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Edited Transcript of SPLK earnings conference call or presentation 29-Nov-18 9:30pm GMT

Q3 2019 Splunk Inc Earnings Call

San Francisco Dec 18, 2018 (Thomson StreetEvents) -- Edited Transcript of Splunk Inc earnings conference call or presentation Thursday, November 29, 2018 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David F. Conte

Splunk Inc. - Senior VP & CFO

* Douglas Merritt

Splunk Inc. - CEO, President and Director

* Ken Tinsley

Splunk Inc. - Head of IR

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Conference Call Participants

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* Fatima Aslam Boolani

UBS Investment Bank, Research Division - Associate Director and Equity Research Associate Technology-Software

* John Stephen DiFucci

Jefferies LLC, Research Division - Equity Analyst

* Kasthuri Gopalan Rangan

BofA Merrill Lynch, Research Division - MD and Head of Software

* Keith Frances Bachman

BMO Capital Markets Equity Research - MD & Senior Research Analyst

* Michael Turits

Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst

* Philip Alan Winslow

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Raimo Lenschow

Barclays Bank PLC, Research Division - MD & Analyst

* Steven Richard Koenig

Wedbush Securities Inc., Research Division - SVP of Equity Research

* Walter H Pritchard

Citigroup Inc, Research Division - MD and U.S. Software Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Splunk Inc. Third Quarter 2019 Financial Results. (Operator Instructions) And as a reminder, this conference is being recorded.

Now it's my pleasure to turn the call to the Corporate Treasurer and Vice President of Investor Relations, Mr. Ken Tinsley.

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Ken Tinsley, Splunk Inc. - Head of IR [2]

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Excellent. Thank you, Carmen. Appreciate that, and good afternoon, everyone. With me on the call today are Doug Merritt and Dave Conte.

After the close of market today, we issued a press release with our Q3 results, and it's also posted on our website. This call is being broadcast live via webcast. And following the call, an audio replay will be available on the website as well.

On this call, we will be making forward-looking statements, including financial guidance and expectations, including our forecast for our fourth quarter and full years of fiscal 2019 and 2020; trends and expectations regarding innovation, partners, customers, markets, demand, strategies, revenue and bookings mix and predictability; and our expectations regarding our investments, products and technologies. These statements reflect our best judgment based on factors currently known to us, and actual events or results may differ materially. Please refer to documents we file with the SEC, including the Form 8-K filed with today's press release. Those documents contain risks and other factors that may cause our actual results to differ from those contained in our forward-looking statements. These forward-looking statements are being made as of today, and we disclaim any obligation to update or revise these statements. If this call is reviewed after today, the information presented during this call may not contain current or accurate information.

We will also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP and non-GAAP results is provided in the press release and on our website.

With that, let me turn it over to Doug.

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Douglas Merritt, Splunk Inc. - CEO, President and Director [3]

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Thank you, Ken. We drove fantastic results in Q3, thanks to strong execution in the field and the most exciting .conf in Splunk's history. We delivered $481 million in total revenue, up 40% over last year.

Our success comes from new and existing customers extending their adoption of Splunk as their platform for data analytics and machine learning, both on-prem and in the cloud.

At .conf18, we hosted nearly 10,000 people and shared our newest wave of product innovation. We announced updates to our existing products, including new versions of Splunk Enterprise and Splunk Cloud, with better performance, scale, machine learning and analytics abilities.

A few of the new capabilities include a machine learning toolkit connector for Apache Spark and a container for TensorFlow; Guided Data Onboarding to help customers move data into the platform; Splunk SmartStore, which allows compute and storage tiers to be independently scaled on business demands; Splunk on Docker to cover deployments in Docker containers; Metrics Workspace to monitor and analyze metrics data in an efficient, intuitive user interface; and the crowd favorite, Dark Mode, which is perfect for SOC and NOC environments.

We released Splunk for Industrial IoT, our first IoT solution, which provides a simple view of the complex industrial data environment to minimize downtime and shift operations from -- and shift our operations from reactive to proactive.

We announced the new release of Splunk IT Service Intelligence, or ITSI, to help customers better predict and prevent problems through a series of enhanced capabilities like KPI predictions and predictive cause analysis. And an entirely updated security suite with new versions of Splunk Enterprise Security or ES; User Behavior Analytics, or UBA; and Phantom.

We also announced an exciting new suite of beta capabilities, which we call Splunk Next. Splunk Next evolved from conversations with our customers who asked us to focus on 3 major areas: one, to work with their data wherever it lives; two, to further embed AI and ML in our platform to create action-driven outcomes; and three, to empower users across their organizations on any device. Splunk Next announcements, like our Data Stream Processor and Data Fabric Search, mean you can refine and adjust data as it moves across the stream and then search across multiple data stores in Splunk or elsewhere.

And additional capabilities like Business Flow, natural language processing and Splunk mobile can empower new users regardless of their technical skill set or physical location to investigate, monitor and act on their data no matter where it lives.

During the keynotes, we welcomed leaders in Starbucks and BMW who shared how they're using Splunk to make things happen in their organizations. And I was honored to be joined on stage by Arnold Donald, CEO of Carnival Corporation. He shared how Carnival creates meaningful guests interactions, both on and off their fleet of floating cities. Carnival relies on Splunk to monitor connectivity in the ships, monitor their mobile apps and keep their own and their guests' data safe. Ultimately, helping to provide a seamless digital experience.

Since our first product shipment, Splunk has taken a different approach to data. Unlike other data technologies, you do not have to know the questions you'll ask before you deploy our solutions. The magic of Splunk is that we embrace the complexity and chaos of an ever-changing data landscape and allow you to find insights from your data without the high entry cost of cleansing, parsing and structuring.

Our goal remains the same, to become the ubiquitous machine data platform, the standard in every organization, solving our customers' data challenges around IT operations and application delivery, security compliance and fraud as well as business analytics and the Internet of Things. These markets are going through a shift to an analytics and machine learning-based approach, where Splunk is uniquely poised to lead this change and deliver for our customers.

Transitioning to customer success in Q3, let's start with IT. Softbank purchased Splunk Cloud to speed up troubleshooting for mobile devices and application management. Softbank already uses us for IT and AIOps and expects Splunk Cloud to improve efficiency and performance across infrastructure and operations management.

ATB Financial, Alberta's largest homegrown financial institution, expanded their use of Splunk Cloud and brought on ITSI 1 year after their first Splunk investments. ATB Financial has been using Splunk Cloud to make their online activity data available across teams and will now use Splunk for mobile app monitoring and executive reporting.

Chicago Public Schools, one of the largest public school districts in the country, expanded their use of Splunk Cloud to help automate their Servicenow ticketing process, along with other IT monitoring and response workflows.

Moving to security. Longtime Splunk customer, Norfolk Southern, expanded their use of Splunk Enterprise and ES to better lead with an analytics-driven approach to security. With Splunk, they will use data to gain visibility into the threat environment at machine speed while also meeting compliance standards with positive train control, the federal safety mandate that controls trains to avoid accidents.

The Department of Home Affairs, which brings together Australia's federal law enforcement, national security and criminal justice-related functions and agencies, replaced its legacy SIEM with Splunk Enterprise. With Splunk, they can centralize security management on a single platform and better handle the big data scale of their security operations center.

Texas A&M University selected Splunk Enterprise as the foundation of their security operations strategy. The university chose Splunk for continuous threat analysis, monitoring and investigation as well as satisfying compliance requirements. A&M also plans to arm their cybersecurity researchers with Splunk's machine learning capabilities in order to develop and improve threat modeling to better detect advanced threats.

Highlighting a handful of customers who standardize on Splunk as a machine data platform. Randstad, a global leader in the HR services industry, bought Splunk Cloud, ITSI and ES to support their global IT infrastructure services. We will help Randstad extend the company's infrastructure monitoring across the business and leverage Splunk as a SIEM at the heart of their SOC. We would like to thanks our partner TCS for their support and collaboration in initiating this opportunity.

SendGrid has gone all in on Splunk, expanding Splunk Enterprise across their customer support, compliance, professional services and engineering teams. SendGrid uses Splunk to debug in DevOps, help their customer meet SLAs and keep their customer-facing platform online. Thanks to our partner Presidio Capital, who was instrumental in this transaction.

The Naval Postgraduate School is a new Splunk customer, purchasing Splunk Enterprise, ITSI and ES. The school plans to use ITSI to keep a wide range of mission-critical IT systems online while ES will sit at the heart of their new SOC.

And longtime customer, Clemson University, purchased Splunk Enterprise, ES, ITSI and UBA. Clemson uses Splunk to thwart cyber threats, monitor campus-wide IT and integrate into their campus platform to support student success.

We also saw a continued global adoption in our cloud business. A sampling of our cloud wins in the quarter include Teachers Mutual Bank, one of the largest in Australia, who is a new customer that bought Splunk Cloud and ES to optimize their security operations and improve their security posture. Teachers Mutual Bank expects we obtain end-to-end visibility, ensuring a safe environment to their customers' business.

New customer FLEETCOR Technologies bought Splunk Cloud to improve their security posture. Splunk was selected because we can support all of FLEETCOR's data sources and will augment their current SIEM. Thanks to new Splunk partner dataND, who supported this opportunity.

Personalized video marketing platform, SundaySky, moved to Splunk Cloud as their central platform to provide complete transparency into IT and business operations as well as for research and development use cases.

To highlight the impact that Splunk can provide on the IoT front, one of my favorite keynote presentations at .conf was Boulos El Asmar from BMW Group. BMW Group took us through their Splunk journey, starting with a small Splunk Enterprise license and just one security use case to now where BMW group is using Splunk to drive innovation across their business. BMW is using our machine learning toolkit to predict traffic dynamics as well as our natural language capabilities to help them speed time to value, allowing them to simply ask questions to Splunk via Alexa.

On the manufacturing side, Splunk Industrial Asset Intelligence helps plant floor engineers keep production up and running by correlating IoT data. Amsterdam's public transport operator, GVB, is a new Splunk customer purchasing Splunk Enterprise to support use cases in IoT, IT and business intelligence. GVB will be using Splunk to better monitor and act on their real-time passenger information services, providing users with a better, more efficient and well-informed public transportation experience. Big thanks to our partner at ditp for their support in this opportunity.

And it was another big quarter of customer focus innovation with AWS, and I'm just back from re:Invent. This week, we launched a new integration with AWS Security Hub and then added capability to query against CloudWatch log insights. We also released integrations this quarter with Web Application Firewall and Trumpet. This is in addition to our many other integrations, including the Splunk App for AWS.

In summary, we delivered a great Q3. This year's .conf was our biggest and best ever. As always, it's exciting to see so many of our customers and partners and to hear their enthusiastic feedback about Splunk's products and people. Customer success is our #1 company priority, and our efforts and investments are paying off. I'm looking forward to continuing this momentum.

Thanks again to all of our customers and partners, and thanks to everybody who works at Splunk.

And finally, I want to take a moment to congratulate you, Dave. As I'm sure you all saw, Dave has announced he's going to retire. Dave is staying onboard until March of 2020 as we initiate a search for his successor, and I appreciate he is going to stay and help with the transition. I can't overstate what Dave has done for Splunk. His leadership, accomplishments and the foundation he helped create will continue to serve us well. I speak for all of us at Splunk when I say that it has been an honor to work side by side with Dave over the years. Thank you so much. And now over to you, Dave.

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David F. Conte, Splunk Inc. - Senior VP & CFO [4]

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All right. Thanks, Doug, and I certainly appreciate those very kind words.

To open, I'm looking forward to reviewing our results following another very strong quarter for Q3, which is our largest ever, then providing an update for Q4, the full year and our outlook for our next fiscal year, fiscal '20.

Before I do, remember that almost 2 years ago, I set several important and material expectations for our multiyear business transformation from primarily a perpetual company to one that is mostly renewable, shifting our go-to-market strategy to drive 75% of our software sales to renewable by next year. I can tell you that our execution towards this goal has significantly exceeded the expectations we set in January of '17, and my confidence in delivering the $2 billion revenue milestone in fiscal '20 has never been higher.

When I retire, I'll have spent over 8 years with the company after completing this latest transition. Over the next several quarters, I'm really looking forward to helping the company extend its market leadership as the ubiquitous platform for our customers' data. Now back to our report.

Before I detail actual results and discuss guidance, I want to clarify 2 things regarding the strength and growth of our business. I've said that the best measure of our overall business momentum is software revenue, which is the combination of on-prem license and cloud revenues. When looking at the mix of transactions on-pre, there's both a tailwind from longer duration and a headwind from fewer perpetual contracts. When aggregating these, we estimate we'd recognize tailwinds of about $40 million for the last 9 months, i.e., year-to-date.

However, as we said, the strategic shift to renewable contracts includes delivering more of our software via the cloud, which we all know is recognized ratably. So obviously, this represents a headwind to overall revenue. Consistent with overachieving our makeshift a year early, it follows that we realize more cloud transactions than originally anticipated. Specifically, year-to-date, the growing contribution from cloud to total software sales has resulted in a headwind of about $43 million. So as we've said, we believe the shift in both mix and duration has a net neutral impact on total software revenue as they generally offset one another and are therefore not material.

To give you a sense to just how rapidly our cloud business is growing, the current ARR of cloud only is about $200 million, which is nearly double from a year ago. For simplicity, something we always strive for here, our outlook in fiscal '20 is based on a consistent mix and duration level that we're realizing in fiscal '19, and we expect any deltas resulting from head and tailwinds to be immaterial at this level of scale.

Now more on FY '20 in a minute. Let's move on to the current period results. Q3 total revenues were $481 million, a 40% increase over last year. Software revenues, again, the total of license and cloud, were up 49% from Q3 of last year, totaling $325 million. Cloud revenue was $45 million, up 87% over last year. Education and professional services represented 8% of total revenues. International operations contributed 24% of total Q3 revenues, and we added over 500 new customers and recorded 111 7-figure orders during the quarter.

Now turning to profitability and other results, which are all non-GAAP. Operating income was $65.4 million, representing a positive margin of 13.6%. Q3 overall gross margin was 85% comparable on a year-over-year basis. Net income was $57.6 million or $0.38 per share, using a weighted average share count of 153 million shares. Operating cash flow in Q3 was $59 million, while free cash flow was $52 million. And we ended the period with about $2.8 billion in cash and investments, reflecting the net proceeds of about $1.8 billion from our convertible debt offering we closed during the quarter.

Again, the best indicators of our business momentum are software revenues and also RPO. Recall that RPO includes backlog, so the total of revenues plus the change in RPO should provide a better estimate of in-period bookings than the traditional billings calculation. With that, we ended Q3 with total RPO of $950 million versus $602 million for Q3 of last year, up 58% and reflective of our bookings achievement thus far this year.

Okay, now turning to guidance. We expect Q4 revenues of approximately $560 million and non-GAAP operating margin of a positive 25% to 26%. For the full year, we are now expecting total revenues of approximately $1.74 billion, up from the $1.685 billion, and we are increasing our FY '19 non-GAAP op margin target to range between 11.5% and 12% positive.

For EPS purposes, since we expect to be non-GAAP profitable for Q4 and the full year, you should use fully diluted weighted average share counts of 155 million in Q4 and 152 million for the full year.

Looking forward to next year. The investments we're making in products and field continue to fuel our growth. We expect our momentum this year will translate into next year with FY '20 total revenues of $2.15 billion, exceeding the $2 billion expectation I set 2 years ago. Again and to be clear, this revenue target is based on a constant mix and duration assumption for software contracts as compared to this year with any deltas expected to be immaterial.

For your models, please remember that just as we saw this year, 606 caused us a steeper revenue ramp during the year than we've seen historically. As such, I expect total revenues in 2020, fiscal '20, will be weighted 40-60 first half to second half, with the largest seasonal impact visible in Q1.

In closing, Q3 execution was outstanding, and I expect a very strong finish to the year. I'm extremely proud of everything we've accomplished thus far, transitioning from $100 million private company to a public company, targeting well above $2 billion in total revenue. It's been terrific contributing for such a long time, and I've had the pleasure and honor to work with so many great people of the company and all of you on the call. I'd like to thank all the current and former Splunkers and especially all the folks in the finance team. I'm looking forward to the next year here and helping ensure we continue to deliver in fiscal '20 and well beyond.

On that note, thanks so much, and we'll open up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from John DiFucci with Jefferies.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [2]

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Dave, we appreciate the long runway you're giving your team here, but it truly has been a great pleasure working with you. It really has. So we're going to miss you, but it looks like we got you for a while still.

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David F. Conte, Splunk Inc. - Senior VP & CFO [3]

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Thanks, John. Yes, yes. Appreciate it.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [4]

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Yes. Listen, these results look really strong here. But as you guys know, there are some question over how much of that strength is because of ASC 606 and this is perhaps expanding duration of on-prem term license. So Dave, thanks for that $40 million of a tailwind over the first 3 quarters of the year. That's helpful. You can look at it 3 quarters over 3 quarters. Is there something you can give us though so -- I mean, I would -- and then currently you have [up to 9]. But could you tell what it was this quarter? Like it's $40 million over 3 quarters. It's probably not dividing by 3. Can you break it out per quarter and we could sort of make that adjustment?

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David F. Conte, Splunk Inc. - Senior VP & CFO [5]

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Yes. So John, thanks for the question. First, thanks for acknowledging that we quantified our estimate for the 9 months at $40 million in terms of a tailwind. But please don't forget I was explicit to point out that the shift to renewable includes the shift to ratable cloud, and that was about a $43 million headwind for the same period, okay?

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [6]

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Yes.

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David F. Conte, Splunk Inc. - Senior VP & CFO [7]

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Now in terms of quarter impact. Not dissimilar, and John, you've been with us since the IPO, and you know we talk about mix for so long. And it was really frustrating because it would jump up and down every 90 days, highly influenced by large transactions. And that remains to be the case today, which is why I think the best way to think about it is over not a 90-day period, but I've given you now a 9-month period. And then importantly, if you think about the size and scale of our business in fiscal '20 and you look comparably between fiscal '19 now $1.740 billion growing to $2.150 billion. Those -- our model has consistent assumptions between those 2 years for both duration and mix. So I think even if there are gyrations between the 2 categories, it's going to be immaterial at that level of scale.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [8]

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Okay, okay. Well, listen, this is something for us to chew on tonight. So that's helpful. If I might just ask one other quick question, and I think that Susan was working to carve out a commercial segment to focus on new customer adds, assuming smaller customers. And your customer adds have been pretty consistent at around 500 new ones a quarter over the last, geez, I don't know, probably a couple of years now.

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Douglas Merritt, Splunk Inc. - CEO, President and Director [9]

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Yes, for a while.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [10]

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Which is a nice number, right? It's 500 new customers. That's a nice number every quarter. But is there -- I was just curious. How is that going? And how should we look at that number? Should we expect that -- is, by her doing this, is it working and that's keeping the number at 500? Or should we expect that to increase? Or how should we be thinking about that?

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Douglas Merritt, Splunk Inc. - CEO, President and Director [11]

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Yes. Good question, John. So yes, she did -- we did institute a commercial segment this year and have been growing it throughout the year. I feel like that group is -- certainly in Americas is gaining a ton of traction, and I think it's performing well. And we have been investing in the other regions as well, and those are starting to stabilize. I think that's a helper to ensure that we at least maintain that 500. There's a whole list of other things that we're doing product-wise. A lot of those came through with the .conf announcement that will make it easier for the customers to onboard themselves and should appeal to lower end or net new customers. We're not including things like VictorOps into those numbers, which we probably are going -- should contemplate at some point in time given that, that's a core Splunk capability now. But when we set out that target 2 years ago, it was a 3-year target to get to 20,000 total customers. I feel like we're still well on track for that number and are continuing to free up investment on both the product and the field side so that we can bring the benefit of Splunk to every customer in the globe, not just the 18,000 to 20,000 that we've highlighted as the immediate targets.

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Operator [12]

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Our next question comes from Michael Turits with Raymond James.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [13]

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And of course, Dave, congrats on the relatively long-term outlook for retirement, retirement nevertheless.

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David F. Conte, Splunk Inc. - Senior VP & CFO [14]

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Thank you.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [15]

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So first one just for you. You gave us a sense for what the duration was last quarter, you said it was 33 for the first half. I was wondering if you could update us in terms of where we are now with this quarter and year-to-date. And also, what impact that extension and duration might have as we come into the renewal period a couple of years out since we're doing -- we're signing much longer deals now?

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David F. Conte, Splunk Inc. - Senior VP & CFO [16]

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Sure, Michael. Our year-to-date duration remains consistent for the year, which is about 33 months. And that's the blended duration between all of our renewable contracts, both on-prem term and our subscription cloud contracts. In terms of our outlook going forward. Again, when we were modeling and setting the objective to get to 75% renewable, we thought, of course, we're going to have a recurring stable of contracts that will come up for renewal. And as we've been accelerating towards that goal, we're seeing that group of contracts obviously grow beyond our original expectations based on really, really strong execution in the field. So when we model forward and we think about the foundation that, that provides from a model perspective, it's really strong and stronger than when we first set the objective originally. All that's great on the financial model side. But I think more important strategically, we've learned that it's by far the best way to enable our customers to deploy and adopt our solutions. And as Doug has said and we said a bunch of times, customer success is #1 for us. And everything that we do from the investment portfolio that we manage here is all focused on that as the prime directive. So having these kinds of contracts out in the market for our customers to leverage really puts them in great position to consume our products.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [17]

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Okay. And then, Doug, you made a couple of comments about IoT becoming a hotter and hotter area as there were a number of [missed] announcements by Amazon at re:Invent regarding the extension of their IoT platform. Can you talk a little bit more specifically about the investments you're making in IoT and like business, non-IT analytics in general and what we -- where that money is going and what we should expect in terms of strategy?

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Douglas Merritt, Splunk Inc. - CEO, President and Director [18]

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Yes. Absolutely. So the key IoT announcement that we made at .conf was the release of Industrial Asset Intelligence which is like other premium apps, Enterprise Security, ITSI, is a collection of dashboards, queries, alerts focused specifically on predictive maintenance in industrial shops. However, the biggest issue that we've talked about for a number of years on extending beyond the technical footprint within IT and cybersecurity is making it easier for less technical people to play with the data in Splunker. I really would say play with data period because it's an issue within the industry overall. But play with data within Splunk and then take actions on that data as well. And there were hosts of announcements we made at .conf to help lower that bar from our new mobile platform with an augmented reality and a future virtual reality framework that makes it far easier for people to visualize what's happening in the environment around them. The demo that [Jesse,] the leader of that product gave, was walking through manufacturing shop floor or a very complex data center and being able to visualize from every item within that floor how -- what its [health] looked like and then take proactive activity. We introduced a product called Business Flow, which represents the data within Splunk through a business journey or a process journey, I should say. That is, I think, a much more approachable interface for anyone that's involved in marketing, operations, manufacturing to see how their actual reality of their environment is performing. That was prompted by one of our customers to help them see customer interaction patterns and purchase behavior through the machine data. We introduced natural language processing as an application so that you can actually have a written or -- sorry, a verbal interaction with Splunk, and it automatically translates SPL queries. So we're attacking it from a multitude of angles so that we can continue to broaden or allow our customers to broaden from their more technical cyber and IT personnel.

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Operator [19]

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And our next question comes from the line of Raimo Lenschow with Barclays.

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Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [20]

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And Dave, congrats from me as well. Although I have to say I'm slightly confused because you've just done 606, and you're all kind of pretty much done with the subscription transition. And now you kind of ride off. You should have done it the other way around maybe. But the -- a question from me, Doug. You've been at AWS, and most of us were at re:Invent. Can you talk a little bit to what's the kind of changing nature of competition you see or potentially see from cloud, cloud-native vendors that are all popping up there, like there was a distinct kind of change in terms like how many guys are kind of doing similar things there. What are you seeing in the market on that one?

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Douglas Merritt, Splunk Inc. - CEO, President and Director [21]

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Yes. It's a -- the -- from a day in/day out basis, with Q3 is an example, we really haven't seen any change in competitive dynamics. We continue with really impressive win rates. I think we're -- we continue to work within accounts to allow them to understand the power that Splunk provides, and that winds up helping us a lot in the competitive landscape. The -- within AWS and the cloud vendors, those are really, really complex environments as we all just got to see through Andy Jassy's very impressive 3-hour keynote. So many different services and capabilities coming online all the time. Every one of those exuding a whole bunch of different data. And they've got different attempts within AWS to help capture that data so that AWS customers can make sense of it. We integrate with all those different services and their different data capture devices, whether it's CloudWatch, Kinesis Firehose, Lambda. There's a lot of different vehicles within AWS and within GCP and Azure that exists so that customers can see what's happening with that environment. And we were first to table with CloudWatch a couple of years ago to have our integration ready. We were right there with them with their latest announcement, integrating into the Insights [capability release of] CloudWatch as well as Security Hub. And so our focus and why that innovation agenda is so important at .conf and why we're pushing hard in the product front is to stay in front based on our customer needs and customer feedback and customer demand with different capabilities that are being released around us. And we all -- for most of our customers, we see them continue to operate in a heterogeneous environment. So we've got to stay on top of and be able to define additional value in an AWS environment, but we also got the added advantage of being able to live in and play with the on-prem scenario sets and the multi-cloud scenario sets that most of at least our customers and people that we talk to are dealing with in a day-in and a day-out basis.

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Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [22]

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Okay. Make sense. And then I might have missed it. But Dave, did you talk to what is kind of the mix on security and some of other use cases this quarter?

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David F. Conte, Splunk Inc. - Senior VP & CFO [23]

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Raimo, no, we didn't talk about it because it was uneventful and consistent with what we've been experiencing over the last handful of quarters. So yes.

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Operator [24]

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And our next question comes from Philip Winslow with Wells Fargo.

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Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [25]

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Also, Dave, best of luck to you. I know that the only reason you'd be leaving Splunk is maybe to pursue your true dream, which is General Manager of the Raiders.

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Douglas Merritt, Splunk Inc. - CEO, President and Director [26]

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And they could use Dave's help right now.

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Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [27]

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Maybe they can use Splunk, the machine learning plus machine data, anything right now. But seriously, though, congrats, Dave. It's been a great ride.

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David F. Conte, Splunk Inc. - Senior VP & CFO [28]

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Thanks a bunch. I appreciate it.

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Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [29]

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Yes. Two quick questions. One just a quick housekeeping item for you, Dave. You mentioned duration of 33 months for the 9 months this year. What was that metric for the 9 months last year? And then also just for the team, just a broader question on pricing and in particularly just larger deals, any update that you have on pricing and then particularly as you get to these larger deals that Doug highlighted on the call. It seems like you were talking about multiple different use cases here, way more data volume. How is that impacting the pricing conversation when you're talking about going down the pricing curve, using more and more use cases? How is that changing the conversation as the deal sizes do increase, the use cases within those deals increase?

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David F. Conte, Splunk Inc. - Senior VP & CFO [30]

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Yes. Hey, Phil, it's Dave. First as it relates to duration and the Raiders, let's just say unlike the Raiders, Splunk is leading the league in the offense. Putting up a lot of points on the scoreboard. So I'd love if the Raiders could replicate that. Duration again for the 9 months through this fiscal year was 33. The comparable 9-month period prior year was about 26. And then as it relates to pricing, Doug?

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Douglas Merritt, Splunk Inc. - CEO, President and Director [31]

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Yes. So my favorite initial lead-in for pricing is we know that folks are never happy with the price, but the one thing I hear from our customers is they're always happy with the value. And our issue with pricing, I think, has been and continues to be how do we provide predictability to our customers. I think we've done a better job over the past couple of years of making customers aware of the ability, the possibility of unlimited contracts and other buying vehicles that lock down their perspective on how much they're going to owe Splunk over a time period. I think probably the biggest impact over the past 9 months and this year has been that shift to term. Because now the customers can lock in a 3-year perspective of either consistent data usage or in many cases, escalating data usage. And it's a little bit easier to give them a little bit more than they might need without the permanent impact that you have on a perpetual contract as we had in the past. So I think some of that pricing noise is going down, and we're never done. We are always focused on trying to make it more transparent and easier for customers. And are -- we -- stay tuned for additional focus areas to help there. But the other piece that customers are also asking for, and ultimately, what they're looking at is a TCO compare. "How much does it cost me to get value from this data? And how quickly do I get that value?" And a chunk of that comes back down to infrastructure utilization. It's as much as people might want to focus on the software, in most cases, in virtually every case, their spend on infrastructure far exceeds their spend on software. And we have constantly been striving to lower that for them as well. The new Data Fabric Search that we demoed at .conf was literally a 1,500% plus increase in performance on what is considered today to be the #1 search performance product in the industry. So that is a way to dramatically get more efficiency from existing infrastructure. We also announced SmartStore, which is the splitting of compute and storage so that you can now elastically scale out compute when you've got a bunch of high correlation or compute-intensive jobs and/or independently scale out storage when you're ingesting a ton of data and might not be as aggressively querying those indices, which again has a very dramatic impact on TCO. So this pricing thing, we -- I've never heard a customer be happy with any price of any item out there that any of us consume as consumers or businesses. So it's always something that all of us have to wrestle with. And with Splunk, we're acutely aware of the feedback that we get from customers. And I think we're making a dent, and we'll continue to lean forward quarter after quarter to make it easier and more understandable for customers on what they will owe Splunk.

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Operator [32]

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And our next question comes from Kash Rangan with Bank of America Merrill Lynch.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [33]

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Well, I'll have a start at Dave. Dave, it's just the age. It's just the stage. We disengage. We turn the page, but you've always been grace under pressure.

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David F. Conte, Splunk Inc. - Senior VP & CFO [34]

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Well done, Kash. I was looking forward to that. Of course, grace under pressure is [my favorite] album, following the [people's] album. Awesome, thank you for the constant Rush reminder. Much appreciated.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [35]

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I also owe some of the contribution to a client who suggested a piece of this. So for the client, thank you. He is also a Rush fan, by the way. He knows that he is on the call. I just can't name him. Congratulations. This is spectacular. You guys are accelerating at scale while canceling out the headwinds versus the tailwinds. My question for you is, as you look at the use case mix, I mean, you're going to be a $2 billion revenue company. Clearly, the opportunity is there to grow this company to be much larger, $5 billion, $6 billion, $7 billion who knows. I mean, when you look at successful companies like Salesforce.com or Workday, they always had a second act, a third act or a fourth act. So how do we look at Splunk? I mean, is there going to be a fourth use case, a fifth use case, a sixth use case that could end up being a big hundred -- multi-hundred million dollar opportunity or billion dollar opportunity? Because it's hard to think of Splunk going from $2 billion to $6 billion, $7 billion while maintaining the same mix of use cases, such as security, operations or SIEM, if you will, and IT operations. There's got to be something, a third act, a fourth act. How do you envision the future for Splunk 4 to 5 years from now? That's it for me.

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Douglas Merritt, Splunk Inc. - CEO, President and Director [36]

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So first of all know, I know this is hard to believe that vision, how we get to $5 billion, $6 billion with security and IT. I honestly think we can get to $5 billion, $6 billion with security and IT. Now we do have lots of other plans, but I just wanted to pause there for a second. When I look at the installs that we have across our existing customer base and how broadly we are being used, what data sources we're adjusting across the security and IT set of use cases and how many -- how much utilization we have at ITSI and how many additional apps they've deployed that they've built themselves or they have downloaded from Splunkbase just within security and IT. We are a fraction of what is necessary for the vast, vast, vast majority of the customer base. So I'd say 95% of the customer base is still not getting the full analytics and monitoring, detection and investigation capability that they could or should just within security and IT. And that said, the power of Splunk, we talk about the -- a percentage of business every quarter where a sales rep has said they bought this solution for a security use case or an IT use case or a nonsecurity IT use case. We know that, that's just the beginning of the journey. And we've got -- if we're successful, they're implementing a whole host of use cases outside of IT and security. The IAI, Industrial Asset Intelligence, IAI, man, that's a tough one to -- acronym to spin out. It's -- we've been saying, we -- as we see patterns emerge, we'll start to either facilitate the ecosystem to release apps that we'll highlight or build these apps ourselves. And I think that, that was -- that and Business Flow are -- Business Flow being a little bit more of the business -- the line of business usage [paramater set] are the first 2 apps that we've released in the history of the company that are focused outside of IT and security. And we do believe at Splunk that there is a huge opportunity. And again, probably tens of thousands to hundreds of thousands of potential applications to cover the needs of the functional users across all of the industries and the different industrial use cases and more of the industrial IoT or IoT segment. So that -- a lot of the products investments we've been making and the underpinnings of what we announced at .conf from the Splunk developer platform or Splunk Developer Cloud, I should say, to a handful of these other releases, Business Flow, NLP, mobile, AR, TV. They are geared toward opening up those opportunities as well as continuing to expand the types of data that would flow through Splunk technology to power those use cases, like the data stream processor product that now allows us to monitor and wrangle and operate on data across the stream before it ever hits our index or any other data source. So there's both platform expansion we're doing on core capabilities as well as our own investments in use cases on top of that platform and encouragement of the ecosystem to build out different use cases in the platform as well.

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Operator [37]

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And our next question is from Keith Bachman with Bank of Montreal.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [38]

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And Dave, good luck. Thanks for giving us ample lead time for the transition. I did have a clarification and a question. First, a clarification to you, Dave. You mentioned that duration should be a neutral event, plus or minus some small noise in FY '20, call it 33 months. And so therefore, as analysts, I assumed that we'll see the mix between short-term and long-term DR remain relatively consistent as we think about FY '20. And then the question I'll throw out to the team is I wanted to go back to competition for a second, and I just wanted to get your take and a little bit different segue in that. Are you seeing a difference between, say, smaller mid use cases versus large use cases like security? And what I mean by that is Splunk seems, at least the feedback we're getting dominating the larger use cases, including security. But one of your competitors may be picking up more in some of the smaller midrange activities, Elastic. I just want to see if that's some of the competitive dynamics that you're seeing, Elastic taking some of the smaller work cases. And organizations are, frankly, I think perhaps, using both Splunk on those larger use cases, maybe Elastic in some of the smaller cases. So clarification then a question on competition.

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David F. Conte, Splunk Inc. - Senior VP & CFO [39]

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Yes. Hey, Keith. It's Dave. Thanks for the questions. I think you're thinking about the model for fiscal '20 and the geography of DRs in the right way, and it should be comparable to how we print this fiscal year. So we'll -- we set out this objective to transform the business. We're getting there early, which is -- makes fiscal '19 not as comparable per se to '18. But I'm obviously quite enthusiastic about the trajectory that we're on having materially updated our revenue expectations for fiscal '20, and pointing out that those would be comparable for what we deliver for fiscal '19. And I think that's the right way to think about it. Now let me turn to Doug on the competitive side.

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Douglas Merritt, Splunk Inc. - CEO, President and Director [40]

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Yes, on the competitive front, whether it's Elastic or other data technologies, it's a highly heterogeneous world. And Splunk, the core use case for Lucene is document search. So in many cases -- I would guess in almost every single case, every business has got Lucene and some variant of Lucene -- including Splunk, by the way -- for document search capabilities. We're going always going to coexist with tens to hundreds, in most cases, of different data technologies. I do -- what we do see on the competitive front when we compete with Elastic is that people may have started with Elastic for a use case and either the complexity of that one use case gets high enough where the challenge -- the start to bump into challenges on the flexibility, workability, extensibility of what they started with and then turn to Splunk. Or they now start to get the realization that while they may have only started 1 or 2 data sources and it was a kind of predictable set of questions they were going to ask of that technology and they realized that they should probably pile 10 other data sources in and there's a lot more -- a lot less predictability on the investigations they're going to be doing or the different monitoring act that they're going to take against that landscape. And then again, Splunk becomes a very differentiated opportunity for them. It's very difficult in that landscape to get the type of flexibility and data-driven outcome that these organizations want.

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Operator [41]

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And our next question is from Fatima Boolani with UBS.

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Fatima Aslam Boolani, UBS Investment Bank, Research Division - Associate Director and Equity Research Associate Technology-Software [42]

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Doug, maybe to start with you. You mentioned again this quarter a ton of IT ops use cases in your prepared remarks. And to Dave's point around the business mix being consistent from a use case perspective, I wanted to understand from your view what you need to do either from a technical or product or go-to-market perspective to really replicate the type of success you had in the security analytics arena. And as we kind of think about DevOps becoming the more influential buyer in the enterprise, how are you positioned from that standpoint? And just a financial follow-up for Dave, if I could.

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Douglas Merritt, Splunk Inc. - CEO, President and Director [43]

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Thanks, Fatima. Good question. So I think a lot of the quick rise in security was a combination of 2 things. One, obviously, cyber has become a critical component for everyone to understand and address. So that alone is just with the Board scrutiny and the potential risk that people face has become a pretty heavy drumbeat to make sure that you have got the degree of insight that you need into your landscape. And two, there is a very clear replacement category that there's this whole SIEM market in the way that Splunk approaches that problem because of the flexible underpinnings of Splunk enterprise was pretty differentiated. Now in the IT ops arena, ITSI, the whole orientation around ITSI was to provide that same degree of flexibility in that IT operations side. It took ES 5 years to begin to get significant foothold and traction. I think the first coding on that was done back in '09 and '10 when we really -- I think the first time we talked about SIEM replacement cycle, and our confidence with that was 3 or 4 quarters ago. So it takes a while for these products to mature. And right now, I think we're in the third year with ITSI. And we are starting to see more completeness with ITSI and more situations where a 20-, 30-, 40-year old systems management framework or [mantra monitors] is now being replaced with ITSI. So my hope and Rick's orientation, Rick Fitz, as the leader of that IT ops group, is that with continued growth investment and focus, we can be talking on a future call about the replacement cycle opportunity in the IT ops side. Now the other piece you mentioned is equally important. That replacement is within that existing IT, the heavyweight IT ops segment. And a lot of excitement and new energy and new workload is going to next-gen DevOps. And that we have a whole host of different insights, the lighter weight applications within Splunk. They are focused more on the DevOps arena. And the acquisition of VictorOps was really primarily focused on DevOps, on -- a true next-gen environment where every developer owns their code end to end without that handoff to sustaining its IT ops. And stay tuned for more releases in that category. That's -- in addition to the SOC and the NOC, the next-gen DevOps portfolio is one that we're really excited about and are developing progressively towards. And the strategic landscape is something we're looking forward -- toward as well.

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Fatima Aslam Boolani, UBS Investment Bank, Research Division - Associate Director and Equity Research Associate Technology-Software [44]

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That makes a ton of sense. I really appreciate the detail. Dave, a quick follow-up for you. You talked about the accelerated shift towards more of the ratable business being a pretty big drag on your cash flow profile this year. So if you can just give us an update on how that should shake out as we kind of barrel through the end of the year. And at a very high level, what is that trajectory for cash flow from operations look like next year as we sort of think about that and also kind of internalize some of the headquarters-related CapEx you're going to be doing next year? And that's it for me.

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David F. Conte, Splunk Inc. - Senior VP & CFO [45]

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Okay, Fatima. It's Dave. So as we've mentioned at the beginning of the fiscal year, we expected fiscal '19 to be a cash flow trough as we made a material shift toward renewable. And as we know, those are billed typically on an annual basis versus the full contract value. So with the overachievement on that objective in terms of renewable, certainly, that would add additional pressure and from a cash flow perspective. But that's being offset by strong over delivery of our plan in the field. So obviously, the fourth quarter is our largest quarter of the year, and we have plenty of execution that we have to go nail down, and that is going to ultimately translate to the amount of cash flow that we generate for fiscal '19. But I'm confident that we're on the right direction in that way and that '19 again will be that trough year. So then when you look forward, hey, what about cash flow going forward? I think, again, when you see stability in the percentage of our business that is renewable and stability or consistency, I should say, in terms of duration, then the business starts to normalize from a cash flow yield perspective. And that's what we expect to see for fiscal '20. As it relates to CapEx, we are enviably light capital expenditure consuming company outside of the facility work that we do in terms of global footprint. We're really excited about many of the spaces that we've been developing around the world. And in particular and of late, we've made some significant investments in terms of creating the right footprint for Splunk in the Bay Area. Of course, we know that the Bay area is one of the more expensive places to rent space and of course to build out those facilities. But like we did a couple of years back when we expanded in San Francisco and we expanded at the South Bay at the same time, we quantified what we expected the incremental or the total cash flow or, I should say, capital expenditures and therefore the impact of free cash flow would be from those facility build-outs. And we'll do the exact same thing as we finalize our plans for our latest phase of facility expansions.

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Operator [46]

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Our next question comes from Walter Pritchard with Citi.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [47]

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A couple of questions, Dave, for you. Just on the duration and impacts and so forth, I think a lot of us were very focused on the license impact. Can you maybe help us understand how you're getting to the cloud impact and then if there's any impact as it relates to the amount of booking that you're deferring into maintenance and how that may come back in any way? And then I just had a follow-up.

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David F. Conte, Splunk Inc. - Senior VP & CFO [48]

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Yes. Hey, thanks, Walter. Yes, there's certainly been focus on license, which makes a lot of sense. And as candidly, the reason that I have been very deliberate over the last -- I don't know how many periods, to point out software revenue is the best way to look at our growth because you have to contemplate, well, how much of your software is now being delivered in the cloud that doesn't hit the license line. So when we look at the drag or the headwind from the ratability of cloud, we look at it in terms of, well, how much is it growing as a percentage of our business that is in lieu of what would otherwise in our model be on-prem, i.e., the on-prem is the license line, the cloud is the service line. So you have got to look at those 2 sides of the equation together. In terms of the impact on deferred and maintenance, again, I think the best way to think about it from a performance perspective is to measure how we're performing in fiscal '19 compared to fiscal '20 because all of those transformations that we will have been executing under will basically be complete, and perhaps, not coincidentally aligns with the timing of my tenure of 8-plus years with the company. I know Raimo pointed out that I've done all the hard stuff on 606 and model transition like isn't it time to enjoy those labors, and the truth of that is absolutely. That hard work, we see the light at the end of the tunnel in terms of we are now at a consistent level of components of our go-to-market. And therefore, the components flow to revenue and the balance sheet will normalize over time, not dissimilar to the cash flow commentary that I just provided for Fatima.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [49]

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Great. And then maybe a follow-up off-line for you on that. But just on the margin for next year, I know you didn't give an explicit -- I think at Analyst Day in March, you talked about a 14% operating margin in 2020. Is that still the way we should think about profitability next year?

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David F. Conte, Splunk Inc. - Senior VP & CFO [50]

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Yes, we didn't explicitly update what we provided in Analyst Day. And as is consistent with our cadence on this call, we focused on the visibility that we have and making sure we're giving that to all of you folks in terms of the revenue. We've got to get through the end of the fiscal year, measure up the [beams] and look at the investments that we have on the table, and we'll provide an update at that time.

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Operator [51]

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And our final question will come from Steve Koenig with Wedbush.

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Steven Richard Koenig, Wedbush Securities Inc., Research Division - SVP of Equity Research [52]

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Thanks to you, Dave, for all that you've done for us.

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David F. Conte, Splunk Inc. - Senior VP & CFO [53]

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My pleasure. Thank you. It's a team effort. Everybody here at the company. Everybody out there that put their trust in us as investors and you guys that spend all your time grinding on what is not necessarily the simplest model in software. So much appreciation to you, all your colleagues as well.

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Steven Richard Koenig, Wedbush Securities Inc., Research Division - SVP of Equity Research [54]

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Awesome. Thanks so much, Dave. What I'd love to ask you guys about is maybe, if you can, give us a little color on -- do you have a playbook for converting perpetual customers? And what does that playbook consist of? And how do the mechanics of that work? Maybe just a little color there. And also, I'm curious to know, are there any incentives for cloud sales this year over and above any incentives for recurring sales? And maybe more generally, the more strategic question is, what's driving the strong Splunk Cloud adoption and execution, particularly this year, beyond any sort of sales incentives?

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David F. Conte, Splunk Inc. - Senior VP & CFO [55]

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Yes. It's Dave. Let me talk about sales incentives for a second. We've been, I think, very transparent that we've been on this multiyear journey, having been born as a perpetual company to one that wants to deliver our solutions, obviously, on-prem but also in the cloud and leveraging the renewable structure. And I think we're pretty clear that as we look to accelerate our move in terms of that shift that we had this multiyear adjustment to how we align the incentives in the field moving where perpetual was the first-class citizen to now having renewable be the first class citizen. So as a pool, we think about renewable. As it relates to cloud, what we experienced in the field is it is absolutely most relevant around use case, customer preparedness, the needs and requirements in terms of how they want to leverage our technology ultimately differentiates between are they going to use a renewable term contract on-prem? Are they going to use a cloud instance for that particular data source? And we continue to see a very high percentage of customers that are with us in the cloud are also on-prem customers. That unlike the incentive plan where we say, okay, like perpetual shouldn't be a first-class, we don't really go into that level of specificity on cloud because it's so customer-driven.

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Operator [56]

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And ladies and gentlemen, this concludes our Q&A session for today. I would like to turn the call over to Ken Tinsley for any final remarks.

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Ken Tinsley, Splunk Inc. - Head of IR [57]

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Great. Thank you, Carmen. I appreciate that. Thanks for your help today. And thanks, everybody, for joining us. Have a great evening, and enjoy the holidays.

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Operator [58]

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And ladies and gentlemen, with that, we thank you for participating in today's conference. This concludes the program, and you may all disconnect. Have a wonderful night.