Splunk Inc. (NASDAQ:SPLK) Q3 2022 Earnings Conference Call December 1, 2021 4:30 PM ET
Ken Tinsley - Head of IR
Graham Smith - Interim CEO
Jason Child - CFO
Shawn Bice - President of Products & Technology
Teresa Carlson - President & Chief Growth Officer
Conference Call Participants
Kasthuri Rangan - Goldman Sachs
Brent Thill - Jefferies
Michael Turits - KeyBanc
Raimo Lenschow - Barclays
Matthew Hedberg - RBC Capital Markets
Kirk Materne - Evercore ISI
Karl Keirstead - UBS
Bradley Sills - BofA Securities
Keith Bachman - BMO Capital Markets
Keith Weiss - Morgan Stanley
Good day and thank you for standing by, and welcome to the Splunk Inc. Third Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised this call is being recorded. [Operator Instructions]
I would now like to hand the conference over to your host today, Ken Tinsley, Vice President of Investor Relations and Corporate Treasurer. Please go ahead.
Thank you, operator, and good afternoon, everyone. With me on the call today are Graham Smith, Jason Child, Shawn Bice and Teresa Carlson. After market closed today, we issued a press release, which is posted on our Investor Relations website, along with supplemental materials. This conference call is being broadcast live via webcast, and following the will be available on our website.
On today's call, we will be making forward-looking statements, including financial guidance and expectations such as our forecast for our fourth quarter and full year of fiscal '22 and '23 as well as our future expectations of revenue mix, renewals, duration, RPO growth, cloud growth, bookings, cloud gross margin and operating cash flow; as well as trends in our markets and our business, our strategies and expectations regarding our products, technology, strategy, customers, demands and 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. Please refer to documents we file with the SEC, including the Form 8-K filed with today's press release. Those documents contain risks and other factors that may cause our actual results to differ from those contained in our forward-looking statements.
These forward-looking statements are being made as of today, and we disclaim any obligation to update or revise these statements. If this call is reviewed after today, the information presented during this call may not contain current or accurate information.
We will also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP and non-GAAP results is provided in the press release and on our website.
With that, let me turn it over to Graham.
Thank you, Ken, and good afternoon, everyone. Before I talk about our Q3 results and business momentum, I'd like to first introduce myself. As you all learned a few weeks ago, Doug Merritt has stepped down as President and CEO, and the Board has appointed me Interim CEO while they conduct a search to identify Splunk's next leader. I've served as a member of our Board of Directors since 2011, taking on the Chair role in 2019. Since I retired from the CFO role at Salesforce in 2015, I have served and continue to serve on the Boards of category leaders and innovators across the SaaS landscape.
Splunk is an extraordinary company. Having spent a decade on the Board, I've always appreciated the power of our products, but it's a true honor to be leading its passionate, customer-focused employees.
What differentiated Splunk's technology when I became a Board member, our unmatched scalable index is still a critical and unique component of our platform. Over the years, we've built on that index to offer an extensible data platform that powers purpose-built solutions for security and observability, giving tens of thousands of organizations the ability to break down silos and investigate, correlate and take action on data at incredible scale.
What's more, over the last 1.5 years, Splunk has become the data foundation upon which our customers have adapted to a remote work environment and navigated the immense challenges and opportunities created by global pandemic.
I want to thank Doug for his innumerable contributions to Splunk. Doug built Splunk's amazing go-to-market muscle in his early years at the company and then took on the critical product and business model transformations, which have enabled Splunk to become a global tech leader that it is. Under Doug's leadership, Splunk has grown from $450 million in revenue to now nearly $3 billion in annual recurring revenue, propelling us towards a future where every organization can harness the full power of its data.
Turning to our quarterly results. Our Q3 execution was strong as we continued to deliver high value to our customers around the world. Q3 was Splunk's first $1 billion cloud quarter with cloud ARR reaching $1.1 billion and growing 75% year-over-year. This was our 11th straight quarter of 70-plus percent cloud ARR growth. Our cloud bookings mix jumped to 68%, our highest ever. And our cloud dollar-based net retention rate increased to 130%. Total ARR grew 37% from the year ago period, keeping Splunk in the rarefied group of multibillion-dollar companies growing faster than 30%.
In October, we welcomed more than 20,000 Splunk customers, prospects and partners to our .conf user conference. We showcased Splunk as the data foundation for the hybrid world. And we showed how our customers can unlock innovation by building resilience, improving security and gaining end-to-end visibility of their data. We announced numerous platform innovations to help customers take action on data wherever it originates. We revealed our new Ingest Actions capability, enabling organizations to take action on data motion to redact, filter and route data to Splunk or to external S3 storage. Ingest Actions is just one of the new ways we are helping our customers manage their high-value data more economically.
We also highlighted enhancements to federated search, providing a unified search experience whether the data is in the cloud or on-prem. This type of hybrid capability continues to differentiate Splunk even as we accelerate our cloud transformation.
As we all know, security continues to be essential to digital transformation. So at .conf, we also highlighted our capabilities like risk-based alerting, threat intelligence management and SOAR visual playbook editor to help customers detect, investigate and respond to threats faster through increased automation.
One of our most important security wins in Q3 was with the U.S. Navy. Our partner, Leidos, and the U.S. Navy expanded their use of Splunk to further secure their mission-critical systems, adding Splunk for real-time monitoring of mission systems, which includes cybersecurity, NetOps and continuous monitoring.
Splunk's observability offering significantly improve performance, productivity and innovation across complex, hybrid and cloud-native architectures. Our newly announced capabilities, including Splunk App for Content Packs, Real User Monitoring for Mobile and AlwaysOn Profiling are just a few of the new offerings that are empowering developers, site reliability engineers and IT professionals to keep systems running and power the next phase of digital innovation.
Progressive, the #1 commercial auto insurer in America, has expanded their already during Q3. Progressive, which is one of the more than 90 Fortune 100 companies that we are proud to count as our customers, decided to transition to Splunk Cloud with workload pricing during the quarter, gaining full stack visibility with Splunk's entire Observability Suite.
Our security and observability offerings are individually very powerful. But the true power of Splunk is when these solutions all come together on our differentiated data platform, providing customers the data foundation they need to thrive in today's hybrid unpredictable world.
For example, during Q3, the University of Virginia selected the Splunk Cloud platform for data-driven security and the ability to search, analyze and visualize data across their IT infrastructure. Also in Q3, a Canadian telco selected Splunk security and observability to help keep millions of users connected through a variety of wireless TV and phone services. They chose Splunk to enable their entire team to observe, understand, decide upon and act on security instance from a single platform.
Beyond our product news, we unveiled a number of advancements at .conf to help customers accelerate their cloud migrations to Splunk Cloud. We expanded the availability of workload pricing to all of our Splunk Cloud customers, providing the freedom to put more data into the Splunk platform and the choice to use it when customers want to bring even more value to their organization.
We also launched our new Government Logging Modernization program, which further equips U.S. government agencies to meet new cybersecurity mandates.
Finally, we announced our reimagined Splunk Partner Program and joined an elite group of 10 other software companies as Accenture and Splunk took our partnership to the next level with the launch of the Accenture-Splunk Business Group.
As we look forward, my immediate focus as Interim CEO will be on maintaining our momentum throughout Q4 and into fiscal '23. I'm grateful to work alongside a world-class management team, who I'm confident will ensure we execute well in our most important new business and renewals quarter.
As we prepare for next year, I'm excited to continue building on our strong foundation to best position Splunk for long-term success. We have an extraordinary opportunity to enable even more customers to make the move to Splunk Cloud. We've seen that customers who use Splunk Cloud are able to reallocate resources to higher-value tasks, take advantage of more flexible pricing and scale and rapidly benefit from our latest product innovations.
I didn't hesitate to step in as the Interim CEO at Splunk based on my strong belief in our technology, our employees and the huge opportunity ahead to help customers turn data into doing.
I thank you all for welcoming me today and look forward to answering your questions. Jason?
Thanks, Graham. And adding my thanks and appreciation to Doug for his leadership and partnership in my time here. We've never been in a stronger position to fuel our continued growth.
Onto the quarter. Once again, our execution was very strong, and we ended with total ARR of $2.83 billion, up 37% year-over-year. Cloud ARR surpassed $1 billion for the first time, ending at just over $1.1 billion, up 75%. We ended the quarter with 635 customers with ARR greater than $1 million, up 43%. 270 of these customers had cloud ARR over $1 million, up 96% over last year.
Our continued focus on customer cloud adoption drove a sharp increase in bookings mix this quarter with cloud accounting for 68% of total software bookings, a 14-point sequential increase and the highest rate we've ever reported. This resulted in $130 million of net new cloud ARR, more than double from Q3 last year; and total net new ARR grew almost $200 million, up 41%.
As we've called out before, our view of bookings has been skewed by shorter overall contract duration related to our customers' transformation to cloud as well as the change in our field compensation plans, specifically intended to drive average term contract duration downward, which in the near term we see trending to between 18 and 24 months. By shortening contract durations, we’ve found that customers will engage sooner on the Splunk Cloud adoption or expansion strategy. With these factors continuing to normalize, RPO bookings is becoming a better indicator of bookings momentum. And in Q3, total RPO bookings was $804 million, up 56% over last year.
On the P&L. Q3 cloud revenue was $243 million, up 68% over last year, reflecting acceleration of customer adoption of our cloud platform. Total revenues were $665 million in Q3, up 19% and somewhat muted from shorter-term contract durations. Professional services and education accounted for 8% of total revenues in the quarter.
On margins, which are all non-GAAP. Cloud gross margin was 65% in Q3, up 3 points from last year as we realized leverage from scale and elasticity of the platform. Total gross margin was 77%, down slightly on a year-over-year basis due to the greater proportion of revenue contribution from cloud. Operating margin was negative 10% in Q3, significantly better than planned due to our bookings and top line outperformance plus some expense savings from converting .conf to fully virtual.
On the balance sheet, we ended the quarter with $1.6 billion in cash and investments after the repurchase of 5.5 million shares of our common stock for an aggregate $808 million. Since we began our repurchase program in July, we have repurchased a total of 6.9 million shares at an average price of $145.23 per share, more than offsetting the potential dilution from the conversion of the notes we issued to Silver Lake Partners early this year and completing repurchases under the $1 billion authorization.
Turning to guidance. The demand environment remains strong, and customer engagement is excellent, especially for existing customers planning their hybrid deployments, as you can see in our higher cloud mix. We believe cloud momentum will continue, and we're now expecting approximately 70% mix in Q4, higher than we previously expected. Based on this, we're increasing our cloud ARR target to between $1.325 billion and $1.35 billion at year-end, while our total ARR target remains in the $3.085 billion to $3.135 billion range.
On the income statement, the cloud transition continues to drive variability in our revenue and operating margin results. With significantly higher anticipated cloud mix in Q4, revenue growth will be tempered, just as we've seen in several prior quarters.
With our highest-ever projected cloud mix of 70%, we expect total revenues of between $740 million and $790 million in the fourth quarter. On the expense side, while we have been realizing gradual leverage in our cost of services line, the pace of cloud gross margin expansion has been slightly lower than planned. For Q4, we are expecting cloud gross margin will be roughly in line with Q3 as we continue to migrate our installed base on to the newest version of our services.
For OpEx, our overall expense run rate is slightly better than planned, and we expect a non-GAAP operating margin of between minus 2% and minus 8% in Q4. For the full year, higher cloud mix is driving lower total revenues, and therefore, pushing operating margins lower to between negative 15% and negative 17%. Our outlook for full year operating cash flow was unchanged at approximately $100 million.
Looking further out, as we start thinking about next year, we expect customer demand will remain strong. For fiscal '23, our initial view of total ARR is approximately $3.9 billion with our cloud business reaching at least $2 billion of ARR by year-end.
To highlight our accelerating growth, it took us 3 years to grow cloud ARR from $200 million to $1 billion, and now we expect it will take us only 15 months to grow up from $1 billion to $2 billion.
In closing, Q3 was another strong quarter following an excellent first half. The overall demand environment remains robust, and our continued push on cloud adoption is accelerating our transition into its final phase. As a team, our relentless focus is on customer success, and we're set up well for a strong finish to the year.
With that, let's open it up for questions.
[Operator Instructions] And our first question comes from Kash Rangan from Goldman Sachs.
I'm curious to get your thoughts on the CEO search. What are the attributes is the Board looking for? And I also wanted to call out the tremendous cloud performance in the quarter. The 68% is a significant metric. You're guiding to 70%. And that, I guess, becomes a question for Jason. As you project that out, 20% of your ARR in the next fiscal year is going -- actually, 50% is going to come from cloud. What does that mean for the longer-term cash generation potential of the business? How much more confident or not are you with respect to the longer-term cash generation of the business as a result of the cloud transition, which is playing out even more quicker than we expected? Kudos.
Well, thank you, Kash. Yes, good to reconnect. I think we necessarily thought. But no, it's great to be back. It's very energizing.
In terms of the CEO search, I think the Board is off to a fast start. We are finalizing the spec. We've already engaged a headhunter. So we're running fast. And obviously, we want to have a great process.
From a point of view of attributes, I think, clearly someone who has operated a business at multibillion-dollar scale, I think, is really important. And then probably I would personally also think someone who is very comfortable basically setting the vision for a technology product, not an [APA] technology product, and someone who can do a great job of translating the technology needs of customers into business value. I think those are really important skills for the CEO to have.
Jason, do you want to answer the second part of Kash's question?
Yes. Yes. So on the cloud kind of gross margin and impact on overall impact on cash generation, I know we had said previously that we expect -- we had a long-term target of a 20% cash yield or operating cash flow divided by ARR. We still do believe that, that, of course, will occur in the future. The timing, we're still working on. And there's kind of 3 primary levers.
You pointed out the cloud mix. That certainly is one piece. Today, our cloud is at about 65% gross margin. We do -- and of course, our on-prem's at 95%. I do -- we do expect that to go up over time. We're still kind of working on the nuances of the large-scale cloud migrations, where we have to first focus on meeting customer success and then second, work on the margin optimization.
The second piece is tuning the cloud gross margin -- the first piece was cloud mix. The second piece was cloud gross margin. And then the third piece is really on the operating expenses.
The last 2 years, we've had limited cash flow or negative cash flow because of changing our invoicing approach. We're now past that. We're past that. So our inflow will be tied to ARR. It's the outflow that will be tied to that cloud gross margin, cloud mix. And we're working through those pieces. I hope to be able to provide a much more -- a more specific update to what that target will be next quarter. But we're still very confident in that 20% number. It's just a little more work to do on predicting the timing of these 3 different factors.
And our next question comes from Brent Thill from Jefferies.
Graham, maybe just get your perspective on where you see the biggest opportunities. Obviously, been involved with the company for quite some time. Where are you seeing perhaps the biggest greenfield where you think you can have a bigger impact?
And quickly for Jason. I think there's been some frustration from investors about the miss-make approach as it relates to where the numbers are. I understand the cloud mix is moving around. But where do you feel we're at in terms of the cloud mix and where you expect that to settle out now relative to the guide? And just curious if we're now kind of past the point now where you feel that, that cloud mix is really taken over, and we should expect less volatility in the quarter-to-quarter numbers?
All right. Thanks, Brent. Also good to reconnect. Obviously, early days, but I think the 3 things I'm already looking at are -- I think moving customers to cloud is obviously a key focus for the company making that transition super successful. But I think it’s pretty clear that once we move customers to cloud, the workloads only increase over time. So I think there's a lot of upside in the future from expansion within accounts. And obviously, we have many of the biggest accounts in the world.
It's quite amazing, if you sort of look at our large account growth, up 96% year-on-year with 270 customers with more than $1 million of cloud. So a lot of opportunity there. I think international clearly has sort of more or less kept pace with Americas as a region. But I think over time, we -- I would hope we could accelerate that. It feels like there's a huge opportunity in Europe and Asia Pac. And there were some really exciting deals in Q3 in both those regions.
And then I think the third area I'd pick is obviously observability. I think we were a little late to launch our product, but I think it's important to understand, as we think about observability, there's clearly metrics in tracing that we tended to focus on as the outcome of the acquisitions we did a couple of years ago but we also have logging that's related to observability and ITSI that's really, really under part of that umbrella. So I think our overall business there is good. We're happy with the growth rate. But clearly, it's a huge market, and I think there's room for us to do better, even better in that area.
And then on the cloud mix assumption. So, we saw 68% all time high last quarter. And as I mentioned in the remarks -- prepared remarks about 70% is our expectation for Q4. We said previously, we don't know where it tops out, probably 80% to 90% range probably, but again, customer success really is our primary motivation. So we're going to do whatever works for customers. The path from 70 to 80 and 90 obviously is a -- we're not that far away. So the volatility on cloud or -- cloud revenue and operating margins should continue to dissipate or minimize -- I’m sorry get smaller. If you look at revenue growth last year, we were what, minus 5% or 6% for the year. First three quarters of this year, we've been in the kind of high teens to 20-ish percent range. So we are coming out of it. You also saw RPO bookings at plus 56% year-on-year. Current RPO booking is also strong. So the metrics are normalizing.
That said, when you have a big step up in a single quarter like we did this last quarter, it does cause a little more pressure on the revenue number. That said, that's why really the best number to focus on really is ARR. I think for probably the next year, that will be -- continue to be steady, ARR, cloud ARR and then cash flow. And then I think by '24, you'll start to see the revenue and GAAP metrics start to come more in line and have less volatility than they've had in the recent quarters.
And our next question comes from Michael Turits from KeyBanc. Your line is now open.
So I just wanted to ask you Jason a bit more about the cloud transition, especially from the CFO's perspective. You're moving also to a new platform, and that platform is multi-tenant and should really help is with those cloud gross margins. So what's been the progress year-to-date on moving over to that newer platform? And why are we seeing that slowdown in that expansion of cloud gross margins?
Michael, thanks for the question. This is Jason. The expert on kind of all things around the cloud infrastructure migration and some of the challenges and opportunities that we have, really Shawn is the guy that is the expert on that. So I'd love to actually have Shawn take over.
Sure. So this is Shawn Bice, and it's nice to meet everybody. For those who I haven't spoken with before, I've pretty much spent most of my career in data. I was at Microsoft for about 17 years, led SQL Server for many of those as well as building Azure data in the early days. Plenty of scars from -- going from a box software company to a cloud company. And then I spent the last 5 years running Amazon data services. So in that context, we were able to build some of the largest data services in the cloud today. So that's things like DynamoDB or Amazon Aurora, Amazon RDS.
So with that backdrop, when Splunk started, a lot of customers basically start with smaller workload. And the reason they start with a small workload is it's pretty simple to take that. You put it in Splunk Cloud. And really, what you're doing is learning how Splunk Cloud operates and understanding the differences between that and something on-premise. And then as these customers have gone on that journey, they gain confidence. They become familiar. And what we see today is customers now bringing massive workloads. And when they bring these massive workloads, we have to basically work really close with them to fine-tune our systems to ensure that they're getting the exact capacity when they need it. And then, of course, they're not being charged for any capacity when they don't need it.
And then the last thing that I would say on this, having built some of the largest systems in the cloud with data, you cannot let customers -- you can't take any risk or chance of getting something wrong because the type of workloads that run on these foundational data systems, they just can't afford any interruption. If you interrupt Netflix, literally hundreds of millions of people are not watching videos; or if you interrupt the rideshare application, you could have tens of millions of people that just can't order or track a car.
So the point of that is, you've got to spend -- you got to be very, very intentional and diligent around how we build those systems that effectively automate and run everything underneath the covers. And that's basically why we're a bit behind on cloud margin.
And then the last thing I would say is we're always going to make incremental progress, and we'll always keep you updated along the way.
Okay. So from your perspective, Jason, is it more a question of the cloud gross margins themselves are not expanding or just simply that you're moving faster on that mix shift?
Well, I would say that because of the things that Shawn said and the larger workloads, the cloud gross margin is moving a little slower than what we've said previously. But then when you compound that with the fact that the cloud mix has accelerated pretty significantly in the last quarter, you have kind of the double effect.
We still are confident about being able to get to the 70-plus percent margin. That is basically industry standard when you look at the benchmarks. It's just a matter of working through all these large migrations and making sure we're first focused on the customer success aspect and then working out the optimization second.
And our next question comes from Raimo Lenschow from Barclays.
Graham, all back here on your new adventure. The -- 2 quick questions, one for Jason. Can you talk a little bit about the duration? Because that's obviously coming down. Is there kind of a level that you feel comfortable as kind of the right level? And then related with that, as we think about more cloud -- you're becoming more a cloud company, if you look at the new bookings. Is there a level where that kind of levels out because like there are industries, I'm thinking financial services or whatever, it still will have on-premise. And so if I think about the 74 you guide for Q4, are we actually coming closer to a level where the numbers get more stable? You seem to be hinting at that. But like in theory, we should be getting close to that actually now, and hence, the stabilization of numbers and guidance should come soon. Just speak to that, please.
Thanks, Raimo. I guess first on the duration impact. I think we said last quarter that we've seen it bounce around a bit on term. And the primary reason is we think it's actually helpful to not incent our sales team to try to drive up durations per term. We actually wanted to -- we want to going down because we know that the vast majority of our customers want to make their migration to either hybrid or full cloud deployment. And so we only compensate for 12 months and not beyond that.
So that's kind of the best lever to kind of manage it. And so as a result, we're really focused on what works best for our customers. We do see some, I guess, variableness to the duration number just based on what the mix of customers in the quarter is.
I think the range that you've seen for the past couple of quarters as high as 24-ish and then as low as 18-ish is a pretty good range for the near term. We'll let you know if we see anything different, but that's, I think, a pretty good range to focus on going forward.
In terms of the stabilization, yes, so the reason we provide the bookings mix that's cloud is because that's kind of the lead indicator. And I know you've kind of done a lot of this following, Raimo. And you've seen that whatever that bookings mix is -- that's on a TCV basis, by the way. When you flow that into ARR, it takes roughly about a year before you see the bookings mix translate to a similar ARR mix. And then the revenue mix ends up being even a little after that.
So I think you're going to see the numbers start to -- they've been stabilizing this year. They'll even stabilize more next year. I think 24% is when they'll be really hopefully kind of done with a lot of the transformations that you've seen. That said, I think you've seen already quite a bit of stabilization with positive high teens to 20-ish percent revenue growth, RPO bookings back to positive, actually 56%, and current RPO also in line in the 30-ish percent range. So I think we're seeing it, but I think the -- you'll continue to see it normalize over the next year or so.
And our next question comes from Matt Hedberg from RBC Capital Markets.
I guess for either of you. Could you talk about new customer -- new cloud customer adoption? You guys talked about workload pricing for all the comp. Are you seeing acceleration? Obviously, you're seeing strong results out of your cloud business, but are you seeing acceleration in new customer additions on the cloud side?
I'm going to take that. This is Teresa Carlson. For those of you who have not met me, I've been here at Splunk for almost 7 months, and I'm the President and Chief Growth Officer. Before coming here, I spent 11 years at Amazon Web Services, where I founded our Public Sector business, our Aerospace and Satellite business, and I ran our industries. And prior to that, I was at Microsoft for almost 10 years, where I ran our Federal Government business.
So our win rates overall continue to go up. We show improved win rates across the board. And on the cloud, in particular, we have 270 customers with cloud ARR greater than $1 million, which is at 96% year-over-year. And what we've also -- obviously, with the 68% cloud mix and net new cloud at 107%, what we saw is that our customers now that have been term are moving to cloud. So that's a big trend. And then the pipeline of that trend, of them wanting to go faster -- someone earlier asked about financial services and how -- does that like end if they're using a combination of on-prem and cloud? But what we see here and what I saw in my previous world in AWS is that actually just grows.
So the opportunity is new wins that in addition to that is net new workloads across the board. So it's very positive both on net new growth of existing customers moving to cloud and then new customers overall that want to get that are cloud-first.
Got it. Actually, maybe a follow-up for you. As we start to think about turning the calendar to fiscal '23, is the sales force where it needs to be in terms of both, I guess, capacity and productivity relative to your ARR guide next year?
Well, let me start with productivity. Our productivity is really high. So I feel fantastic about our productivity. And something that I don't know if you are aware of at Splunk that I actually think is a competitive differentiator that I have not used in the past, but we have kind of 2 motions in our selling organization. We have a team that focuses on net new, and we have a team that focuses on renewal and adoption. And I have found since I've been here, that has been a huge help in terms of working with our customers directly and moving them faster because you have these 2 motions in parallel you're working with customers. So I feel really good about that.
However, just in general in the industry, we're not immune to what's happening in the industry with people leaving. I think the good news for both Shawn and myself is we were growing so fast at AWS, we didn't know anything but rapid hiring and onboarding. So we are just employing that. And what we've all decided as a leadership team here is within our go-to-market, we are not going to slow down. So we are going to rapidly recruit, hire and train as fast as possible.
And then the other thing that we're doing is we're taking an approach around the world to look at regional growth because what Graham said, we're seeing great growth around the world, not just in the U.S. So we're really taking approach of around the world, their sales and technical orgs to focus on what matters to them. But I feel good. We're in great shape right now. I just want to keep moving fast.
And our next question comes from Kirk Materne from Evercore ISI.
Maybe just to start, I'll follow up with Teresa while we have her. Can you just talk about the performance of the federal business this quarter? Obviously, a big quarter usually for federal. Some of the trends maybe you're seeing on -- in that particular industry? And then I have just a follow-up for Graham and Jason.
So our federal business, it did well, and we expect to have actually a very good Q4 with federal also. One of the things -- I think you remember last quarter, we announced that we had FedRAMP, and that's actually really helped our pipeline. We had quite a few customers actually that were ready to go, waiting on FedRAMP. So we're seeing them now start their pilot, which will go into production.
You also heard about Leidos. I'm super excited about that win, and that was also a result of our ability to have FedRAMP. So we expect to get net new programs.
But just in general, not even just with Splunk, with my years of working with federal government, I've actually seen a trend where the government is actually moving to buying throughout the year, not just in the end of the year quarter because of everything that's happened with CR and they're also moving to a lot more OTAs.
So our federal business is strong. And I think with FedRAMP, you'll even continue to see that get stronger. Hopefully, because I'm here, I want to see it get stronger because I like that business.
That's really helpful. And then, Graham, I was wondering if maybe you could just give a bit of a view from a Board member that's stepping in as CEO. Obviously, there's a lot of very frustrated shareholders. I'm sure some are on the call with you. How are -- how is the Board thinking about, I guess, things that are at your disposal, buybacks, things like that, to try to, I don't know, bridge the stock between where you are today and where obviously you hope to be? Obviously, the optics are what they are. But I think there's a pretty big obviously, and where the stock is trading. I was wondering if you just provide maybe a little perspective on that, if you would.
Sure. Thanks, Kirk, and good to reconnect. So my job right of, obviously, internal improvements we can make just as part of running a business that I think certainly play to my strengths.
I think beyond that, I mean, we'll certainly have a Board-level discussion on whether there are other things that we might want to do, but I wouldn't want to speculate on those now. And yes, there is a big disconnect. I sort of -- I just look at our customer base, our technology assets, our -- frankly, our account presence in so many large important enterprises, our global reach, the management team here, the employees, I mean, I can't begin to describe the disconnect there, I'm afraid. So that's -- we'll leave that for time to solve.
And our next question comes from Karl Keirstead from UBS.
Graham, nice to hear your voice again. And I wanted to direct this question to Jason. We weren't expecting fiscal '23 guide on this call. So thank you for providing that. I think that's a positive. And I just wanted to ask if you might unpack it a little bit, and in particular, the $3.9 billion in ARR. And the extent, Jason, to which you might be embedding a measure of conservatism for a couple of things, the somewhat murky macro environment out there, but also the fact that you're undertaking a CEO search and you probably have a desire not to leave an incoming CEO too tough a guide to meet. So to what extent might you be embedding things like that or other factors in your outlook for year-end ARR?
Thanks, Karl. I would say first, I think the -- clearly, the fundamentals are very, very strong. The ARR growth of 37%, RPO bookings at 56%, dollar-based net retention and 130%. So I think with that strength, there's still clearly been questions about our long-term outlook. And so I felt like, and I think we felt, it was really necessary just to provide an early view for FY '23. We are going out 5 quarters on our ARR guidance. And certainly, there is uncertainty. We've talked in the past about most of our customers trying to time their hybrid and cloud transformations. And so with that uncertainty, we wanted to provide a number that we felt we had very high confidence on ensuring we could hit that number.
Clearly, we have a $50 million range just on Q4 alone. So as we get through Q4, we'll tighten that range. And as we progress into next year, I think we'll maybe get a little tighter on what our expectations are. But again, I just thought it was important to have at least an early indicator of a high confidence number.
Great. I think that's appreciated. And then, Jason, if I could ask a follow-up really on the revenue line. It's -- and I think you're sympathetic with all of us, it's tough to model. Sometimes you guys beat pretty cleanly. Other times, it's a little bit lighter as the mix shifts. I guess as term duration compresses and as Teresa and her team do a good job increasing the cloud bookings mix, I can understand why that might create some pressure on revenues. But in the third quarter, actually, your 665 million came up pretty appreciably above your guidance. So despite these pressures, what caused the revenue upside in the October quarter? And why would that necessarily reverse in 4Q?
Yes. I think the -- I mean the $15 million beat was mostly -- there's a combination of factors, but the reality is we're also comping a pretty weak Q3 a year ago. I think as we all recall. And so the year-on-year growth was at 19%. But if you were to normalize, it would have been closer to, I think, what the guidance range is for Q4, which is in the kind of single-digit percentage range.
And overall, given that cloud, we're now expected to hit 70%. The fact that we saw a positive revenue growth, I feel pretty good about. Last year, we were obviously heavily negative. And so I think during these next few quarters, you'll just have to continue to rely on ARR as the metric.
I'm hoping there's been -- I know it's been tough for you guys to reconcile that number to other numbers. But as you now see bookings and current RPO bookings coming much more in line with ARR growth, hopefully, that provides a little more comfort around the overall top line growth.
And our next question comes from Brad Sills from Bank of America Securities.
And maybe a question for Teresa, while we have you on, please. There was -- earlier in the year, the cloud release, you delivered on a lot of work integrating the Observability Suite with Signal and Omnition and Plumbr and Rigor. Curious what the customer reception has been since then in terms of interest pipelines or even deals with regard to this concept of one suite to run logs, metrics and traces under one?
So really positive. We launched -- as you saw, we launched in May. And I've learned over the years of launching new things and you take things into the field, it takes a little bit of time for the field to get the motion going and how they actually really get their mission down to talk to the customer. But it's gone really well and throughout since May, we're getting more wins pretty significant actually. We're happy with where we are. We always want to do better, of course, but we're really happy. The motions are good. Customers are really starting to understand observability because observability is kind of this big word that there's multiple workloads underneath. And so when we start diving in with the customers and sharing the types of workloads and solutions, then they say, "Okay. Tell me more. Can we run a pilot?"
So we're happy. The team has good motion. We have sellers in the field that we have targeted accounts we're working, and we have technical specialists in the field. And then we're working, of course, really closely with Shawn's team as we get feedback from customers because in early days of launching, we want to make sure we're taking that good customer feedback, so he and his team can take that and build it into new feature functionality into the next year. So we feel really good about it. And I think we're going to -- you're going to continue to see really positive growth in our Observability Suite.
That's great to hear. Thanks, Teresa. And one more, if I may, just on the contract duration for Jason. With the shorter duration that you're seeing here, does that go in tandem with the customer planning to move to cloud? In other words, are they signing shorter-duration term deals with an anticipation of going to the cloud? Is that kind of a one-to-one relationship when you have that kind of a shorter-duration deal?
Largely, they're correlated. I'm not exactly sure what the rSquared is, but it's definitely high. But yes, that's why we took away the compensation mechanism for more than 12 months. We know that's what customer intention is. We have, obviously, a lot of cloud as well as hybrid cloud migrations in place and expect those to continue. So I think they're highly correlated.
And our next question comes from Keith Bachman from BMO.
I'd like to ask 2 questions, one for Graham, and then I'll come back to Jason. First on Graham, to a previous question, you used the phrase "stock disconnect," and it certainly seems to be embedded in the valuation. And one of those, I'd like to ask around that is the leadership change. But last year has been pretty tough. And it seems like Splunk is starting to make a transition where a lot of the metrics are settling out and kind of coming over the hill, so to speak. So why is this the right time for a leadership change? Because the signal it really sends in contributing to that stock disconnect that something is not working. So if you could just speak to that?
Sure. It's a great question, Keith. And I think if I put my Board hat on, the job of the Board is to represent the shareholders and ultimately build long-term shareholder value. And I think over the years, we've had very open and frank and honest and friendly discussions with Doug about what -- how long his tenure would be and sort of where is Doug's sweet spot as a CEO. And I think most people at some point -- there's a zone of operation where all managers at some level have better and more relevant skills.
And so I think as we got to the end of this year, it just became, I think, fairly clear that as you look at the next milestones for Splunk, we'll finish this year somewhere around $2.5 billion in revenue, obviously, over $3 billion ARR. You look at next year's guidance, the following year, clearly, we're getting to be a really large company at that point. We have aspirations clearly to be in the top 10 software companies of all time. And so at some point -- when you have that discussion, we got to the conclusion that it was time for a change. So then it's a question of what's the best way to bring about that change.
And I think -- ultimately, I think, leaving Doug in the role for a long uncertain period potentially while predecessors search for is kind of a tough place to put the CEO in the company. And so the Board concluded this was the right route forward. I mean there's -- that was our judgment, and we stand by it. And I think my tenure on the Board and my experience with the management team led us to believe this was a good transition plan. I'm here for as long as I need to be.
Doug s still here and is absolutely helping me with the transition, certainly helping to ease with the fourth quarter. So I think there's no sort of mystery behind this. It was simply a sort of recognition, I think, that now is a time of strength. The company had strong great quarters together. We've got -- we have a strong Q4 outlook. Always better, I think, to meet that transition at a time of relative strength.
And I know the numbers are kind of confusing, and we spend a fair amount of time explaining those each quarter. But I can tell you the Board views the fundamentals of the business, which, to us, our ARR growth, cloud growth, those are really strong. And I think we feel the business is going really well. So...
Okay. Fair enough. Jason, I'd like to come to you on operating expenses and just how we should be thinking about it. So the first 3 quarters OpEx is up about 25% year-over-year. And as we think about next year, you mentioned that it was -- OpEx was going to be a key contributor to cash flow. But is there any directional barometers that you can give us on OpEx expenses because those are within your control? Will that be -- will that continue to grow in the mid-20% range? Or any directional barometers you could give would be helpful. That’s it for me and many thanks.
We're -- I mean, honestly, we're still going through our annual planning process, and that's why I didn't provide an OCF update now. We will definitely get you something next quarter. I did kind of point out the 3 levers of cloud mix, and that especially is important because the cloud growth and the mix of gross margin; and as well as the OpEx levers, which really -- the biggest piece in OpEx really is we have a very large go-to-market function that's having to both support an on-prem business as well as cloud business as well as all the migrations in between. And so we'll work through those details. We'll provide those -- get to an update on those assumptions for next quarter.
And our last question comes from Keith Weiss from Morgan Stanley.
Graham, you said -- the numbers are kind of confusing. I got to admit, I'm pretty confused here. You guys guided cloud ARR $1.1 billion to $1.11 billion for Q3. You came in below that. You came in at $1.106 billion, right, or at the midpoint of the range. Like you didn't beat cloud ARR, but your cloud mix is higher than expected when it was like in that -- like right in the middle of your guidance range. Like that to me doesn't sound like an overly strong quarter. Like why is the cloud mix higher and revenue is lower if you're just like in the middle of your guidance range?
Okay. So yes, we had a fairly tight range on cloud. We did deliver net new cloud ARR of $130 million, second biggest quarter behind Q4 of a year ago ever. And so yes, it's $4 million below. So I think on net new, that's, what, 2.5% or something difference. And there's just a lot of moving parts. And it's -- I'd call it a very small impact.
We certainly had line of sight to overall ARR and the cloud ARR. We came in, what, $5 million ahead, so a couple of percent above overall and $4 million below the top end of the range, but certainly in our range. So a couple of percent below there.
I mean, overall, the fact that we had really strong net new ARR, I think, second best quarter, that's kind of what we're most proud of. And we're guiding to a pretty significant increase in next quarter in cloud. So overall, I realize there's a lot of pieces moving and it's hard to reconcile them. But the overall fundamental strength, if you look at the slides that we provide, the net new ARR growth speaks for itself. So I don't know what else to say but...
Right. But I mean you made the point earlier that this is against an extremely easy compare because you guys had a very poor quarter in 3Q a year ago. And you -- like I just want to understand like the cloud is pressuring your revenue growth, but you didn't exceed your targeting cloud. You exceeded your target on non-cloud ARR. So it seems like that would buttress revenue growth. There's just a -- like I don't understand how Q3 aligns to Q4 in terms of kind of where you're guiding to on revenues and why revenues had to come down after you beat on non-cloud ARR.
Well, because cloud mix is going up to 70% in the quarter, and that has the biggest impact on revenues.
You didn't exceed your cloud ARR target, but cloud mix is ahead of your target?
Cloud mix is ahead of our target next quarter. And this quarter, it was a little bit ahead. Cloud mix, now the other thing is cloud mix is on a TCV basis. And so I think, unfortunately, the reconciliation you're doing is a little bit of apples to fruit -- or apples to oranges. So, yes.
So what's happening -- like what's happening with contract value is different than what's happening within ARR?
Well, I mean they don't directly correlate. They do correlate but not directly.
Got it. And then I guess this one is for Graham. Just in terms of the CEO transition, I understand companies do CEO transitions all the time, right? And we often talk about succession planning way ahead of time, and you have plans in place on sort of how you're going to do that succession planning. What seems unusual doing it like in the middle of a Q4? I think it's the timing that people are kind of scratching their heads around. I would have assumed that the Board had talked about succession planning and talked about sort of CEO transitions many times in sort of the life cycle. What was the impetus in Q3, like to do it rather than like after Q4 or have something kind of more in place? Like what was the impetus to do it like right after Q3 in the middle of trying to close your biggest quarter of the year?
Well, actually, Keith, I think the end of Q3 is generally the best time to do these kind of transitions. Actually, we did -- we've done our previous 2 sort of transitions: one, go free to Doug; and then before that, the Head of Sales at the end of Q3.
I think Q4 generally has a momentum of its own. So I think there's a lot of salespeople who are -- who've been working deals, hopefully, they bring to fruition in the fourth quarter. So I think there's a momentum in Q4 that probably doesn't exist in any of the other quarters. So I think we certainly looked at that and considered that this was a good time to do it.
And of course, yes, you always want to be able to promote from an internal management team, if possible. And certainly Splunk has done that in the past, but we weren't ready to do that at this particular time. So it just didn't work out.
And now I would like to turn the call over to Graham Smith for closing remarks.
All right. Well, thank you again for joining us. Great to reconnect with many of you from a few years back. I do want to thank Doug, again. I mean I can't -- nobody can underestimate just the amount of blood, sweat and tears Doug put into the success of the company and is absolutely a huge, huge part in the long-term success of the company and navigated some really tough transitions over the last few years. So I want to recognize that.
I come back to -- Splunk is just an important company in the industry. There's no 2 ways around that. I talked earlier about the fundamentals, cloud ARR growth, account growth, net dollar-based retention rate. I think the numbers will start to normalize in this year. I think it will be really FY '24 before they're kind of back to normal, but things will be, I think, clear as we go through this year. I am really excited and energized to be here. And I think we're all -- we have a lot to prove in Q4, and I think we're extremely excited to talk to you back in February for the Q4 call. So thanks so much for joining us today.
Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.