Nutanix, Inc. 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition, results of operations and cash flows should be read in conjunction with the consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. The last day of our fiscal year is July 31. Our fiscal quarters end on October 31, January 31, April 30 and July 31. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" or in other parts of this Annual Report on Form 10-K. See also "Special Note Regarding Forward-Looking Statements" above. Overview Nutanix, Inc. ("we," "us," "our" or "Nutanix") provides a leading enterprise cloud platform, which we call the Nutanix Cloud Platform, that consists of software solutions and cloud services that power our customers’ hybrid cloud and multicloud strategies. We seek to provide an enterprise cloud platform that empowers our customers to unify various clouds - private, public, distributed - into one seamless cloud, allowing enterprises to choose the right cloud for each application. Our enterprise cloud platform allows enterprises to simplify the complexities of a multicloud environment with automation, cost governance and compliance. Our enterprise cloud platform can be deployed on a variety of qualified hardware platforms or, in the case of our cloud-based software and software as a service ("SaaS") offerings, via hosted service or delivered pre-installed on an appliance that is configured to order. Non-portable software is delivered or sold alongside configured-to-order appliances with a license term equal to the life of the associated appliance. Our subscription term-based licenses are sold separately, or can be sold alongside configured-to-order appliances. Configured-to-order appliances, including our Nutanix-branded NX hardware line, can be purchased from one of our channel partners, original equipment manufacturers ("OEMs") or directly from Nutanix. Our enterprise cloud platform is typically purchased with one or more years of support and entitlements, which includes the right to software upgrades and enhancements as well as technical support. Product revenue is generated primarily from the licensing of our solutions. Support, entitlements and other services revenue is primarily derived from the related support and maintenance contracts. Prior to fiscal 2019, we delivered most of our solutions on an appliance, thus our revenue included the revenue associated with the appliance and the included non-portable software, which lasts for the life of the associated appliance. However, starting in fiscal 2018, as a result of our business model transition toward software-only sales, more of our customers began buying appliances directly from our OEMs while separately buying licenses for our software solutions from us or one of our channel partners. In addition, starting in fiscal 2019, as a result of our transition towards a subscription-based business model, more of our customers began purchasing separately sold subscription term-based licenses that could be deployed on a variety of hardware platforms. As we continue our transition to a subscription-based business model, we expect a greater portion of our products to be delivered through subscription term-based licenses or cloud-based SaaS subscriptions. We had a broad and diverse base of approximately 17,360 end customers as of July 31, 2020, including approximately 915 Global 2000 enterprises. We define the number of end customers as the number of end customers for which we have received an order by the last day of the period, excluding partners to which we have sold products for their own demonstration purposes. A single organization or customer may represent multiple end customers for separate divisions, segments or subsidiaries. Since shipping our first product in fiscal 2012, our end customer base has grown rapidly. The number of end customers grew from approximately 14,180 as of July 31, 2019 to approximately 17,360 as of July 31, 2020. Our solutions are primarily sold through channel partners, including distributors, resellers and OEMs, and delivered directly to our end customers. Our solutions serve a broad range of workloads, including enterprise applications, databases, virtual desktop infrastructure, unified communications and big data analytics, and we support both virtualized and container-based applications. We have end customers across a broad range of industries, such as automotive, consumer goods, education, energy, financial services, healthcare, manufacturing, media, public sector, retail, technology and telecommunications. We also sell to service providers, who utilize our enterprise cloud platform to provide a variety of cloud-based services to their customers. 54 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) We continue to invest in the growth of our business, including the development of our solutions, hiring for critical roles in our global teams, projects to increase the demand for our solutions and other sales and marketing initiatives. The number of our full-time employees increased from approximately 5,340 as of July 31, 2019 to approximately 6,170 as of July 31, 2020. We have an engineering team focused on distributed systems and IT infrastructure technologies at our San Jose, California headquarters and at our research and development centers in India, North Carolina, Washington, Serbia and Germany. We have in the past also expanded our international sales and marketing presence by continuing to build out our global teams and continuing to invest in sales and marketing initiatives, such as additional demand generation spending to increase pipeline growth. We plan to, in the long term, invest in our global engineering team to enhance the functionality of our enterprise cloud platform, including our newer subscription-based products, introduce new products and features to build upon our technology leadership, as well as expand our global sales and marketing teams in the long term. However, as discussed further in the "Impact of the COVID-19 Pandemic" and "Factors Affecting Our Performance" sections below, in response to the ongoing and rapidly evolving COVID-19 pandemic, we have proactively taken steps to manage our expenses. As a result, our overall spending on such efforts will fluctuate, and may decline, from quarter to quarter in the near-term. Impact of the COVID-19 Pandemic The ongoing and rapidly evolving COVID-19 pandemic has significantly curtailed the movement of people, goods and services worldwide, imposed unprecedented strains on governments, health care systems, educational institutions, businesses and individuals around the world, including in nearly all of the regions in which we operate, and has resulted in significant volatility and uncertainty in the global economy. In response to the pandemic, authorities, businesses, and individuals have implemented numerous unprecedented measures, including travel bans and restrictions, quarantines, shelter-in-place, stay-at-home, remote work and social distancing orders, and shutdowns, which have impacted and will continue to impact our workforce and operations, as well as those of our customers, vendors, suppliers, and partners. In response to the COVID-19 pandemic, we have also been required – or have deemed it necessary – to take a number of actions to protect and assist our employees, customers, and partners, including: temporarily closing all of our offices (including our California headquarters) around the world; requiring our employees to work remotely; implementing travel restrictions that allow only the most essential business travel; and postponing, cancelling, withdrawing from, or converting to virtual-only experiences (where possible and appropriate) our in-person customer, industry, analyst, investor, and employee events, including our 2020 .NEXT customer and partner events, our 2020 Investor Day, and our fiscal 2021 sales kick off; and offering extended payment terms of up to 60 days to certain partners through July 2020. As a result of such actions, as well as the general effects of the COVID-19 pandemic, our business and operations have experienced and may continue to experience numerous negative impacts, including: curtailed demand for certain of our solutions; reduced IT spending; delays in or abandonment of planned or future purchases; lengthened payment terms; lengthened sales cycles, particularly with new customers and partners who do not have prior experience with our solutions; supply chain disruptions; and voluntary and involuntary delays in the ability to ship, and the ability of our end customers to accept delivery of, the hardware platforms on which our software solutions run. We also expect the reduced manufacturing capacity caused by the pandemic to result in increases in the prices of certain components used to manufacture such hardware platforms, which may increase the price of those hardware platforms for our end customers. The travel bans, shutdowns, social distancing restrictions and remote work policies have also made it difficult or impossible to deliver on-site services to our partners and end customers, and to meet with our current and potential end customers in person. We have also seen positive impacts, including increased demand for our virtual desktop, desktop-as-a-service, and end-user computing solutions as a result of our end customers enabling their employees to work remotely. 55 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) We have also quickly adapted to the new work environment, leveraging digital, video, and other collaborative tools to enable our teams to stay connected with each other, and our sales, marketing and support teams to continue to engage with and remain responsive to our partners and end customers. Furthermore, we have taken, and expect to continue to take, a number of proactive actions to manage our operating expenses in light of the uncertainty caused by the COVID-19 pandemic, including: effecting a global hiring pause outside of a small number of critical roles; implementing a 10% reduction in executive salaries, effective April 2020; pausing all merit salary increases and bonus payments; and implementing two, non-consecutive, mandatory one-week furloughs for our employees in the U.S., along with two, non-consecutive, voluntary one-week unpaid leave periods for our employees outside the U.S. Although the full impact of these actions is uncertain, they have resulted in a reduction in our operating expenses, including sales and marketing expenses. See the section titled "Risk Factors" in Part II, Item 1A of this Form 10-Q for further discussion of the possible impact of these actions on our business and financial performance. The duration, scope and ultimate impact of the COVID-19 pandemic on the global economy and our business remain highly fluid and cannot be predicted with certainty, and the full effect of the pandemic and the actions we have taken in response may not be fully reflected in our results of operations and financial performance until future periods. Our management team is focused on guiding our company through the emerging challenges presented by COVID-19 and remains committed to driving positive business outcomes. Although we do not currently expect the pandemic to affect our financial reporting systems, internal control over financial reporting or disclosure controls and procedures, the continued impact of the pandemic on our business and financial performance will be highly dependent upon numerous factors, many of which are beyond our control. See the section titled "Risk Factors" in Part II, Item 1A of this Form 10-Q for further discussion of the possible impact of the COVID-19 pandemic, as well as the actions we have taken in response, on our business and financial performance. Key Financial and Performance Metrics We monitor the following key financial and performance metrics: As of and for the Fiscal Year Ended July 31, 2018 2019 2020 (in thousands, except percentages) Total revenue $ 1,155,457 $ 1,236,143 $ 1,307,682 Year-over-year percentage increase 36.6 % 7.0 % 5.8 % Subscription revenue $ 330,645 $ 648,415 $ 1,030,180 Software and support revenue (TCV revenue) $ 898,143 $ 1,130,822 $ 1,284,227 Total billings $ 1,417,484 $ 1,514,660 $ 1,580,092 Subscription billings $ 581,923 $ 916,000 $ 1,276,413 Software and support billings (TCV billings) $ 1,160,170 $ 1,409,339 $ 1,556,637 ACV billings $ 328,811 $ 428,564 $ 505,179 Run-rate ACV $ 650,166 $ 944,444 $ 1,219,965 Gross profit $ 769,427 $ 932,015 $ 1,020,993 Adjusted gross profit $ 786,593 $ 965,287 $ 1,063,655 Gross margin 66.6 % 75.4 % 78.1 % Adjusted gross margin 68.1 % 78.1 % 81.3 % Total deferred revenue $ 631,207 $ 910,044 $ 1,183,441 Net cash provided by (used in) operating activities $ 92,540 $ 42,168 $ (159,885) Free cash flow $ 30,168 $ (76,284) $ (249,373) Non-GAAP operating expenses $ 883,244 $ 1,239,567 $ 1,518,697 Total end customers 10,610 14,180 17,360 56 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Disaggregation of Revenue and Billings The following table depicts the disaggregation of revenue and billings by type, consistent with how we evaluate our financial performance: Fiscal Year Ended July 31, 2018 2019 2020 (in thousands) Disaggregation of revenue: Subscription revenue $ 330,645 $ 648,415 $ 1,030,180 Non-portable software revenue 543,952 449,131 208,158 Hardware revenue 257,314 105,321 23,455 Professional services revenue 23,546 33,276 45,889 Total revenue $ 1,155,457 $ 1,236,143 $ 1,307,682 Disaggregation of billings: Subscription billings $ 581,923 $ 916,000 $ 1,276,413 Non-portable software billings 543,952 449,131 208,158 Hardware billings 257,314 105,321 23,455 Professional services billings 34,295 44,208 72,066 Total billings $ 1,417,484 $ 1,514,660 $ 1,580,092 Subscription revenue — Subscription revenue includes any performance obligation which has a defined term and is generated from the sales of software entitlement and support subscriptions, subscription software licenses and cloud-based software as a service ("SaaS") offerings. • Ratable — We recognize revenue from software entitlement and support subscriptions and SaaS offerings ratably over the contractual service period, the substantial majority of which relate to software entitlement and support subscriptions. These offerings represented approximately $243.9 million, $376.4 million and $508.8 million of our subscription revenue for fiscal 2018, 2019 and 2020, respectively. • Upfront — Revenue from our subscription software licenses is generally recognized upfront upon transfer of control to the customer, which happens when we make the software available to the customer. These subscription software licenses represented approximately $86.7 million, $272.0 million and $521.3 million of our subscription revenue for fiscal 2018, 2019 and 2020, respectively. Non-portable software revenue — Non-portable software revenue includes sales of our enterprise cloud platform when delivered on a configured-to-order appliance by us or one of our OEM partners. The software licenses associated with these sales are typically non-portable and have a term equal to the life of the appliance on which the software is delivered. Revenue from our non-portable software products is generally recognized upon transfer of control to the customer. Hardware revenue — In transactions where we deliver the hardware appliance, we consider ourselves to be the principal in the transaction and we record revenue and costs of goods sold on a gross basis. We consider the amount allocated to hardware revenue to be equivalent to the cost of the hardware procured. Hardware revenue is generally recognized upon transfer of control to the customer. Professional services revenue — We also sell professional services with our products. We recognize revenue related to professional services as they are performed. 57 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Non-GAAP Financial Measures and Key Performance Measures We regularly monitor total billings, subscription billings, professional services billings, software and support billings (TCV billings), ACV billings, run-rate ACV, adjusted gross profit, adjusted gross margin, free cash flow and non-GAAP operating expenses, which are non-GAAP financial measures and key performance measures, to help us evaluate our growth and operational efficiencies, measure our performance, identify trends in our sales activity and establish our budgets. We evaluate these measures because they: • are used by management and the Board of Directors to understand and evaluate our performance and trends, as well as to provide a useful measure for period-to-period comparisons of our core business; • are widely used as a measure of financial performance to understand and evaluate companies in our industry; and • are used by management to prepare and approve our annual budget and to develop short-term and long-term operational and compensation plans, as well as to assess our actual performance against our goals. Total billings is a performance measure which we believe provides useful information to investors, as it represents the dollar value under binding purchase orders received and billed during a given period. Subscription billings and professional services billings are performance measures that we believe provide useful information to our management and investors as they allow us to better track the growth of the subscription-based portion of our business, which is a critical part of our business plan. TCV billings is a performance measure that we believe provides useful information to our management and investors as it allows us to better track the true growth of our software business by excluding the amounts attributable to the pass-through hardware sales that we use to deliver our solutions. ACV billings and run-rate ACV are performance measures that we believe provide useful information to our management and investors, in particular as we progress further on our subscription-based business model transition, as they allow us to better track the top-line growth of our business during our transition to a subscription-based business model because they take into account variability in term lengths. Free cash flow is a performance measure that we believe provides useful information to management and investors about the amount of cash used in or generated by the business after necessary capital expenditures. Adjusted gross profit, adjusted gross margin and non-GAAP operating expenses are performance measures which we believe provide useful information to investors, as they provide meaningful supplemental information regarding our performance and liquidity by excluding certain expenses and expenditures, such as stock-based compensation expense, that may not be indicative of our ongoing core business operating results. We use these non-GAAP financial and key performance measures for financial and operational decision-making and as a means to evaluate period-to-period comparisons. Total billings, subscription billings, professional services billings, software and support billings (TCV billings), ACV billings, run-rate ACV, adjusted gross profit, adjusted gross margin, free cash flow and non-GAAP operating expenses have limitations as analytical tools and they should not be considered in isolation or as substitutes for analysis of our results as reported under generally accepted accounting principles in the United States. Total billings, subscription billings, professional services billings, software and support billings (TCV billings), adjusted gross profit, adjusted gross margin, free cash flow and non-GAAP operating expenses are not substitutes for total revenue, subscription revenue, professional services revenue, software and support revenue (TCV revenue), gross profit, gross margin, cash provided by (used in) operating activities, or GAAP operating expenses, respectively. There is no GAAP measure that is comparable to either ACV billings or run-rate ACV, so we have not reconciled either ACV billings or run-rate ACV numbers included in this Annual Report on Form 10-K to any GAAP measure. In addition, other companies, including companies in our industry, may calculate non-GAAP financial measures and key performance measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures and key performance measures as tools for comparison. We urge you to review the reconciliation of our non-GAAP financial measures and key performance measures to the most directly comparable GAAP financial measures included below and not to rely on any single financial measure to evaluate our business. We calculate our non-GAAP financial and key performance measures as follows: Total billings — We calculate total billings by adding the change in deferred revenue, net of acquisitions, between the start and end of the period to total revenue recognized in the same period. 58 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Subscription billings — We calculate subscription billings by adding the change in subscription deferred revenue, net of acquisitions, between the start and end of the period to subscription revenue recognized in the same period. Professional services billings — We calculate professional services billings by adding the change in professional services deferred revenue, net of acquisitions, between the start and end of the period to professional services revenue recognized in the same period. Software and support billings (TCV billings) — We calculate software and support billings, also referred to as TCV billings, by adding the change in software and support deferred revenue (TCV deferred revenue), net of acquisitions, between the start and end of the period to software and support revenue (TCV revenue), recognized in the same period. Software and support revenue and billings (TCV revenue and billings) include software and support, entitlements and other services revenue and billings. ACV billings — We calculate ACV billings as the sum of the ACV for all contracts billed during the period. ACV is defined as the total annualized value of a contract, excluding amounts related to professional services and hardware. We calculate the total annualized value for a contract by dividing the total value of the contract by the number of years in the term of the contract, using, where applicable, an assumed term of five years for contracts that do not have a specified term. As there is no GAAP measure that is comparable to ACV billings, we have not reconciled ACV billings numbers to any GAAP measure. Run-rate ACV — We calculate run-rate ACV as the sum of ACV for all contracts that are in effect as of the end of the period. For the purposes of this calculation, we assume that the contract term begins on the date a contract is booked, irrespective of the periods in which we would recognize revenue for such contract. As there is no GAAP measure that is comparable to run-rate ACV, we have not reconciled run-rate ACV numbers to any GAAP measure. Adjusted gross profit and adjusted gross margin — We calculate adjusted gross margin as adjusted gross profit divided by total revenue. We define adjusted gross profit as gross profit adjusted to exclude stock-based compensation expense, the amortization of acquired intangible assets and costs associated with other non-recurring transactions. Our presentation of adjusted gross profit should not be construed as implying that our future results will not be affected by any recurring expenses or any unusual or non-recurring items that we exclude from our calculation of this non-GAAP financial measure. Free cash flow — We calculate free cash flow as net cash provided by (used in) operating activities less purchases of property and equipment, which measures our ability to generate cash from our business operations after our capital expenditures. Non-GAAP operating expenses — We define non-GAAP operating expenses as total operating expenses adjusted to exclude stock-based compensation expense, costs associated with business combinations, such as amortization of acquired intangible assets, revaluation of contingent consideration and other acquisition-related costs and costs associated with other non-recurring transactions. Our presentation of non-GAAP operating expenses should not be construed as implying that our future results will not be affected by any recurring expenses or any unusual or non-recurring items that we exclude from our calculation of this non-GAAP financial measure. 59 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) The following table presents a reconciliation of total billings, adjusted gross profit, adjusted gross margin, free cash flow and non-GAAP operating expenses to the most directly comparable GAAP financial measures, for each of the periods indicated: Fiscal Year Ended July 31, 2018 2019 2020 (in thousands, except percentages) Total revenue $ 1,155,457 $ 1,236,143 $ 1,307,682 Change in deferred revenue, net of acquisitions 262,027 278,517 272,410 Total billings (non-GAAP) $ 1,417,484 $ 1,514,660 $ 1,580,092 Gross profit $ 769,427 $ 932,015 $ 1,020,993 Stock-based compensation 11,525 18,861 27,348 Amortization of intangible assets 5,641 14,248 14,777 Impairment of lease-related assets — — 537 Other — 163 — Adjusted gross profit (non-GAAP) $ 786,593 $ 965,287 $ 1,063,655 Gross margin 66.6 % 75.4 % 78.1 % Stock-based compensation 1.0 % 1.5 % 2.1 % Amortization of intangible assets 0.5 % 1.2 % 1.1 % Adjusted gross margin (non-GAAP) 68.1 % 78.1 % 81.3 % Operating expenses $ 1,049,835 $ 1,530,056 $ 1,849,914 Stock-based compensation (166,343) (287,868) (324,650) Change in fair value of contingent consideration 2,423 832 — Amortization of intangible assets (914) (2,528) (2,603) Acquisition-related costs (1,757) (721) — Impairment of lease-related assets — — (2,465) Other — (204) (1,499) Operating expenses (non-GAAP) $ 883,244 $ 1,239,567 $ 1,518,697 Net cash provided by (used in) operating activities $ 92,540 $ 42,168 $ (159,885) Purchases of property and equipment (62,372) (118,452) (89,488) Free cash flow (non-GAAP) $ 30,168 $ (76,284) $ (249,373) 60 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) The following table presents a reconciliation of subscription billings, professional services billings and software and support billings (TCV billings) to the most directly comparable GAAP financial measures, for each of the periods indicated: Fiscal Year Ended July 31, 2018 2019 2020 (in thousands) Subscription revenue $ 330,645 $ 648,415 $ 1,030,180 Change in subscription deferred revenue, net of acquisitions 251,278 267,585 246,233 Subscription billings $ 581,923 $ 916,000 $ 1,276,413 Professional services revenue $ 23,546 $ 33,276 $ 45,889 Change in professional services deferred revenue 10,749 10,932 26,177 Professional services billings $ 34,295 $ 44,208 $ 72,066 Software revenue $ 630,675 $ 727,098 $ 742,367 Hardware revenue 257,314 105,321 23,455 Product revenue 887,989 832,419 765,822 Support, entitlements and other services revenue 267,468 403,724 541,860 Total revenue $ 1,155,457 $ 1,236,143 $ 1,307,682 Software and support revenue (TCV revenue) (1) $ 898,143 $ 1,130,822 $ 1,284,227 Change in software and support deferred revenue (TCV deferred revenue), net of acquisitions 262,027 278,517 272,410 Software and support billings (TCV billings) (1) $ 1,160,170 $ 1,409,339 $ 1,556,637 (1) Software and support revenue and billings (TCV revenue and billings) include software and support, entitlements and other services revenue and billings. Factors Affecting Our Performance We believe that our future success will depend on many factors, including those described below. While these areas present significant opportunity, they also present risks that we must manage to achieve successful results. See the section titled "Risk Factors" for details. If we are unable to address these challenges, our business and operating results could be materially and adversely affected. 61 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Investment in Growth We plan to, in the long term, invest in sales and marketing so that we can capitalize on our market opportunity, including growing our sales and marketing teams, continuing our focus on opportunities with major accounts and large deals, which we define as transactions over $500,000, expanding our focus on opportunities in commercial accounts, as well as other sales and marketing initiatives, such as demand generation spending to increase our pipeline growth. Historically, we have significantly increased our sales and marketing personnel, which grew by approximately 17% from July 31, 2019 to July 31, 2020. However, as discussed above in the section titled "Impact of the COVID-19 Pandemic," in response to the COVID-19 pandemic we have proactively taken steps to reduce our expenses and, as a result, our overall investments in growth and the size of our sales and marketing teams will fluctuate, and may decline, in the near term. We estimate, based on past experience, that our average sales team members typically become fully ramped up around the start of their fourth quarter of employment with us, and as our newer employees ramp up, we expect their increased productivity to contribute to our revenue growth. As of July 31, 2020, we considered approximately 69% of our global sales team members to be fully ramped, while the remaining approximately 31% of our global sales team members are in the process of ramping up. As we continue to focus some of our newer and existing sales team members on major accounts and large deals, and as we continue our transition toward a subscription-based business model, it may take longer, potentially significantly, for these sales team members to become fully productive, and there may also be an impact to the overall productivity of our sales team. Furthermore, the effects of the COVID-19 pandemic and the measures we have implemented in response, including postponing, cancelling or making virtual-only certain in-person corporate events at which our sales team members have historically received in-person sales enablement and related trainings, may further increase, potentially significantly, the time it takes for our sales team members to become fully productive. We are focused on actively managing these realignments and potential effects. We also intend, in the long term, to grow our global research and development and engineering teams to enhance our solutions, including our newer subscription-based products, improve integration with new and existing ecosystem partners and broaden the range of technologies and features available through our platform. However, as discussed above in the section titled "Impact of the COVID-19 Pandemic," in response to the COVID-19 pandemic we have effected a global hiring pause outside of a small number of critical roles and, as a result, the overall growth in our global research and development and engineering teams will fluctuate, and may decline, from quarter to quarter in the near-term. We believe that these investments will contribute to our long-term growth, although they may adversely affect our profitability in the near term. 62 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Transition to Subscription Starting in fiscal 2019, as a result of our transition towards a subscription-based business model, more of our customers began purchasing separately sold subscription term-based licenses that could be deployed on a variety of hardware platforms. As we continue our transition to a subscription-based business model, we expect a greater portion of our products to be delivered through subscription term-based licenses or cloud-based SaaS subscriptions. Shifts in the mix of whether our solutions are sold on a subscription basis have and could continue to result in fluctuations in our billings and revenue. Subscription sales consist of subscription term-based licenses and offerings with ongoing performance obligations, including software entitlement and support subscriptions and cloud-based SaaS offerings. Since revenue is recognized as performance obligations are delivered, sales with ongoing performance obligations may reflect lower revenue in a given period. In addition, other factors relating to our shift to selling more subscription term-based licenses may impact our billings, revenue and cash flow. For example, our term-based licenses generally have an average term of less than four years and thus result in lower billings and revenue in a given period when compared to our historical life of device license sales, which have a duration equal to the life of the associated appliance, which we estimate to be approximately five years. In addition, starting in fiscal 2021, we are beginning to compensate our sales force based on ACV instead of total contract value, and while we expect that the shift to an ACV-based sales compensation plan will incentivize sales representatives to maximize ACV and minimize discounts, it could also further compress the average term of our subscription term-based licenses. Furthermore, our customers may, including in response to the uncertainty caused by the COVID-19 pandemic, decide to purchase our software solutions on shorter subscription terms than they have historically, and/or request to only pay for the initial year of a multi-year subscription term upfront, which could negatively impact our billings, revenue and cash flow in a given period when compared to historical life-of-device or multiple-year term-based license sales. Revenue for our solutions, whether or not sold as a subscription term-based license, is generally recognized upon transfer of control to the customer. For additional information on revenue recognition, see Note 3 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K and "Critical Accounting Estimates" later in this "Management’s Discussion and Analysis of Financial Condition and Results of Operations" section. Market Adoption of Our Products The public cloud and, more recently, hybrid cloud paradigms, have changed IT buyer expectations about the simplicity, agility, scalability, portability and pay-as-you-grow economics of IT resources, which represent a major architectural shift and business model evolution. A key focus of our sales and marketing efforts is creating market awareness about the benefits of our enterprise cloud platform. This includes our newer products outside of our core hyperconverged infrastructure ("HCI") offering, both as compared to traditional datacenter architectures as well as the public cloud, particularly as we continue to pursue large enterprises and mission critical workloads and transition toward a subscription-based business model. The broad nature of the technology shift that our enterprise cloud platform represents, the relationships our end customers have with existing IT vendors, and our transition toward a subscription-based business model sometimes lead to unpredictable sales cycles. We hope to compress and stabilize these sales cycles as market adoption increases, as we gain leverage with our channel partners, as we continue to educate the market about our subscription-based business model, and as our sales and marketing efforts evolve. Our business and operating results will be significantly affected by the degree to and speed with which organizations adopt our enterprise cloud platform. Leveraging Channel Partners and OEMs We plan to continue to strengthen and expand our network of channel partners and OEMs to increase sales to both new and existing end customers. We believe that increasing channel leverage, particularly as we expand our focus on opportunities in commercial accounts, by investing in sales enablement and co-marketing with our partners and OEMs in the long term will extend and improve our engagement with a broad set of end customers. Our business and results of operations will be significantly affected by our success in leveraging and expanding our network of channel partners and OEMs. 63 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Customer Retention and Expansion Our end customers typically deploy our technology for a specific workload initially. After a new end customer's initial order, which includes the product and associated software entitlement and support subscription and services, we focus on expanding our footprint by serving more workloads. We also generate recurring revenue from our software entitlement and support subscription renewals, and given our transition to a subscription-focused business model, software and support renewals will have an increasing significance for our future revenue streams as existing subscriptions come up for renewal. We view continued purchases and upgrades as critical drivers of our success, as the sales cycles are typically shorter as compared to new end customer deployments, and selling efforts are typically less. As of July 31, 2020, approximately 67% of our end customers who have been with us for 18 months or longer have made a repeat purchase, which is defined as any purchase activity, including renewals of term-based licenses or software entitlement and support subscription renewals, after the initial purchase. Additionally, end customers who have been with us for 18 months or longer have total lifetime orders, including the initial order, in an amount that is more than 4.2x greater, or 4.6x greater excluding the value of hardware purchases, on average, than their initial order. This number increases to approximately 12.4x, or 13.9x excluding hardware, on average, for Global 2000 end customers who have been with us for 18 months or longer as of July 31, 2020. These multiples exclude the effect of one end customer who had a very large and irregular purchase pattern that we believe is not representative of the purchase patterns of all of our other end customers. Our business and operating results will depend on our ability to retain and sell additional products to our existing and future base of end customers. Our ability to obtain new and retain existing customers will in turn depend in part on a number of factors. These factors include our ability to effectively maintain existing and future customer relationships, continue to innovate by adding new functionality and improving usability of our solutions in a manner that addresses our end customers’ needs and requirements, and optimally price our solutions in light of marketplace conditions, competition, our costs and customer demand. Furthermore, our ongoing transition to a subscription-based business model may cause concerns among our customer base, including concerns regarding changes to pricing over time, and may also result in confusion among new and existing end customers, for example, regarding our pricing models. Such concerns and/or confusion can slow adoption and renewal rates among our current and future customer base. Therefore, as we continue our transition, we may need to enhance our efforts to educate our end customers and as a result incur higher sales and marketing costs. Components of Our Results of Operations Revenue We generate revenue primarily from the sale of our enterprise cloud platform, which can be deployed on a variety of qualified hardware platforms or, in the case of our cloud-based SaaS offerings, via hosted service or delivered pre-installed on an appliance that is configured to order. Non-portable software is delivered or sold alongside configured-to-order appliances with a license term equal to the life of the associated appliance. Our subscription term-based licenses are sold separately, or can be sold alongside configured-to-order appliances. Our subscription term-based licenses typically have a term of one to five years. Our cloud-based SaaS subscriptions have terms extending up to five years. Configured-to-order appliances, including our Nutanix-branded NX hardware line, can be purchased from one of our channel partners, OEMs or directly from Nutanix. Our enterprise cloud platform is typically purchased with one or more years of support and entitlements, which includes the right to software upgrades and enhancements as well as technical support. Our platform is primarily sold through channel partners, including distributors, resellers and OEMs. 64 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Product revenue — Product revenue consists of software and hardware revenue. A majority of our product revenue is generated from the sale of our enterprise cloud operating system. We also sell renewals of previously purchased software licenses and SaaS offerings. Revenue from our software products is generally recognized upon transfer of control to the customer, which is typically upon shipment for sales including a hardware appliance, upon making the software available to the customer when not sold with an appliance or as services are performed with SaaS offerings. In transactions where we deliver the hardware appliance, we consider ourselves to be the principal in the transaction and we record revenue and costs of goods sold on a gross basis. We consider the amount allocated to hardware revenue to be equivalent to the cost of the hardware procured. Hardware revenue is generally recognized upon transfer of control to the customer. Support, entitlements and other services revenue — We generate our support, entitlements and other services revenue primarily from software entitlement and support subscriptions, which include the right to software upgrades and enhancements as well as technical support. The majority of our product sales are sold in conjunction with software entitlement and support subscriptions, with terms ranging from one to five years. Occasionally, we also sell professional services with our products. We recognize revenue from software entitlement and support contracts ratably over the contractual service period. The service period typically commences upon transfer of control of the corresponding products to the customer. We recognize revenue related to professional services as they are performed. Cost of Revenue Cost of product revenue — Cost of product revenue consists of costs paid to third-party OEM partners, hardware costs, personnel costs associated with our operations function, consisting of salaries, benefits, bonuses and stock-based compensation, cloud-based costs associated with our SaaS offerings, and allocated costs, consisting of certain facilities, depreciation and amortization, recruiting and information technology costs allocated based on headcount. Cost of support, entitlements and other services revenue — Cost of support, entitlements and other services revenue includes personnel and operating costs associated with our global customer support organization, as well as allocated costs. We expect our cost of support, entitlements and other services revenue to increase in absolute dollars as our support, entitlements and other services revenue increases. Operating Expenses Our operating expenses consist of sales and marketing, research and development and general and administrative expenses. The largest component of our operating expenses is personnel costs. Personnel costs consist of wages, benefits, bonuses and, with respect to sales and marketing expenses, sales commissions. Sales and marketing — Sales and marketing expense consists primarily of personnel costs. Sales and marketing expense also includes sales commissions, costs for promotional activities and other marketing costs, travel costs and costs associated with demonstration units, including depreciation and allocated costs. Commissions are deferred and recognized as we recognize the associated revenue. We expect sales and marketing expense to continue, in the long term, to increase in absolute dollars as part of our long-term plans to increase the size of our global sales and marketing organizations. However, as discussed above in the section titled "Impact of the COVID-19 Pandemic," in response to the COVID-19 pandemic we have proactively taken steps to reduce our expenses, including (i) effecting a global hiring pause outside of a small number of critical roles; (ii) implementing travel restrictions prohibiting all non-essential business travel; and (iii) postponing, cancelling, withdrawing from, or converting to virtual-only experiences (where possible and appropriate) our in-person sales and marketing events, including our 2020 .NEXT customer and partner events and our fiscal 2021 sales kick off. As a result, our sales and marketing expense will fluctuate, and may decline, in the near-term. Additionally, as we continue our transition to a subscription-based business model, we anticipate needing to adjust the compensation structure of our sales force, which may lead to fluctuations in our commissions expense and overall sales and marketing expense as a percentage of revenue and on an absolute basis. 65 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Research and development — Research and development ("R&D") expense consists primarily of personnel costs, as well as other direct and allocated costs. We have devoted our product development efforts primarily to enhancing the functionality and expanding the capabilities of our solutions. R&D costs are expensed as incurred. We expect R&D expense, in the long term, to increase in absolute dollars as part of our long-term plans to invest in our future products and services, including our newer subscription-based products, although R&D expense may fluctuate as a percentage of total revenue and, on an absolute basis, from quarter to quarter. In addition, as discussed above in the section titled "Impact of the COVID-19 Pandemic," in response to the COVID-19 pandemic we have effected a global hiring pause outside of a small number of critical roles and, as a result, our R&D expense will fluctuate, and may decline, from quarter to quarter in the near-term. General and administrative — General and administrative ("G&A") expense consists primarily of personnel costs, which include our executive, finance, human resources and legal organizations. G&A expense also includes outside professional services, which consists primarily of legal, accounting and other consulting costs, as well as insurance and other costs associated with being a public company and allocated costs. We expect G&A expense, in the long term, to increase in absolute dollars, particularly due to additional legal, accounting, insurance and other costs associated with our growth, although G&A expense may fluctuate as a percentage of total revenue and, on an absolute basis, from quarter to quarter. In addition, as discussed above in the section titled "Impact of the COVID-19 Pandemic," in response to the COVID-19 pandemic we have effected a global hiring pause outside of a small number of critical roles and, as a result, our G&A expense will fluctuate, and may decline, from quarter to quarter in the near-term. Other Income (Expense), Net Other income (expense), net consists primarily of interest income and expense, which includes the amortization of the debt discount and issuance costs associated with our 0% Convertible Senior Notes, due in 2023 (the "2023 Notes"), interest income related to our short-term investments and foreign currency exchange gains or losses. During fiscal 2019 and fiscal 2020, we recognized $29.3 million and $31.3 million, respectively, of interest expense related to the amortization of the debt discount and issuance costs associated with the 2023 Notes. Provision for Income Taxes Provision for income taxes consists primarily of income taxes for certain foreign jurisdictions in which we conduct business and state income taxes in the United States. We have recorded a full valuation allowance related to our federal and state net operating losses and other net deferred tax assets and a partial valuation allowance related to our foreign net deferred tax assets due to the uncertainty of the ultimate realization of the future benefits of those assets. Results of Operations The following tables set forth our consolidated results of operations in dollars and as a percentage of total revenue for the fiscal years presented. The period-to-period comparison of results is not necessarily indicative of results for future periods. 66 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Fiscal Year Ended July 31, 2018 2019 2020 (in thousands) Revenue: Product $ 887,989 $ 832,419 $ 765,822 Support, entitlements and other services 267,468 403,724 541,860 Total revenue 1,155,457 1,236,143 1,307,682 Cost of revenue: Product (1)(2) 276,127 143,078 71,312 Support, entitlements and other services (1) 109,903 161,050 215,377 Total cost of revenue 386,030 304,128 286,689 Gross profit 769,427 932,015 1,020,993 Operating expenses: Sales and marketing (1)(2) 649,657 909,750 1,160,389 Research and development (1) 313,777 500,719 553,978 General and administrative (1) 86,401 119,587 135,547 Total operating expenses 1,049,835 1,530,056 1,849,914 Loss from operations (280,408) (598,041) (828,921) Other expense, net (9,306) (15,019) (26,300) Loss before provision for income taxes (289,714) (613,060) (855,221) Provision for income taxes 7,447 8,119 17,662 Net loss $ (297,161) $ (621,179) $ (872,883) (1) Includes stock-based compensation expense as follows: Fiscal Year Ended July 31, 2018 2019 2020 (in thousands) Cost of revenue: Product $ 2,580 $ 3,535 $ 5,334 Support, entitlements and other services 8,945 15,326 22,014 Total cost of revenue 11,525 18,861 27,348 Sales and marketing 65,060 107,751 126,015 Research and development 74,389 140,519 153,252 General and administrative 26,894 39,598 45,383 Total stock-based compensation expense $ 177,868 $ 306,729 $ 351,998 (2) Includes amortization of intangible assets as follows: Fiscal Year Ended July 31, 2018 2019 2020 (in thousands) Product cost of revenue $ 5,641 $ 14,248 $ 14,777 Sales and marketing 914 2,528 2,603 Total amortization of intangible assets $ 6,555 $ 16,776 $ 17,380 67 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Fiscal Year Ended July 31, 2018 2019 2020 (as a percentage of total revenue) Revenue: Product 76.9 % 67.3 % 58.6 % Support, entitlements and other services 23.1 % 32.7 % 41.4 % Total revenue 100.0 % 100.0 % 100.0 % Cost of revenue: Product 23.9 % 11.6 % 5.4 % Support, entitlements and other services 9.5 % 13.0 % 16.5 % Total cost of revenue 33.4 % 24.6 % 21.9 % Gross profit 66.6 % 75.4 % 78.1 % Operating expenses: Sales and marketing 56.2 % 73.6 % 88.7 % Research and development 27.2 % 40.5 % 42.4 % General and administrative 7.5 % 9.7 % 10.4 % Total operating expenses 90.9 % 123.8 % 141.5 % Loss from operations (24.3) % (48.4) % (63.4) % Other expense, net (0.8) % (1.2) % (2.0) % Loss before provision for income taxes (25.1) % (49.6) % (65.4) % Provision for income taxes 0.6 % 0.7 % 1.4 % Net loss (25.7) % (50.3) % (66.8) % Revenue Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) Product $ 887,989 $ 832,419 $ (55,570) (6) % $ 832,419 $ 765,822 $ (66,597) (8) % Support, entitlements and other services 267,468 403,724 136,256 51 % 403,724 541,860 138,136 34 % Total revenue $ 1,155,457 $ 1,236,143 $ 80,686 7 % $ 1,236,143 $ 1,307,682 $ 71,539 6 % Total revenue by bill-to-location was as follows: Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) U.S. $ 648,805 $ 682,340 $ 33,535 5 % $ 682,340 $ 706,110 $ 23,770 3 % Asia Pacific 240,247 271,712 31,465 13 % 271,712 265,092 (6,620) (2) % Europe, the Middle East and Africa 224,392 238,356 13,964 6 % 238,356 277,489 39,133 16 % Other Americas 42,013 43,735 1,722 4 % 43,735 58,991 15,256 35 % Total revenue $ 1,155,457 $ 1,236,143 $ 80,686 7 % $ 1,236,143 $ 1,307,682 $ 71,539 6 % 68 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Product revenue decreased year-over-year for fiscal 2019 and fiscal 2020 due primarily to the decrease in hardware revenue, as more and more customers are purchasing hardware directly from our OEMs. In addition, our product revenue has been impacted by our continued transition to selling subscription term-based licenses, as these licenses generally have had an average term of approximately four years, while those with a duration equal to the life of the associated appliance have an estimated life of approximately five years. The total average contract term was approximately 4.3 years, 4.1 years and 3.8 years for fiscal 2018, 2019 and 2020, respectively. Total average contract term represents the dollar-weighted term across all subscription and life-of-device contracts billed during the period, using an assumed term of five years for licenses without a specified term, such as life-of-device licenses. Support, entitlements and other services revenue increased year-over-year for both fiscal 2019 and fiscal 2020 in conjunction with the growth of our end customer base and the related software entitlement and support subscription contracts. Our total end customer count increased from approximately 10,610 as of July 31, 2018 to approximately 14,180 as of July 31, 2019 and to approximately 17,360 as of July 31, 2020. Cost of Revenue and Gross Margin Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) Cost of product revenue $ 276,127 $ 143,078 $ (133,049) (48) % $ 143,078 $ 71,312 $ (71,766) (50) % Product gross margin 68.9 % 82.8 % 82.8 % 90.7 % Cost of support, entitlements and other services revenue $ 109,903 $ 161,050 $ 51,147 47 % $ 161,050 $ 215,377 $ 54,327 34 % Support, entitlements and other services gross margin 58.9 % 60.1 % 60.1 % 60.3 % Total gross margin 66.6 % 75.4 % 75.4 % 78.1 % Cost of product revenue The year-over-year fluctuations in cost of product revenue are in line with the corresponding fluctuations in hardware revenue. For fiscal 2019 and fiscal 2020, as compared to the respective prior year periods, the decreases in cost of product revenue were due primarily to the decreases in hardware revenue, as more and more customers are purchasing hardware directly from our OEMs. Product gross margin increased by 13.9 percentage points, from 68.9% in fiscal 2018 to 82.8% in fiscal 2019, and by 7.9 percentage points, to 90.7% in fiscal 2020, due primarily to the higher mix of software revenue, as we continued to focus on more software-only transactions. Cost of support, entitlements and other services revenue Cost of support, entitlements and other services revenue increased year-over-year for both fiscal 2019 and fiscal 2020 due primarily to higher personnel-related costs, relating to growth in our global customer support organization, and other costs associated with supporting our growing end customer base. The increases in personnel-related costs were driven primarily by increases in our customer support, entitlements and other services headcount of 40% from July 31, 2018 to July 31, 2019 and 19% from July 31, 2019 to July 31, 2020. Support, entitlements and other services gross margin increased by 1.2 percentage points, from 58.9% in fiscal 2018 to 60.1% in fiscal 2019, and by 0.2 percentage points to 60.3% in fiscal 2020, due primarily to personnel-related costs growing at a slower rate than support, entitlements and other services revenue. 69 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Operating Expenses Sales and marketing Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) Sales and marketing $ 649,657 $ 909,750 $ 260,093 40 % $ 909,750 $ 1,160,389 $ 250,639 28 % Percent of total revenue 56.2 % 73.6 % 73.6 % 88.7 % Sales and marketing expense increased year-over-year both for fiscal 2019 and fiscal 2020 due primarily to higher personnel-related costs and sales commissions, as our sales and marketing headcount increased year-over-year by 36% in fiscal 2019 and 17% in fiscal 2020, as well as increased sales and marketing activities related to demand generation, brand awareness, promotions, trade shows and partner programs as part of our efforts to penetrate and expand in global markets. Research and development Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) Research and development $ 313,777 $ 500,719 $ 186,942 60 % $ 500,719 $ 553,978 $ 53,259 11 % Percent of total revenue 27.2 % 40.5 % 40.5 % 42.4 % Research and development expense increased year-over-year both for fiscal 2019 and fiscal 2020 due primarily to higher personnel-related costs, including stock-based compensation expense, as our R&D headcount increased year-over-year by 27% in fiscal 2019 and 13% in fiscal 2020 in an effort to continue the expansion of our product development activities, including new products. For fiscal 2019, this increase includes additional headcount and stock-based compensation expense related to employees who joined the Company through acquisitions. General and administrative Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) General and administrative $ 86,401 $ 119,587 $ 33,186 38 % $ 119,587 $ 135,547 $ 15,960 13 % Percent of total revenue 7.5 % 9.7 % 9.7 % 10.4 % General and administrative expense increased year-over-year both for fiscal 2019 and fiscal 2020 due primarily to higher personnel-related costs, including stock-based compensation expense, as our G&A headcount increased year-over-year by 30% in fiscal 2019 and 10% in fiscal 2020 in order to support our growing business. The increase in G&A expense was also impacted by higher depreciation and legal and outside services costs, in line with the general growth of the business. Other Expense, Net Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) Other expense, net $ (9,306) $ (15,019) $ 5,713 61 % $ (15,019) $ (26,300) $ 11,281 75 % The increase in other expense, net for fiscal 2019 was due primarily to interest expense associated with the amortization of the debt discount and issuance costs for the 2023 Notes, as the 2023 Notes were issued during the second quarter of fiscal 2018, partially offset by interest earned on short-term investments. 70 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) The increase in other expense, net for fiscal 2020 was due primarily to higher foreign currency losses, primarily related to operating expenses denominated in foreign currencies and our increasing foreign business. The increase in other expense, net was also impacted by lower interest income due primarily to sales of investments during fiscal 2020. Provision for Income Taxes Fiscal Year Ended July 31, Change Fiscal Year Ended July 31, Change 2018 2019 $ % 2019 2020 $ % (in thousands, except percentages) Provision for income taxes $ 7,447 $ 8,119 $ 672 9 % $ 8,119 $ 17,662 $ 9,543 118 % The year-over-year increase in the provision for income taxes in fiscal 2019 and fiscal 2020 was due primarily to higher foreign taxes as a result of higher taxable earnings in foreign jurisdictions, as we continued our global expansion. The provision for income taxes in fiscal 2019 was partially offset by a one-time U.S. valuation allowance release related to a business combination and a one-time tax benefit related to the change in tax law. We continue to maintain a full valuation allowance on our U.S. federal and state deferred tax assets and a partial valuation allowance related to our foreign net deferred tax assets. Liquidity and Capital Resources As of July 31, 2020, we had $318.7 million of cash and cash equivalents, $3.3 million of restricted cash and $401.0 million of short-term investments, which were held for general corporate purposes. Our cash, cash equivalents and short-term investments primarily consist of bank deposits, money market accounts and highly rated debt instruments of the U.S. government and its agencies and debt instruments of highly rated corporations. In January 2018, we issued Convertible Senior Notes with a 0% interest rate for an aggregate principal amount of $575.0 million. There are no required principal payments prior to the maturity of the 2023 Notes. For additional information, see Note 6 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Due to investments in our business as well as the potential cash flow impacts resulting from our continued transition to a subscription-based business model, we expect our operating and free cash flow to continue to be negative during the next 12 months. Notwithstanding that fact, we believe that our cash and cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced product and service offerings, the continuing market acceptance of our products, the impact of COVID-19 pandemic on our business, our end customers and partners, and the economy, and the timing of and extent to which our customers transition to shorter-term contracts or request to only pay for the initial term of multi-year contracts as a result of our transition to a subscription-based business model. On August 26, 2020, we entered into an investment agreement (the "Investment Agreement") with BCPE Nucleon (DE) SPV, LP ("Bain") relating to the issuance and sale to Bain of $750 million in an initial aggregate principal amount of 2.5% Convertible Senior Notes due 2026. The transactions contemplated by the Investment Agreement are expected to close on or prior to September 24, 2020, subject to satisfaction of the customary closing conditions set forth in the Investment Agreement. For additional details, refer to Note 15 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. 71 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Cash Flows The following table summarizes our cash flows for the periods presented: Fiscal Year Ended July 31, 2018 2019 2020 (in thousands) Net cash provided by (used in) operating activities $ 92,540 $ 42,168 $ (159,885) Net cash (used in) provided by investing activities (503,555) (16,850) 24,559 Net cash provided by financing activities 578,616 67,104 57,797 Net increase (decrease) in cash, cash equivalents and restricted cash $ 167,601 $ 92,422 $ (77,529) We retrospectively adopted Accounting Standards Update ("ASU") 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents, effective August 1, 2018. Our statement of cash flows for the fiscal year ended July 31, 2018 has been adjusted to conform to the new standard. Cash Flows from Operating Activities Net cash generated from operating activities was $92.5 million and $42.2 million and net cash used in operating activities was $159.9 million for fiscal 2018, 2019 and 2020, respectively, representing an increase of $77.8 million and decreases of $50.4 million and $202.1 million, respectively, as compared to the respective prior year periods. The generation of cash during fiscal 2018 and 2019 was due primarily to increasing billings and collections, partially offset by higher operating expenses as we continue to invest in the long-term growth of our business. The use of cash during fiscal 2020 was due primarily to our higher net loss from operations. Cash Flows from Investing Activities Net cash used in investing activities of $503.6 million for fiscal 2018 primarily consisted of $716.4 million of short-term investment purchases, using a significant portion of the proceeds from the 2023 Notes, $62.4 million of purchases of property and equipment and $22.2 million of net payments for business combinations, partially offset by $297.5 million of maturities of short-term investments. Net cash used in investing activities of $16.9 million for fiscal 2019 primarily consisted of $468.1 million of short-term investment purchases, $118.5 million of purchases of property and equipment and $19.0 million of net payments for business combinations, partially offset by $588.8 million of maturities of short-term investments. Net cash provided by investing activities of $24.6 million for fiscal 2020 primarily consisted of $645.8 million of maturities of short-term investments and $75.4 million of sales of short-term investments, partially offset by $607.2 million of short-term investment purchases and $89.5 million of purchases of property and equipment. Cash Flows from Financing Activities Net cash provided by financing activities of $578.6 million for fiscal 2018 primarily consisted of $563.6 million of net proceeds from the 2023 Notes, after deducting the initial purchasers' discount and debt issuance costs, $88.0 million of proceeds from the sale of the warrants in connection with the 2023 Notes and $72.0 million of net proceeds from the sale of shares through employee equity incentive plans, partially offset by $143.2 million of cash used to purchase bond hedges in connection with the 2023 Notes and a $1.7 million debt payment in conjunction with a business combination. Net cash provided by financing activities of $67.1 million for fiscal 2019 primarily consisted of $69.2 million of net proceeds from the sale of shares through employee equity incentive plans, partially offset by a $1.0 million acquisition-related contingent consideration payment and a $1.0 million debt payment in conjunction with a business combination. 72 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Net cash provided by financing activities of $57.8 million for fiscal 2020 consisted of proceeds from the sale of shares through employee equity incentive plans. Contractual Obligations The following table summarizes our contractual obligations as of July 31, 2020: Payments Due by Period Total Less than 1 Year 1 Year to 3 Years 3 to 5 Years More than 5 Years (in thousands) Principal amount payable on convertible senior notes (1) $ 575,000 $ — $ 575,000 $ — $ — Operating leases (undiscounted basis) (2) 182,585 46,007 94,272 38,113 4,193 Other commitments (3) 62,453 59,722 2,131 600 — Guarantees with OEMs 81,215 51,215 30,000 — — Total $ 901,253 $ 156,944 $ 701,403 $ 38,713 $ 4,193 (1) For additional information regarding our convertible senior notes, refer to Note 6 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (2) For additional information regarding our operating leases, refer to Note 7 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (3) Purchase obligations and other commitments pertaining to our daily business operations. From time to time, in the normal course of business, we make commitments with our OEMs to ensure them a minimum level of financial consideration for their investment in our joint solutions. These commitments are based on revenue targets or on-hand inventory and non-cancelable purchase orders for non-standard components. We record a charge related to these items when we determine that it is probable a loss will be incurred and we are able to estimate the amount of the loss. Our historical charges have not been material. As of July 31, 2020, we had accrued liabilities related to uncertain tax positions, which are reflected on our consolidated balance sheet. These accrued liabilities are not reflected in the contractual obligations disclosed in the table above, as it is uncertain if or when such amounts will ultimately be settled. Uncertain tax positions are further discussed in Note 12 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As of July 31, 2020, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the applicable periods. We evaluate our estimates, assumptions and judgments on an ongoing basis. Our estimates, assumptions and judgments are based on historical experience and various other factors that we believe to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements, which, in turn, could change the results from those reported. The critical accounting estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are described below. 73 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Revenue Recognition Some of our contracts with customers contain multiple performance obligations. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price ("SSP") basis. For deliverables that we routinely sell separately, such as software entitlement and support subscriptions on our core offerings, we determine SSP by evaluating the standalone sales over the trailing 12 months. For those that are not sold routinely, we determine SSP based on our overall pricing trends and objectives, taking into consideration market conditions and other factors, including the value of our contracts, the products sold and geographic locations. If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative SSP. We determine SSP based on the price at which the performance obligation is sold separately. If the SSP is not observable through past transactions, we estimate the SSP, taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations. Refer to Note 1 and Note 3 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information on revenue recognition. Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. We recognize uncertain tax positions only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. Stock-Based Compensation We measure and recognize compensation expense for all stock-based awards, including stock options and purchase rights issued to employees under our 2016 Employee Stock Purchase Plan ("2016 ESPP"), based on the estimated fair value of the awards on the grant date. We use the Black-Scholes-Merton ("Black-Scholes") option pricing model to estimate the fair value of stock options and 2016 ESPP purchase rights. The fair value of restricted stock units ("RSUs"), is measured using the fair value of our common stock on the date of the grant. The fair value of stock options and RSUs is recognized as expense on a straight-line basis over the requisite service period, which is generally four years. For stock-based awards granted to employees with a performance condition, we recognize stock-based compensation expense using the accelerated attribution method over the requisite service period when management determines it is probable that the performance condition will be satisfied. The fair value of the 2016 ESPP purchase rights is recognized as expense on a straight-line basis over the offering period. We account for forfeitures of all share-based awards when they occur. Our use of the Black-Scholes option pricing model requires the input of highly subjective assumptions, including the fair value of the underlying common stock, expected term of the option, expected volatility of the price of our common stock, risk-free interest rates and the expected dividend yield of our common stock. The assumptions used in our option pricing model represent management’s best estimates. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. 74 Table of Contents NUTANIX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Business Combinations We account for our acquisitions using the acquisition method. Goodwill is measured at the acquisition date as the excess of the purchase price over the fair value of the assets acquired and liabilities assumed. Significant estimates and assumptions are made by management to value such assets and liabilities. Although we believe that those estimates and assumptions are reasonable and appropriate, they are inherently uncertain and subject to refinement. Additional information related to the acquisition date fair value of acquired assets and assumed liabilities obtained during the measurement period, not to exceed one year, may result in changes to the recorded values of such assets and liabilities, resulting in an offsetting adjustment to the goodwill associated with the business acquired. Uncertain tax positions and tax-related valuation allowances are initially established in connection with a business combination as of the acquisition date. We continue to collect information and reevaluate these estimates and assumptions quarterly. We will record any adjustments to our preliminary estimates to goodwill, provided that we are within the one-year measurement period. Any contingent consideration payable is recognized at fair value at the acquisition date. Liability-classified contingent consideration is remeasured each reporting period, with changes in fair value recognized in earnings until the contingent consideration is settled. Goodwill, Intangible Assets and Impairment Assessment Goodwill represents the excess of the purchase price over the fair value of the assets acquired and liabilities assumed, if any, in a business combination, and is allocated to our single reporting unit. We review our goodwill and other intangible assets determined to have an indefinite useful life for impairment at least annually, during the fourth quarter, or more frequently whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Goodwill is tested for impairment by comparing the reporting unit's carrying value, including goodwill, to the fair value of the reporting unit. We operate under one reporting unit and for our annual goodwill impairment test, we determine the fair value of our reporting unit based on our enterprise value. We may elect to utilize a qualitative assessment to determine whether it is more likely than not that the fair value of our reporting unit is less than its carrying value. If, after assessing the qualitative factors, we determine that it is more likely than not that the fair value of our reporting unit is less than its carrying value, an impairment analysis will be performed. We will compare the fair value of our reporting unit with its carrying amount and if the carrying value of the reporting unit exceeds its fair value, an impairment loss will be recognized. Assessing whether impairment indicators exist or if events or changes in circumstances have occurred, including market conditions, operating fundamentals, competition and general economic conditions, requires significant judgment. Additionally, changes in the technology industry occur frequently and quickly. Therefore, there can be no assurance that a charge to operating expenses will not occur as a result of future goodwill, intangible assets and other long-lived assets impairment tests. To date, we have not recorded any impairment charges related to our goodwill and intangible assets. Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued, we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements. Recent Accounting Pronouncements Refer to "Recent Accounting Pronouncements" in Note 1 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. 75 Table of Contents