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 theSecurities and Exchange Commission . Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "predict," "intend," "may," "might," "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, operating margins, gross margins, operating income and the proportion of transactions that will be recognized ratably; •the effects of the macroeconomic environment and the novel coronavirus ("COVID-19") pandemic on our business and operations and those of our customers, including impacts on information technology and cybersecurity spending; •market opportunity; •expected benefits to customers and potential customers of our offerings and our user-driven network; •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; •leadership changes and workforce attrition; •our ability to provide compelling, uninterrupted and secure cloud services to our customers; •expectations about competition; 24
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•economic and industry trends or trend analysis; •the impact of geopolitical events, including the war inUkraine ; •our acquisitions, including the expected impacts of such acquisitions; •expectations about seasonality; •revenue mix; •expected impact of changes in accounting pronouncements and other financial and non financial reporting 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 climate change, natural disasters and actual or threatened public health emergencies. 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 solutions that use data from digital systems to help organizations identify opportunities for optimization and innovation and keep those systems secure and performing effectively. This class of 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 and actions that improve technology and business outcomes. Our solutions for Security and Observability empower users in technology roles, including Development Operations ("DevOps"), IT Operations ("ITOps"), and cyber security, to monitor and secure digital systems more quickly and efficiently. Business users leverage our offerings to gain visibility into their digital processes to deliver better experiences, improve decisions and drive better results. 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 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 technology continue to grow. The COVID-19 pandemic significantly increased the importance of being a digital, data-driven organization and we believe the importance of data-driven innovation will only continue to increase over time. The pandemic accelerated the adoption of new ways to work and exerted an enormous amount of pressure on organizations of all kinds to deliver better experiences and outcomes, and to enable entirely new offerings and business models. We believe this global shift in the business environment and the related challenges are here to stay and that Splunk enables organizations to rise to these challenges by leveraging technology to achieve greater efficiency, agility, security, and drive a sustained competitive advantage. When organizations use Splunk to improve their security postures and build resilience, they are able to innovate more effectively.
We typically base our cloud services annual subscription fees on either the volume of data indexed per day including a fixed amount of data storage, or purchased infrastructure, data storage and bandwidth our customers require to support the
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underlying workload. We are seeing an increasing share of our business being based on workload pricing. We recognize the revenues associated with our cloud services ratably over the associated subscription term. For our license 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, our operating margins and revenue as an increasing percentage of our sales becomes recognized ratably. Our shift to a cloud services delivery model is dependent on customer choice. As a result, the pace of the shift may fluctuate and the mix of cloud services and license revenue may continue to vary from quarter to quarter. Therefore, 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 an annual billings 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 inthe United States and internationally. We have utilized and expect to continue to engage in acquisitions to contribute to our long-term growth objectives. Additionally, we expect to continue to make investments in private companies with complementary technology and business models with the objective of establishing longer-term strategic relationships.
Impact of Current Economic Conditions and the COVID-19 Pandemic on our Business
Prolonged world-wide economic uncertainties or downturns could adversely affect our business operations or financial results, including financial and credit market fluctuations, changes in economic policy, increased inflation and responsive actions, rising interest rates, labor shortages, supply chain disruptions, trade uncertainty, changes in tariffs, sanctions, international treaties, other trade restrictions, natural disasters, outbreaks of pandemic diseases such as COVID-19, political unrest and social strife, acts of terrorism, armed conflicts, such as the war inUkraine , and other global conflicts or other impacts from the macroeconomic environment. These macroeconomic conditions have caused and could continue to cause a decrease in corporate spending on enterprise software in general and negatively affect the rate of growth of our business. Toward the end of the second quarter, and continuing through the third quarter of fiscal 2023, we saw changes in customer buying patterns due to the uncertain macroeconomic environment, including a slower pace of expansions and migrations to cloud services, and longer sales cycles. Additionally, certain customers have entered into shorter duration contracts than expected. We will continue to closely monitor the macroeconomic environment and its effects on our business and on global economic activity, including customer spending on information technology. The COVID-19 pandemic continues to affect how we and our customers and partners are operating our businesses, including due to supply chain disruptions and financial market fluctuations, and the duration and extent to which this will have long-term impacts on our business, results of operations and cash flows is uncertain. We continue to focus on helping our employees, customers, and communities while preparing for the future and the long-term success of our business. We currently allow many of our employees to continue to work remotely if they prefer and we will continue to evaluate our workforce strategies and operations, taking into consideration factors such as treatments, vaccine progress, and public health recommendations. We also continue to evaluate our real estate needs and have in the past made the decision to exit certain office space leases. As we continue to assess our needs, we may decide to exit additional office space leases which could result in further changes to 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 macroeconomic environment and the ongoing COVID-19 pandemic on our business. 26
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Key Business Metrics
We use certain key financial and operating metrics to evaluate our performance and monitor the growth of our business as we continue to shift to a cloud services delivery 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 cloud services delivery 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 underU.S. GAAP on an annualized basis, as it is an operating metric that can be impacted by contract start and end dates and renewal rates. ARR is not intended to be a replacement for forecasts of revenue.
The following presents our Cloud ARR and Total ARR (in millions):
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Number of Customers with ARR Greater than
We monitor the number of customers with Cloud ARR greater than$1 million and Total ARR greater than$1 million at the end of a reporting period. An increase in this metric is an indicator of our ability to attract and scale with large enterprise customers who may have a broader array of use cases that align with the Splunk platform. The following presents the number of our customers with Cloud ARR greater than$1 million and Total ARR greater than$1 million:
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Dollar-Based Net Retention Rate
We quantify our net expansion across existing cloud customers through our cloud dollar-based net retention rate ("Cloud DBNRR"). We calculate Cloud DBNRR by dividing the Cloud ARR at the end of a period ("Cloud Current Period ARR") by the Cloud ARR of the same group of customers at the beginning of that 12-month period. Cloud Current Period ARR includes existing customer renewals and expansion, is net of existing customer contraction and churn, and excludes new customers. For the trailing 12-month Cloud DBNRR, we take the dollar-weighted average of the Cloud DBNRR over the trailing 12 months. The following presents our trailing 12-month Cloud DBNRR:
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Free Cash Flow
Splunk considers free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated or used by the business. Free cash flow represents operating cash flow less purchases of property and equipment and capitalized software development costs. The following presents our free cash flow (in millions):
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Below is a calculation of free cash flow:
Nine Months Ended October 31, (In thousands) 2022 2021 Net cash provided by (used in) operating activities$ 173,642 $ (4,641) Less purchases of property and equipment (9,229) (9,830) Less capitalized software development costs (5,806) (5,843) Free cash flow$ 158,607 $ (20,314)
Remaining Performance Obligations ("RPO") Bookings
RPO Bookings is an indicator of overall bookings momentum. We calculate total RPO Bookings as total revenue plus the change in total RPO. Total RPO is separately disclosed in Note 9 "Revenues, Accounts Receivable, Deferred Revenue and 28
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Remaining Performance Obligations" of our accompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q. The following presents our total RPO Bookings (in millions):
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Below is a calculation of total RPO Bookings:
Nine Months Ended October 31, (In thousands) 2022 2021 Total revenues$ 2,402,603 $ 1,772,545 Change in RPO (17,771) 79,866 Total RPO Bookings$ 2,384,832 $ 1,852,411 29
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Three Months Ended
[[Image Removed: splk-20221031_g9.jpg]] [[Image Removed: splk-20221031_g10.jpg]] [[Image Removed: splk-20221031_g11.jpg]] [[Image Removed: splk-20221031_g12.jpg]] 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 ofOctober 31, 2022 , our offerings have been deployed by over 90 of the Fortune 100 companies. 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 2023 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 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. Although the aforementioned seasonal factors are common in the technology industry, historical patterns should not be considered a reliable indicator of our future sales activity or performance. 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. 30
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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 primarily consist of revenues from term 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. 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. Maintenance revenues as a percentage of total revenues were 13% and 18% for the three months endedOctober 31, 2022 and 2021, respectively. Maintenance revenues as a percentage of total revenues were 14% and 20% for the nine months endedOctober 31, 2022 and 2021, respectively. •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, 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 31
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costs for compensation of our IT personnel, costs associated with our IT infrastructure and software subscriptions. Operating expenses are generally recognized as incurred. We generally expect revenue growth to outpace spending in the following categories. Accordingly, we expect the decline in expenses as a percentage of revenue to continue. 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 the 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)
Our income tax provision (benefit) consists of federal, state and foreign income taxes. Because of our history ofU.S. operating losses, we have established a full valuation allowance on ourU.S. deferred tax assets. We regularly assess the need for the valuation allowance. If we determine that an adjustment is needed, we will record the necessary adjustment in the period that the determination is made. 32
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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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