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spk11: Thank you for standing by, and welcome to the Splunk, Inc. First Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. As a reminder, today's program may be recorded. And now I'd like to introduce your host for today's program, Ken Tinsley, Vice President of Investor Relations. Please go ahead, sir.
spk01: Great. Thank you, Jonathan, and good afternoon. With me on the call today are Doug Merritt and Jason Child. After market closed today, we issued a press release, which is posted on our website. Also note that we have posted supplemental material on the investor relations webpage as well. This conference call is being broadcast live via webcast, and following the call, an audio replay will be available on the website. On today's call, we will be making forward-looking statements, including financial guidance and expectations, such as our forecast for our second quarter, as well as future expectations of revenue mix, renewals, duration, RPO growth, cloud growth, and gross margin, as well as trends in our markets and our business, and our expectations regarding our acquisitions, products, technology, strategy, customers, and demand with markets. These statements are based on our assumptions as to the macroeconomic environment in which we will be operating and reflect our best judgment based on factors currently known to us and actual events or results may differ materially. Many of these assumptions relate to matters that are beyond our control and changing rapidly, including the impact of COVID-19 pandemic on our business and that of our customers and the overall economic environment. Related to this uncertainty, certain customers have and may in the future continue to decrease or delay spending commitments, particularly for certain high dollar and long-term contracts. Please refer to documents we file with the SEC, including the Form 8-K filed with today's 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 the website. With that, let me turn it over to Doug.
spk06: Thank you, Ken, and thanks to everyone on the call for joining us. It was a great start to our new fiscal year, and our business fundamentals have proven strong as ever. We have now turned the corner into the second half of the journey we embarked on just over two years ago to become a cloud-first company. With more than 50% of software bookings now coming from cloud, our financial model is rapidly evolving into that of a true SaaS business. We are navigating our business through multiple and simultaneous transformations to deliver customer success while becoming the leading data platform in the cloud. We do that by being hyper-focused on our customers' needs. We are transforming our business and pricing models We are innovating our portfolio of products and cloud services, and we're optimizing how we engage, deliver, and measure value to our customers. Helping our customers make the transition to the cloud is our highest priority. In Q1, we ended with cloud ARR of more than $877 million, up 83% over last year. We're honored to see the high interest in our cloud offerings, and we will continue to focus on maintaining our high-growth cloud trajectory and accelerating the transition where possible. Also, for the first time, more than half of our net new cloud ARR utilized workload-based pricing. We rolled out this pricing structure to ensure that value is aligned to the cloud consumption model. Workload pricing delivers flexibility in data types, data volumes, and data value, all of which are critical for improved business outcomes as customers move to the cloud. Surpassing the 50% mark is a strong indicator that our new pricing mechanism is being embraced by our customers. As a cloud-first company, we are aggressively investing in the right people with the right leadership skills required to drive us through this important phase of growth. In the last year, we've attracted incredible talent while continuing to invest in leaders from within. We've welcomed over a dozen new executives from cloud companies like AWS, Salesforce, Google, Okta, Dropbox, and Autodesk, among others. Most notably, in April, we welcomed Theresa Carlson as President and Chief Growth Officer, and just last week, we welcomed Sean Weiss as our President of Products and Technology. Both Theresa and Sean have extensive experience scaling hyper-growth cloud businesses from their experiences at both AWS and Microsoft. Our ability to attract such high-caliber talent is a massive testament to where we are as a company today and to the opportunity that lies ahead. I'm excited to partner with Teresa and Sean to take our customers to the next level by scaling and driving both our company and our cloud growth. In the past year, data increasingly became an essential service, and cloud adoption accelerated rapidly. This occurred just as we entered a pivotal moment in our transformation to the cloud, and we were primed to help our customers through the unprecedented dynamics this past year. These macro market conditions play to the strengths of our platform, We continue to enhance our offerings to deliver engaging experience across the Splunk platform with cloud-native solutions purpose-built for IT, security, and observability teams. Beginning with our observability portfolio, which has the most extensive breadth and depth of any modern architecture in the market, this has enabled our cloud business to accelerate even further by expanding into previously untapped departments within the enterprise. In April, Gartner named us a visionary in their 2021 Magic Quadrant for Application Performance Monitoring, or APM. Paired with our strong placement in GigaOhms radar for cloud observability, in which we are a leader and the only outperformer, we're seeing growing market recognition for our vision in APM and our leadership in observability. At the beginning of May, we announced general availability for Splunk Observability Cloud, the only full-stack, analytics-powered, and enterprise-grade observability solution. At our launch event, we showcase that our observability cloud brings together the world's best-in-class solutions for infrastructure monitoring, APM, real user monitoring, synthetic monitoring, log investigation, and incident response. Developers and site reliability engineers, or SREs, can now get all of their answers in one elegant interface with unified metrics, traces, and logs, all collected in real time without sampling and at any scale. I'd like to take a moment to recognize our product design team for their dedication to delivering a completely reimagined end user experience for our customers in the Splunk Observability Cloud. We now offer one of the market's most integrated and easy to use observability platforms for developers, SREs, cloud ops, and their leadership. A number of customers, Blue Apron, Rappi, Quantum Metric, and Lenovo, just to name a few, are already finding success with the Splunk Observability Cloud. As one of many examples, Care.com relies on our solution to holistically understand their entire environment, allowing developers to quickly find and fix errors, improve application architecture, and accelerate future releases. But the Splunk Observability Cloud is a single platform to fulfill all of its observability needs, Care.com has accelerated their mean time to investigate and resolve incidents from more than an hour to less than 10 minutes, creating a much better customer experience. Our customer success with the Splunk Observability Cloud builds on our ongoing expertise in serving customers' IT-specific needs. For example, one of the largest not-for-profit medical care providers in the U.S., expanded their use of Splunk Enterprise to better monitor and scale critical applications across their hospitals and medical offices. They rely on our platform to streamline their operations through real-time analytics and AIOps capabilities, detecting and resolving issues before they impact their 12 million plus members and helping scale services keep up with the extraordinarily high demand brought on by COVID-19. Turning to security, now more than ever in a pandemic world rife with phishing attacks, malware, and attempted breaches, it's clear that security is a data problem. Our inaugural State of Security report, just released last week, zeroed in on the overall greatest challenge organizations face, rising cloud complexity, particularly as the shift to hybrid architectures continues to expand into a multi-cloud ecosystem. As I shared during my keynote at last month's RSA conference, Organizations need a unified, data-centric view across their cloud environments, paired with the right analytics and insight from across the ecosystem for intelligent detection and response. That's among the top reasons for our acquisition of TrueStar, which extends our leadership in security analytics through cloud-native intelligence. As a cloud-delivered solution designed to prioritize data within today's threat landscape, TrueStar is perfectly suited to enhance the level of cloud security that our platform offers today. TrueStar also shares our belief in heightened automation so that SOC teams can prioritize more critical work. In addition, its APIs enable customers to bring data-driven intelligence into all stages of incident response. Finally, TrueStar's relationships with technology partners across the security communities equip customers with immediate access to the latest threat information and security research. And please report that we closed our TrueStar acquisition late last week. We look forward to our customers seeing the powerful effects of having TrueStar within the Splunk family to further accelerate time to value and resolution for security teams. Many customers turned to us last quarter for security, including Deloitte Canada. One of Canada's largest professional services firms and cybersecurity service providers, Deloitte Canada uses Splunk Cloud and Splunk ES as its SIM platform to consistently detect and respond to the evolving threat landscape. In addition to their use of Splunk internally, they also maintain a longtime strategic partnership with us to develop a cyber intelligence center with full visibility across their security tools, including antivirus tools, onsite security operations, implementation services, and more, helping Deloitte safeguard their customers and their personal information from cyber threats. Splunk is also providing mission-critical services to the U.S. Department of Defense. Working in close partnership with Kerasoft Technology, We're providing the DoD with asset management and cybersecurity software as part of a core enterprise technology agreement. This designation, valued at $833 million over the next 10 years, is part of the DoD's well-respected enterprise software initiative. As always, we thank all of our customers and partners for their continued commitment to bring data securely to every question, every decision, and every action. In closing, As organizations continue to reinvent themselves in the cloud, we are providing our customers with end-to-end visibility across any environment and at any stage of their cloud journey. This is one of the many reasons why today, more than 90 of the Fortune 100 are our customers. As I mentioned at the start, we have rounded the corner on our business model transition. We now have a deep bench of tenured cloud leaders to operate at scale. We will continue to develop and recruit the best cloud talent to meet the high demands for our customers. We have an industry-leading portfolio of IT, security, and observability products and cloud services to capture the massive market opportunity in front of us. Our hard work over the past few years has set us up for the next phase of our growth, and we couldn't be more excited about where we are today and what lies ahead. I want to thank our Splunkers for their tenacity and resilience in helping us make these transitions and staying focused on the needs of our customers. I also want to once again thank our customers, who are the reason we exist. Their belief in the power of Splunk gives us absolute confidence and conviction in our value proposition and the massive potential that data has to help every organization thrive in the data age. With that, I'll hand it over to Jason.
spk05: Thanks, Doug, and good afternoon, everyone. Thanks for joining us. Q1 was an excellent start to the year with total ARR of $2.47 billion, up 39% year over year. Cloud ARR was $877 million, up 83% over last year, and we ended the quarter with 537 customers with ARR greater than $1 million, up 46%. Of these, 203 had Cloud ARR over $1 million, nearly twice as many as the year-ago period. Our cloud business momentum remains strong as our Cloud ARR growth has exceeded 70% in each of our last six quarters, and we expect strong growth to continue. As we outlined in our last analyst day, cloud growth is driven by three primary components. First, our existing cloud customers expanding their data volumes, which you can see in our consistently high DBNRR. Second, our new customers opting for initial deployments in cloud. And third, our existing on-prem customers moving to cloud. Contributions from these sources fueled $67 million in net new cloud ARR and Q1 of 74% over last year. For your reference, we've added a slide in the supplemental deck to depict the strength of net new cloud ARR generation. We believe these trends are highly durable and will continue to drive sustainable long-term cloud growth. Back to the quarter. We ended the period with total RPO of $1.86 billion of 8% over Q1 of last year, and the portion of RPO which we expect to recognize as revenue over the next 12 months was $1.2 billion of 21% from last year. With a substantial base of perp to term conversions coming up for renewal this year, we expect total RPO growth rates to return to double digits in the second half of the year. On the P&L, Q1 cloud revenue was $194 million, up 73% over last year, reflecting continued acceleration of customer adoption of our cloud platform. Total revenues were $502 million in Q1, up 16%, and beginning to reflect more comparable average year-over-year term contract durations as we lap the first anniversary of the pandemic. On margins, which are all non-GAAP, cloud growth margin was 60% in Q1, up slightly from last year, with continued progress towards our long-term target of at least 75% as we realized the benefit from scale and elasticity of the platforms. Total gross margin was 72% down on a year-over-year basis due to the greater proportion of revenue contribution coming from the cloud. Operating margin was negative 35% in Q1, slightly below plan due to higher infrastructure costs and performance-based compensation expenses from bookings outperformance. As I've said, operating margin is impacted by lower revenue recognized from shorter average term contract duration and growing cloud mix. Turning to guidance. So far this year, we've seen continued improvement in the demand environment and customer engagement remains high. We expect to end Q2 with cloud ARR of $950 to $960 million and total ARR of between $2.59 and $2.61 billion. On the income statement, the cloud transition will continue to drive variability in our revenue and operating margin results. In Q2, we expect total revenues of between $550 and $570 million depending on cloud mix, with a non-gap operating margin of approximately minus 25% reflecting our normal seasonal pattern. On cash flow, recall that two years ago we shifted to annual invoicing from upfront cash collection in our standard contract terms. This caused a temporary timing disruption in cash collections and caused negative full-year operating cash flow. We are now starting to lap the impacted contracts, which will yield a return to full-year positive cash flow. In closing, Q1 was a great start to fiscal 22, and we're pleased to have the most challenging phase of the transitions behind us. The overall demand environment is strong, and with our product and services innovations, plus new high-caliber field and product leadership with Theresa and Sean, our setup for continued high growth has never been better. With that, let's open it up for questions.
spk11: Certainly. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Cash Rankin from Goldman Sachs. Your question, please.
spk02: Hi. Thank you very much, Doug and team. Congratulations on the ARR number. That looks quite solid, particularly the cloud number. Doug, if you could talk about the things that are not going to change for Splunk going forward and things that will change, because you're bringing these executives from AWS for a reason, arguably. So what should we expect in terms of their expected contributions? What is your mandate for these two executives? And one for you, Jason, it looks like the cloud mix is improving, but we're still seeing some volatility with the RPOs, CRPO, billings, and free cash flows. At what point do those metrics start to settle in and produce the cadence that investors would like? Thank you so much, and congrats.
spk06: Thank you very much for the question. The consistency that Teresa and Sean get to add to is a maniacal focus on customers and customer success. We've made that our number one corporate priority years ago. We made cloud first transition our number one corporate initiative three-plus years ago. So they get to come in after years of focused execution on transitioning our portfolio to be cloud-first and then expanding in key and critical areas like all the great work on our observability cloud that just went GA a month ago or a few weeks ago. What I'm excited about is we have two unbelievably well-proven leaders that have sat on top of 10 billion-plus portfolios that have been growing tremendously It's as fast or faster than any of the incredible growth numbers that AWS overall is posting. And the scale that they've witnessed, the operating rhythm and cadence that they've become part of and driven, the partner focus that they have leveraged and executed on within their AWS fold and in lives prior to AWS complements who they are as people. Very down to earth. humble, hardworking, they can go deep as well as stay high, and the relationships that they bring from AWS, from Microsoft, and from the many, many people they interact with outside, I think will be a long-paying set of dividends for Splunk, our partners, our customers, our employees as well. I'm really, really thrilled to have both of them join our ranks, but they're complemented, as I talked about, by over 15 senior executives that are coming, not just made at AWS, but from Salesforce, Google, Okta, Adobe, key organizations that are cloud first in their orientation. And these are people much like Teresa and Sean that have infinite choice on where to land. So they understand the company, they understand our opportunity and how well positioned we are. And I'm excited to both feel the continued benefits that we've seen from the people that have landed and the impact and jolt that Teresa and Sean will have. Jason, over to you.
spk05: Yeah, thanks for the question, Ash. On CRPO and RPO, so CRPO, you know, I think it was a 21% growth in Q1. It was 23 back in Q4. I expect the CRPO numbers to stay in that range because of, you know, you have a cloud environment see RPO that's growing much faster. You have a non-cloud that's going much slower. And so the combination, I think, will stay somewhere in the range that you've seen for the past couple quarters. Total RPO has been down very much because of the lower duration that we saw last year. We have seen term duration continue to come down a little bit. I do expect to see total RPO accelerate pretty significantly well into the double digits by the end of this year. but it's going to take a while as we're lapping a lot of these duration changes, which did decrease throughout the year last year. Wonderful.
spk02: Look forward to the cloud journey. Thank you so much. Great numbers. Thanks, Cash. Thanks, Cash.
spk11: Thank you. Our next question comes from the line of Brent Thill from Jefferies. Your question, please.
spk03: Doug, a lot of questions about the go-to-market this year and how you've optimized the sales team now and what seems to be a cleaner model this Can you just walk through the changes you made in Q1 and how you think the rest of the year will unfold? And for Jason, I know you got into negative 30% margins. I think you came in a little worse. So I think investors are asking, you know, what was the delta between your plan and what happened on the operating margin side? Thanks. Thanks.
spk06: Thanks, Brent. I will kick it off. As we talked about in the last call, we have moved the sales force a couple years ago from total contract value to last year annual contract value, and this year we're separating out incremental expansion versus renewal. Ultimately, what we want to get to is a consumption-based metric. So as we talk about these transformations, getting to a portfolio that is cloud-native, serverless, and really represents what we want and expect to deliver to our customers is key. And then aligning the rest of the organization is critical as well. I'm excited about the experience that Teresa brings, as well as other key additions that we've had, to ensure that we not just have the right metrics and focus areas for our sales teams, but that we have the right processes, scale, support, and complimentary teams to make sure that our sales teams are successful and that they engage most effectively with net new customers and the many, many customers that are on-prem that still need to convert to our cloud offering as we focus on the value add, the high return on investment that customers get when they move to cloud and they moved to workload or entity-based pricing, which is a resounding success within our customer base right now. Jason, on the out margin?
spk05: Yeah, so there's three factors on why the operating margin came in a little lower than what we were expecting. I'd say first, we did outperform on our Q1 targets specifically on ARR, which did lead to our quota-carrying reps earning higher commissions. Second, We are, you know, I think it's good, but we are a little higher than where we expected in some of the critical areas of quota carrying reps and software developers. And then lastly, we did have higher OPEX related to cloud deployment costs for a bunch of the new products and services that were launched in Q1. And so those were, I think, largely, mostly kind of one-time impacts. I don't expect to see the increased cost flow through Q2. for the rest of the year.
spk03: Great. Thanks for the call.
spk11: Thanks, Brian. Thanks, Brian. Thank you. Our next question comes from the line of Raymond Lenchtel from Barclays. Your question, please.
spk04: Hey, thank you. Doug, you mentioned the launch of the Observability Cloud a couple of weeks ago going to EA. Can you talk a little bit about, first, feedback here? How are customers using it? Like, you know, is it a broad-based? adoption, is it more on logs, et cetera, or like how do we see that there? And then a follow-up for Jason is on the duration, like where are we on that journey of lower durations? Are we kind of close to, you know, the level that we're seeing now, or is there more to come? Thank you.
spk06: Thanks, Remo. Yeah, the focus for the Observability Cloud was to drive clear and effective integrations. across the many different components that in collection make up the observability suite, from APM to digital experience management to monitoring to synthetic monitoring, et cetera. I think the team has done an incredible job of driving really rapid and effective integration, and then just as importantly, renewed and revitalized and unified user experience for our customers. I think it gave Care.com as one of the deeper dives on my prepared remarks, where they're really focused on the totality of the different capabilities that we've brought to bear with this observability suite. Customers can pick and choose, but ultimately, as you are driving high volume of net new application capabilities on a cloud-first basis, developing in AWS or other clouds, you really need the entire observability cloud to get that job done effectively, which is why we've been so focused on making sure that we've got the breadth and depth of features that drive that effective performance of the application development teams, the DevOps teams, the site reliability engineering teams, and cloud ops teams that organizations are so dependent on as they transition to be a digital-first set of companies.
spk05: On the contract duration piece, I'd say first for cloud, continuing multi-year agreement is continually or is remaining our primary motion, and our compensation plan does include incentives to drive this outcome where possible. I would say that the Q1 impact was impacted because we did have some shorter duration deals that were related to expansion, and we wanted to co-term those. with existing contracts. So I do expect to see the cloud duration go back up into the kind of mid to high 20s. For term, we do continue to work with customers on the right timing of their eventual migration to cloud. In many cases, customers are choosing to extend their term contracts over a shorter period than they've done historically as they anticipate moving to cloud. So as a result, I do expect to see some downward pressure throughout the year on term durations. Good. Thank you. Well done. Thanks, Ramo. Thanks, Ramo.
spk11: Thank you. Our next question comes from the line of Matt Hedberg from RBC Capital Markets. Your question, please.
spk08: Oh, hey, guys. Thanks for the questions and well done as well on the ARR side. Kind of a two-point question, I guess, for Doug. Obviously, with all of these breaches, it strikes me that you guys are in a really good position to help you know, both the public and private sector, you know, with your SIM, broader security solutions, you know, it feels like the ability to sift through the noise is more important than ever. So I guess, could you talk to, you know, could we be in front of a bit of a SIM cycle? And secondarily, obviously, the DoD contract is great. Is there even further opportunity from the U.S. governments?
spk06: Great questions, Matt. So I'll start with the end and work back, which was, yeah, it was great to see that DOD contract. Obviously, you know, multiple years of focusing on success with that total contract to realize all the benefits there. The latest cyber set of initiatives that President Biden pushed out, I think, were thoughtful and definitely, I think, are going to continue to drive not just the right behavior and opportunity for public sector organizations, but I think dramatically benefit the commercial as well. But we are – we're really excited about our public sector business. We've had a long tenure there, not just in the U.S., but in other major countries around the world. And obviously, Teresa's general go-to-market skills are fantastic, but the leverage that she is able to exert on her public sector business should be a big boost to them as well. Yeah, none of us are happy other than maybe the hackers and people that are on the other end about the negative cyber activity we're seeing. It is something that is obviously extremely important for every organization around the world to get their arms around. And I agree with you completely that we have taken a data as a security problem approach as a very unique stance seven, eight years ago that the world is slowly starting to swing toward. The dilemma for anyone that wants to do that is you must be able to be the heterogeneous collection service. The average CISO is dealing with well over 50, often 100 or more, different vendor-specific solutions that make up their landscape. And while cloud has the ability to enhance the security posture, it also creates even more divergent data sources and more surface area that you've got to pay attention to. So being... The data-driven agnostic collection vehicle for customers I think is a very important position. Our SIEM products are key, but as we all know, SIEM keeps expanding, and we've dramatically refactored our security suite to not just include SIEM, but insider threat capability, orchestration, automation, Hopefully you just saw we GA'd our mission control framework, very open approach to integrating all tooling that exists out there for SOX. We GA'd our SOAR capability as a cloud-oriented offering. So we're focusing very aggressively on continuing to keep pace with the breadth and depth that SOX and cyber teams need, including the addition of the TrueStar set of capabilities and that awesome company that actually closed late last week. And while we don't want to be ambulance chasing in any way, this environment is definitely making security front and center for CEOs and boards of directors.
spk08: Super helpful caller. Thanks a lot, guys. Thanks, Matt.
spk11: Thank you. Our next question comes to the line of Keith Bachman from Bank of Montreal. Your question, please.
spk10: Yes, thank you. One for Doug and one for Jason, if I could. Doug, I wanted to start with you. in terms of trying to understand better your deployment capabilities. And what I mean by that is you obviously go through a business transition where you're offering both on cloud and on-premise and migrating customers to use your cloud capabilities. But I wanted to reverse that lens and ask you where you actually are deployed. Is it more for on-premise situations like at Bank of Montreal versus where interacting with, say, cloud deployments at the customer level? And the reason I'm asking is just, you know, some concern as more and more workloads shift to the cloud, that as those on-premise deployments shift to the cloud, that you might lose a little bit of share in that process. So, again, not asking how your customers are subscribing to you, but where Splunk is attaching to, if you will, and then have a follow-up for Jason.
spk06: Sure. One, when we talk about our cloud solutions, the way that the language we probably need to shift to is we are a SaaS organization. We are providing Splunk as a service to our customers. And that SaaS deployment is truly best in class at this point in time. It is cloud native, serverless, very, very effective in the job that it performs, as you can see from our growth rates. So the number one value prop that we are focused on with customers is why would you do low value, very difficult work in an area that it could be managed for you? And not only are you going to get a better TCO, but you're going to get much higher quality delivery because of the many, many people that we deploy around our automation frameworks, our site reliability and cloud ops capability, etc., The data sources just continue to grow. Cloud, it's nice to talk about the AWS cloud, the GCP cloud, or the Azure cloud, but there are hundreds of services within those cloud environments. The services are continuously changing as they need to, to be competitive. That means that the APIs, the data flows, the turbulence within that environment are high. All those are additional sources of streaming data or data at rest for Splunk, as well as the multitude of tools that are third-party that live in those clouds, as well as all the different tooling and hardware components that are self-managed by organizations. So that goes kind of back to that sweet spot of data volumes continue to grow. And our DBNRR, again, is very clear and consistent within our cloud framework, shows that the additional products that we're releasing things like the observability cloud, in addition to the growth around data and complexity within our customers, is a good positive trend. And we're trying to counteract that with customers to being much more efficient with how we deploy our solutions so they can do more at the same cost, knowing that those other factors are going to increase the envelope that they have to deal with.
spk10: Okay, so Doug, just put words in my mouth. Do you consider Splunk indifferent to the data sources, whether it be on-prem or cloud?
spk06: Absolutely. Yeah, it doesn't matter to us at all. Okay.
spk10: Okay. Great. Jason, one for you. The cloud gross margins, your ARR and dollars are going up, but sequentially your cloud gross margins have declined, again, modestly, but from Q3 21. And so I just want to try to understand, you know, what are the reasons that the cloud gross margins have declined for the last couple of quarters? And how should we be thinking about those cloud gross margins specifically as we think about the next couple quarters? Thank you.
spk05: Thanks, Keith. I would just – I guess the short answer to your question is in Q4 as well as Q1, there's been new products that we've released specifically in Splunk Observability Cloud that have led to some movement in gross margin, unfortunately, down, but we don't see that as long-term. And so I would expect that we are certainly on track to hit our long-term target of 75% Cloud GM. Our expectation, I think we said last quarter, was we hope to end this year at 70% exit in the year, and that's currently what we still plan for.
spk10: Okay, great. Thank you.
spk05: Thanks, Keith.
spk11: Thank you. Our next question comes from the line of Kirk Mattern from California. Evercore ISA. Your question, please.
spk07: Thanks very much, and congrats on a solid quarter. I guess, Doug, the first question would be for you. Six months ago, we sort of got more aware of the fact that as customers are moving over from term to cloud that there might be some shrinkage of the deal terms, things like that. Do you guys feel like you have your hands around that? You have a big base of renewals coming up. Have you been able to sort of get in front of those so that you know, the kind of discussions that customers want to have you're better prepared for at this point in time. It seems like that's happening, but I just want to get your view on that and if anything's changed maybe over the last six months, you know, in that regard.
spk06: Good question, Kirk. So, yeah, we are – part of the headwinds we're seeing within the term business is, as we've seen across Splunk, term or cloud, the – Current customer expansion rate has always been a very positive factor for our ARN revenue. But if you're sitting in term and you're unsure when you're going to go to cloud and what that looks like, the expansion rate for a term customer is probably going to be muted while they're trying to establish what their cloud footprint looks like. The positive tailwind is they've moved to cloud by itself, even on a flat basis. X size on term, I'm the exact same size on cloud, the AR goes up because of the overall billing of cloud that includes the infrastructure that we're passing to the customer. And the majority of customers, I'd say probably the vast, vast, vast, vast majority have a step up when they move to cloud because of that nature of expansion of data and expansion of use cases with Splunk. the number one focus area that Teresa immediately has dug into that she's building on from what the team was doing, but I think we can get better at, is being super crystal clear on what a blocker is for a on-prem customer to get to cloud and making sure that we have not just right sales motions, but we've got the right technical support, the right pro-serve, the right partners, and any appropriate incentives to assure them that this journey to cloud is going to be as smooth as we've seen it be for thousands of customers now, so that they can get on the same value basis that we see with those native cloud customers, get them to workload-based pricing, much more friendly metric, and see the number of users go up, the number of use cases go up, and the overall ROI continue to tilt positively for that customer. So when we're looking out Q2, Q3, Q4, that number one vector is, how many of those customers that are currently on-prem are going to move to cloud. We obviously complement that with the roughly, we said last call, roughly a third of cloud AR is driven from new customers. And then, as Jason said in his prepared remarks, we've clearly got a DBNRR that's positive as well. So we're not wholly dependent on that cloud, the on-prem to cloud transition. That's a benefit of our install base, but it's definitely a factor that's really important for us.
spk07: Okay. And Jason, one for you, I realize the income statement profitability measures are kind of masked by the transition. But when we think about you all coming out of this and normalizing a little bit, I mean, every sort of other enterprise software company has seen some benefits from remote work, whether it's real estate savings, whether it's less travel. I mean, is there any reason that sort of overall efficiency of the business model shouldn't be higher as we normalize on sort of just the revenue transition versus where you were you know, say a year or two ago? I mean, are you seeing some of those same benefits I guess we're seeing in companies that frankly are already, you know, sort of fully cloud in a cloud revenue model?
spk05: I'm hopeful, but I think it's early since really hardly anyone's returned to work and therefore hasn't really returned to travel. It's hard to know exactly how the market will actually react. I do think it's certainly reasonable to think that with the productivity gains we've seen that we should be able to flow that through. That said, we also have one of the bigger cloud transformations in recent history going on. And so I don't know any benefits we get on OPEX is probably going to be dwarfed, unfortunately, by whatever the revenue recognition impacts of the transformation.
spk07: Okay. Thanks, guys.
spk11: Thanks, Kirk. Thank you. Our next question comes from the line of Brad Sills from BFA Securities. Your question, please.
spk09: Oh, great. Hey, guys. Thanks for taking my question. I wanted to ask about a comment you made, Jason, earlier that part of the reason for the duration move is that you're seeing a higher mix of co-term deals. What's driving that? Is this simply customers coming back more often? more kind of mid-term and expanding at a greater rate than in the past? And if so, where is that incremental demand coming from?
spk05: So we had a couple big deals this last quarter that were co-term deals in cloud. And so that was why we saw such a kind of a pronounced reduction in cloud duration. Certainly, the observability suite is one of the key drivers for that. That said, I don't know that this is expected to continue. We'll see. It's just with the large deals, they happen pretty infrequently. Our expectation is that you will see cloud duration get back up to the kind of mid to high 20s through the balance of this year.
spk09: Got it, great, thanks. And one more, if I may, please. Just with this latest release and observability, it sounds exciting. How far along are you with the integration of some of the recent acquisitions, Plumber, Rigger, Omniscient? There's a lot in there that you guys have acquired, and I know there's been a lot of work on integrating that. Thank you so much.
spk06: Yeah, absolutely. That release was the integration of all those acquisitions release with the unified UI. Now the task continues. There are still additional features across infrastructure monitoring, APM, synthetic monitoring, et cetera, that we are intent on adding. We've got to make sure the observability suite is lit up in all the key regions of the world and available locally within those different domains. We've got to make sure that it fits into the compliance frameworks that different entities, federal government is a good example, are bound by. And we've got to continue to focus on driving ease of use on try, find, buy. So we're really, really excited. We're way ahead of where we thought we'd be with the help of some key acquisitions, but also really focused execution from our engineering teams to drive that unified footprint. It is really clear from the analysts at this point in time that we are way ahead of everybody else on breadth and depth of functionality And now it's about driving awareness, getting more at-bats, and continuing on those key focus areas that I just walked through.
spk09: That's great. Thanks, Doug. Thanks, Jason.
spk11: Thank you. Thank you. And our final question for today comes from the line of Greg Moskowitz from Mizzou. Your question, please.
spk00: All right. Thanks for taking the question. So, Doug, it's actually a good segue to my question on Observability Cloud and Do you expect that this is going to help you land a lot more net new logos going forward? And then for Jason, you know, naturally this is a very different pricing model for you in that it's all host-based. What impact do you anticipate this having on the model going forward? Thanks.
spk06: Awesome. Thanks, Craig. So I'll steal a little bit of Jason's thunder on. We are really focusing with our solutions, observability, security IT, on a simple, single metric around entities. so that if all you're focused on is that suite, you know how to license it, and it's value-tied, and it's clear for the end user. And then we continue to focus on a single metric to the platform, which is that workload-based pricing metric. So I listened very, very intently to our customers. Customer success is number one priority. We don't like your data volume metric, so we've focused on that. We've delivered, and we're excited to see the momentum we're getting with entity-based pricing on our solutions. workload with the underlying platform. And then I'm just totally blanked on the beginning of your question, Greg, which was? Net new logos. Net new logos, yes. We had said last call that roughly a third of Cloud AR is from new customers. We are seeing some positive trends with new customers. I have said for a couple of the key lever, I'm beginning to see a more dramatic increase in net new accounts. was going to be having a easy button around cloud. So we are beginning to see that. There's more work to do. The Observability Suite certainly is a new buyer within existing customers. We have not had a strong set of initiatives around that DevOps team and all the people that run the DevOps team. So we're excited to leverage our position within security and IT to traverse over to DevOps. Ultimately, all three of these entities, SecOps, ITOps, DevOps, have to work together. The end customer doesn't care about the individual jobs of those tech leaders. They care about the solution they're getting. So tying those together is really important. We think that we're unique as the only vendor that can effectively serve all three independently or on a combined basis. And we are absolutely internally measuring and very, very focused on net new customer count increases as our whole cloud portfolio continues to perform.
spk00: All right. Makes sense. Very helpful. Thanks, Doug.
spk11: Thanks, Greg. Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Doug Merritt for any further remarks.
spk06: Great. Thank you. We really appreciate all you tuning in today. We are really proud of the progress we've made on every front. We have turned the corner on our journey to become a cloud-first company, really clear corporate initiative for multiple years, and are proud of that execution. We take a cloud-first approach in everything we do, from delivering high value to our customers to working with our partners and really ensuring that there is high value opportunities for our partners as we move to cloud, as well as which features and capabilities we're delivering from a cloud-first basis. I believe that we've never been better aligned with our market opportunity than we are right now. On top of that, our business is now led by cloud executives with proven track records of scaling cloud businesses of 10 plus billion dollars, which we obviously are very focused on becoming over the coming years. And we're poised to work closely with our customers as they continue their transitions to the cloud. Our position is exceptionally strong. I've never been more bullish on our growth outlook. And thank you again. Have a great evening.
spk11: Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.
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