 million.
non-GAAP gross margin of approximately 84%.
And non-GAAP operating margin of 9% to 10%.
Moving on to the full year outlook with one quarter left the guidance for fiscal year 'twenty three is as follows.
<unk> the links of $915 million to $925 million a.
The year over year growth of 22% at the midpoint of the range.
Revenue of $1.84 billion to $185 billion a year.
But your growth of 17% at the midpoint.
non-GAAP gross margin of approximately 84%.
non-GAAP operating margin of 6% to 7%.
Year over year improvement of over 10 points of margin at the midpoint.
Free cash flow of $125 million to $135 million.
Implying a free cash flow margin of 7% at the midpoint.
I will now provide some color on our full year guidance.
First we have seen continued new one expansion opportunities for our solution. Despite the uncertain macro environment.
However, as Rajeev mentioned and similar to last quarter, we have seen a modest elongation of sales cycles likely due to increased deal inspection.
Our fiscal year, 'twenty, three new and expansion ACB performance.
Impacted by some of these macro dynamics and is performing slightly below our expectations entering the year and what we believe its longer term potential is.
We have considered this dynamic and our updated guidance.
The windows business continues to perform well.
It tends to be at a lower aggregate average contract duration compared to our new and expansion business.
Our relative economics on renewals have also continued to improve overtime as the renewals team is improved execution.
Second similar to our comments last quarter, the fully our guidance assumes that contract durations will decrease slightly compared to fiscal year 'twenty two.
Third as stated previously non-GAAP operating margin outlook for fiscal year 'twenty, three is 6% to 7%.
The one time expenses related to the third party software to view this range would have been 7% to 8%.
Finally, the updated free cash flow guidance of $125 million to $135 million includes the impact of the following non recurring items totaling about $65 million.
Approximately $10 million of cash usage in Q3 for non recurring tax obligation related to a portion of our employee at a huge vesting, which is nonrecurring because it was due to the delayed filing of our 10-Q.
Approximately $31 million and net cash outflow expected in Q4 from the previously mentioned litigation settlement.
Approximately $15 million for legal and advisory fees related to the third party software to view across Q3, and two four and.
And finally.
And $11 million estimated payment in Q4 for the potential resolution with a third party software vendors.
In closing we are pleased that our Q3 results reflect our continued execution towards our stated objective of sustainable profitable growth and we expect to continue that focus with that operator. Please open the line for questions.
Thank you again, ladies and gentlemen, if you would like to ask a question. Please press star one on your telephone again to ask a question. Please press star 111 moment for our first question.
Our first question comes from a lot of Jim fish with Piper Sandler Your line is open.
Okay.
Hey, guys nice quarter and.
Congrats on getting the investigation behind you and it appears fairly minimal.
It will impact.
We kind of all talked about here.
Maybe just starting off on the assumptions around.
And what you guys are seeing with sales cycles, obviously, we've talked about elongated sales cycles for some time now we're hearing it from others in the space I guess, how much of elongated sales cycles slowed or hinder that.
Expansion rate with existing customers and I know youre not going to give the exact but our net retention rates closer to essentially <unk> now than where.
Where we were kind of before entering this year or is it actually dipped a bit lower just given the macro economy.
Jim Let me Scott.
Some qualitative commentary you can give you some numbers there.
So first of all I think you've talked about and that when you look at our renewals by the way.
The newest Westwater solid okay, no no issues city from the macro piece now.
Now when you look at the.
The macro sense in terms of the impact it impact from both new logos that spend that expansion business with our existing customers.
The impact of similar to what we saw last quarter Vacates.
Longer in terms of deals.
<unk> more by some customers and what we've seen is therefore, the sales cycle has gotten modestly longer.
Now the other factor here, which is common during this kind of an environment is that customers. Some customers. It can tend to sweat their existing assets.
The environment, which of course has an impact in terms of foot UN expansion business for us they might continue to run as long as they can before they spend more money.
So if you look at that the impact is on our FY 'twenty, three new and expansion ACB.
Because of these dynamics and what I'd say overall quantitative color for that.
That new and expansion business for us is performing slightly below our expectations.
Entering the year.
And also are below what we believe has long term potential.
So liquidity one item.
Yes, Jim Thanks for the question on and not all are and as you know that we don't really disclose that on a quarterly basis, Jim but what I will say is that it sort of still in the range that I think we had talked about at our last investor day in that 21, 25%.
Range and so I'll leave it at that with regard to <unk> specifically.
Yes.
That's helpful.
I appreciate that and maybe Rajeev for you your favorite question.
Any impact yet from your vantage point with the ongoing acquisition of really your top competitor.
And outside of that direct competition I guess, what are you seeing from negative hyperscale or offerings in the traditional raise obviously you just alluded to so I'm sweating of assets just trying to understand the competitive landscape here.
You guys are still solid.
Solid growth.
Yes, I think.
First of all not a whole lot of fees compared to last quarter on that so clearly on the on the Broadcom piece in terms of the acquisition.
Suddenly seeing that higher level of engagement continue to do that with many customers around the world who are looking to look at their options manage potential risks associated with this acquisition.
I think talking about the sales cycle tends to be nine to 12 months and so we haven't quite seen you're factoring in meaningful benefit from this in FY2023.
Now on the other side of the equation from a competitive dynamic as cloud native or Hyperscale.
The piece of it what I would say is if anything I think.
Our customers have gotten much more careful about what to put in the public cloud versus simply going all to the public cloud. So we see much more focus in terms of what should I be running on Prem what should I be using in the public cloud how can they look at optimizing that and that's actually playing to our strengths and.
And suddenly helping us.
Our.
Our strategy around helping our customers operate in a hybrid multi cloud world and it's helping us.
Okay.
Thank you one moment please.
Our next question comes from the line of Mike Cecos.
Of Needham Your line is open.
Hey, guys. Thanks for getting me on here.
And I'll, let go similar comments to my tier here it's for us.
Congrats on getting the audit Committee investigation behind you in the <unk>.
Moving on to the next chapter.
I wanted to highlight the strength that you guys called out this quarter and then the uptick in guide could you help us think through.
How the quarter played out maybe more from a linearity perspective as each progressive months.
<unk> worked through the quarter.
Or is it building or was the outperformance snowballing over the course of the quarter or was it really more dedicated to a specific month within the quarter as far as how how trends played out and then my follow up I'll just ask it now but.
Good to see the slight uptick on gross margins as well is there anything you can do to help us wrap our heads around what's driving that.
That uptick in gross margins and how sustainable that is as we think about the Google.
Global in Jeopardy of the business. Thank you again.
Thank you Mike So first I'll take the question on linearity and then the other I would say it was largely as expected there wasn't any significant.
Unusual trends compared to typical Q3's, Mike So that's on the linearity.
And then on gross margin what I would say is we continue to be really focused on efficiency.
All of that so in terms of I think.
Sustainable. This is I think what was your question, we think that we will be in that.
Range, maybe move around a little bit one of the things. We are focused on is continuing to make sure that we are attaching professional services, where it makes sense, especially for some of the newer parts of our portfolio to make sure customers are adopting them.
Secondly, and we're helping them to sell so it might move around a little bit here and there, but you saw the guide for the full year as well, which factors in all of those moving pieces at this point.
It makes a lot of sense. Thank you very much.
Mike.
One moment please.
Our next question comes from the line of pendulum Barra of Jpmorgan. Your line is open.
Oh, Great Hey, guys, congrats on the quarter and great to hear the conclusion of the investigation.
Rajiv seems like a lot of innovation, that's coming out of.
New tactics in the dock next you talked about project Beacon, which seems like a Holy Grail I think Vmware has kind of traded as well talk to us about kind of where are the building blocks of the technology.
Around that about multi hybrid cloud paas platform and.
What where are we.
How long is it going to take for us to get them CEO product launch.
Yes. So if you look at that project peak and just a quick recap of that is it's a multi cloud platform as a service focused on data offerings.
Companies building apps once using the set of services and b to be able to run them any way completely portable on any underlying substrate, whether it would be a cloud native on any public cloud or whether it'd be on plan. So thats.
The quick recap of division.
If you look at.
This is clearly what we said that cognex is that is this is a multiyear journey for us and it happens in multiple steps. If you look at where we are we have a foundation for that today with our mechanics database service.
We today offer that on Prem on a mechanics underlying substrate.
Companies manage databases in a consistent way and variety of databases.
We are on a path to make that offering available on top of native public cloud substrates. So that'd be the first step in the roadmap.
And we will comment on that in terms of specific execution, when we get closer to releasing it.
And then beyond that will be other services.
For example, things like messaging streaming cashing et cetera that we.
Overtime.
Some of these could also be done in partnerships. So like I said, we started with new tanks database offering in over multiple years, we will get to that Tony.
And and I also expect that there will be a broader ecosystem of people like us who are.
Likeminded in terms of establishing this truly hybrid vision.
Building apps and being able to run them everyday.
Understood understood. Thank you for that and Rukmini.
Maybe my math is wrong here or maybe I'm getting the numbers wrong. It seems like there is a little bit of.
Cautious sentiment going forward.
When I look at the guidance I think youre raising the revenue guidance by $40 million and you beat by something like 13 or 14, if I, if I read that correctly.
Help me.
No.
What gives you confidence if the macro is actually getting a little bit worse.
Thank you Priscilla and for that question so.
A few pieces. So let me start with and I know your question was on revenue, but if I just start with ACD billings here for a second we didn't take that guide up as well right from 2015 to $99 25, and as you point out we took revenue up as well. So one is that we feel good given all the caveat right to the point about the modest elongation of it.
Cycle.
In some cases as Richard touched upon earlier I believe.
If it's a new logo, we see customers choosing to start to sweat their assets out a little longer. So some of those dynamics are playing out but I think a few things that.
We believe sort of bolsters that.
That overall guidance as our renewals business as we said from day one.
When we started the yard has continued to perform well right and with that mix growing overtime that.
That helps us form a pretty strong foundation.
For the guide overall and then the one other point I'll make is.
ACB billings is more of a transactional quarter over quarter number right. It's things that are built into the quarter, but revenue obviously flow them as a waterfall over time. So there's also the net revenue benefit we're seeing and we've talked about this each quarter. This year from recognizing more license revenue right from the future start date orders than we were.
Sorry.
As a boost upstream on the revenue side that his seat on the on the billing side. So those are some of the things that are that are.
Driving that guide pendulum.
Can I can have one follow up lastly did you bring your assumption on that start date.
So we haven't specifically divulge what those assumptions are offering to them, but I think it's fair to say that.
Overall, we have seen the supply chain dynamics normalize, but our some of our partners going in we had assumed that things would be better right towards the end to end of the yard.
But we hadn't assumed it will be completely normal alright, but at this point it does seem like those have largely normalized.
Got it thank you very much.
Thank you.
Thank you one moment please.
Our next question comes from the line of George Wang of Barclays. Your line is open.
Hey, guys congrats on the quarter and the successful completion of the investigation.
I have two questions first of all.
Any do you have any comments on the channel partners, especially on the service provider, especially against this.
Calm the backdrop and the Vmware.
Hopefully post merger.
You guys can gamble Lau from service providers any thoughts on that.
Absolutely George I'll tell you I mean, thats, a larger large untapped opportunity for us.
That's another market that historically, we have not spent a lot of time on and only recently have we really started engaging with our service provider partners. In fact, it's already bearing fruit for us.
Last quarter the quarter before some of the largest piece in the quarter came through the service provider channel. So we keep adding to our service provider partners.
We actually have high hopes in terms of that being in a strong channel for us going forward.
I would still say is that we are still in the first innings of a baseball game to put that analogy when it comes to our service provider and then billings up out of the market and to your point I think clearly there is a very large established service provider that channel.
With VM that today and beyond.
We only now building out and I think some of those channel partners that was quite a theyre going to be certainly more inclined to work with us more so going forward.
Great also rajeev quick follow ups.
In terms of the land expand are you seeing from an increasing attach to the wholesale is back.
And.
Especially given the kind of more mature and kind of business model and the kind of some of the additional use cases, maybe you can unpack that would come to quantify.
Okay.
Tache kind of growing over time for our platform, Yes, Theres no Doug I mean, I think if you recall, we came out with.
Simplified solutions oriented product portfolio.
A while ago and we are now seeing an increasing portion of our diesel coming through that new portfolio.
Now as part of that the very specific things that we've seen is mechanics cloud management.
Notably higher attachment mechanics code management as part of what we sell today.
I know it would be fair and organics cloud infrastructure, that's a very logical if that's a fluid management and we see that certainly happening.
In fact, and then I think on the other pieces I think mechanics.
<unk> service tends to be somewhat more of a specialized cell because it is targeting database admin and develop but versus the core infrastructure. So that's not as much of an attach although we are trying to attack that more with database workloads running on our platform.
Then.
You look at sort of if this is the last component of our portfolio that thirdly I think.
It is also seeing a good attacks. So so we are actually quite happy with how this.
<unk> portfolio is growing and being adopted in the market and we've got some other suddenly wanting to adopt more and more of the entire portfolio. So it's.
And people, who want to build a cloud like I said very common for them to consider.
The whole thing cold stack, which would be NCI and TM plus some in the U S.
Okay, great. Thanks, again, I will go back to the chip.
Thank you.
I'm on the plays.
Our next question comes from a lot of meta Marshall of Morgan Stanley . Your line is open.
Great I appreciate it congrats on the quarter guys.
Hum.
You guys have commented on hybrid cloud optimization product projects or data center modernization projects.
Clearly a theme across the multiple name.
For the past few quarters.
Where do you think customers are on that journey.
Great.
Date of what their data centers are looking like.
Sure.
Does that kind of involved you just spoke about.
Deeper adoption of the portfolio, but I guess I'm just wondering does that involve kind of a deeper conversation about what <unk> products can be used kind of upfront.
So maybe just kind of where are we and the great outcome, there and state on hybrid cloud and just does that involve kind of more services upfront from the channel.
Yes, I think Thats a very good question meta so in fact I'm just.
Continental's fit under the <unk>.
Yesterday with one of our large enterprise customers.
What I would say is I think.
Yes. They were five years ago, there were a set of customers who said we are going to go to the public cloud.
<unk> cloud first and now it's much more about our cloud operating model, which is.
They liked what the cloud offers in terms of agility self service.
Set of services.
And sometimes an opex model instead of a capex model in terms of consumption. They liked it but not necessarily a location right. So if you just go through everything in the public cloud they realize that cost optimization to this as a growing and important part of what they are.
Needless to date, so what we are seeing right now is much more discussions around this hybrid multi cloud.
People wanting to run workloads across both locations and for us.
One of the things that we are working hard to do is to actually build our vendors within our customer base about the fact that we do actually have offerings that are very relevant to them in terms of enabling them to operate across all of this because if you recall our own history as a company. We started at most people customers and offer to the HCI company.
Hyper converged infrastructure and we've been working hard to get.
Our narrative out in terms of what we can do for them today.
And let me talk about how we can actually help them operate across both these environment very well very efficiently.
I think the conversation becomes much more strategic with our customers and they start using more of our portfolio and certainly more of our services.
To implement some of the capabilities there so I would say again for us.
There's a lot of I think still.
Opportunity here is that this whole hybrid operation and mindset from a customer that is opening up.
Okay, great. Thanks.
And maybe just maybe.
Okay.
So in the back of the envelope, but it would seem as if opex come down quarter on quarter and the guide is that all just from one time impacts that you've kind of got in fiscal Q3 underlying.
Opex.
Actually relatively stable or is there anything that I'm just gonna handler.
No that's exactly right the underlying opex when you back out some of these onetime nonrecurring items that I talked about.
Relatively stable I mean, theres, some moving pieces, but really small so you are correct that the pre tax.
Close out Q3 should be relatively stable.
Okay perfect. Thanks.
Thank you.
Thank you Martin.
Please.
Our next question comes from the line of Jason Ader of William Blair. Your line is open.
Yes. Thank you wanted to just follow up on that last question.
After rajeev.
In terms of what you've seen over the last five years, let's say.
The kind of the case.
Of customers shifting workloads to the public cloud refactoring applications, a lot of initiatives around that over the last five years.
In this environment of cost optimization have you seen enterprises sort of take a step back and say you know what maybe we were moving a little bit too quickly.
And you'll.
Give things a little more evaluation in five when you talked about <unk>.
So maybe just kind of paint a picture for us in terms of this last.
I don't know 12 months versus what you've seen in the prior.
For four years.
Yes, Jason I would say that the dialogue has definitely changed over the last year on this topic.
I think they've got a set of customers who said we are going to re factor, let go more everything to the public cloud.
And I think they ran into two issues one was that it actually was pretty expensive for them to re factor in the first place.
And and then secondly, once they did we factor in ran everything into the public cloud and if they are starting to operate at scale. I mean, it's it's an easy on ramp right in the sense that upfront as many of you like the ease of use and so forth, but then as you start using a lot of the services. Then you start the bill going up and you soon realize that yes.
At a significant premium.
Compared to what you were doing before.
And so that consciousness is now very much cost optimization is very much a key part of many of our customers thinking.
And so now like I had mentioned to me just a question that is definitely.
It's not a close my eyes. So it means the fact everything more to the public cloud that's no longer the conversation.
All right I think it's much more about okay, I'm going to have a process for figuring out what I'm going to go footwear.
<unk>.
In fact, I heard one customer had mentioned.
The established a target state architecture approach for every app that they have in their portfolio and.
They're going to then decide what to do about that if you're going to be running in the data center.
It makes sense to re factor it.
Et cetera, So I think people are being much more careful about managing their application portfolio now than they were before.
Got you and then just a quick follow up on that.
As I think about things like EMC, II and Vmware on AWS.
The pushback that we always got on that as well.
That's great and it's an easy lift and shift but.
It's sort of a stop gap right ultimately you want to have the pre factored and I guess.
If a customer does go that route and.
UMC too.
What's the risk.
Your mindset.
The re factoring is just sort of inevitable step on that App and then potentially you lose the app.
Yes, I think first of all two points, yes customer can lift and shift and take it easily to the public cloud there is no doubt about it now.
They re factor and start creating a cloud native version of the App one of the things Thats a little less understood about <unk> is that even in that scenario, we can actually run that very efficiently and even for pure cloud native App you can take a cloud native app, that's been fully factored and run it on in situ unbanned metal fan AWS.
Azure and get significant advantages both in terms of potential cost savings, but also in terms of ease of management.
And the ability to have one team manage your on Prem in your cloud environments with a single set of foods.
Those are sustainable.
<unk> also seen examples of where we can deliver depending on the application itself might suggest substantial cost savings in terms of ongoing run time costs as well so that combination plus.
We look at our future when you look at things like project Beacon.
People can now build these cloud native apps using affordable set of data services.
They can decide whether they want to lend them. So for US we don't think of NTT <unk> as a temporary hey, migrate and then youre out of the picture, we actually think it migrated operate and if you also look at it from a cloud provider perspective.
If you are on AWS, and Amazon and Azure.
Do you really care about.
Customers consuming services it doesn't matter whether they are using mechanics are not as long as those ads are running in the hyperscale environment.
So theres not a so so this combination is what makes sense to quite sticky overtime.
Very helpful. Thanks.
Thank you one moment please.
Our next question comes from the line of.
Romsey Mahara of Bank of America. Your line is open.
Hi, yes. Thank you.
Was wondering if you could comment on demand maybe by vertical do you see anything different, particularly in financial services or government or healthcare.
This quarter and what trends are you seeing currently in those verticals.
One three so yes, both financial services and health care are important verticals for us.
I will say, we have not seen any significant changes I mean, I know people talk about what's been happening in the banking world.
But we have not seen.
Any significant changes in demand patterns, if anything from some of the larger banks, we are seeing more engagement with us than before.
And so so nothing significant for us to report in terms of changes.
Okay, Thanks, Rajiv and as a follow up.
Gross margins, obviously very strong, but the broader demand environment kind of week in and there are lots of pockets in the overall market that I've gotten more competitive in and frankly increased levels of discounting across many areas of the data center. So I was wondering if you saw any of those kind of trends and if you didn't partake.
It did it did you leave revenue on the table or billings on table.
And of course as you can imagine we look at that very closely and manage that and our asps have been quite steady part of the reason.
Most of our selling is that value.
Look we have a team of cloud economists, who actually build economic models for almost any other significant deals we have and talk about and showcase the tcl benefits customer guest by using our solution and thats, how we justify the pricing.
So yes of course, it's a competitive environment out there, but we haven't seen anything significant yet that's impacting our gross margins.
Okay. Thank you and if I could sneak one last one in.
Can you maybe just help us think through.
What was the impact backlog drawdown is having on fiscal 'twenty, three and sort of what kind of a headwind that might pose for fiscal 'twenty four.
I'll take that one thank you for the question.
As we said from the beginning of this fiscal year.
Both revenue growth and ACB billings have benefited from the strong backlog level with which we entered the yard.
<unk> revenue specifically has also benefited from this dynamic of recognition of deferred license revenue from the future start date orders as you've talked about in the past right. So the full year results. We expect will reflect a benefit from both of these.
One day, but just a software company, we don't typically kind of.
Specify or guide to backlog or anything like that but yes. Entering this year. We did have a record level of backlog, which is benefiting growth for this year on both revenue and billings.
Okay. Thank you very much.
Thank you. Thank you.
One moment please.
Our next question comes from Dan Bergstrom.
<unk> of RBC capital markets. Your line is open.
Hey, it's Dan Bergstrom for Matt Hedberg, Thanks for squeezing us in here maybe to build on a previous question and the positive outlook. Despite some <unk>.
Macro is with guidance for the fourth quarter did anything change around the level of conservatism in that outlook or are you using.
Consistent approach versus the third quarter.
Hi, Dan I'll take that question, we have been pretty consistent in our approach, though we haven't necessarily.
Become more or less conservative for Q4 as it related to Q3, which I believe was your question did I get the question correctly.
Yeah, perfect. Thanks, and then maybe to verify on free cash flow for the fourth quarter from the prepared remarks, it sounds like Theres, a $31 million in 'twenty.
Dollar outflow.
That may have been expected in the third quarter, but will be in the fourth quarter is that correct.
That is correct.
And if I can just take a minute to maybe talk a little bit of a Q4 free cash flow for the full yard we provided the guide of 125 to 135.
And we also said that there is about $65 million, a onetime outflow, but it's safe to add that you are now at a $190 million to $200 million free cash flow for the year and that less the one.
150, or so million that we've already done that today it would be a reasonable way to think about a normalized Q4 free cash flow with some <unk>.
Normal quarter to quarter adjustments.
Perfect. Thank you.
Thank you one moment please.
Our next question comes from the line of Eric <unk>.
Of JMP Securities. Your line is open.
Yes, thanks for taking the question.
And congrats on the quarter and the audit.
And with regards to the <unk>.
Software compliance issue can you tell us how you learned about that and our.
Are you continuing to use the software from from the two vendors that that you do to work with on this.
Yes.
I can take that Eric.
So yes, we discovered in Madison discovered it.
And then ZIP code as part of a softer exports.
And yes, we are.
Continuing to use the software, but again for the non production use cases that.
We charter market.
And the only thing I would add is we are in contact with both of those vendors at this time and are working towards a commercial resolution.
Alright, very good thank you.
Thank you one moment please.
Okay.
Showing no further question at this time, ladies and gentlemen. This does conclude today's conference. Thank you all for participating you may now disconnect have a great day.
Okay.
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Okay.
Okay.
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