SPLUNK INC. The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our condensed consolidated
financial statements and related notes appearing elsewhere in this Quarterly
Report on Form 10-Q. 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" included in Part II, Item 1A or in other parts of this report and our
other filings with the
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Table of Contents "plan," "project," "potential," "seek," "should," "target," "will," "would" and similar expressions or variations intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements concerning the following:
•our future financial and operating results; including trends in and expectations regarding revenues, annual recurring revenue, deferred revenue, remaining performance obligations, gross margins, operating income and the proportion of transactions that will be recognized ratably; •our acquisitions, including the expected benefits of such acquisitions; •the effects of the COVID-19 pandemic on our business and our operations; •market opportunity; •expected benefits to customers and potential customers of our offerings and our user-driven ecosystem; •investment strategy, business strategy and growth strategy, including our business model transition and the use of acquisitions to expand our business; •our sales and marketing strategy, including our international sales and channel partner strategy; •customer product adoption and purchasing patterns, including renewal, expansion and conversion from on-premises to cloud services; •management's plans, beliefs and objectives for future operations; •our ability to provide compelling, uninterrupted and secure cloud services to our customers; •expectations about competition; •economic and industry trends or trend analysis; •expectations about the benefits of acquisitions; •expectations about seasonality; •revenue mix; •expected impact of changes in accounting rules or standards; •operating expenses, including changes in research and development, sales and marketing, facilities and general and administrative expenses; •sufficiency of cash to meet cash needs for at least the next 12 months; •exposure to interest rate changes; •inflation; •anticipated income tax rates, tax estimates and tax standards; •capital expenditures, cash flows and liquidity; and •the impact of natural disasters and actual or threatened public health emergencies, such as COVID-19.
These statements represent the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included under Part II, Item 1A. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report.
Amounts reported in millions are rounded based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. In addition, percentages presented are calculated from the underlying numbers in thousands and may not add to their respective totals due to rounding.
Overview
Splunk provides innovative cloud and software offerings that deliver and operationalize insights from data generated by digital systems. This data is growing significantly as a direct result of the prevalence and importance of digital systems used by today's organizations. Decades of investment in digital transformation have integrated the hardware and software that comprise digital systems into every aspect of how modern organizations operate. The data generated by these systems contains a comprehensive, real-time record of operations, interactions, and transactions that our offerings convert into insights that improve technology and business outcomes. Our solutions for Security, Information Technology ("IT") Operations, and Observability empower users in technology roles, including application development, IT operations, and cyber security, to monitor and secure digital systems more quickly and efficiently. Business users leverage our offerings to gain visibility to their digital processes in order to deliver better experiences, improve decisions and drive better results in areas including supply chain, inbound and outbound logistics, manufacturing, sales, and service.
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Table of Contents Our offerings provide visibility to our customers' diverse technology infrastructure including systems deployed on the edge, on premises, and in private and public cloud environments, running software ranging from embedded through monolithic apps to cloud native ones. We also believe our offerings empower operational transformation, helping customers move from reactive, non-scalable and ineffective approaches to proactive, automated, and AI-assisted processes that drive better outcomes even as the scale and complexity of their infrastructures continue to grow.
The COVID-19 pandemic has illustrated and significantly increased the importance of being a digital, data-driven enterprise. The pandemic continues to exert pressure on organizations of all kinds to support new ways of working, to deliver better experiences and outcomes, and to enable new offerings and business models. We believe that Splunk enables organizations to rise to these challenges by leveraging technology to achieve greater efficiency, agility, security, and drive a sustained competitive advantage.
We typically base our cloud services annual subscription fees on the volume of data indexed per day including a fixed amount of data storage or purchased infrastructure and data storage our customers require to support the underlying workload. We are seeing an increasing number of customers shift to workload-based pricing. We recognize the revenues associated with our cloud services ratably over the associated subscription term. For our software offerings, we typically base the license fees on either the estimated daily data indexing capacity or the compute power consumed to support our customers' workload and we generally recognize the license fee portion of these arrangements upfront. As a result, the timing of when we enter into large license contracts may lead to fluctuations in our revenues and operating results because our expenses are largely fixed in the short-term.
Our revenue mix has shifted from sales of licenses to the delivery of cloud services and we expect it will continue to shift in favor of cloud services. Our transition to a predominantly cloud services delivery model has impacted, and it will continue to impact the timing of our recognition of revenue as an increasing percentage of our sales becomes recognized ratably, as well as our operating margins as cloud services become a larger percentage of our sales. Our shift to a subscription model is dependent on customer choice and our ability to predict our revenue and margins in any particular period has been, and may continue to be, limited. We have also shifted from generally invoicing our multi-year contracts upfront to invoicing on an annual basis. Accordingly, we have seen the timing of our cash collections extend over a longer period of time with the transition to a subscription model than it has historically.
We intend to continue investing for long-term growth. We have invested and
intend to continue to invest in product development to deliver additional
features and performance enhancements, deployment models and solutions that can
address new end markets. We expect to continue to expand our sales and marketing
organizations to market and sell our offerings both in
We have utilized and expect to continue to engage in acquisitions to contribute
to our long-term growth objectives. During fiscal 2021, we acquired companies
that expand our observability capabilities, including companies that offer
auto-instrumentation, real user monitoring, application performance monitoring,
advanced synthetic monitoring, web optimization and network performance
monitoring. During fiscal 2022, we have continued to invest in our long-term
growth including through our acquisition of
Impact of COVID-19 on our Business
The ongoing COVID-19 pandemic has created significant global economic uncertainty, adversely impacted the business of some of our customers, partners and vendors, and has impacted our business and results of operations in the past and could further impact our results of operations and our cash flows in the future.
COVID-19 has continued to impact, and could further impact, our business and
that of our customers as a result of quarantines, various local, state and
federal government public health orders, and other restrictions. For example, we
are monitoring office use in the global offices we have selected to re-open,
allowing all of our employees to continue to work remotely if they prefer,
allowing our employees to elect not to travel, implementing in-person, onsite
and travel safety protocols, and we have shifted certain of our customer-focused
and corporate events to online-only or hybrid experiences. These operational
changes could extend into future quarters. The long-term impact of COVID-19 on
our operational and financial performance will depend on certain developments,
including the duration, spread, and severity of the virus and its variants, as
well as the efficacy of vaccines and vaccine distribution, the response of our
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Table of Contents model, the effect of COVID-19 may not be fully reflected in our results of operations and overall financial performance until future periods.
As additional COVID-19 variants emerge, and the development, distribution and public acceptance of treatments and vaccines progress and public health recommendations change, we continue to evaluate and refine our return to work and distributed workforce strategies. We also continue to evaluate our real estate needs. We have in the past made the decision to exit certain office space leases and as we continue to assess how and to what extent our employees will gradually return to work in our offices, we may decide to exit additional office space leases which could result in further losses associated with our real estate lease assets.
See Part II, Item 1A. "Risk Factors" in this Form 10-Q for further discussion of the impact and possible future impacts of the COVID-19 pandemic on our business.
Key Business Metrics
We use certain key financial and operating metrics to evaluate our performance and monitor the growth of our recurring revenue as we continue to shift to a subscription model.
Annual Recurring Revenue
We use cloud annual recurring revenue ("Cloud ARR") and total annual recurring
revenue ("Total ARR") to identify the annual recurring value of customer
contracts at the end of a reporting period and to monitor the growth of our
recurring business as we continue to shift to a subscription model. Cloud ARR
represents the annualized revenue run-rate of active cloud services contracts at
the end of a reporting period. Total ARR represents the annualized revenue
run-rate of active cloud services, term license and maintenance contracts at the
end of a reporting period. Each contract is annualized by dividing the contract
value by the number of days in the contract term and then multiplying by 365.
ARR should be viewed independently of revenue, and does not represent our
revenue under
The following presents our Cloud ARR and Total ARR (in millions):
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Table of Contents
Number of Customers with ARR Greater than
We monitor the number of customers with Cloud ARR and Total ARR greater than
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Dollar-Based Net Retention Rate
We quantify our net expansion across existing cloud customers through our cloud dollar-based net retention rate ("Cloud DBNRR"). We calculate Cloud DBNRR by dividing the Total ARR from our cloud customer base at the end of a period ("Cloud Current Period ARR") by the ARR of the same group of customers at the beginning of that 12-month period. Cloud Current Period ARR includes existing customer renewals and expansion, is net of existing customer contraction and churn, and excludes new customers. For the trailing 12-month Cloud DBNRR, we take the dollar-weighted average of the Cloud DBNRR over the trailing 12 months. The following presents our trailing 12-month Cloud DBNRR:
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Table of Contents Financial Summary (Dollars in millions)
Three Months Ended
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Our customer base spans numerous industry verticals, including cloud and online
services, education, financial services, government, healthcare/pharmaceuticals,
industrials/manufacturing, media/entertainment, retail/ecommerce, technology and
telecommunications, among others. As of
Our quarterly results reflect seasonality in the sale of our offerings. Historically, a pattern of increased license sales in the fourth fiscal quarter as a result of industry buying patterns has positively impacted sales activity in that period, which can result in lower sequential revenue in the first fiscal quarter. We expect some of this seasonality to continue in fiscal 2022 and beyond as license sales activity continues, however we expect the impact of this seasonality to decrease over time as a higher percentage of our revenues come from cloud services. As we continue to expect seasonally higher bookings and billings in the fiscal fourth quarter, with more of our revenue being recognized ratably there will also be a seasonal impact on our remaining performance obligations and deferred revenue. Our gross margins and operating losses have been affected by these historical trends because the majority of our expenses are relatively fixed in the short term. The timing of revenues in relation to our expense activity, which generally does not correlate directly with revenues, has an impact on cost of revenues, research and development expense, sales and marketing expense and general and administrative expense as a percentage of revenues in each fiscal quarter during the year. The majority of our expenses are personnel-related and include salaries, stock-based compensation, benefits and incentive-based compensation plan expenses. As a result, we have not experienced significant seasonal fluctuations in the timing of expenses from period to period. Although these seasonal factors are common in the technology industry, historical patterns should not be considered a reliable indicator of our future sales activity or performance.
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Table of Contents Components of Operating Results
Revenues
Cloud services revenues. Cloud services allow customers to use hosted software over the contract period without taking possession of the software. We recognize the revenues associated with our cloud services ratably, over the associated subscription term.
License revenues. License revenues consist of revenues from term licenses, and to a much lesser extent perpetual licenses, under which we generally recognize the license fee portion of the arrangement upfront, assuming all revenue recognition criteria are satisfied. License revenues reflect the revenues recognized from sales of licenses to new customers and additional licenses to existing customers, including sales from the renewal of term licenses. Seasonal trends that contribute to increased sales activity in the fourth fiscal quarter often result in lower sequential revenues in the first fiscal quarter, and we expect this trend to continue.
Maintenance and services revenues. Maintenance and services revenues consist of revenues from maintenance agreements and professional services and training.
•Maintenance revenues. When a term license is purchased, maintenance is bundled
with the license for the term of the license period. While we only sell
perpetual licenses on an exception basis, for any existing perpetual license
customers, maintenance is usually renewed on an annual basis. Customers with
maintenance agreements are entitled to receive support and unspecified upgrades
and enhancements when and if they become available during the maintenance
period. We recognize the revenues associated with maintenance agreements
ratably, on a straight-line basis, over the associated maintenance period.
Revenue related to maintenance of licenses as a percentage of total revenues
were 18% and 22% for the three months ended
•Professional services and training revenues. We have a professional services organization focused on helping our customers deploy our software in highly complex operational environments and train their personnel. Training and professional services have stated billing rates per service hour or are provided on a subscription basis, accordingly, revenues are recognized as services are delivered or ratably over the subscription period. We have experienced continued growth in our professional services revenues primarily due to the deployment of our software with some customers that have large, highly complex IT environments.
Cost of Revenues
Cost of cloud services revenues. Cost of cloud services revenues includes salaries, benefits, stock-based compensation and related expenses such as employer taxes for our cloud services organization, allocated overhead for depreciation of equipment, facilities and IT, amortization of acquired intangible assets and third-party hosting fees. We recognize expenses related to our cloud services organizations as they are incurred.
Cost of license revenues. Cost of license revenues includes all direct costs to deliver our products, including salaries, benefits, stock-based compensation and related expenses such as employer taxes, allocated overhead for facilities and IT and amortization of acquired intangible assets. We recognize these expenses as they are incurred.
Cost of maintenance and services revenues. Cost of maintenance and services revenues includes salaries, benefits, stock-based compensation and related expenses such as employer taxes for our maintenance and services organizations, third-party consulting services and allocated overhead for depreciation of equipment, facilities and IT. We recognize expenses related to our maintenance and services organizations as they are incurred.
Operating Expenses
Our operating expenses are classified into three categories: research and development, sales and marketing and general and administrative. For each category, the largest component is personnel costs, which include salaries, employee benefit costs,
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Table of Contents bonuses, commissions as applicable, stock-based compensation and related expenses such as employer taxes. Operating expenses also include allocated overhead costs for depreciation of equipment, facilities and IT. Allocated costs for facilities include costs for compensation of our facilities personnel, leasehold improvements and rent. Our allocated costs for IT include costs for compensation of our IT personnel, costs associated with our IT infrastructure and software subscriptions. Operating expenses are generally recognized as incurred.
Research and development. Research and development expenses primarily consist of personnel and facility-related costs attributable to our research and development personnel. We have devoted our product development efforts primarily to enhancing the functionality and expanding the capabilities of our software and services. We expect that our research and development expenses will continue to increase, in absolute dollars, as we increase our research and development headcount to further strengthen and enhance our software and services and invest in the development of our solutions and apps.
Sales and marketing. Sales and marketing expenses primarily consist of personnel and facility-related costs for our sales, marketing and business development personnel, commissions earned by our sales personnel, and the cost of marketing and business development programs, including advertising programs to promote our brand and awareness, demand generating activities and customer events. We expect that sales and marketing expenses will continue to increase, in absolute dollars, as we continue to hire additional personnel and invest in marketing programs.
General and administrative. General and administrative expenses primarily consist of personnel and facility-related costs for our executive, finance, legal, human resources and administrative personnel; our legal, accounting and other professional services fees; and other corporate expenses. We anticipate continuing to incur additional expenses due to growing our operations, including higher legal, corporate insurance and accounting-related expenses.
Interest and Other Income (Expense), Net
Interest and other income (expense), net consists primarily of interest expense related to our convertible senior notes, gain on extinguishment of convertible senior notes, foreign exchange gains and losses, interest income on our investments and cash and cash equivalents balances and changes in the fair value of forward exchange contracts.
Income Tax Provision (Benefit)
The income tax provision (benefit) consists of federal, state and foreign income
taxes. We recognize deferred tax assets and liabilities for the expected tax
consequences of temporary differences between the tax basis of assets and
liabilities and their reported amounts using enacted tax rates in effect for the
year in which we expect the differences to reverse. To the extent that we
believe any amounts are not more-likely-than-not to be realized, we record a
valuation allowance to reduce the deferred income tax assets. Because of our
history of
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Table of Contents Results of Operations
The following table sets forth our results of operations for the periods presented and as a percentage of our total revenues for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.
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