Ken Tinsley - Corporate Treasurer & VP, IR Doug Merritt - CEO Dave Conte - CFO

Raimo Lenschow - Barclays Brent Thill - UBS Philip Winslow - Credit Suisse Melissa Gorham - Morgan Stanley Jim Fish - Citigroup Jesse Hulsing - Goldman Sachs John DiFucci - Jefferies Mark Murphy - JPMorgan Brian White - Drexel Kirk Materne - Evercore ISI Bhavan Suri - William Blair Matt Hedberg - RBC Capital Markets Brent Bracelin - Pacific Crest Securities Steve Ashley - Robert W. Baird

Good day, ladies and gentlemen, and welcome to the Splunk, Inc. First Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]. As a reminder, today’s conference may be recorded. I would now like to introduce your host for today's conference, Mr. Ken Tinsley, Corporate Treasurer and Vice President of Investor Relations. Sir, please go ahead.

Great. Thank you, Michelle, and good afternoon, everyone. With me on the call today are Splunk’s CEO Doug Merritt; and CFO, Dave Conte. A press release was issued after close of market today, and is posted on our website. This conference call is being broadcast live via webcast, and following the call an audio replay will be available on our website. On this call, we will be making forward-looking statements, including financial guidance and expectations for our second quarter and fiscal year 2017, transaction, product, services mix, as well as the mix between perpetual and ratable transactions, investments in international operations and expected growth in international business, planned investments including product, services, sales, and facilities, market and use case opportunities. These statements 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 with the press release on our website. With that, let me turn it over to Doug.

Thank you, Ken. Hello, everyone and welcome to the call. It is great to be talking to you about the opportunity in front of us as I clip past my two year anniversary at Splunk and six months in the CEO chair. I just came back from our Annual Presidents Club Event where we celebrated our field team success in delivering a strong fiscal 2016. The team is energized and as always our customers are our number one source of inspiration. At that club we had a chance to officially welcome our new Chief Revenue Officer, Susan St. Ledger to Splunk. I’m very excited to have her join the executive team, welcome Susan. We delivered a solid Q1 with $186 million in total revenue, up 48% over last year. Our success continues to come from a combination of our existing customers expanding their deployments and from adding more than 450 new customers to the Splunk family. We see the wave of digital transformation impacting every industry and every enterprise. The amount of data being generated is exploding and that trend will continue. Splunk is the best solution to enable customers to easily and cost effectively collect, analyze, and get maximum value from that data. Our strategy also remains the same, to be the ubiquitous machine data fabric by investing in our data platform, creating high value solutions that leverage our platform, and building a strong ecosystem. As part of this strategy, we will provide customers with best in class solutions targeting specific use cases delivered by our partners and by our market groups. In IT operations and applications development and delivery, security, compliance, and fraud, business analytics, and the Internet of Things. Our commitment to expand our product portfolio continued in Q1. We announced the general availability of Splunk Enterprise 6.4, a new Splunk Cloud release, and the latest versions of Splunk Enterprise Security and Splunk User Behavior Analytics. One of the many new capabilities in Enterprise 6.4 includes new interactive visualizations and open library on Splunk base where customers and partners can develop and share their custom visualizations. We enhanced predictive analytics, improved query performance, and made a series of platform security and management improvements. We also reduced the cost of historical data storage by 40% to 80%. For example, a customer that is indexing 10 terabytes per day with a data retention policy of one year can save over $4 million of storage cost over five years. And if they retain their data usage or replicate data their savings multiply further. Our customer TransUnion put it simply “The previous version of Splunk Enterprise doubled our performance and now the new storage optimization capabilities in Splunk Enterprise 6.4 can significantly lower our storage costs”. In addition we introduced the App for Akamai which allows customers to monitor and analyze the real time performance, availability and security of the Akamai CDN service. We updated our App for ServiceNow to provide insights into incident change and event management processes in ServiceNow instances and the newest release of the App for AWS which helps customers gain end to end visibility across their AWS environment including critical security, operational, and economic insights. We also announced our free add-on for the Google Cloud platform which enables customers to analyze and monitor their security and reliability of their GCP services and Microsoft Azure customers can now purchase Azure Certified Splunk Enterprise clusters in minutes through the Azure marketplace. To increase developer visibility of their DevOps and App Dev environments, we announced the availability of the Puppet Enterprise App for Splunk. Customers can now use Splunk to correlate the data from Puppet environments with metrics and events from across the app delivery chain. This reduces complexity and improves the velocity and quality of software product releases. We also announced that the latest release of Docker includes the Splunk login driver, so customers can easily get data out of containers for monitoring, troubleshooting, and security insights. Our innovation continues to deliver congratulations to the entire products and dev teams. On the partner front, I’m pleased with our strategic alliance with Accenture. They are expanding their bench of trained Splunk Practitioners and we are collaborating on value creation and program delivery to bring new solutions to market. Accenture is leveraging Splunk as a platform to deliver applications to enhance service delivery offerings, including their intelligent automation platform for application service delivery and their new cyber defense platform. Hawaiian Telecom is one of Accenture’s first clients to take advantage of their intelligent application management services with Splunk. The real time insights from Splunk enables the Hawaiian team to be more strategic and proactive on a day to day basis which ultimately improves our customer service and increases productivity. Splunk is now an EMC select partner. EMC customers now have a simple way of purchasing EMC Solutions and Splunk products, global support and services and education. Integrating Splunk’s platform with EMC Solutions will enable our joint customers to maximize the value of machine generated data. And we announced our alliance with Herjavec Group where Splunk Solutions are at the heart of their new managed security service provider offering. Of course we do all this for our customers. We’re recognizing that the more data they put into Splunk, the more value they can realize. That is why I continue to believe that we are very early in capturing our full potential even in our largest accounts. For example, Tesco standardized on Splunk for operational intelligence with an enterprise adoption agreement. The retailer expanded its use cases to include security by purchasing both ES and the Splunk App for PCI compliance. Tesco already drives value across its business with Splunk Enterprise, with benefits including accelerated development cycles and improved performance and customer experience on tesco.com. I’m also really pleased with the rapid growth of Splunk Cloud where we saw orders more than double year-over-year. For example Familysearch has significantly expanded their use of Splunk to support a record increase in system traffic. This expansion will also ensure a smooth transition as they migrate data to Amazon Web Services, vital transactions that Splunk Cloud already monitors. Familysearch leverages the data gathered in Splunk Cloud to monitor the AWS usage and expenses with the Splunk App for AWS. Familysearch also uses Splunk Cloud to validate the continuous delivery of its website services. Okta expanded Splunk Cloud and ES license for HIPAA compliance for the healthcare market. Okta has already been using Splunk Cloud and ES in IT operations and security. Splunk Cloud helps Okta’s IT team ensure its own integrated platform is operating at peak performance and the security team leverages cloud and ES for threat intelligence including the ability to easily detect and quickly respond to security incidents. Travel technology giant Sabre will replace its legacy SIM with Splunk Cloud and ES to ensure the security of their hospitality and travel network. Sabre which provides technology to hundreds of airlines and thousands of hotels and travel agencies chose Splunk because it’s easier to manage, scales better and can more easily understand complex data sources. Other customers choosing Splunk Cloud in Q1 include Chicago Public Schools, Zillow, Thermo Fisher Scientific and a cooperative group in the UK. We also continue to see momentum in our Market Group Solutions. We had great customer wins in IT ops and app delivery, including the U.S. Courts who selected Splunk Enterprise as a platform for their logging service project, a nationwide initiative. This service will be provided to hundreds of U.S. courts to help them meet the judiciaries, IT security and log management policy. The U.S. Courts also expanded its license to introduce Splunk as a data platform to new departments and users in the U.S. courts administrative office and their program offices. U.S. courts already uses Splunk ES and security. GoodData expanded Splunk Enterprise to help support their growing global cloud services platform. Application developers, operation and customer support teams rely on Splunk for IT operations and application delivery and GoodData’s cloud based platform for ISVs and enterprises. Other customer wins in IT ops and app delivery include Clemson University, Chipotle, and the University of Virginia. We’re seeing increased momentum for our IT service intelligence or our ITSI solution. Customers are pleased with how easy the solution is to install and configure and how quickly they are able to improve service levels and customer satisfaction. Existing Splunk security customer World Bank Group invested in expanding their deployment and added IT services intelligence as a modernized enterprise monitoring offering. They anticipate increased visibility into the health of their key applications and services as well as using ITSI to replace their legacy tools. Other customers selecting ITSI in Q1 include the City of Los Angeles Department of Health Services and the Coca-Cola Enterprises. Our performance and customer wins in security continues to be strong as well. One of the world’s largest global financial services firms replaced its SIM with Splunk ES, choosing Splunk over several competitors. Splunk Enterprise is already the platform for IT operations for this bank with proven value delivered across multiple teams and hundreds of users. Leaders at the Dartmouth-Hitchcock Medical Center are strategically prioritizing security in light of a series of recent targeted attacks on healthcare organizations. As part of this plan, Dartmouth significantly expanded its use over the Splunk platform to protect its patients and staff from cyber attacks. It tripled the volume for Splunk Enterprise, ES, and the App for Exchange to monitor and protect additional systems in the hospital. And Denver International Airport standardized on Splunk to strengthen its security posture. DEN is using Splunk to detect cyber attacks and insider threats. The airport is also planning to utilize Splunk in operations and applications teams to gain greater visibility in understanding of their infrastructure. Other customer wins in security include UAB Health System, Jetstar, and LGA Telecom. We are very proud to see Splunk products and people continue to receive industry recognition. Splunk was recently named one of the best places to work in the Bay area for the ninth consecutive year by the San Francisco Business Times. I just want to take a moment to thank our employees. I have never seen a group of people so committed to our customers, culture, and company. I’m proud to be part of such an amazing team. In summary, it was a solid quarter and start to our fiscal year 2017. Thanks to all of our customers and partners and thanks to everyone who works at Splunk. Now let me turn the call over to our esteemed CFO, Dave Conte.

Hi, thanks Doug. Good afternoon everyone. Thanks for joining the call. Q1 was a good start to fiscal 2017 with revenues of $186 million, a 48% increase over Q1 of last year. License revenues totaled $101 million, up 41% over last year and consistent with our expectations of license as a percentage of total revenue. As Doug described, we remain committed to customer success and adoption of our platform and solutions. Once again in Q1 more than 70% of our license bookings came from existing customers. We also added over 450 new customers in the quarter and recorded 318 orders greater than $100,000. In Q1, driven largely by the growth of our cloud business, a ratable mix was 51%. Although it’s early in the year we maintain our full-year ratable mix estimates for software bookings of between 40% and 45%. Look we will obviously keep you posted if our expectations change, as mix continues to vary substantially quarter-to-quarter. As we discussed on the last call, we saw an uptick in license ASPs in the second half of last year reflective of large customer adoption orders. Consistent with the seasonal nature of our business, ASPs in Q1 returned to previous levels of around $50,000 at the high end of our $40,000 to $50,000 historic range. We will continue to monitor ASPs on a full-year basis and we will let you know if there are any updates to report. In Q1, international operations represented 26% of total revenues consistent with previous levels and comparable on a year-over-year basis. We plan to continue to make investments in our international business and look forward to continued growth and global expansion. Our education and professional services represented 9% of revenue in Q1 at the higher end of our range of 5% to 10% and consistent with prior year from a seasonal perspective. Remember since we generally recognize revenue on services when they are delivered and billed, services bookings typically do not flow through the balance sheet as deferred revenue. Turning to margins and other results, which are all non-GAAP. Q1 overall gross margin was 85% consistent with our expectations and reflective of our growing cloud business. Operating loss was $1.4 million, representing a negative margin of about 1%. Q1 net loss was $2.6 million and EPS was negative $0.02 per share based on a weighted average share count of 131.5 million shares. Cash flow from operations was $36 million, while free cash flow was $32 million and we ended the quarter with just over $1 billion in total cash and investments. Now looking forward to the rest of the year, we expect Q2 total revenues of between $198 million and $200 million, with positive non-GAAP operating margins between 2% and 3%. With our Q1 performance, and Q2 outlook, we now expect total revenues for the year to range between $892 million and $896 million, up from our prior guidance of $880 million. Remember that we denominate revenue globally in U.S. dollars and therefore have no foreign exchange exposure to our revenue lines. As we continue our investments in market groups, product teams, the field, and Splunk Cloud, we maintain our full-year non-GAAP operating margin estimate of around 5%. As I have said, and as we saw in Q1 results, operating margin targets include the impact of an increase in cost of services from our ramping cloud business. Additionally, we will continue expanding our services capabilities tailored towards the use cases and solutions that align with our market group focus. We have seen clear evidence that customers who utilize our services have a higher likelihood to deploy more of our software over time. Given these investments in the medium-term we expect to see overall gross margin hover around 85% which is within our long-term target of 85% to 90%, on our way to long-term operating margin target of at least 25%. For EPS, remember since we expect to be profitable on a non-GAAP basis for the balance of the year, for your EPS calculations you should use a fully diluted share count of approximately 136 million shares in Q2 accreting about 2 million shares per quarter thereafter. We will continue to run the business on a positive operating cash flow basis and continue to expect that full-year operating cash flow will be approximately 23% of our updated revenue outlook with the quarterly levels following the trend we have seen over the past several years. As I mentioned on the last call, fiscal 2017 will be an unusually high CapEx year for us as we expect the bulk of our South Bay Campus build out cost to be incurred this year. When combined with global facility expansions to accommodate our growing employee base, we are planning for approximately $50 million to $60 million in total CapEx this year weighted $15 million in the first half and $35 million to $45 million in the second. To give you a sense of recurring CapEx levels, without the South Bay project, our CapEx would be in the $16 million to $18 million range for the year. In closing, our team continues to execute on our mission to deliver exceptional value to our customers. And we are committed to improving the customer experience through continued investments in our products, solutions, and overall global reach. We’re off to a good start and I’m enthusiastic about our outlook for the remainder of fiscal 2017. Thanks much for your time and interest. With that, we will open it up for questions.

Thank you. [Operator Instructions]. Our first question comes from the line of Raimo Lenschow with Barclays. Your line is open. Please go ahead.

Hey thanks for taking my question and congratulations on a great start to the year. I have two, one for Doug and one for Dave. Doug, let’s start with Doug, yes. If you look at the -- we all are nervous about the kind of like what’s going on in the spending environment et cetera and we saw like profit warnings from a good few guys in Q1. Can you talk a little bit about the linearity in the quarter and what you saw in the different regions as well and then I’ve got one follow-up.

Thanks for the question Raimo. What we saw in Q1 was consistent with what I’ve seen in the quarters that I’ve been here in the field and there is a lot of chatter that we’re all hearing around the world and a lot of nervousness that is coming through the news channels but from our customer engagements, there was a pretty typical quarter. We tend to be -- to have a decent chunk of the revenue coming in the last 30 to 45 days and I don’t think it was unusual in anyway and the deal characteristics look relatively similar as well.

Perfect.

Raimo, it’s Dave. Particularly when we think about it from a Q1 perspective like we look at our Q1 over Q1 and look at linearity. So it was fairly typical.

Okay, perfect. And a question for you Dave on if you look at the spending this quarter, if you look like the one number that kind of really accelerated was R&D. Can you talk a little bit about what’s going on there, I mean like sales and marketing et cetera was going to be in line with what I was expecting but R&D seems to be ticking up, what’s going on there?

Nothing more than our continued focus on expanding the product portfolio. So we’ve been brutally deliberate about our investment thesis on products, market groups, which ultimately translates to products and solutions and of course field coverage. So when we look at the impact of those initiatives, there is nothing specific other than continuing to invest and having the right people to deliver on them.

Thank you. And our next question comes from the line of Brent Thill with UBS. Your line is open. Please go ahead.

Good afternoon. Doug, can you talk a little bit about the arrival of Susan and how her view of the go to market, is she anticipating to make any changes. I know you have spent the last two years cementing the sales force, so you effectively won’t think that there would be a lot of change but can you just may be walk through her arrival and how she has seen the organization and for Dave I had a quick follow-up.

Absolutely, Brent, thanks for the question. There is a lot of things that we all love about Susan and one of the core ones is her repeat experience in scaling companies from $100 million to $8 billion plus. And as we’ve talked about for my two years here and I’m sure well before with Godfrey, the growth rates are important to us to maintain at Splunk and that means a lot of scale that we got to drive and in my first week and a half of interacting with Susan while she’s doing the job the constant framing that she has driven with all of her conversation is how do we take the goodness that we have as we really have built a phenomenal sales machine here, not fumble the handoff in anyway which is my number one priority in my first few calls with you guys is honor what we have gone and make sure we don’t miss a beat on the customer revenue front but continue to think thoughtfully and strategically about how do we prep this company for the same continued growth that we have experienced, so we can really execute on the market opportunity that’s in front of us.

Okay. And Dave on the op margin, I know you are not making much change there, we have seen pretty modest margin improvement. And I guess one of the questions we get is, is there a point where you feel that you have got the right investment thing and you are going to start to get some better scale on the bottom-line obviously you won’t get huge scale this year but as you look out, can you just help us walk through and I know you’re not giving guidance for 2018 but there is a lot of questions around the bottom-line here?

Sure. Yes, so if you recall from the last call, I have articulated that our point of view around margin expansion certainly in the -- for fiscal 2017 and then in the medium-term from there would be 100 to 200 basis points a year. With the long-term margin objective of at least 25% and the question that I get is, well, Dave, if I do that math then you’re not going to get to your long-term target for like a decade. The way we think about it is as a lot of these initiatives get to that tipping point where you go from lots of fixed costs to scalability and what you’re adding as a variable cost component we see the trajectory more of a hockey stick in terms of margin expansion. So we will go 100 to 200 basis points and then say, if you drew that line on a five-year trajectory there would be a hockey stick towards the end that accelerates us to 25%. Now if we see dynamics as it relates to cash [indiscernible] the TAM, that say, boy, you know what, we should accelerate our investment, we will let you know but more importantly if and we start getting that critical math then we will accelerate the margin expansion. But our investment portfolio which again I try to be very explicit around our market groups, our solutions, our platform, and importantly our cloud is a pretty broad canvas that we’re putting money at work around.

Thank you. And our next question comes from the line of Philip Winslow with Credit Suisse. Your line is open. Please go ahead.

Hi thanks guys and congrats on a great quarter. Just want to focus on the platform side, I know you’ve been working on trying to penetrate DevOps teams and also just bring on your third-party ISVs. As we kind of go into this year, I’m wondering if you could give us sort of an update on where that stands and sort of what initiatives you have in the pipeline and then just one quick follow on to that?

Thanks, Phil. We’ve had platform and developers that’s one of our key initiatives for multiple years and we keep chipping away at that initiative. Every quarter we get more DevOps and software development lifecycle splunking wins which I think is going to be a continued focus for us and as part of the charter of the IT operations and App Dev market group that Rick Fitz heads up, he has doing a really nice job there, we have brought on some additional top talent underneath him to make sure that we’re communicating effectively across our customer base. The whole lifecycle that you could and should be using Splunk in and around, so you get full benefit. And as we talk about in this call, the Puppet delivery, the App for Puppet, the integration with Docker, we are a very leading edge development organization, we love where the world is going with microservices, containers, and the high velocity of cloud application development and we are committed through our partnership with AWS and our overall perspective in marketplace and ensuring that we keep pushing forward solutions in the marketplace to help with that DevOps world.

Got it. And then just a follow-up question for Dave here on the gross margin side, I mean it’s great news you talked about doubling the number of Splunk Cloud customers and obviously that’s probably shows up in some of that rate ratable percentage is 51% this quarter. But from a gross margin perspective why don’t you just provide us some more color there on the 85%, how much of that is the cloud impact and how should we sort of think about this near and long-term?

Sure, hey, Phil. Yes, clearly and I think I’ve -- again I’ve commented on this in the past but today our level of scale in terms of cloud, it’s a drag on our gross margin. Now from a long-term model perspective, we actually had always -- all the way back to IPO, we had anticipated gross margin range between 85% and 90% with the plan to introduce our cloud offerings. So we’re actually executing as we would expect. As we think about this fiscal year, I kind of think about it as a trough year in terms of the margin profile as that cloud business in particular gets to a level of critical mass where we start to gain operating leverage which will flow through both the gross margin and the op margin lines.

Thank you. And our next question comes from the line of Keith Weiss with Morgan Stanley. Your line is open. Please go ahead.

Great, thanks this is Melissa Gorham calling in for Keith. I just wanted to follow-up on that discussion on Splunk Cloud. So you continue to note very good growth every quarter in Splunk Cloud. So I’d have to assume that it’s going to be fairly meaningful for you all at least on a billings basis. Is there any way that you could help us size I know you’re not going to give us the exact amount, but just help us kind of size how big that business is for you today. And then how we should expect the mix of enterprise versus cloud to sort of progress moving forward?

Hey, Melissa, it’s Dave. We’re not at the stage where we’re going to specifically quantify the size of the cloud business. And I think part of the -- its contribution is obviously growing and you can see it in terms of the cost line that we’ve been talking about. But cloud revenue it doesn’t necessarily replace license revenue but from an accounting perspective, it doesn’t hit the license line. So what’s interesting about its contribution is given our number of customers when we launched cloud, was probably 10,000 plus and our upsell rates in terms of greater than 70% of bookings coming from the installed base. The opportunity for the cloud business to grow as a percentage is challenged because our installed base of customers continue to buy more and more of our on-premise software. But as we continue to progress through the year, we’re looking for the right opportunity to give you guys more color around specifics on the size of the cloud offerings and as those materialize, we will of course share them with you.

Okay, great and then just one quick one on the commentary on ASPs, I know it was down quarter-on-quarter and there is certainly seasonality there and you said difficult comparables. But I just want to clarify was that largely just driven from mix shift in customer contracts and seasonality versus any sort of discounting that was happening in the quarter?

Yes, it’s actually interesting, we had significant uptick in the back half which we talked about and you guys know, I was reluctant to declare a new range and it made sense to wait because so many of our large transactions come in the back half of the year, in fact last year we did I think eight, three eight figure transactions all in the back half of the year. What’s interesting though of course is our previously expected range of 40,000 to 50,000 we are at the top end of that in Q1 when we typically do our fewest number of large orders. So we’re pretty happy with where the ASPs are for now and we’ll see how they trend over time.

Thank you. And our next question comes from the line of Walter Pritchard with Citigroup. Your line is open. Please go ahead.

Hey guys this is Jim Fish calling in for Walter. So one question, one follow-up. Are you guys seeing more budget competition as you compete for budget with the likes of other NextGen vendors such as ServiceNow, New Relic, or like AppDynamics?

Nothing notable, we actually ironically all three of those are customers of Splunk. So we were I think what would I have seen as we tend to be bought together, there is more and more go to market initiatives especially within our channel and partner group where for them to add the value, they may be add, they think through how do I combine Splunk with Palo Alto, how do I combine Splunk with ServiceNow, or with other offerings to make sure that I can drive a value added package into the consumer base. But I don’t see we have such a variety of buying centers we go after right now, I just -- I don’t see this zero some gain happening at this point.

Got it. And then perhaps more for Dave, Dave can you talk more about the dynamics that drove that 51% ratable license bookings in the quarter versus where it’s been. I know I think it was mentioned that Cloud was a big driver but anything else in the quarter?

No I mean, I think it’s a combination right. What has always made the predictability of our mix challenging is individual large transaction can skew the percentages and that’s always the case mostly in a seasonally smallest Q1. So when you look at the composition of our transaction on what is that seasonally small number of handful of transactions in this phase, some cloud transactions skew the percentage upward.

Thank you. And our next question comes from the line of Jesse Hulsing with Goldman Sachs. Your line is open. Please go ahead.

Yes thanks for taking my question. One for Doug and one for Dave. Doug on cloud because you mentioned it a few times in the prepared remarks, what are the use cases that are driving these big orders, are they security, are they IT operations focused, are they something else does it look similar to the rest of your business?

Yes right now it looks really similar. But as I go back and think some of the big orders the six and seven figure orders that has come through in cloud, they are mix between IT operations and security. This past quarter and in our prepared remarks we talked about some big SIM replacement wins. And I think they are immediately going to cloud and try and get quick acceleration and this transition done effectively. And then they’re waiting to see, they can stay in cloud or they can pull that back on-prem which goes back to that hybrid nature that we have within Splunk. We’re completely agnostic and it’s up to the customer to figure out which -- what their strategic direction is with their IT landscape and we will support ensuring that single pane of glass and effective visibility whether it’s cloud on-prem or mix or both.

Got it. And Doug I’m getting some inbound investors on stock-based comp, it was up quarter-over-quarter as a percentage of revenue. How do you expect that to trend through the rest of the year and what should we think about as a trend line over the next couple of years for that as a percentage of revenue?

Hey it’s Dave here. You might recall from the Analyst Day that we showed our history of how stock-based compensation has stimulated, and in particular, back in 2014, we had anomalous situation where we had our annual focal process occurred at the same time that the stock price was at a fairly high level which we’re still amortizing those expenses on a quarterly basis. The way we think about it ultimately is around what’s our dilution rate. So four years ago, 2012, when we went public, our dilution rate was over 10%, and last year it was down to 6%. And when we look forward we think that a normalized level regardless of how many heads we’re adding to the business should be somewhere in that 3% to 5%. I think again that’s how we measure the effectiveness of our stock plans in terms of the absolute dollars that are hitting the stock-based compensation expense. Those will stay at heightened level for a bit and then they are going to start to fall in absolute dollars and of course these revenue increases they will fall as a percentage of revenue.

Thank you. And our next question comes from the line of John DiFucci with Jefferies. Your line is open. Please go ahead.

Thank you. I have a question for Doug and then a follow-up for Dave. Doug new customer, the new customer counts still is respectable at 450 but it’s been two years since that number is gone below 500. I guess can you comment at all in that especially given all sort of top-line those look very strong.

Sure, John. We’ve been -- we have talked in the past years that the new customer initiatives kind of steer set type piece and we kind of expect that 400 to 550 band for a while. We don’t include a number of the initiatives that we put in place because they are different than this Splunk Enterprise customers account. So we’ve got e-commerce capabilities where customers are coming in and doing monthly purchases from us and now we’ve got our Splunk Light product which continues to gain momentum and we do not pollute the compares, we keep those out. But all those we are expecting a payoff overtime. And my expectations are and hopes are that we’ll see the breakout from the band that we’ve been in over the course of FY 2017. As we signed on more partners as we deliver to these new products like Light and what we’re during the cloud right now and then quicker transaction volumes that can occur there. And how we can reach broader customer base is because of that and let’s stay tuned and see.

And John, it’s Dave. You’ll recall that the steer set that Doug described we have seen that trend go from 200 to 300 over a six to eight quarter period and it went 300 to 400 over six to eight quarter period and it’s 400 to 500. In fact last year’s Q1 this time last year, we also reported over 450 new customers. So we are still on that same steer set trajectory but a big chunk of it in addition to the product initiatives that Doug just described goes back to our coverage in the field. So we have great success with our installed customers but having the appropriate amount of resources both our direct field coverage model as well as that channel ecosystem, those are really important investments that we need to continue to focus on so that you will see the -- and then you will see that that next tier in terms of the step ladder up in terms of total customer acquisition.

So I guess like my data and maybe I go back it’s 500 to 600 back to the April 2014 quarter where it was 400. And I just it’s like some of those with e-commerce customers and some of the other -- would they normally have been counted if they didn’t have this sort of new go to market approach; is that what you’re saying why it’s still lower.

And I guess 450 isn’t that much lower than five, it’s just more so people now more go to market resources it just seems like it would be not be a little lower may be a little higher.

Well John the metric that we give is always more than we describe it as more than, so I wouldn’t say it was 450 exactly, no. I wouldn’t say it was more than 500 either. So it’s somewhere in the middle. But I think the spice up and down has been pretty consistent seasonally. You look at Q4 last year versus Q1 this year, there is a pattern that we’ve seen and it’s over a number of years. So I’m not at all concerned in fact and we’re very satisfied with our customer acquisition this quarter and with the last year. So we just have a lot of things we have worked on, we think will ultimately result in reaching the next step of the ladder.

Over satisfied I want to echo that.

Yes, got it, got it guys. Okay. And then quickly Dave if I could just this is another quarter of greater than 40% license growth, so it’s been over three-and-a-half years where you have had license growth in the 40s which obviously that’s supported by continued strong traction of sales field but the consistency is it’s unprecedented at least from what I’ve seen. How much of this -- I’m trying to figure this out like how much it that is smoothing into your financials that ratable portion of the license that just keeps on growing. I don’t know if you can answer that right now but I mean something we will just to figure out you keep getting asked that question. Is there any license in China on that Dave?

Well I mean if you want to look back over beginning of fiscal year deferred revenue, short-term deferred revenue and then what with the subsequent years delivery of revenue. Obviously the component of deferred revenue that license has grown over the last four or five years as our ratable mix has increased. So there is definitely a correlation between absolute short-term deferred subsequent years revenue and the component of short-term deferred that is license that contributes to the license revenue line. I think what’s changing in our business and it’s something that we’re trying to be thoughtful about is back to the cloud contribution. So there are components of deferred now that are cloud becoming a -- it’s still de minimis number from a disclosure perspective but it has a direct impact on license revenue. Again cloud revenue does not flow through the license line; it flows through the services line. So when we think about revenue composition and as our ratable mix continues to include a greater component of Cloud that’s going to cause a change in the profile of license revenue going forward.

Thank you. And our next question comes from the line of Michael Turits with Raymond James. Your line is open. Please go ahead.

Hi guys, John [ph] for Michael. So clearly there is a large market opportunity and at the same time the full-year guide implies roughly 30% OpEx growth. So can you just give us an idea of where and how you are investing to drive incremental revenue growth and then I have a follow-up?

Well this is Dave, I can tell you from all of my peers that we’re not investing in enough. So like our priority have always been the same and it starts with the product and why does it starts with the product because that’s how you drive the best customer satisfaction. We intend to continue to satisfy the demand for our customers in terms of giving them access from their data, so we always start with are we making the right investments in the product. After that it’s in the field, do we have the right coverage, so that we can go out there articulate our value proposition and expand our footprint in terms of install customers in the new ones that we just spent a bunch of time talking about. Those are our priorities. What we added since over the last five years ago, four years ago when we went public, new investments that are adjacent to those fundamentals or the market groups because having the appropriate representation subject matter expertise around the use cases that matter most to our customers is really important. So having high end, so I’m joined around security and Rick Fitz joined around ITOA is absolutely critical back to prime directory which is ensuring that we are satisfying the customers’ needs. So the other element that’s adjacent of course is how do we deliver our products and solutions that equates to cloud. So that’s a really important investment for us because well people want to talk a lot about the cloud momentum which we all recognize is critically important, customers workloads are it’s a binary environment, they have a lot of their data behind a firewall, they have a lot of their data and workload that listen in cloud and it‘s absolutely critical for us in terms of how we satisfy customers that we offer them cloud solution and ultimately something we’re very proud of that we think is of course unique to us and that’s hybrid search across their data locations. So regardless of where your data lives, you can leverage your Splunk Instance to do searches in correlations. So it’s really important and to answer your question like those are the pillars of our investment model, product, coverage, specialization and subject matter expertise and then reaching all the various delivery requirements all back to satisfying the customer.

Okay. And then just looking at the 2Q revenue guide, it appears to be seasonally weaker at the mid-point, 7% quarter-over-quarter versus 11% quarter-over-quarter guide last year. I guess, is there anything specific that we should be aware of that would lead to a slightly weaker F2Q seasonality?

No I wouldn’t read into that.

Thank you. And our next question comes from the line of Mark Murphy with JPMorgan. Your line is open. Please go ahead.

Yes thank you very much for taking my questions. Dave it was nice to see the rebound in the short-term deferred revenue. I was wondering if you could just walk us through the underlying dynamics that drove that number to rebound very nicely here in Q1. I’m wondering was it deal mix is it a change in durations or just some other type of strength in the business?

Hey Mark thanks for the question. Again the short-term number in Q4 was so highly impacted by the duration and types of transactions that we had again a few eight figure transactions obviously can significantly skew the composition or the geography between long-term and short-term deferred. So when you turn to our seasonal Q1, I think it was a more typical behavior in terms of the types of transactions we are doing versus the end of Q4. So I think that comparison is it was more uniform this quarter and we just had some really, really exciting transactions in the fourth quarter that’s through it off a little bit.

Okay. And then as a follow-up Dave, I wanted to follow up on the part of Jesse's earlier question. I think part of -- when people are asking about the stock-based comp, I think part of what we are observing is we are wondering if the trend towards focusing more on GAAP earnings results across the whole landscape of technology companies, it was something highlighted in the Wall Street Journal and then there is speculation that the SEC would crack down more on some of the adjusted earnings which again would broadly affect the entire technology landscape. And I think we’re curious if all of that intensifies is there something you would do to respond to that perhaps pulling back a little on the new RSU issuance or is it -- are you more thinking along the lines of that kind of the natural roll off of the stock-based comp expense that you described that it will essentially take care of itself.

Hi, thanks Mark. I do think the natural roll off is going to mitigate concern around SBC. Again we are very focused on what is the appropriate total rewards package for our employees and I think I mentioned on the last call, in last fiscal year we expanded our headcount about 48%, about 700 employees and it’s absolutely critical for us in terms of going and capturing that TAM. And as Doug mentioned where we are in terms of early innings, is it are we in middle relief or is the closure coming in like we are on the batter’s box here. So we are very proud of our prior fiscal year’s revenue levels. We think that a fraction of the size of the company that we have the opportunity to do so. Again we focus on the absolute dilution level and where that should trend and the combination of that trending lower dilution level with the runoff previously recorded stock-based comp is going to have the absolute number trend down and of course the percentage is going to trend down as well. As it relates to the SEC, we are very attentive to ensuring that we have the right disclosures and the right compliance around any adjustments we make between GAAP and non-GAAP. And I think we take it very seriously and we take great pride in ensuring consistency in our non-GAAP results. I really think if the SEC is doing the right thing to say look when companies are out there exercising the reporting differences between GAAP and non-GAAP, what level of consistency are they applying to those adjustments and what should be considered recurring versus a non-recurring item that you would exclude or cash versus a non-cash item like stock-based comp that you would exclude. So we pay a lot of attention to the consistency of our disclosures around non-GAAP.

Great, thank you very much and I will add my congrats again and like I said it was very nice to see the rebound in acceleration in the billings.

Yes, thank you.

Thanks Mark, appreciate that.

Thank you. And our next question comes from the line of Brian White with Drexel. Your line is open. Please go ahead.

Yes hi Doug on the big deals in the quarter it looked like it grow over 40% year-over-year and actually accelerated I think last quarter was just over 20%. So what did you see in terms of big deals? This is generally a soft quarter, so it goes down sequentially for the January quarter but it accelerated in growth. So what did you see in the big deal market?

If I look back my two years here and even go back further to three or four years ago, a six figure deal was a really compelling deal for the company, as everyone celebrate when we did a half a million dollars or got close to $1 million. And over the past two years we’re now routinely expecting seven and eight figure deals. So I think that we’re doing a better and better job of evangelizing the power of Splunk for multiple use cases within a company and that tends to move the whole ball up into kind of six figure deals being the norm, with seven and eight being real displays people that now have gone worldwide with Splunk. And we saw continuation of that in Q1 with our existing 70% of our -- over 70% of our sales coming from existing accounts and lot of those accounts continuing to expand usage of Splunk internally.

Okay. And if you could add a little color, I thought these partnerships with a couple of the biggest storage vendors EMC and also NetApp. NetApp made an announcement about working with Splunk. What does this tell us about either storage market or what Splunk is doing in terms of partnership in the storage industry? Thanks.

We’ve definitely had a very specific and focus strategy over the past few years on getting much more -- getting a higher level of committed name brand partners that either distributes Splunk or bundle Splunk with their offerings. And what I think that we’ve seen with a team that’s really focused on this is more realization by vendors like Cisco, EMC, and NetApp that Splunk is a great addition to the packages they put into their accounts. It provides visibility, analytics, assurance in the case of NetApp, EMC on the core storage solutions or the infrastructural solutions that those guys are distributing. But it also can be a differentiating in types of apps or visualizations or bundles that they produce to make sure that they’re keeping a competitive advantage and by those they are serving their customer needs. And that’s really but we use with these partners as -- are they Bernie relationships are not of much value. We’ve got a lot of brand name and a lot of marketing momentum for the company. We want real committed relationships in the field where their reps ideally are both commissioned and credited for bundling Splunk or including Splunk. And they really added value with what they are delivering to their customer base.

Thank you. And our next question comes from the line of Kirk Materne with Evercore ISI. Your line is open. Please go ahead.

Thanks very much. Doug I want to pull on that same thread you were talking about your partners in terms of you’re signing Accenture as a system integrator partners, I think a pretty big step forward for you guys given you had to carry sort of all the water in terms of getting Splunk out there just a few years ago. Could you just talk about may be not Accenture specifically but Accenture the relationship with Booz that you announced last year. Can you start to get some greater leverage from a sales perspective as you have this partner network? I guess picking up is that something that can start to I guess positively impact you guys this year or is that something that’s got to take at least 12 to 18 months before we start to see some of the leverage from this broader partner channel. Thanks.

Thanks Kirk and thanks for noticing the Accenture piece that was a surprise that we didn’t get more notice of that when we actually made that announcement because I remember before joining the Splunk hearing how we are so easy to install and so much immediate value that none of those as SIs ever pay attention to us. That’s been another one of those key initiatives at partner group is how do we get Accenture and the other major SIs around the world to understand that. There is a real practice they can develop around Splunk. We might be easier to install initially configure than some of the more complex ERP packages but it’s a very strategic offering and they could actually build a lot of their critical initiatives around Splunk that are the high value, high margin initiatives. And what I excited about the Accenture relationship, obviously it’s a great brand, love the company, great group of folks, and having them backing us from a go to market and SI perspective is a good positive boost but they are wrapping us into different core offerings that they deliver to their account base, in addition they are kind of classic SI, systems integration type work. So a good example that their application, outsourcing business where Splunk is becoming a critical infrastructural component for those contracts already under wraps. Hawaiian Telecom is one of these examples we did this quarter, is one of those first customers where not only do we provide the opportunity for the customer, Hawaiian Telecom to get better visibility into their landscape, but Accenture is lowering their cost of serving as they are delivering the capability into Hawaiian, and they have the ability to generate brand new services because their correlations and different new offerings that can be created that that Splunk is driving as a intelligent engine around that application outsourcing initiative, it’s the same thing with their cyber security initiative they are pushing as well.

I guess I have follow-up. I guess I have one quick follow-up on that. When you think about IoT, you guys seem to be I think pretty uniquely positioned in that broader market however there is always that I guess tension between do you want to develop the solutions yourself or sort of hopefully have a partner base build on top of you. When you think about that particular opportunity, I guess are you -- I guess leaning one way or the other in terms of the best way to sort of break in or help expand that market? Thanks.

Yes, heavily leaning towards partner and even in with security and IT operations not that where we got a lot of strength, it is still is a prominent partner lean. I think it is even harder with IoT because the vertical and geographic specificity is so much higher and you really need domain expertise I think to serve those customers well and just very difficult and unfair ask of Splunk to have enough discrete manufacturing versus process manufacturing versus healthcare and hospitality, we’ve got to turn to the partner channel for that. And on that vein probably they are tune in the 500 Race this weekend, stay tuned and take a look at where Splunk might pop up there. There are some announcements after the weekend when we are allowed to talk about some of the benefits that we are driving in that venue.

Our next question comes from the line of Bhavan Suri with William Blair. Your line is open. Please go ahead.

Thanks guys and congrats, let me add that to the list there. Just to dive into the premium products here, you talk a lot about sort of some of the security stuff and obviously the core business and other things that, when you look at the UBA and some of the premium products, how are those -- how is the uptick there and then may be a couple of examples as how that’s luring on to potentially drive ARPU expansion of some of the accounts that are adding into the core platform?

Yes I think that continued progression yes it’s been so wonderful the enterprise security product to see that gain critical mass and traction in security led deals, it’s becoming almost a standard that we include enterprise security as part of that underlying Splunk Enterprise platform engine and I think the opportunity, I’m thrilled with the User Behavior Analytics add-on because it adds whole different dimension to behaviorally based analytics insider threat that ES by itself wouldn’t be able to provide. I think equally that IT services intelligence initiative that we announced a year ago or three quarters ago are being driven into the marketplace is that same for our existing IT ops customers. We’re seeing a lot of interest as we go back into them to up level, how they are defining services across our IT op landscape and getting effective and holistic visibility on the quality of their services. But all three of those still I would view as lower level extensions of the core platform with ability to deliver more specific solutions on top, so they are almost enabling solutions within those market segments. Going back to our push for a partner involvement and continuing to refine the platform, so it’s easier and easier for third-parties to develop applications and drive their own revenue within Splunk. And I think that in a long-term basis actually the bigger lever for us as far as expansion of footprint and any type of ARPU enhancement.

Got it, got it. And then one quick one from me obviously the Light Splunk Light has been out for a little while and you guys have commented on it not being included in the customer count et cetera. So do you anticipate a shift and obviously the small customers may not as they grow or as they introduce it, do you anticipate a shift from sort of Splunk Light to more of the enterprise platform, could that play out at well or these two fairly different segments in terms of how you are targeting how the products delivered?

We actually have seen Splunk Light as a entry leading sometimes within days or weeks, sometimes a longer basis to a licensee with Splunk Enterprise. But really the whole focus was how we reached all segments of potential users, how to make it easier for one to five person IT team that’s going to have a very different skillset and bandwidth capability to get the same value from Splunk that 100 or 10,000 person IT group is getting from us. There are different segments but they have got similar needs. It’s has been more driving ease of use even higher and quicker time to value, more simplicity in the product turning off some of the configurability of bells and whistles, so that it’s less complicated in the way that’s delivered and consumed by those guys.

Thank you. And our next question comes from the line of Matt Hedberg with RBC Capital Markets. Your line is open. Please go ahead.

Great, thanks. Congrats guys. A follow-up question on the UBA prior question here obviously there seem like there is a lot of momentum coming out of RSA from that particular product lot of buzz, I’m curious when you look at the competitive landscape their competition is never easy but do you find more white space when you are looking at security deals than say core ITOM?

What do you mean by more white space?

Do you see I mean the competitors in ITOM it’s really well defined and I think certainly in ITSM in some security aspects it is more definable but do you see you guys are more than ITSM. And did you see the competitive dynamics, I don’t want to say easier but do you see more of an opportunity there where you sort of you would have a differentiated solution.

I guess it is the right way of saying, so what I -- what we’re seeing with UBA it’s a brand, it’s a different, it’s a more wide open area and it’s very -- it’s pretty unique value prop that we’re driving but it’s a brand new emerging market where there is just like any 1.0 product or any product, there is as much education and evangelism and proving that there is value before you start to get the okay I get the value, now I just want to do business with you, which right I think we’ve gotten through Enterprise Security and SIEM market, people now it’s taking a long time for us to be seen as a true SIEM and security player. But we are now just being practically included in all SIEM, RFPs whether it is Greenfield or replacement. And I think we’re way behind that something like User Behavior Analytics, the market is still trying to figure out how important is it and can a solution really provide the insights and capabilities. I expect that to change. We have seen that changes in the last two or three quarters, it’s starting, people are starting to come to speed but there is still lot of evangelism and again long-term our approach from our own solutions and just as importantly third-party partner solutions is how do we cover as much end to end capability given the complex security and compliance and fraud needs that our customers have, so that they get a single pane of glass effective analytics and the right visibility to make sure that we can keep all of our information and businesses safe.

Thank you. And our next question comes from the line of Brent Bracelin with Pacific Crest Securities. Your line is open. Please go ahead.

Thank you for taking the question. I just want to go back to the cloud impact on gross margins given the momentum you’re seeing doubling obviously we down ticked on the services margins below 70%. How are you generally thinking about that is kind of the new range 65% to 70% if we continue to double here, how should we think about cloud gross margins?

Yes, it’s Dave. We think the minimum from a steady state cloud margin is the 70%. So we obviously have some miles ahead of us to get there, but that's our minimum threshold in terms of expectation.

Okay, very helpful. And then last question from me is really around ITSI. I mean we're still early days you did talk about kind of three examples, Coca-Cola it seems like a pretty high profile example there. But relative to your kind of adoption is this on track with the pace of adoption you thought it would be on or ahead of where you thought it would be on help us understand kind of the path that ITSI is on today and the potential looking out a couple of years.

I think that the IT ops and App Dev team has just done a fantastic job with ITSI. I’d say is probably ahead of where we expected, but there is high expectations for the group. But they’ve really -- they executed really, really well at the very beginning, making sure that we did the right co-development work with our early, early partners we have the right data and testing a new partner reduction program so that what we were confident in the features that were delivered and we wouldn’t let our customers down. And there's still a lot, yes it’s still a very early product and there is both a feature expansion that sort of the product, but I think just importantly the surrounding services and education around the product that we are expanding on connect centric circle type visual, making sure that our partners understand how to implement, how to configure the customers come up to speed on what it takes to the finest service, and how do you keep it current and effective. But it's really been a wonderful thing to watch and I just have to congratulate Rick Fitz and the entire team over and over on a thoughtful and customer first approach for how we roll something out with the fewest hiccups possible.

And deal sizes on ITSI are comparable to what you've seen in the past on ES as well?

That’s a good question, David.

Typically -- they're --

Is it higher?

Typically larger, yes.

So they’re larger deals. Okay very helpful. Thank you.

Thanks Brent.

Thank you. And we have time for one more question from the line of Steve Ashley with Robert W. Baird. Your line is open. Please go ahead.

Perfect, get in under wire Doug I'm going to tip my head, you tell us to tune in the Indianapolis 500 and see what kind of benefits we're driving. That's very; very clever I thought it was quite good. So security and see the sales side of you there. So it's in terms of the security business, number one in the past, sometimes you've given us what percentage that might have been the total and then my question -- my second question is on the security business. Just looking for some color on how concentrated or diverse that businesses in terms of use cases are there a handful of used cases that just dominate that business or you just see why dispersion of use case; is there any color you can give us around them on the security side thing?

So the -- whenever we talk about the amount of revenue going to one of these market segments, and every one of these calls always trying to caveat that, so that’s the initial sale of Splunk and what we expect as we saw a bunch of the use cases or customer examples I gave, is that because we are schema at read and know that data you put in hardened that as security is getting benefit, their colleagues in IT ops, and colleagues in App Dev or their line of business IT folks or faster marketing or sales needs can look over there get the data that the security group may have accumulated and see is there a benefit for them without any additional cost. And that's still one of those that repeat that so many times a Splunk because after almost 30 years in the IT industry starting with a strict database client server world that still goes in my mind, that you can ask totally different questions at the same data and get completed financial different value out of it without ever touching anything akin to an ETL stack or crafting a whole new scheme and repurposing the data. And what we saw this quarter is again in the 40-ish-percent range these new deals being security based. And then with security on the concentration, I think we've become relatively well -- I think we have -- people now associate Splunk with the security operations center dashboard and a SIEM like set of characteristics. So from a first sale basis that that seems to be a lot of where we're focused, but as we all know the security landscape is incredibly diverse and there are so many different use cases, security is a 50,000 foot term and very far away from the ground level of what our customers are doing with. So we will enter in one of those now with ES with the soft type application but then dive into a whole host of more specific use cases as they try and fill up the repository of comprehensive security data.

Thank you. This does conclude the Q&A session for today’s conference. I would like to turn the call back over to Mr. Ken Tinsley for any closing remarks.

Great, thank you, Michelle. I appreciate your help today. Thanks for everyone’s participation. We are available tonight if you have any questions. Hope you have a nice Memorial Day weekend and enjoy the race on Sunday.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.