Splunk Inc. (SPLK) Management Presents at Jefferies Virtual Software Conference (Transcript)

Christel Deskins

Splunk Inc. (NASDAQ:SPLK) Jefferies Virtual Software Conference Transcript September 14, 2020 12:00 PM ET Executives Jason Child – Chief Financial Officer Tim Tully – Chief Technology Officer Analysts Brent Thill – Jefferies Brent Thill Welcome everyone. It’s Brent Thill at Jefferies. We want to welcome the Splunk team and Jason […]

Splunk Inc. (NASDAQ:SPLK) Jefferies Virtual Software Conference Transcript September 14, 2020 12:00 PM ET

Executives

Jason Child – Chief Financial Officer

Tim Tully – Chief Technology Officer

Analysts

Brent Thill – Jefferies

Brent Thill

Welcome everyone. It’s Brent Thill at Jefferies. We want to welcome the Splunk team and Jason Child, CFO; Tim Tully, CTO. Thank you, gentlemen, for joining us.

Question-and-Answer Session

Q – Brent Thill

Let’s talk about the story. Maybe if we can just start off, between both of you just talking about this mega shift to the cloud, obviously, given what’s happening with COVID and we continue here this shift to ongoing digitization of information. I understand that with all these cloud applications that are out and can you just talk a little bit about what you are seeing in current — and how long you expect this to last?

Jason Child

Tim, did you. Go ahead.

Tim Tully

Sorry.

Jason Child

Go ahead.

Tim Tully

Yeah. My connection just broke up a little bit. Yeah. Look, I think, the shift to cloud for us is an obvious one, the customers are sort of demanding and taking us there. In my team, we sort of turn the ship with the entire products and engineering organization to being cloud first to the point where all of our products are released to the cloud first nowadays. That’s a complete 180 from where we were just a couple of years ago.

So it’s a huge transformation for the company and it’s been multiple years that we have been on this journey and a lot of that work of re-architecting Splunk for the cloud is finally coming to fruition and our customer base folks are saying that, they are really excited, they love a lot of our new products, they are going to the cloud and we are there with them.

Just in the last session we are in, I was telling some of the attendees that, what I have seen it in the customer base is, a lot of folks are moving more towards a hybrid world, quite frankly, than being sort of discretely either on-prem or in the cloud. And fortunately Splunk is well-positioned to live in that world.

We have a stream processing solution called DSP that essentially enables that kind of architecture, where you can have both on prem and cloud presence, and move data back and forth between both sides with processing in the middle and that that solution is a natural bridge to folks who want to buy our cloud SaaS solutions, right? Because they can move data from their data center and then fan it out into different formats into different solutions that we have in the cloud.

Brent Thill

And Jason for you just from a financial perspective and how you are looking at this in terms of how you are managing the financial aspects of the business along this, just talk to us about how that’s going.

Jason Child

First of all I will just say that, the work that Tim has done is actually been incredible, especially given the day we hear in the back, like, he is managing and juggling a lot like we all are. So, well done.

Anyways, so in terms of the financial aspects, what I would say is, one of the things that was interesting is, we actually were kind of holding back the cloud business until we started this year. We actually were comping our sales team at less than on-prem.

And the reason why was there was just a lot of work to do to get the product feature set right. Also a lot of work to work on improving the margins, I talked in the past about how there is a bunch of work on working on multi-cloud multi-tenant some of the last testing work we pulled out compute and storage, and so just a lot of technical work to be able to get really the product ready.

And so then when we started this year, we are now actually compensating the sales team for cloud equal to on-prem, and ultimately, customers we feel are going to make whatever choice works best with them. So that timing seemed to work out really well, because once COVID hit it turned out that I think the ability to actually deploy cloud, when you are not having to prepare servers, you are not having to find the people to do the work and kind of corral all the different efforts that it takes.

I’d say [Audio Gap] that difficulty combined with just the fact that the product was really ready has led to a significant acceleration in our — to the point where I think last year we were at about 35%, this year — this last quarter we were at 53% of our software bookings in cloud and we actually are now back in the year at roughly 60% a full two years faster in terms of reaching 60% of our business in cloud on a booking basis versus what we thought at the beginning of the year two years, four years earlier, so we are going to hit at the end of this year instead the end of fiscal 2023. So those are the pieces that we have been managing and so far we are very, very happy with the progress that we are making

Brent Thill

Yeah. Good to see the progress. Tim, just to mention or go back on the cloud first, so from your perspective now you are effectively at parity where it doesn’t matter what the client takes, they can get the same feature set on-prem or on cloud. When do you think that hit parity from a product perspective?

Tim Tully

I mean we have always been at feature parity with what we call Splunk Cloud historically, because as you know what we call Splunk Enterprise Cloud was our own on-prem product running in the cloud. And so, I think, more specifically in terms of the new container based multi-tenant cloud near of architecture, feature parity is there at the Splunk Enterprise bubble where there’s still work to be done a bit is more in the application space specifically around security and IT.

But it’s not a showstopper for folks necessarily to move over, right? I mean, it’s hard to get a 200% and oftentimes you don’t actually want it to be at 100% feature parity, you actually want to take that as a moment to pare back pieces of the past that you don’t actually like. So be at 100% is actually not a goal to be honest, which I think you would hear from most of our leaders is…

Brent Thill

Yeah.

Tim Tully

You take this time to not do that and kill deadweight, right?

Brent Thill

Yeah. Just on security that’s roughly half of the company’s revenue I believe, correct me if I am wrong. I have spent a huge call for you. Many are asking kind of what’s next, what’s left, how do we think the about the evolution of the security business from here?

Tim Tully

Yeah. We announced something called Mission Control, which is essentially our next-generation cloud native SIM, if you will. And what that is a single pane of glass that allows our security users to essentially see the totality of their security posture, but in the cloud and with more advanced third-party integration for other solutions, right?

And so what that is — what I call internally the brand new unification theorem of security for us, right? It’s a brand new UI. It’s built for people to consume in the SOC [ph]. It’s not just a rendition of your security posture in a Splunk [Audio Gap] meant to be consumed by that security analyst, who’s sitting in the security operating center. And again, the key there is the ability to plug and play third-party solutions from other sort of niche aspects of security into that solution, so that you have one single pane of glass.

My perspective on security is sort of like a humongous spectrum of different frequencies of colors of a rainbow. And it’s hard to cover every aspect of every single frequency and so you need a tool like Mission Control that can actually pull all of these together into one UI and that demand is coming very specifically from CECLs [ph] and leaders in the SOC and that’s what mission controls they are there to deliver.

So you are going to see features on that added very, very quickly and you would see more about it at our conference next month and we are going to push it very hard. There are other things that we have working in the lab in terms of security. I can’t quite say it yet but stay tuned there is much more to the story in my mind.

Jason Child

Yeah. Brent, I would just add that on the views that kind of Gartner security total addressable market. I think we are in any kind of 2.5% kind of low single-digit range. And if you look just at like SIMs, some of the sweet spots we are at, there we are going to be higher we are in the maybe in the mid to high teens but we are still, there is still a ton of runway.

And then with some of the new features that Tim mentioned, we feel like that also expands beyond just the current parts of security that we are addressing today helps us get to attack the rest of the security kind of total addressable market, which again we are in the kind of low single-digit percentage.

Brent Thill

That’s great. A lot of questions about SignalFx and what that’s going to add. There is a lot of attention on EPM and that market and where you can be given the success of others like down trace [ph] and others in the market. Can you just talk to us a little bit about the overall trajectory with SignalFx and then specifically on EPM?

Jason Child

Yeah. So maybe about a year ago we acquired a SignalFx and we bought another company called Omnition at the same time. Omnition by far and away was the best distribute traces I had ever seen. And we spent the first few months of those acquisitions really calling them together and we have released that unified version in March of this year.

Sort of the next stage of that story was to have logs sitting together with metrics and traces. And we have been working on that for the last six months, as well as a brand new user interface to modernize it and make it more usable, easier to go back and forth between logs, metrics and traces and making it more accessible for a wider variety of users not just like the super, super power developer user.

So you are going to see a lot of news from us in the next month or so at our conference where we are going to reveal a lot of that work coming to fruition where logs, metrics and traces are together with that new UI, as well as some other sort of interesting announcements in the space of observability. I prefer to use the word observability as opposed to APM, because APM tends to narrow you down into aspects of observability in my mind.

Brent Thill

Okay. There have been a ton of questions just in the last two weeks and this wasn’t in the script, but just talking about the new coming IPO’s of Snowflake and Sumo, and I am just curious if you can talk to architecturally. There are some questions about in one vendor take on another vendors market and whatever. But where do you see kind of where Snowflake and Sumo sit relative to where you guys are not?

Jason Child

Well, I see Snowflake more and sort of the traditional data warehousing buyer, right? They want some kind of alleppey style of solution. I see some OLTP usage as well to be honest. But it’s — they are playing in a slightly different world than Splunk, right?

We live more in the unstructured world of log aggregation and log collections, Snowflake is much more in the structured world. So it’s a different buyer. So it’s a little — I would call it more complimentary to Splunk than anything else.

In terms of Sumo, it’s a different solution slightly in a different space, right? It’s more for SMBs in my mind a little bit more down market. We tend to do much more up market with where people have larger concerns around the scale and being able to have long term storage durability and being able to write queries that span years, right? So it’s still a little bit in a different segment.

Brent Thill

Jason, the adoption of infrastructure by pricing that was a big move that you guys pivoted to, maybe just talk, I think, you mentioned in the last calls, it’s going to take a while to rollout this new and existing customers come back to you. But what have you seen so far, it seems like, which checks we have had and very positive and it seems like the sales force and the partner ecosystem starting to brace this, what are you seeing from your lens?

Jason Child

Yeah. I’d say so far it’s a relatively small portion of our customer base has moved to the infrastructure base or workload based pricing. But customers that have increased the amount of data that they have put in the Splunk and that’s exactly what we are hoping to drive with the pricing.

We talked about a big customer win on the second quarter call and we talked about how the way customers have — if you do heavy querying than under the old congestion based model. You could really pay a lot and it’s hard to predict and that’s where our fund remains.

So what we are doing is giving customers the choice to say, if you want to buy on the existing congestion based pricing, that’s great. We will also offer you a workload based pricing alternative, which is going to be either a virtual core for cloud or it’s going to be vCPU, virtual CPU for on-prem and we will let you make the choice.

And what we have found is that just by giving our customers the choice, I think that already is really helping them to understand the cost drivers and then for the folks that really just don’t like congestion based pricing they find it hard to predict or hard to budget and they are more — a lot of those folks are using more workload based, they are really happy with it. And then, some customers are actually stuck with the old pricing, but they feel better about it because now they have a choice.

I think overall what I would say is, because we have customers, we don’t have kind of self-serve customer. But all of our customers are negotiated via sales team through contracts that are multiyear duration on average, usually two and a half to three years. So what that means is you are not going to see the new pricing unless you are coming up for renewal.

So we have been about — we are about a year into the new pricing. So it’s probably going to take us another year and a half to two years before the full customer base sees it. And so that’s why the adoption so far is relatively low, but we really liked the customer reaction thus far and really feel very happy with the kind of the progress at the momentum that we are seeing.

Brent Thill

There was questions around Splunk Cloud and in separating compute versus storage and talking about how you can do that, how far along are you in that journey? You obviously want everyone to store their data there, but maybe they don’t want to get completely charged. How are you handling that?

Tim Tully

Well, I mean, that’s the journey we have been on for quite some time. In fact some of that some of the architecture work for that actually predates even my arrival at Splunk, right? The sort of first leg of that story was it materializes something called smart store, which is a feature that essentially lets you move colder Splunk buckets to blob storage in the cloud and then it certainly page it in and out on demand depending on the workload.

What we have done is really extend that story much more deeper or much more deeply, I should say, into fully coordinative container-based Kubernetes deployments all driven sort of the way you would imagine to terraform and it uses things like STO and envoy and all these things, I mean, the HUD [ph].

What we have done is really come to a point where this thing is fully operational. It’s being already used within aspects of our observability solution instead of Mission Control, which I just spoke about a minute ago on the security side and you are going to see this thing really power our traditional Splunk Enterprise cloud users moving forward that some of these new customers will come on Board, we will move to that first and that’s just right around the corner. And stay tuned at our conference again next month to tune in more, because we will basically double click on the architecture, talk about timelines and when people will start adopting?

Jason Child

I’d say just apply the numbers to it, that was the driver, what Tim talked about is the driver of why I think our margins were very, very low a couple of years ago, even two years ago there were in the 30%-ish range and last year came into the 50%s, now we are just approaching 60%, the goal — we told to folks we will be above 60%, in the low 60%s by the end of this year expects to be approaching 70% end of next year. And all of the work that Tim just mentioned is certainly core to actually be able to drive those improvements.

Brent Thill

You are waiving a lot of architectural work. Congrats. That’s a lot.

Tim Tully

Yeah. He’s actually yelling downstairs. I am having a little problem hearing you sometimes.

Brent Thill

Yeah. Jason, just when you think about the overall environment, we obviously went to air brakes came on. No one knew what was happening. You have heard kind of this continued improvement, I think you guys called out, it was a good quarter, but still tough out there. But when you think about kind of your plans and hiring in that and direct core to carrying reps and going — kind of trying to get back to normal. How do you think about this year and what changes you have made around hiring and go-to-market resources, how was that shifted through the year for you?

Jason Child

So it’s been a tricky year for us, because we are not just dealing with COVID, we are also dealing with a pretty significant transformation where the sales motion for a cloud is different than it is for on-prem. And actually the good news is it’s actually a — it’s a tighter sales cycle, because you are now selling a hosted solution, you are not having to deal with multiple folks in an entity that you have to deal with procuring hardware, there’s probably some headcount required, as well as the actual license.

And so that’s great news. I would say that said, COVID is certainly — it certainly made predictability of like of what really, I mean, for us we have to predict what our customers are predicting and there’s just a lot of uncertainty out there. And while I know a lot of folks and some of the companies have started been very positive about macro, I think, most of the companies I have seen that have been positive have also removed all the guidance took it down and then now taken apart back up to some extent, but not quite to where they started. We are kind of one of the few that actually has maintained our ARR guidance throughout the year.

And so from our perspective we are continuing to hire DQC’s. We are having to — we are growing 50% ARR last quarter, I think, it’s six or seven quarters in a row over 50%. And so, it’s just — that kind of growth we have to be continuing to invest in sales capacity, because again, we are not a self-service model, we are — the sales team drives all of the growth.

And then also now cloud growth accelerating in last quarter from 82% to 89%, now we are, well, between $400 million to $1 billion. I think we are the fastest growing cloud company on ARR basis out there and so that means we also have to continue to step up for capacity.

And obviously, we gave out a three-year CAGR that says we expect to maintain a 40% compounded annual growth from last year through FY’23 and we haven’t changed that guidance, so we are definitely going to continue to be hiring.

And then, of course, we are also making investments in Tim’s team. We have been — we have made a lot of tuck-in acquisitions to continue to evolve our platform to be really the best next-gen platform to handle massive data sets for security IT and observability, and those investments we are going to continue to make because of the growth trajectory we have seen and continue to forecast through FY’23.

Brent Thill

Tim, are there any verticals where you are like while this could be pretty, pretty big what we are seeing kind of a minor adoption today. Is there any — anyone that casting out to you, again, I am making this up whether it’s healthcare or government or are there any big ones where you are like wow we are kind of just hitting the tip of the iceberg here?

Tim Tully

Yeah. There are. I can’t tell you. There is like major ones for sure that are — I think, we have the right ingredients work, we just sort of have to pull the trigger. That being said, I think, there is a lot of growth still remaining in the observability security and IT ops front.

We can go much bigger and much more broad than we have, and I think, over time you will see a little bit of both, but I don’t want to get into what’s the next big vertical for us. That being said, they are readily apparent in my mind.

Brent Thill

Okay. And Jason, maybe last question, the true north of the $1 billion cash flow. I think you are pretty clear you feel confident that you can get there, maybe just walk us through the things that you are seeing that giving you a lot more confidence?

Jason Child

It’s — I mean, it’s relatively simple and that is, as we continue to grow ARR, we will produce roughly 20%-ish of ARR will become operating cash flow and that is a yield — cash yield that we — I think 2013 to ‘18, we were between 20%, 24% every year.

So as we kind of move through the transformation and now actually start to get all three layers, when you have a three-year deals and we charge upfront just for one year at a time, it’s going to take us until middle of FY’22, until we start to get the full all three layers of the cash inflow finally coming back to mid this time last year.

Next year you will see us turn positive middle of next year and then when you take your ARR projections times roughly is 20%-ish plus or minus that puts you right in that $1 billion range and if you were to look at our operating margin on ARR basis, it would tie also pretty close to that percentage. And so that’s how you get there — that’s from a numerical standpoint that’s how you get there.

Brent Thill

Great. Thanks for joining us. Always great to have both you guys with us. So thanks for all your time and helping educate investors with the story.

Tim Tully

Thank you, Brent.

Jason Child

Thank you.

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