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spk10: The conference will begin shortly. To raise your hand during Q&A, you can dial star 1 1.
spk16: Good day, and thank you for standing by. Welcome to Splunk Inc. Second Quarter 2023 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 11 on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ken Tinsley. Please go ahead.
spk10: Thank you, operator, and good afternoon. With me on the call today are Gary Steele and Jason Child. After market closed today, we issued our press release, which is also posted on our investor relations website, along with supplemental material. This conference call is being broadcast live via webcast, and following the call, an audio replay will be available on our website. On today's call, we will be making forward-looking statements, including financial guidance and expectations, including our long-term growth and profitability, our forecast for our third quarter and full year of fiscal 2023, and our future expectations of revenues, cloud mix, total ARR and cloud ARR, cloud gross margin, operating margin, operating and free cash flows, and rule of 40 scale, as well as trends in our markets and our business, our strategies and expectations regarding our business, products, technology, customers, demand, and markets. These statements are subject to risks and uncertainties and based on our assumptions as to the macroeconomic environment and reflect our best judgment based on factors currently known to us. Actual events or results may differ materially. Please refer to documents we filed 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'll 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 Gary.
spk11: Good afternoon and thanks for joining today's call. Q2 was my first full quarter as Splunk CEO. After four months of leading this incredible team of Splunkers and meeting with more than 100 customers in 100 days, the reasons that drove my decision to join Splunk are as true now as they were the day I started. Splunk is deeply embedded within the tech stacks of the world's largest enterprises. Looking across the software landscape, I am confident that we are uniquely positioned for long-term durable growth and profitability. Our customers appreciate what we do for them, and they are looking to invest more and drive greater value with Splunk. Why? Well, simply put, no one else can do what we do. The value we bring to customers is evident in our second quarter results, with total revenues growing 32% to $799 million, exceeding our expectations. Our team achieved this top-line outperformance while also exceeding our op margin expectation for the quarter as our focus on balancing growth with profitability began to deliver. We continued to see good customer engagement during the quarter with strong competitive win rates consistent with what we've seen in the past couple of years, a high net retention rate, and good business momentum. We ended the quarter with 723 customers with total annual recurring revenue, or ARR, of more than $1 million, up by 33 customers from last quarter and up 24% year-over-year. Despite our solid top and bottom line, our cloud ARR and total ARR came in short of our own expectations. This was largely due to the slowing of a number of larger cloud migrations and expansions as customers became more cautious with their Q2 budgets. As many of our customers opted for shorter-term commitments with Splunk beginning in the second half of the quarter, this lower-than-expected cloud adoption resulted in lower cloud ARR and, as a result, total ARR. Our customers tell us that they understand the importance of moving to the cloud and that they remain on their path to migrate and expand their highly complex infrastructure over time. Cloud transformation is a time- and cost-intensive strategy, as we've talked about on these calls, and we support the pace our customers take. Even given near-term pressures, our high competitive win rates indicate that our customers continue to choose Splunk. To offer further context, today I'm going to focus on what I'm hearing from my customer conversations and the changes I've been driving inside and outside Splunk during my first full quarter leading the business. First, as a recurring theme with my conversations, Splunk and our products are mission critical. Organizations rely on our unified security and observability platform to navigate today's unpredictable world, and customers are eager to partner with us. We are deeply embedded into business processes, tech stacks, and security and IT strategies of the largest and most innovative organizations on the planet. Our criticality has been most evident in my conversation with leaders I personally know best, chief information security officers. Today's boards and chief executives are empowering their CISOs to make buying decisions beyond their legacy security-specific technology and across the business, often in partnership with the CIO. Our unique combination of security and observability products provides CISOs with unparalleled visibility and the depth of detection and response that modern organizations demand. For example, just last month, I met with the CISO, CIO, and CTO of a Fortune 50 transportation company and a longtime Splunk customer. Splunk is helping them improve business-critical board-relevant metrics like mean time to detection and mean time to resolution. As these leaders told me, we are integral to their security and observability and enable broader resilience across the company. The customer continues to expand on the Splunk platform as their security and observability needs continue to grow. Equipped with end-to-end visibility across security, IT, and DevOps alike, our customers are able to react more quickly to unexpected events and adapt. Especially within the context of today's macro environment and cost constraints, organizations have less margin for error. Any disruption could be devastating. We help our customers improve the resilience of their critical systems, making our technology all the more relevant and mission critical across the organization. Last quarter, we hosted .conf and our global partner summit in Las Vegas. I spent the week meeting with our customers and learning more about their challenges and the unique value we deliver. Our customers, CISOs, CIOs, and CTOs, together with the industry analyst community, really responded favorably to the value we showcased and the innovations we delivered at .conf, along with RSA in June and even Black Hat earlier this month. During the quarter, Gartner ranked Splunk number one in both IT operation and security markets in the Gartner market share report. Now let's take a look at a few transactions from the quarter. In Q2, we closed a multimillion-dollar three-year Splunk security and cloud deal to secure a U.S. state government. Through workload pricing, Splunk will provide the scalability and flexibility they need to oversee security over 20 separate IT departments. Splunk's end-to-end visibility helped us displace an incumbent and beat out a competitor as part of the deal. On the observability side, an international financial services company that you all know very well extended and enhanced their Splunk investment with a multi-million dollar Splunk observability deal. Despite a lower cost offer from a competitor, we won by demonstrating our effectiveness, value, and ability to provide customers full visibility. Turning to the Splunk platform, last quarter, one of New Zealand's largest banks expanded their use of Splunk Cloud after using ITSI and enterprise security across the business. The bank will now leverage Splunk across its new banking platform to support its microservices development, adding to its existing audit and regulation compliance use cases on our platform. In the second half of the year, you'll see us remain agile and disciplined in delivering best-in-class solutions to customers as they navigate today's unpredictable macro landscape. When it comes to how Splunk goes to market, an immediate change I've set in motion since joining has been to double down on our CISO relationships and realign our resources to help them tackle their most urgent challenges. Again, security is a data problem and CISOs need Splunk. We've also observed that given today's threat landscape, CISOs budgets are among the most resistant to changes in the macro environment. It should be no surprise that security is already our primary customer use case today, and we believe that it will continue to be in the future. We have begun to see that the world is changing and cybersecurity is coming together with observability to drive better business resilience for our customers. As we help our customers improve the security and resilience of their critical systems, we're also continuing to drive efficiencies within our own internal operations. This is consistent with what you've heard from Jason and team over the past quarters as we have focused on our operating expenses and multi-year transition to become a multi-cloud and hybrid company. Remember, it's because of our own business transformation that our customers are able to migrate and expand their Splunk instances and use Splunk to support their other large cloud migrations. As such transformation continues to scale across the global community, it is essential that my leadership team and I continue to serve as a force of stabilization, both to customers and to our own Splunkers. Now let's take a look at the Splunk team. Following our CEO transition and the rebuilding of parts of our leadership, I've been focusing on our staffing structure and sales capacity. While we continue hiring across Splunk, our quota-carrying and customer-facing teams are our highest staffing priority. This and further operational updates, as Jason will address, led to our higher operating margin in the second quarter. To close, despite a few headswinds, this quarter we experienced good customer engagement, as evidenced by consistently high net retention and competitive win rates, and solid momentum with large orders overall. As we continue to make progress on our own business transformation, we're focused on taking a balanced approach to operations and efficiencies. With that, I'll hand the call over to Jason. Thanks, Gary.
spk14: In the face of some clear headwinds, our execution in Q2 was solid. And with the continuing normalization of our revenue model, plus good progress on our expense optimization efforts, we substantially outperformed on the top and bottom lines for the quarter, and we're increasing our outlook for revenue, margins, and cash flow for the second half. In Q2, total revenues were $799 million, up 32% over last year, significantly higher than expected, reflecting higher license revenue from term contracts. Cloud revenue was $346 million, up 59%, reflecting continued adoption of our cloud platform. Note that professional services and education were 7% of total revenues in the quarter. RPO bookings was $794 million, up 17% over last year, which was lower than planned as several customers slowed their expansions or significant deployments due to macro uncertainty. This caution was also apparent in our shorter contract duration, which was down about two months versus last year. On a duration adjusted basis, RPO bookings growth was 29% just to give you a sense of the impact on total bookings. That said, our renewal and expansion rates continue at a very strong pace given our high customer value proposition. Our reported cloud DBNRR remained consistently high at 129% with our overall DBNRR a few points lower due to a slower pace of cloud migrations. We ended the quarter with total ARR of $3.33 billion, up 27% year over year, and cloud ARR of just over $1.5 billion, up 55%. As Gary mentioned, we had 723 customers with ARR greater than $1 million, up 24% year over year, And 352 of these customers had cloud ARR over $1 million, up 50% over last year. On to margins, which are all non-GAAP. Cloud gross margin was 69% in Q2, up 9 points from last year, tracking well to our target of 70% by year-end, as we continue to realize leverage from the scale and elasticity of the cloud platform. Total gross margin was 79%, up 3 points year-over-year, and reflecting the sharp improvement in cloud margin. Operating margin was positive 4% in the quarter, significantly better than our expectation due to our top-line performance, plus good execution on the expense optimization efforts that Gary has helped install as part of our balanced growth and profitability focus. Turning to guidance. For the remainder of the year, with the macro-related uncertainty and changes in customer buying patterns, We are adjusting our full-year total ARR target to $3.65 billion and cloud ARR to $1.8 billion. The majority of the ARR adjustment is primarily attributable to a slower pace of existing customer migrations and expansions of their cloud deployments, given the uncertain economic environment. Given this, we are now expecting an ending cloud mix closer to 60% this year compared to our initial estimate of around 70%. On the income statement, with the continued normalization of our model and given the revenue outperformance in the first half, we are increasing our full-year revenue expectations by $50 million to between $3.35 and $3.4 billion. Combined with our ongoing expense efforts, we now expect a non-GAAP operating margin of approximately 8% this year, up from our prior target of 2%. Just to unpack some of the details around our expense initiatives and what's driving leverage, Some of the areas we're focused on include rationalizing usage of outside services for only the most critical projects, limiting T&E to customer-facing travel and support, and then we're also taking a more thoughtful approach to hiring increasing overall sales capacity. In the past, we've been aggressively adding new headcount and now we're more closely scrutinizing requirements and our ability to leverage existing capacity. And finally, we're assessing our global real estate portfolio and right-sizing space for our post-pandemic return to office needs and opting for serviced offices where it makes sense. We don't believe any of these efforts will impact our overall growth rate. For cash flow, we expect our improving out margin to translate to stronger cash flow. So today, we're also raising our full-year operating cash flow target by $20 million to $420 million. And to highlight the historically-like CapEx requirements of the business, Today we are introducing free cash flow as the primary cash generation metric going forward. This move also highlights our focus on the balanced growth and cash flow capabilities of our model. We expect to generate free cash flow of at least $400 million this year, and with the updated guidance we've provided, we're now tracking to 38% on the Rule of 40 scale. For Q3, we expect total revenues of between $835 and $855 million, with non-GAAP operating margin of between 6% and 8%, reflecting cost efforts and continued profitability improvement. In closing, in the face of a few headwinds, execution in Q2 is solid, and operating leverage in our model is improving and returning to pre-transformation levels. With that, let's open it up for questions.
spk16: And thank you. As a reminder to ask a question, you'll need to press star 11 on your telephone. Please stand by, we compile the Q&A roster. And one moment for questions. And our first question comes from John DeFucci from Guggenheim Securities. Your line is now open.
spk07: Thank you. I think this question It kind of goes to both of you, both Gary and Jason. We understand the macro backdrop slowing a bit, and it makes a ton of sense. Jason, you're really clear on why you're raising revenue versus reducing the AR. It's due to the mix shift, and that makes a lot of sense too. But it sort of begs the question, why? Why are customers hesitating to mix? to shift more to cloud or why are they shifting less than you thought they would or less than they have been? Does it have anything to do with their confidence in Splunk Cloud or is there, I don't know, something greater there?
spk11: No, this is Gary. I think it's pretty straightforward. What we saw was that as we worked through these larger customers that have very complex Splunk implementations, they want to have a high volume of data. You know, we today have customers ingesting over a petabyte a day into Splunk, that combined with the range of applications that have been developed under Splunk, those are pretty complex migrations. And so what we saw was people just putting that off. And that showed no lack of confidence in Splunk or the willingness or wanting to expand. It was really just a timing thing. Jason, what would you add to that?
spk14: Yeah, John, I would just add that, you know, again, the renewal rates actually were right in line with where they've been and actually right on plan. It's really the cloud migrations and then some of the expansions on workloads that customers want to move into cloud. Given kind of uncertainty, we just saw a little more of an elongated sales cycle and a little more of a desire to kind of be a making those investments now versus doing it, you know, sometime in the near future.
spk07: If I might just a quick related one follow-up, I mean, it's scrutinizing some of your own expenses makes sense too. Um, the one thing you didn't, I don't think you mentioned, and I'm kind of glad you didn't, but I just want to ask around R and D investment, um, because obviously Splunk is a technology company and you have a lot of, a lot of, um, offerings that, that, uh, you know, that I think need some more integration, and you've had changes at the top of the product area. I was just wondering if – how you think – and maybe, Gary, this is for – how do you look at investment in R&D, and how do you think that plays out over the near-to-medium term?
spk11: Yeah, no, I think, to your point – Innovation is a critical piece of our overall strategy at Splunk. We also think that aspect will continue to fuel long-term durable growth. So we will continue to invest in R&D. And one of the things that is part of my focus has been driving leadership and organizational change to help us drive better execution on the R&D front. But at a very simple level, we'll obviously keep investing in products and technology because that's what our customers rely on.
spk07: Great. Thank you very much, guys.
spk10: Thanks, Sean. Good to have you back.
spk16: Thank you. And ladies and gentlemen, we ask that you limit yourself to one question and one follow-up. Again, that's one question and one follow-up. One moment for our next question. And our next question comes from Ramo Lenshow from Barclays. Your line is now open.
spk08: Hey, thank you. And, yeah, good to see John back as well. Two quick questions. So can I stay on that cloud migration tool? Like what does it tell me about the value that customers are seeing or like how much work is involved in migration? Because you would think like cloud is kind of where everyone wants to go. So why would I slow that down? Maybe could you speak to that a little bit? And then one for Gary as well. You kind of talked about that greater focus on the CISO. Can you talk a little bit about how that plays into that bigger observability theme? And I did ask last quarter already, but maybe you can address it more like how CISO and observability kind of are related because I got a lot of questions from investors around that refocusing there. Thank you.
spk11: You bet. Cloud is definitely a priority for our customers, and they see a multi-cloud hybrid environment as where they're headed. And so I think it's actually pretty simple in that these customers have very complex Splunk environments because of the range of applications that have been developed and the volume of data they have. And there's just work required to do that, and that actually costs something. That's not free, that work to get the migration done. And so it's just a timing of when those migration efforts will begin. They are, the one thing that I saw very consistently is that customers want to go to Spunk Cloud and that there's a high desire to get there. It's just a determination of when. And then going, Raymond, to go to your second question regarding CISO, we're seeing a couple trends here that we think are really important. One, and we referenced this in our prepared remarks, we are beginning to see more CISOs owning the broad data set for which companies are driving broader business resilience initiatives, and business resilience really spans thinking about how do you protect yourself from some form of cyber activity, including breach, but also how do you ensure that your applications are up and running at all times. And the issue that we see now more frequently is when some event happens, organizations need to determine very quickly is it a cyber-related event or is it some form of application outage. And so the commonality here is single data set across both of those environments. And our alignment to CISOs is where we're always anchored. And so it's obviously a very good place to enter an organization and then enables us to then drive a broader observability conversation across the organization.
spk08: Okay, makes sense. Congrats. Thank you.
spk11: Thank you. Thanks very much.
spk16: Thank you. And one moment for our next question. And our next question comes from Brent Phil from Jefferies. Your line is now open.
spk04: Gary, on some of these cloud pushouts, if you kind of double-clicked into those and looked at competitive win-loss, and also if you look at execution, is there any factors playing into the sales team's deficiency on this or some of these customers saying they're going a different direction, or do you feel like, hey, that you check that box and that's not a concern for you.
spk11: Yeah, it's absolutely not a concern for me. So as we indicated in our prepared remarks, again, we saw competitive win rates stay the same. We did not see competitors changing the impact on those decisions. And I would go back to the point that Jason had made that a renewal rate stayed incredibly consistent. And so when you look across all of the metrics, it really bodes for the fact that people are just simply taking a little more time as they think about these cloud migrations. It really has nothing to do with competitive or nothing to do with willingness to continue to expand and invest in Splunk.
spk04: Okay. And just a quick follow-up. The on-prem piece seems really strong. Can you just balance that dynamic of what you're seeing there?
spk11: Yeah. I think the one thing that's really clear to me, so in my – 100 days and 100 customer meetings, which was kind of amazing. The one thing that was really clear is that the customers that we serve today will be hybrid for a very long time. And so cloud will play a very important role for them, but as will their on-prem. And the one very cool thing that uniquely differentiates Splunk is the ability to use Splunk across this multitude of environments and do so in a seamless way. And it really goes back to even features that we introduced at .conf where things like federated search, edge actions, all those things really give us an advantage in this world that is complex and hybrid.
spk16: Thank you. Thank you. And one moment for our next question. And our next question comes from Phil Winslow from Credit Suisse. Your line is now open.
spk01: Hey, thanks, guys, for taking my question. I just want to focus on new customer wins. Obviously, your dollar-based net retention was strong again this quarter, but you mentioned slowdown of expansions expected in the second half. What are you seeing in terms of new customer wins in the first half? And then we'd look at your cloud guidance for the second half. How much of it is a slowdown in just that dollar-based net expansion that you all talked about versus also potentially a sort of change called new logo wins?
spk11: Yeah, Phil, interesting question. what we saw was very consistent new logo wins across the first half. So there was nothing different in Q2 than what we saw in Q1. And I'll let Jason dive in here if he wants to add color on that.
spk14: Yeah, I mean, if you look specifically at ARR and contribution coming from existing versus new customers, we've, I think, said historically that roughly 80% of any given kind of bookings or ARR in a given quarter Roughly 80% comes from existing customers and expansions, and 20% comes from new. That's been pretty consistent, and it remained consistent in Q2.
spk01: Got it. Thanks. And then going back to just the question about sort of any sort of slowdown on the expansion side, or even the new logo win, are you seeing sort of a slowdown because you're potentially also seeing elongation of sales cycles, not just simply because of the slowdown of cloud, but because of more components? To your point, Gary, sort of selling observability and security. Or is this just sort of a high-level slowdown not having to do with incremental components from Splunk?
spk11: When we look at the slowdown, it was really specifically these cloud migrations where customers planning a big migration, it just takes time. And so it wasn't related to additional components that ultimately made the deal more complex or anything like that. It was really, you know, these cloud migrations are just big. Lots of data, lots of applications, all that need to be moved. And it's a project that requires staffing both on the customer side and oftentimes the addition of support professional services resources to assist.
spk16: Got it. All right. Thanks, guys.
spk11: You bet.
spk17: Thanks, Phil.
spk16: Thank you. And one moment for our next question. And our next question comes from Matt Hedberg from RBC. Your line is now open.
spk03: Great. Thanks for taking my question, guys. Jason, for you, I'm wondering, is there any way for you to quantify the impact in some of these slowed or delayed cloud implementations in the quarter? And, you know, have any of them closed in Q3, or are you expecting some of these to sort of maybe push out into next fiscal year?
spk14: Sure. So if you look at Q2 results, the expectations on ARR versus where we came in, you know, we missed by roughly 40-ish million. You know, roughly about 80% of that came from cloud. And then within cloud, you know, the majority of it did come from cloud migrations. So, you know, our guidance really is just kind of flowing that through to the rest of the year. So we're basically making assumptions that any of these kind of, you know, any of the pauses or kind of scrutinizing budgets and kind of delaying things, we assume that that's not going to be caught up necessarily in the next quarter or two. So, you know, if something changes, we'll see. But right now, our, you know, kind of all the messaging we seem to get in the back half of Q2 was that there's just a lot of folks pausing, you know, I guess a little bit like what we're doing ourselves on some of our outside spend. And so, you know, hopefully, you know, learn more about macro and what's going to unfold in the second half. But we're not making big assumptions on catch-ups in the near term. As I think we said in a couple of the earlier questions, renewal rates are still very consistent. Expansion is just a little bit lower in the near term. But everything that we see indicates this is really about timing. And so we think that once folks have maybe a little more confidence in the macro situation that will allow them to be able to make those expansions, which they can do anytime. They don't have to do it just on renewal.
spk03: Got it. Super clear. And then I think what gets missed in all this is this is becoming a much more efficient company. And, you know, you beat on profitability, taking cash flow up a bit. You know, I think you outlined some of the cost cutting things that you're looking at. And I think what's important is you don't think any of it's going to impact top line growth. I'm wondering if you could talk about the timeframe for some of these cost cuts. Is it multiple years? Is it this year? Any sense for where we are in that cost synergy equation?
spk11: Yeah, Matt, great question. I think one of the things that I tried to focus on in my first 90 days and first quarter was bring this more balanced perspective to how we can deliver long-term durable growth with increasing margins and cash flow and there's obviously we saw in the quarter there was low-hanging fruit and opportunity and as Jason outlined in his script you know we're focused on a number of areas and some of these things will see immediate benefit from and some will take more time so things like real estate that takes more time because you we have leases to unwind etc but other things like the uses of outside resources contractors etc those can have more immediate effects Jason, anything you'd add to that?
spk14: Yeah, I think what you saw in Q2 is that we grew our OPEX at roughly 5% year-on-year, very consistent with what we did in Q1. So there's a number of actions that Gary said. Some of them are short-term. Some of them are longer-term. We do expect to have pretty significant cost leverage going forward, I'd say for the near future. uh definitely through the rest of this year and and certainly well into the next year or two uh we'll provide more insight on that when we provide guidance uh later in the year um but there's there's certainly you know i think you guys have pointed out that we've had a relatively high cost base and relatively low margin and so uh this is certainly i think a time frame as we get more efficient and then certainly as gary's brought in a really strong focus on a balance of growth and profitability This is allowing us to really kind of stage and implement a lot of these different actions that we've been contemplating but now actually being able to realize. Great to hear. Thanks, guys. Thanks, Matt.
spk16: Thank you. And one moment for our next question. And our next question comes from Michael Turridge from KeyBank.
spk17: Your line is now open. Thank you. Hello, Michael. Your line's open. Are you on mute? Hey, can you hear me? This is Eric on for Michael. We got you. Yes, go ahead, Eric.
spk09: Great, thanks. So I just wanted to ask Jason a question. So, I mean, the license had some strong upside in the quarter and it was understandable that the cloud migrations were a little bit less than expected, but If I look at kind of your net new ARR growth, it seems like cloud was 90% or more of the kind of net new ARR growth. I'm just trying to square the two in terms of the strong license revenue quarter versus what looks like a strong mix of cloud as a percentage of new ARR.
spk14: Yeah, I think the short answer is term duration. was better than we had expected, which is what really benefits the revenue line because of ASE 606. And overall, on a comparative basis, I think I said about 80% of the ARR miss was cloud. There was still a little bit of slowdown in license, and that, again, is going back to some of the macro uncertainty and some of the kind of cautious approach that we certainly heard from a number of our customers towards the end of the quarter.
spk09: Great. And Gary, if I could just ask you, is there any change in kind of customer behavior in terms of where they're sending data, if not to Splunk? Are they using ingest actions at all? Are they using any other tools to kind of control the amount of data they're sending to Splunk?
spk11: Yeah, no, it's a really interesting question. So one of the things we're very focused on working with our customers to help manage their overall total cost of ownership. And so helping them think through where they want data to live over the long haul and how to then leverage these new features and capabilities that we've introduced, like federated search. So from a single console, you could get access to Amazon data sitting in S3. And so we just see customers thinking very hard about where they want that data to live and how do they want to optimize their overall cost of the Splunk implementation. And these features that we recently released, we think we've seen really positive feedback from customers. And so we're really encouraged by that, and I think it's the right message for customers given the volumes of data people want to put in Splunk.
spk17: Thanks, Eric. Justin, let's go to the next question, please.
spk16: Thank you. And one moment for our next question. And our next question comes from Mike Sykos from Needham. Your line is now open.
spk05: Hey, guys. You have Mike Sykos here. Thanks for letting me on. And I just wanted to take a different tack on those elongated sales cycles or some of this caution we're talking to with those cloud migrations. Can you help us think through the customer behavior? And really, is it tied more specifically to a geography or a specific vertical? Or is it relatively broad-based in nature when you're looking at those customers that chose to delay?
spk11: Yeah, no, great question. We saw pretty consistent behavior across geo. So the Americas, EMEA, and APAC. And we didn't see isolation to specific verticals. I wouldn't characterize it that way. And I think it was much more about the environment that people were thinking about migrating versus the vertical or the geo they were in.
spk05: Very helpful. I appreciate that. And then if I could, with the follow-up for Jason, I know that we spoke to the ARR missing in Q2 and the expectations now with the reset for the full year. I'm curious if you could help us think through the contract durations there. Could you help us? with any color as far as how those durations are expected to move or change as we looked at 2H versus where we were in 2Q or even a year ago?
spk14: Yeah, I would expect the durations that we saw in Q2, which were about kind of mid to high 24s for cloud and then mid 22-ish for term, I would expect to see cloud probably remain similar. Term, I think, probably is somewhere, we've said for a long time, it's something we don't control. We don't actually incent the sales folks since our sales force only gets a quote relief for 12 months. So it's usually between 18 and 24. Our expectation is probably in that 20 to 22-ish range. But again, it's not an easy number for us to forecast given it really comes down to customer preference.
spk05: No, I appreciate you pointing out it's beyond your control. But thank you for helping us think through some of the parameters when you guys went about formulating that guidance. Much appreciated. Thank you very much. You bet. Thanks, Mike.
spk16: Thank you. And one moment for our next question. And our next question comes from Brad Sills from RBC. Your line is now open.
spk06: Oh, great. Hey, thanks, guys. This is Brad Sills from V of A. Thanks for taking the question. Just one on the macro, the commentary you provided here on some of the larger expansion deals. On the one hand, it sounds like you've got this larger footprint, more complexities to some of these deals, and that's having an impact. And then on the other hand, there's some macro, it sounds like, as well. Could you just help us parse through those two things? Would you say it's one more than the other? And then were there any kind of commonalities in use cases? Was it outweighed to IT? Security was a bit more resilient. Any more color there, please?
spk11: Yeah. What was interesting, and I noted this earlier in the discussion, we did see a change from what we saw in prior quarter. And so this really all started basically in the last month of our quarter. So when we started to see different buying behavior, elongated sales cycles, deals pushing, it was really in the last month. So I would then attribute that very much to macro versus the circumstances surrounding the customer, because it was very different than what we had seen prior quarter. Understood. Thanks for that. And then going back to your second part of your question, which was, was it more IT or security? It's very difficult in our environment to pull those apart. But I would say generally it was more IT-oriented than it was security-oriented. But that's very qualitative on our part because we don't have perfect metrics on this one.
spk06: Makes sense. Makes sense. Thanks for that, Gary. And then one more, if I may, please. One of the categories that you mentioned you're focusing on to kind of drive efficiency here is sales productivity. I wonder if you could just elaborate a little bit more on that. Is that just simply a larger footprint that you now have available with observability to sell into some of these renewal expansion deals and you generate more productivity that way, or is there something else we should be keeping in mind? Thanks again.
spk11: Yeah, I think it's really simple on our side. It's just how do we continue to grow capacity to take advantage of what is a great market opportunity, and how do we align our resources appropriately to take advantage of that? We've And I think with that, you've heard on these calls, we want to make sure that we're well aligned to the security buyer. That's also important. So I think it's really just alignment around the opportunity.
spk06: Makes a lot of sense. Thanks again.
spk17: Thanks, Brett.
spk16: Thank you. And one moment for our next question. And our next question comes from Steve Koenig from SMPC NICO America. Your line is now open.
spk02: Great. Thanks, guys. Appreciate you taking my questions. I got one for Gary, and then I've got a follow-up for Jason on financials. So, Gary, you know, the macro is affecting a lot of companies, not just Splunk, and it tends to be in different areas. and sometimes it's the newer areas of their business where they aren't as established. You know, I'm wondering for Splunk, you know, you've been on the board for a while and you've seen this. This isn't the first time that, you know, Splunk has seen some variability in terms of customers expanding in cloud or migrating to cloud. You know, it has happened previously. And I'm wondering, what can Splunk do to get customers off the dime on Splunk Cloud and get, you know, get those migrations and expansions accelerating? And then I have one follow up, if you don't mind.
spk11: Yes. So I haven't been involved up until the last four months, so I wasn't on the board or anything. So this is all brand new to me. But from my perspective, it's all good. But from my perspective, you know, for us, we're really trying to make it as easy as possible for customers to do the assessment, understand what it takes to migrate and really do everything we can to assist them in that effort. And so You know, we think about that in the context of how do we bring services to the table? How do we bring the right partners to the table? And while a lot of that activity has been going on, we're going to double down to make sure that we're doing everything we can to support those efforts to get, using your words, get customers off the dime. Got it.
spk02: Okay. Great. Thanks for that. And then for you, Jason, just help me square. Your commentary that cloud expansions were lighter than expected, as well as migrations, with the metric you gave on cloud database net retention was 129, which is really only a point lower than last quarter. So maybe help me square those things. Thanks very much.
spk14: Yes, Steve, on the DBNRR, cloud DBNRR, that is a trailing 12-month metric. That said, even on total within cloud expansions, very, very small, you know, small changes from Q1 to Q2. It's just, it is a very, very sensitive metric. And so, you know, in this case, what we had said was previously we expected the year to end at about 70% cloud mix. You know, now we're saying we think it's going to probably stay around 60th percent. And so that is, you know, that 10% differential is really what's driving the difference. And, you know, we've talked in the past, about how when someone moves to cloud, it's about 1.5x versus on-prem or versus term. And so that's where the majority of the impact is. And when someone makes a cloud migration, that impact doesn't show up in dollar-based net retention. Most of it is in overall, and that's because they haven't been in cloud, and so therefore they're not really expanding to existing cloud. That's why the impact is more felt on overall dollar-based net retention and less within cloud.
spk02: Got it. Great. Okay. Thanks, Dylan.
spk14: Thanks, Adrian.
spk16: Thank you. One moment for our next question. And our next question comes from Gray Powell from BTIG. Your line is now open.
spk13: Okay, great. Thanks for taking the question. So, I got a couple here. Gary, I know you were not at Splunk back in early 2020, but I'd just be really curious. How does the environment today feel like what you saw relative to back then? And then I guess my follow-up would be, at Proofpoint, you all had a very conservative guidance philosophy. So I guess the question is, is some of the ARR reset here, is that just related to your being at the company for over a quarter now and officially putting your mark on the company?
spk11: Yeah, a couple things. So going back to your first part of your question, Gray, so in terms of the buying environment today, I think we just see general concern about recessionary concerns, et cetera, that have flowed all the way to the CFO, and they're scrutinizing and thinking through priority of spend. And I think that's what has led to the slowdown of these cloud migrations and expansions, as we talked about. And then relative to guidance philosophy, I think for me, I've been here 90 days, right? Like it's, well, I guess we're working on four months now. And so we need to be super thoughtful about our guidance going forward in this turbulent time. So try to be thoughtful.
spk12: All right. Fair enough. Thanks for the, I had to give that one a shot. Thank you.
spk16: Thanks, Greg. Thank you. And one moment for our next question. And our next question comes from Fatima Bulani from Citi. Your line is now open.
spk00: Good afternoon, gentlemen. Thank you for taking my questions. Gary, to start with you, just with respect to the slower velocity of migrations and expansions, I want to focus more on the expansion piece. As a broad observation, you know, we've heard from some of your peers around maybe some belt tightening on migration. cloud adoption and cloud utilization and, you know, the so-called consumption models. I'm curious if you can comment on how that dynamic impacts your cloud business and your cloud expansion rate. And then I have a follow-up for Jason, if I may.
spk11: Yeah, I think it's a really good question. I think what we're seeing is people are being super thoughtful about how much they're willing to commit on that expansion side. And it's just – I think you're using your words, the belt tightening, that's effectively what we feel. And it's not, obviously, we're not in a consumption model. People are trying to plan what their usage of Splunk will be over some period of time. And I think they're trying to rein in what, and you probably understand this, there's so much passion within Splunk within these organizations that lots of individuals across the organization want to use Splunk. And I think they're trying to hold that back and be very thoughtful to pull back on how much they really need.
spk00: Fair enough. Jason, for you, I'd be remiss if I didn't ask you about the renewals ACV pipeline that you've talked about for several quarters now. But just more in the context of free cash flow conversion, I believe you were at a billion, billion and a half on the renewals ACV. So I'm wondering why we're not seeing, you know, for lack of a better term, more oomph on your free cash flow and free cash flow conversion as those renewals kind of come through the door after your durations on invoicing have normalized. And that's it for me. Thank you.
spk14: Thanks, Fatima. I guess on the renewal base, what we had said previously is roughly $1.5 billion, and that was set when customers first migrated largely from PERP to Term and Cloud roughly two to three years ago. Those folks are now coming due. we are, you know, as I mentioned earlier, we're seeing very consistent high renewal rates. So that hasn't changed. The only thing that's changed is we're seeing a little less, you know, expansion to, you know, mostly tied to their, I guess, confidence in what their future data volumes will be. And so that's probably the thing that we saw most in Q2. We'll see how that flows throughout the rest of the year. In terms of the impact on cash flow, I mean, we did have that baked into our initial operating cash flow guide when we had $400 million as our target. We did take that up by $20 million this quarter. You know, it's halfway throughout the year. And hopefully we'll be able to, as we deliver on these expansions and renewal and expansions, you know, then hopefully we'll be able to deliver continued cash flow growth throughout the year.
spk00: Thank you so much.
spk17: Thank you.
spk16: One moment for our next question. And our last question is going to come from Young Kim from Loop Capital Markets. Your line is now open.
spk15: Thank you. Hey, Gary. Can you remind us your near-term strategy regarding your observability suite? Is slower cloud migration affecting that business? Are you fine-tuning your go-to-market around that, given you kind of pushed the combined security and observability push since you've been on board? Thanks.
spk11: No, we see tremendous opportunity on the observability suite, and we've seen great adoption across IT, leveraging logs and then bringing in metrics, traces, etc., Nothing's changed from our perspective about that opportunity. We're incredibly enthusiastic about the competitiveness, and we're seeing some great customer wins, and we noted one of those in our prepared remarks today. So we feel very, very good about that. There's no fundamental change in our strategy there, and we want to continue to leverage the strength that we've traditionally had with logs to go capture opportunities more broadly across metrics, traces, and the other components of the overall suite. So we feel really good about it.
spk15: And then, Jason, real quick, just to be clear, when customers are renewing their term deals, are they renewing at a typical three-year length? And just remind us the billing frequency around those term deals.
spk14: Yeah, I would assume that in the appendix of the website slides that we released with earnings earlier today, You can see the durations for both cloud and term. I would assume that they're consistent and expect that they will be consistent for the remainder of the year in that roughly 27-ish months range for cloud and 20 to 22 months or so for term. In terms of the invoicing, we bill them annual up front for the next 12 months. And that's a change that we made a couple years ago. And the reason, of course, our cash flow went down is we used to bill everything up front, and then we went to annual up front. And we're now done mapping that, which is why you're seeing our cash collection now start to normalize. Okay, great. Thank you so much. Thanks, Ewan.
spk16: And thank you. And I am showing no further questions. I would now like to turn the call back over to Gary Steele for closing remarks.
spk11: Thank you very much. I wanted to take a moment and thank everyone for joining us on the call today. We were pleased with the results we delivered, even in the face of some macro headwinds. And we feel like we have the right positioning given our balanced approach to growth and profitability. We look forward to talking with you all soon. Thank you so much.
spk16: This concludes today's conference call. Thank you for participating. You may now disconnect.
spk10: The conference will begin shortly. To raise your hand during Q&A, you can dial star 1 1.
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