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Splunk Q4 Earnings Preview

Mar. 03, 2021 9:56 AM ETSplunk Inc. (SPLK)17 Comments


  • Splunk is in the midst of a business model transition, from upfront licenses to subscription, from on-premises to cloud. It reports earnings after the close today.
  • Achieving this move is exceptionally difficult as a public company, since it requires recognized revenue and earnings to slow or go backwards, whilst building up deferred revenue and cash flow.
  • The market tends to react more keenly to recognized revenue and earnings measures - accounting measures - than it does hard-to-discern improvements in cash flow and balance sheet strength.
  • This makes Splunk a challenging stock to own whilst it attempts the transition. We're at Neutral as a result, but we are watching the fundamentals closely indeed.
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At A Critical Juncture

Since around the late 1990s, when subscription software began to come back into fashion (the original version being mainframe timeshare!), a rising number of companies born with a perpetual license model have seen that the certainty from subscription revenue in the end provides for a more relaxing relationship with Wall Street. In the last five years or so this has reached tipping point. Salesforce (CRM), the first at-scale cloud IPO, was an oddity when it first came to market. Investors and sell-side analysts alike were puzzled by the accounting and struggled to value the company as a result. The method is simple once you understand it, and has now become orthodox, but it wasn't obvious to everyone at the

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This article was written by

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Comments (17)

Cestrian Capital Research profile picture
Our latest on transitioning to the cloud: seekingalpha.com/...
Good call being conservative with this name. Down 18.4% since you published this article vs. 9% increase in S&P.

Still, wonder if this is a good entry down here...
Cestrian Capital Research profile picture
@dgiinvestor generally speaking we file "cloud transition" stocks under "too hard and too many things that can go wrong" given how many other places there are to put our hard earned. SPLK is down a lot and when we get time we'll take another look. But it's hard to get motivated to do so, to be honest. Growth names are just easier. (Especially when everyone has decided that Growth Is Just So Over Right Now).
I like your lucid articulation!
It would perhaps be useful to touch on the ARR metric in your otherwise detailed analysis.
The summary, as you aptly pointed, is that the stock is currently listless. Good for only short term, swing trading.
Any comments now after the Splunk earnings?
Splunk story is buried under the Selling General & Admin Expenses. Something is seriously wrong with the above expense. Last 5 years above expense is more than 65% of revenue. Even in 2020 the expense has increased when travel expenses should be low considering all COVID related restrictions. This suggests that deep down some expenses are directly linked to the sales and unless those expenses are reduced the company can never return to profit.
With revenue above $2 Billion the company should better manage expenses and return to profit.
HumphreyAppleby profile picture
I read through the comments by the SA Editors, but thought I would post my concerns about the quarter here.
People seem to be looking at the ARR number and concluding that the problems are over.

Does anyone know what ARR means?

In other words, Splunk reported Cloud ARR growth of 83% YOY, but the reported financials show Cloud revenues grew 72% YOY, and that was down from 80% in the previous sequential quarter. In fact, Cloud Revenue YOY growth YOY over the last 4 quarters was 81% (Q1), 79% (Q2), 80% (Q3), and 72% (Q4). As is put in context, that 72% growth hardly looks like a "pop."
Moreover, cloud operations margins dropped from 56.2% to 55.8%.

Did anyone bother to look at Maintenance revenues? YOY was -39%. Enterprise software revenues were -3% YOY and Total Revenues YOY were -6%.

Just to save you a trip to Wikipedia, ARR growth simply means that Splunk was able to sign customers to contracts longer than one year. If all the signings were just one year, the ARR growth would have been 72%, or equal to the reported numbers. SaaS vendors typically sign customers to one-year deals, but those customers pay month to month. Splunk has always been focused on signing Enterprise customers to 3-year term deals, and that is what they are doing as they move to cloud. You should note that signing a 3-year deal means that the customer gets an additional discount for that longer-term deal signing. Does anyone have any idea of ASP, per volume grouping, in year 1 vs. year 2 and year 3?, or was that discount taken upfront, and recognized ratably over the term of the contract? Neither do I, but the working assumption is that the discount was more than zero.

Therefore, Splunk only recognizes the revenue from the first year of the deal and defers the remainder of the contracted revenues (depending on how the contract is written) to the Balance sheet. Deferred Revenues were up $267M in Q4 vs, Q3, but the NET increase vs. 2020 was $201M, so $66M of the previous Q3 balance was recognized as revenue in Q4. Therefore, the Net New increase in total revenue was $679M, not $745M – which means that YOY revenues would have decreased by 14%. It's sure nice to have that bank of deferred revenues, which is why they focus on signing customers to longer-term deals.

Summary. The quarter wasn't nearly as good as the analysts think.
@HumphreyAppleby do you know Cloud ARR is the leading indicator of Cloud Revenue?
HumphreyAppleby profile picture
@Crowded Place What a charming insight. Unfortunately, the numbers don't support your assertion. Per financial statements, Cloud ARR, Q1F21 = 81%, Q2 = 89% (nice one, Splunk gets "hall pass"), Q3 = 71% (oops), Q4 = 83%.
Cloud GAAP Rev: Q1 = 81%, Q2 = 79%, Q3 = 80%, Q4 = 72%.
How many quarters would you like to lag to prevent rejection of H0?
Robin12 profile picture
Thank you very much for your analysis. I don't know very much about the company, but your writing Style is brilliant - the best I've read so far on SA.

Just wanted to say thank you. It is always a pleasure reading your articles!
Ted Stamas profile picture
This is not an apples to apples comparison, but Nuance Communications $NUAN went through a similar transition about five years ago. The stock treaded water for a few years, then tripled once the transition was completed.
Cestrian Capital Research profile picture
@Ted Stamas Great point, Autodesk (ADSK), Cadence (CDNS) and others have succeeded too. It is absolutely do-able and SPLK could well succeed. We just want to see a little evidence of success before going long the name.
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