Splunk Inc. (NASDAQ:SPLK) Bank of America 2023 Global Technology Conference June 7, 2023 5:00 PM ET
Company Participants
Gary Steele – President and CEO
Brian Roberts – SVP and CFO
Conference Call Participants
Bradley Sills – Bank of America
Bradley Sills
Great. Welcome, everybody. Delighted to welcome Splunk to the conference here. Very fortunate to have CEO, Gary Steel with us; CFO, Brian Roberts. Thank you both for joining.
Gary Steele
Great to be here.
Bradley Sills
You both. Yeah, welcome to the conference. Katie White is here as well, Investor Relations. Thanks, Katie. So yes, the format, I’ll go through some questions here, and then we’ll give you guys a chance to ask a question or two, if you want, feel free to raise your hand, and we will get a mic over to you.
And Brian, I think you want to —
Brian Roberts
Before we kick off, we may make forward-looking statements today. So we encourage you to read our SEC filings to see a discussion of potential risk factors that could cause actual results to differ from these statements.
Question-and-Answer Session
Q – Bradley Sills
Wonderful. So Gary and Brian, you just reported a nice Q1, nice start to the year. So I just wanted to get your kind of — your take — what are the key highlights that you want to mention here? And what’s the investor feedback then?
Gary Steele
Yeah. No, great question. So we were really pleased with the results. We’re very happy with the execution. I think there’s some really interesting customer win highlights. We won the largest public sector cloud deal in our history that was characterized as an eight-figure deal.
We also won an eight-figure observability deal. And it was where the customer wanted to consolidate down to a single vendor to help drive single framework architecture around observability. And that was a loyal Splunk customer where we basically extended our reach into durability on that. And I think at a high level, what we see is just some great marquee strategic wins that give us confidence in our long-term growth profile and our opportunity ahead of us.
We’re continuing to invest heavily across both security and observability. And changes that we made from a positioning and a go-to-market perspective over the last year, I think, are really resonating. And I think it’s shown up with really good numbers. I’ll let Brian comment a little bit on the financials.
Brian Roberts
Yeah. No, we’re super pleased 16% top line ARR growth. And then when you look in terms of bottom line, if you look at OpEx, on a non-GAAP basis, we were down 1% year-over-year. And on a GAAP basis, even more so 2% on negative 2% OpEx growth. And again, that’s just the work on the SBC. So like there are very few companies that I think, reported that type of growth with OpEx down year-over-year.
Bradley Sills
Yes, yes, absolutely. And one of the metrics that stood out to me was the free cash flow upside in the quarter, $30 million that you raised for the full year. So Love to get your thoughts on what were the sources of upside, Brian, on free cash flow? I know it’s a North Star metric now.
Brian Roberts
So absolutely. There’s two components to it. If you look at our outlook in Q1, we had said $475 million of free cash flow. We came in at $486 million, a single quarter. So there’s $11 million there. And then if you look at our outlook, we thought at the beginning of the year, that OpEx would grow 7%. We updated that on the most recent call, we now think it’s between 5% and 6% OpEx growth. So less than half of ARR growth. And so the cash portion of that gets us to $30 million. So it felt great to raise at the end of Q1, already up $30 million on free cash flow.
Bradley Sills
Yeah. Great. No.
Gary Steele
And the thing that I would comment on as well is when I joined, we really started the set of efficiency initiatives, having Brian on board now has been four months. He’s been a great partner to help continue to drive that. And we see plenty of opportunity to continue to see free cash flow expansion. And we — one of the critical things that we did in the summer of last year is really think about what the structure of our workforce should be over time.
And as a result of that, we opened some global technology centers where we’re finding amazing talent, but doing it in a much lower cost way — and this is something that will yield benefits over the course of the next five-10 years. It’s not something that is in-period current quarter kind of thing. It’s really having great opportunity and value to the company over a long haul. And it also extends the opportunity about how do we ensure that we’re getting our SBC under control. And that’s been a big focus of mine too. We — we’ve been quite high, and we really felt like we needed to turn that around, and this was a critical part of that.
Bradley Sills
Wonderful. And maybe we could just double click on that a little bit more. I know it’s a big cultural shift. This focus on operating efficiency. How has the company embrace that? What are some of the measures you put into place here that are driving the kinds of results you’ve seen already?
Gary Steele
Yeah. It’s been interesting. I think it’s been really well received. I think it dovetails nicely into what’s happening in the economy broadly. So doesn’t feel that far off from what I think other people would see at other companies. But we started early. We started basically the day I walked in the door. I just felt like there was opportunity for efficiency. I had spent a lot of time doing that in my prior role.
But we think about it holistically, we think about the structure of the workforce, we think about every dollar how we spend it. We think about it in the context of gross margin. And so we’re taking a very holistic approach, but it’s a multiyear journey. And some of these things will pay off in the short term, some things will pay off over the longer haul, but we think there’s plenty of opportunity for continued efficiency that ultimately drives free cash flow.
Brian Roberts
Yeah. I think the one thing I’d add in terms of just the cultural impact. One of the great things Gary did when he joined is we have a weekly town hall of the entire employee base. And so it’s such a powerful communication channels because it was — I don’t want say it was a reeducation, but it was like, no, no, no, it’s not a choice. Its durable growth and increasing profitability and free cash flow.
And then just every week we reinforce that. And I think you look at the results of Q1, again, negative 2% GAAP OpEx growth that says a lot.
Bradley Sills
Absolutely. No, that’s great. And renewal rate has been very strong. I know you don’t disclose it, but I think it’s evident in the NRR number, and I think you’re a best-of-class enterprise levels. What would you attribute that to, Gary, very sticky installed base here?
Gary Steele
Yeah. I think it’s that exact point. It’s a very sticky installed base, which it just implies that we’re mission-critical to the way they drive their security teams, the way they think about visibility across their IT footprint and across this next generation of apps. And so the role that we play is so critical that we’re — we benefit from a very high renewal rate.
Bradley Sills
Great. And you mentioned this enterprise class, what makes Splunk enterprise class. I think we see it in the results. We see it in the renewal rate, and we do our channel checks every quarter, and it sounds very, very resilient. Customers getting a lot of value out of the platform. What is it that makes Splunk irreplaceable in the enterprise?
Gary Steele
One of the things that is incredibly unique and it’s been a hallmark of the company from its founding is our ability to take high volumes of data, be able to index it and create results from queries in real time. It’s a really hard technical problem. And I spent a lot of time this last year visiting a lot of our bigger customers and the volumes of data that customers bring into Splunk and the kinds of things they do with it is truly amazing.
Like I was with a customer that does 2 petabytes a day. Every single day, they in just 2 petabytes in the Splunk. We index it and they do analytics on top of that data. That’s a really hard problem to solve. And so it’s that fundamental volume and scale that makes us different. It’s the flexibility of the platform to allow you to solve a whole set of broad use cases we’re not narrow. And it’s the ability in the observability world where there’s no sampling. So you can capture every bit of Trace data every single thing and do it at scale that gives you the insight and visibility that you truly need to run world-class apps.
Bradley Sills
Wonderful. What would you say the misperception is on Splunk? I get this question a lot. It seems like customer satisfaction is low. The company has been through a number of transitions, whether it’s pricing or billings or cloud and I know a lot of that’s behind the company now.
Gary Steele
Yeah. No, I think it’s true. I think we’ve gone through a number of transitions. I think from a Wall Street perspective, we’ve had financials that were you’ve lived through this a little bit of difficult to digest.
Bradley Sills
Absolutely.
Gary Steele
And I think as Brian and I have been talking about, there’s really two critical metrics that we should be judged by a top line metric, which is ARR and ARR growth and a bottom line metric, which is free cash flow. And I think sometimes because of ASC 606, people get confused about revenue and not margin and those things. But in reality, if you just focus on ARR and free cash flow, you can see through.
We also went through a very difficult transition from a cash flow perspective where we’re billing customers upfront over three years ago to today where it’s all annual billing. So I think the difficulty on the financial side, I think we’ve gotten through that.
Now the other thing that is true is we operate in a very big market with a very big TAM. And there are lots of companies that would like to play a role in that market and take some share of that. And so I think that’s what’s created some of the noise as well. And we feel very good about our ability to continue to deliver great outcomes for security and observability customers.
And I think one of the fundamental changes that we made that I think will play out and play out in an important way over time. When I joined we were — our positioning was all about data to everything, so basic platform positioning. And when I joined itself like we were focused on the needs of our buyers. So thinking about the CISO and what is the CISO need and what does the head of DevOps need or what does the CTO need, and how do we ensure that we’re addressing their specific requirements.
And so through the changes in our go-to-market, we’ve really aligned on how we deliver value to those people. And I think that will ultimately help push down some of this noise that’s been in the market for a long time.
Bradley Sills
Great. Wonderful. And you took over as CEO over a year ago.
Gary Steele
Yeah, it’s been about 14 months.
Bradley Sills
Yeah, 14 months. So looking back now, I mean, what were some of the initial focus areas, strategic changes, if you will, or operational changes that you’ve instituted and now looking back a year later, year plus, where have been some successes and where are some of the efforts that are still underway?
Gary Steele
Yeah. I think one of the main things that changed is we had a lot of people change. And so it’s really a brand-new team. So Brian was the most recent addition. Brian joined us in January. I mean it’s great having a partner to help drive the overall financial model for the business, the efficiency that we’ve been seeing. But we had lots of changes.
So we brought in a new Head of Product. He joined us in the fall. He’s done an amazing job. He then subsequently brought in our new CTO. She joined us the last month-ish. She’s an amazing person. I think will deliver great outcomes on the AI side of things. We brought in a new Chief People Officer. She was really my partner in helping drive down SBC and the restructuring of our equity-based compensation. And she and I had worked in the past together and so we were able to move really, really fast on that. A lot of times, those things take years, and we were able to do something in share months.
And then we appointed new customer office are really thinking about how do we enter our customers are getting maximum value from Splunk.
So I think the people side was a big focus for me. And then when I walked in the door, I said we’re going to be more efficient. Like was first and foremost. And so driving balance between growth and profitability was super important. And so we started a set of initiatives there. We’re obviously delivering on those. I think there continues to be more to be done.
And then the other piece for me has been how do we continue to improve the pace of innovation? I think there’s a tremendous amount of value that we can deliver for our customers. And under Tom Casey’s leadership, who’s running product now, we’re seeing those benefits there’s more there. And as we talked about on our earnings call, I got so we’re bullish about AI. We’re at the very beginning of that journey. We some really interesting things historically. But we’re moving at an accelerated pace on that front because we think there’s value to be delivered there.
So I feel very good about the progress we’ve made over the course of the last year. I spent a lot of fun. I think we have a lot more to do and thrilled to be part of the team.
Bradley Sills
That’s great. Great. Maybe if you could elaborate a bit more because we know there’s a lot of focus here on efficiency, single seller mode is one of those key initiatives. Maybe if you could elaborate on that, how that can drive efficiency and then some other initiatives that are under way?
Gary Steele
And I can team up on this. So one of the observations from a go-to-market perspective is that we had a lot of people surrounding the customer, and we weren’t very efficient. Like I would go to media and you’d see a whole bunch of Splunkers and like, why do we have so many people in this meeting. I don’t know that it was always clear to a customer who their sales rep was. And so we moved to what we call the single seller model.
Historically, we had a different seller for different product lines, like we had a different seller for security, a different seller for observability. We had a separate seller for a cloud. So just a lot of people in the mix on deals. We moved to the single seller model at the top of October. It resulted in a riff of roughly 300 Splunkers. And so that was the restructuring we did in the fall. That simplified then the number of people calling on a customer.
We assume that all of those people would be capable and competent to sell to the security team. And they’re backed up then by a set of advisers to give them the technical knowledge on specific competitive areas or specific product areas. And then we continued that into the beginning of this fiscal year where we focused our sales team on selling new use cases, delivering more value to customers. And historically, that was more focused on just cloud migrations. That’s literally salespeople were just thinking about doing cloud migrations.
So this evolution of our go-to-market to get to a single seller and now to be focused on use cases and value selling, I think it’s been really transformational. I think the positive results really played out in Q1. But that’s been a pretty big transformation for us and one that’s gone — it’s gone very, very smoothly.
Bradley Sills
Brian, do you want to comment on another area?
Brian Roberts
Yeah. I mean I’d say we’ve been very thoughtful to Gary’s point around our workforce strategy. And I think that is something that will just be a catalyst for opportunity for a number of years. But it’s not like it was X, Y and Z, it’s just being thoughtful, right, and just being very prudent when just looking at expenses, the zero-based budgeting mindset. Really trying to justify spend because there’s lots of things, especially for a company that’s been around for 20 years.
You’re spending a lot of money on lots of different things because you’ve done it historically. And I think Gary and I are not afraid to ask what should we be — what is the ROI of this.
So those types of conversations, I think, again, it manifests in the fact that Q1, we’re down on a GAAP basis, down 2% year-over-year. It’s a result of those things. It’s not — yeah, we’ve made — there were certain cost actions with it, et cetera, but it’s really being more thoughtful on all the other expenses.
Bradley Sills
Yeah. And to that point, I mean, there are investment initiatives underway. I mean you’re continue to integrate the observability suite and then in the cloud, furthering the cloud. So it sounds like you are still hiring and you’re still investing maybe hiring from different locations.
Brian Roberts
Yeah, headcount was up 4% year-over-year into Q1.
Gary Steele
And I think the other thing I would say is even in the choppy economic conditions that we’ve experienced that we’ve talked about on our earnings calls, we’ve continued to invest in go to market. So as a very specific example, if you look at our business today, we’re kind of two thirds– roughly two thirds the Americas and one third international.
We have been underrepresented in some of these international markets. And so we’ve been hiring. So we have been growing our sales organization even in the face of some of this chunk the economic environment because we want to be well positioned. As we begin to see the economy improve, we want to see our growth accelerate.
And so we wanted to make that investment and we’re willing to make those trade-offs. We’re growing in this area while we’re looking for efficiencies and other.
Bradley Sills
Got it. Great. And maybe back to the single-seller model. You would think that would bring in larger deals. If you’re asking a rep to sell all three components that you described, security, IT, observability. Is that your observation in the pipeline? Where has the success been there? And how is that proven metrics?
Gary Steele
I think where I see the wins, frankly, and the opportunity is these big deals that you referenced, the biggest public sector cloud deal that we had ever had. The consolidation opportunity that we took in the financial service information technology company where they could standardize on that. So I think those are the kinds of things that we’re seeing — where we’re seeing this real benefit of getting a single-seller model really home.
Bradley Sills
And a lot of that comes down to a single database, single source of the truth, if you will. And you guys cover logs, metrics and traces, APM, et cetera. So how is that resonating with customers? Do you feel that the product set is at the point now where it is integrated? Is there still more work to be done there?
Gary Steele
We’ve made tremendous progress. And if you just go back in time, we got into the observability market through a series of acquisitions, basically six acquisitions that got done. And the development team has done a phenomenal job of bringing all that capability together into our Observability Cloud.
Middle part of last year, we were really getting to focus hard on how do we ensure that people that are using our observability cloud, get all the value at power from the Splunk platform. And so a lot of integration has happened with the core. There’s probably more to be done there but we’re winning big deals, and it’s really working.
Bradley Sills
Great. Great. Okay. Wonderful. And let’s see, maybe we could go to the — maybe to you, Brian, guidance for ARR, free cash flow margin of 20% is implied in your guidance here. Is that a reasonable metric for gauging free cash flow kind of ARR, free cash flow conversion, if you will? Is that the way you think about it?
Brian Roberts
Yeah. I mean the one thing as you think about the business, 95% of our free cash flow is Q1 and Q4, right? Because we typically — our bookings are then collected the subset. I think when you look at our guide this year for free cash flow with the new guidance of 8 05 to 8 25, it’s 89% to 93% year-on-year growth.
So in terms of margins now are 19.5% to 19%, up from just 11.6% last year. So just massive improvement and, I’d say, a choppy macroeconomic environment but I think it’s really important to understand there’s structurally nothing about Splunk that prevents it from having the margins of other large software companies.
So I think we are — it’s early, and we just need to keep. I think the onus is on the company. We just need to keep putting up quarter after quarter after quarter in terms of just execution because I think again, it was a complicated story. Free cash flow during the business transformation was — it went negative. Hard for sort of that — and now we’re coming out of this. And I think, again, we’ve said publicly, we expect healthy growth next year in free cash flow.
So this will be an ongoing story for us. And when we get the Investor and Analyst Day later this year, we’ll give you what is the long-term ARR target. What are all of the expenses as a percentage of ARR and then what’s free cash flow margin?
Bradley Sills
Okay. Well, then I won’t steal your thunder. That was my next question. Any targets, but we’ll hear that at our Analyst Day, of course, Okay. Thank you.
Great. And Gary, you’ve talked about how you kind of pulled back on the cloud. You mentioned that was a focus when you came in and you realize, well, the focus should be elsewhere selling solutions as opposed to the cloud. It sounds like that was the real.
Gary Steele
I think we were forcing customers to the cloud when they were ready to go to the cloud. And I think one of the things that we fundamentally believe is that the TCO and the opportunity around the cloud is phenomenal. But customers will get there. It’s just getting there on their time frame versus our time frame. And I believe that all of our larger customers will all have a multi-cloud hybrid environment. And one of the things that will continue to differentiate Splunk is our ability to operate across that broad complex environment. I think it will be a strategic advantage for us.
Bradley Sills
And what does that mean? I mean, for hybrid cloud, how do you manage hybrid cloud for some of these larger accounts?
Gary Steele
Yeah. It’s super simple. You have the ability then to run Splunk across those different environments. You have the ability to do queries and data analytics across the environment and do it in a seamless way is because it’s more and more of an issue when you think about things like data privacy rules. So you might need to stand up Splunk environment in another country, but in a stock, you want to have a single view of what’s going on. You can do that through our federated search capabilities with this long. It’s actually very cool. And I think it really speaks to the flexibility that we need to deliver our customers to get the capabilities that they need.
So we think this ability to run on-prem as well as cloud will be a long-term, very important strategic differentiator.
Bradley Sills
That’s — and it seems like you’ve kind of retrenched to security. That’s, I think, in the past, 75% of the retrans — I mean we got focused the better way. Was that — I mean is that the way to think about it?
Gary Steele
I mean, I think the main thing to IT at some point is —
Bradley Sills
Something that we should expect or observability become — those to become more of an emphasis.
Gary Steele
I think what we did was as follows, we were in this broad platform mode when I joined. And I felt like we had lost our focus on the security buyer and delivering value to that buyer and those practitioners. And so getting alignment ensure that we’re delivering value to that — those very important buyers was super important to me.
And if you look at broadly across Splunk, we’ve said consistently that over half of our business is security related. And the reason we’ve never given an exact number is we don’t have an exact number because people can use the Splunk platform in a lot of really interesting ways. And we can’t always tell exactly how it’s being used. But what’s really clear where we’ve had tremendous opportunity is entering account through security, building that relationship, showing the power of what you can do with Splunk and then typically slides and grows into the IT function, where they drive resilience in the IT function.
And then with this next generation of microservices, Kubernetes-based apps, having that broad visibility using metrics traces, synthetics, everything else you want to do extends our path into observability. But we typically land with security.
Bradley Sills
Okay. Wonderful. Maybe we could dive into observability a little bit. What is the state of the observability suite? Do you feel like you have the components now? There have been a number of acquisitions over the years. There’s been a lot of effort integrated. It’s integrated into the cloud offering. I understand. So how would you describe kind of the state of that suite today? And when do you think it hasn’t happened already, you go more materially after that in the go to market?
Gary Steele
Yeah. I think a couple of things. One is we feel really good about the capabilities and for us to deliver at scale observability that large customers need. So being able to do full fidelity, no tracing, do it at scale, large apps, lots of data ingestion, we will differentiate ourselves every day at the high end of the market. And so we feel very good about the core capabilities.
We’re continuing to show progress on the level of integration that we have between the durability Cloud at our core, that’s getting better every single day, and that’s the feedback we’re getting from customers. So we feel very good about the trajectory and our ability to go more broadly after this market.
As we went into our sales kickoff this year and the focus on use case selling, observability was a big part of that. And I think that’s why we’ve seen some early nice big strategic wins as a result.
Bradley Sills
Wonderful. Great. Thank you. Why don’t we see if there are any questions from the audience? If you have a question, please feel free to raise your hand. We’ll get a mic over to you. Hamza, Nancy. Why don’t we start with Hamza and we’ll go to Nancy, please? Right in the front here.
Unidentified Analyst
Everyone’s talking about AI, obviously. Can you just talk to us about how you foresee yourself on integrating that into the business?
Gary Steele
Sure. And we talked a little bit about this in our prepared remarks and our earnings call week and half ago. First and foremost, we’ve been doing a lot of work in AI field for a long time, but we’re continuing to extend and accelerate that now.
So first and foremost, there’s a — it’s called an SPL assistant. So SPL is our search language that allows you to data analytics on our platform. We released this assistant based on a model a year ago roughly. And so we’re now updating that and seeing some real progress there based on the knowledge and learnings that we’ve had working with customers.
And so what does that do? Ultimately, it really lowers the barrier to get great outcomes from Splunk. So enter in English language, what you’re trying to do and the actual code of what you want to do gets generated automatically. That’s — and that’s something that we think really extends the reach of where we can deliver value. So that’s first and foremost.
Two is machine learning has been a core part of platform for a long time. We released a machine learning toolkit in 2017. It’s been downloaded, I don’t know, over 200,000 times. And so we see tremendous opportunity broadly in ML in areas like anomaly detection. So how can we find anomalies from a security perspective more effectively? But we think there’s tremendous opportunity to extend that into the automation work we’re doing for the SOC, the automation work that we do broadly in Ali. So how do you automate run books and those kinds of things? And we’re early in this journey, but we feel really good about it.
Bradley Sills
Great. Thank you. Nancy, please.
Unidentified Analyst
[Indiscernible] day on what your customers will really need from their systems to extract a lot of that quantifiable value above and beyond the initial productivity issues of time is money, right? What do you think that journey looks like, right? Because you have a lot of data. Companies have always said, if we could just use it smarter. What are the steps and sort of time frame do you think it will be — you cited a couple of things that you see within your own shop that you’ll start to benefit from. But what do you think the journey will look like for corporate America in terms of if we invest in this, we are going to get a return went that?
Gary Steele
Yeah, for sure. So I think let’s talk about it in terms of personas and buyers because I think it’s an easier way to think about the problem and not be quite so generic. So I think in the security world, the opportunity for us is to provide better, faster detections because we can leverage this broad data set to do really interesting ML. And I think you will start to see — you’ll see those benefits even within the next year.
But what does that mean in terms of people, et cetera, it just gets easier and requires less team for — to work the SOC.
So detections, automation, a lot of manual stuff gets done today in the security world. It’s super manual. That will get better and better and better. And so the number of people and the efficiency that you see in the stock continues to improve.
I think those are the biggest opportunities, and you see those, I think, this year, next year, the following year. This is not like we’re going to wait for some magic to happen because you can increment your way there. In the observability world, the opportunity there because Corporate America is not there today, is the ability to identify problems before they happen and take action before they happen.
We’re in this, what happened? How long is it going to take to figure it out? Like that has to change dramatically. And that’s a — it’s a combination of people, so less people required. And ultimately more customer service value because these things are down. I mean, it’s pendant, you’ve got something down and so your customers can interact. It’s costing you. It’s top line benefit.
And so I think you will see that business disruption shrink, which has tremendous top line value. And I think that’s more, I don’t know. It’s probably 24 months-ish in that time frame, but it’s not 5 years. These are reasonably short-term windows.
So I think you get top line benefit, I think the only negative that people need to think about is threat actors now have more sophisticated to those to use as well. Yeah. And they’re going to be good at it. And so it’s going to it ultimately, I think, will continue to force corporations to think about their security spend. They’re not going to be reducing their security spend because it’s going to be harder.
Bradley Sills
Makes sense. Well, we’re out of time, guys. Thank you so much again.
Gary Steele
Thank you. Appreciate it.
Brian Roberts
Thank you.
