Despite near-term headwinds, this software provider has a long runway for growth.
By Rodney Nelson | 08-25-16 | 06:00 PM | Email Article

 Splunk's second-quarter results largely outstripped our expectations, with the outperformance almost entirely driven by a surge in Splunk Cloud deals. The ratable mix of Splunk’s sales continues to drift higher, which can create near-term headwinds to the firm’s financial performance, but we ultimately believe that the economic benefits of cloud subscriptions will at least meet (if not exceed) those of the traditional on-premises model. As we recalibrate our model to account for greater cloud subscription growth, we are raising our fair value estimate to $62 per share from $57 previously, though our no-moat rating remains intact.

Rodney Nelson is an equity analyst for Morningstar.

Second-quarter revenue rose 43% versus the prior-year period to $212.8 million, roughly 7% ahead of our internal forecast. While license revenues of $115 million were roughly in line with our expectations, maintenance and service revenues (which contain cloud revenues) rose more than 60% year over year to $97 million. Despite the short-term headwinds that accompany ratable subscription revenue, we are encouraged by the size of the cloud deals. Four of the 10 largest deals the firm signed in the quarter included Splunk Cloud, each of which were seven-figure wins.

One area we expect to see consistent improvement over the next several years is sales and marketing spending, which has been notoriously high for a company with the sales magnitude of Splunk. Sales and marketing spend fell 400 basis points as a percentage of revenue in the quarter, though the impact of these improvements were partially offset by the lower gross margin profile of cloud revenue. Non-GAAP operating margin expanded roughly 70 basis points to 3.9%. Management indicated that while cloud revenue remains less than 10% of total revenue, the cloud bookings run rate reached $100 million in the quarter. We think a number of factors are helping to drive cloud adoption for Splunk, most notably enterprise comfort with hosting applications and sensitive data in the cloud.

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