Logo of jester cap with thought bubble with words 'Fool Transcripts' below it

Image source: The Motley Fool.

Splunk Inc. (NASDAQ:SPLK)
Q3 2019 Earnings Conference Call
November 29, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the Splunk Inc. third quarter 2019 financial results. At this time, all participants are in a listen-only mode to prevent background noise. If anyone needs assistance during the conference, just press * and 0. Later, we will have a question and answer session. As a reminder, this conference is being recorded.

Now, it's my pleasure to turn the call to the Corporate Treasurer and Vice President of Investor Relations, Mr. Ken Tinsley.

Ken Tinsley -- Corporate Treasurer and Vice President of Investor Relations

Excellent. Thank you, Carmen. Appreciate that and good afternoon, everyone. With me on the call today are Doug Merritt and Dave Conte. After the close of market today, we issued a press release with our Q3 results and it's also posted on our website. This call is being broadcast live via webcast and following the call, an audio replay will be available on the website as well.

On this call, we will be making forward-looking statements, including financial guidance and expectations, including our forecast for our fourth quarter and full years of fiscal 2019 and 2020. Trends and expectations regarding innovation partners, customers, markets, demand, strategies, revenue, and bookings mix and predictability and our expectations regarding our investments, products, and technologies.

These statements reflect our best judgement based on factors currently known to us and actual events and 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 in.

We will also discuss non-GAAP financial measures which are not prepared in accordance with generally acceptance accounting principles. A reconciliation of GAAP and non-GAAP results is provided in a press release and on our website.

With that, let me turn it over to Doug.

Douglas Merritt -- President and Chief Executive Officer

Thank you, Ken. We drove fantastic results in Q3 thanks to strong execution in the field and the most exciting .conf in Splunk's history. We delivered $481 million in total revenue, up 40% over last year. Our success comes from new and exiting customers, expanding their adoption with Splunk as their platform for data analytics and machine learning. So, it's on prem and in the cloud.

At .conf18, we hosted nearly 10,000 people and shared our newest wave of product innovation. We announced updates to our existing products, including new versions of Splunk Enterprise and Splunk Cloud, with better performance, scale, machine learning, and analytics abilities.

A few of the new capacities include a machine learning toolkit connector for Apache Spark and a container for tension or flow, guided data onboarding to help customers move customers into their partner, Splunk SmartStore, which allows compute and storage tiers to be independently scaled on business demands, Splunk on Docker to cover deployments in Docker containers, metrics workspace to monitor and analyze metrics data in an efficient, intuitive user interface, and the crowd favorite, dark mode, which is perfect for SOC and NOC environments.

We released Splunk for industrial IoT, our first IoT solution, which provides a simple view of the complex industrial data environment to minimize downtime and shift our operations from reactive to proactive. We announced a new release to Splunk IT Service Intelligence or ITSI to help customers better predict and prevent problems through a series of enhanced capabilities like KPI predictions and predictive cause analysis and an entirely updated security suite with new versions of Splunk Enterprise Security or ES, user behavior analytics or UBA, and Phantom.

We also announced an exciting new suite of beta capabilities, which we call Splunk Next. Splunk Next evolved from conversations with our customers, who asked us to focus on three major areas -- one, to work with their data wherever it lives, two, to further embed AI and ML in our platform to create action-driven outcomes, and three, to empower users across their organizations on any device.

Splunk Next announcements, like our Data Stream Processor and Data Fabric Search mean you can refine and adjust data as it moves across the stream and then search across multiple data stores in Splunk or elsewhere. And additional capabilities like business flow, natural language processing, and Splunk Mobile empower new users regardless of their technical skillset or physical location to investigate, monitor, and act on their data no matter where it lives.

During the keynotes, we welcomed leaders from Starbucks and BMW who shared how they're using Splunk to make things happen in their organizations. I was honored to be joined on stage by Arnold Donald, CEO of Carnival Corporation. He shared our Carnival creates meaningful guest interactions both on and off their fleet of floating cities. Carnival relies on Splunk to monitor connectivity on the ships, monitor their mobile apps, and keep their own and their guests' data safe, ultimately helping to provide a seamless digital experience.

Since our first product shipment, Splunk has taken a different approach to data. Unlike other data technologies, you do not have to know the questions you'll ask before you deploy our solutions. The magic of Splunk is that we embrace the complexity and chaos of an ever-changing data landscape and allow you to find insights from your data without the high entry costs of cleansing, parsing, and structuring.

Our goal remains the same, to become the ubiquitous machine data platform, the standard in every organization, solving our customers data challenges around IT operations and application delivery, security compliance and fraud, as well as business analytics and the internet of things. These markets are going through a shift to an analytics and machine learning-based approach, where Splunk is uniquely poised to lead this change and deliver for our customers.

Transitioning to customer success in Q3, let's start with IT. Softbank purchased Splunk Cloud to speed up troubleshooting for mobile devices and application management. Softbank already uses us for IT and AI ops and expects Splunk Cloud to improve efficiency and performance across infrastructure and operations management.

ATB Financial, Alberta's largest homegrown financial institution, expanded their use of Splunk Cloud and brought on ITSI one year after their first Splunk investment. ATB Financial has been using Splunk Cloud to make their online activity data available across teams and will now use Splunk for mobile app monitoring and executive reporting.

Chicago Public Schools, one of the largest public school districts in the country, expanded their use of Splunk Cloud to help automate their service and out-ticketing process along with other IT monitoring and response workflows.

Moving to security, longtime Splunk customer, Norfolk Southern, expanded their use of Splunk Enterprise and ES to better lead with an analytics-driven approach to security. With Splunk, they will use data to gain visibility into their threat environment at machine speed, while also meeting compliance standards with positive train control, a federal safety mandate that controls trains to avoid accidents.

The Department of Home Affairs, which brings together Australia's federal law enforcement, national security, and criminal justice-related functions and agencies, replaced its legacy SAM with Splunk Enterprise. With Splunk, they can centralize security management on a single platform and better handle the big data scale of their security operations center.

Texas A&M University selected Splunk Enterprise as the foundation of their security operations strategy. The university chose Splunk for continuous threat analysis, monitoring, and investigation as well as satisfying compliance requirements. A&M also plans on their cybersecurity researchers with Splunk's machine learning capabilities in order to develop and improve threat monitoring to better detect advanced threats.

Highlighting a handful of customers who standardized on Splunk as their machine data platform, Randstad, a global leader in the HR services industry, got Splunk Cloud, ITSE, and ES to support their global IT infrastructure services. We will help Randstad expand the company's infrastructure monitoring across the business and leverage Splunk as a SIM at the heart of their SOC. We would like to thank our partner, TCS, for their support in collaboration in initiating this opportunity.

SendGrid has gone all in on Splunk, expanding Splunk Enterprise across their customer support, compliance, professional services, and engineering teams. SendGrid uses Splunk to debug and DevOps, help their customer meet in SLAs, and keep their customer-facing platform online. Thanks to our partner, Presidio Capital, who was instrumental in this transaction.

The Naval Post Graduate School is a new Splunk customer, purchasing Splunk Enterprise, ITSI, and ES. The school plans to use ITSI to keep a wide range of mission-critical IT systems online while ES will stay at the heart of their new SOC. Long-time customer Clemson University purchased Splunk Enterprise, ES, ITSI, and UBA. Clemson uses Splunk to thwart cyber threats, monitor campuswide IT, and integrate into their campus platform to support student success.

We also saw continued global adoption in our cloud business. A sampling of our cloud wins in the quarter include Teachers Mutual Bank, one of the largest in Australia, who is a new customer that bought Splunk Cloud and ES to optimize their security operations and improve their security posture. Teachers Mutual Bank expects to obtain end to end visibility, ensuring a safe environment for their customers' business.

New customer Fleetcor Technologies bought Splunk Cloud to improve their security posture. Splunk was selected because we can support all of Fleetcor's data sources and will augment their current SIM. Thanks to new Splunk partner, DataMD, who supported this opportunity.

Personalized video marketing platform Sunday Sky moved to Splunk Cloud as their central platform to provide complete transparency into IT and business operations as well as for research and development use cases.

To highlight the impact that Splunk can provide on the IoT front, one of my favorite keynote presentations at .conf was Boulos El-Asmar from BMW Group. BMW group took us through their Splunk journey, starting with a small Splunk Enterprise license and just one security use case to now, where BMW Group is using Splunk to drive innovation across their business. BMW is using our machine learning toolkit to predict traffic dynamics as well as our natural language capabilities to help them speed time to value, allowing them to simply ask questions of Splunk via Alexa.

On the manufacturing side, Splunk Industrial Asset Intelligence helps plant floor engineers, keep production up and running by correlating IoT data. Amsterdam's public transport operator, GVB, is a new Splunk customer, purchasing Splunk Enterprise to support use cases in IoT, IT, and business intelligence. GVB will be using Splunk to better monitor and act on their real time passenger information services, providing users with a better, more efficient, and more informed public transportation experience. Big thanks to our partner at DITP for their support in this opportunity.

And it was another big quarter of customer-focused innovation with AWS. I'm just back from re:Invent. This week, we launched a new integration with AWS Security Hub and an added capability to query against cloud watch log insights. We also released integrations this quarter with web application firewall and Trumpet. This is in addition to our many other integrations, including the Splunk app for AWS.

In summary, we delivered a great Q3. This year's .conf was our biggest and best ever. As always, it's exciting to see so many of our customers and partners and hear their enthusiastic feedback about Splunk's products and people. Customer success is our number one company priority and our efforts and investments are paying off. I'm looking forward to continuing this momentum.

Thanks again to all of our customers and partners and thanks to everybody who works at Splunk. Finally, I want to take a moment to congratulate you, Dave. As I'm sure you all saw, Dave has announced he's going to retire.

Dave is staying on board until March of 2020 as we initiate a search for a successor and I appreciate that he's going to stay and help with the transition. I can't overstate what Dave has done for Splunk. His leadership, accomplishments, and the foundation he helped create will continue to serve us well. I speak for all of us at Splunk when I say it has been an honor to work side by side with Dave over the years.

Thank you so much and now, over to you, Dave.

David Conte -- Senior Vice President and Chief Financial Officer

Thanks, Doug. I certainly appreciate those very kind words. To open, I'm looking forward to reviewing our results following another strong quarter for Q3, which is our largest ever, and providing an update for Q4, the full year, and our outlook for our next fiscal year, Fiscal 20.

Before I do, remember that almost two years ago, I set several important and material expectations for our multi-year business transformation, from primarily a perpetual company to one that is mostly renewable, shifting our go to market strategy to drive 75% of our software sales to renewable by next year. I can tell you that our execution toward this goal has significantly exceeded the expectations we set in January of '17 and my confidence in delivering the $2 billion revenue milestone in Fiscal 20 has never been higher.

When I retire, I'll have spent over eight years with the company after completing this latest transition. Over the next several quarters, I'm really looking forward to helping the company extend its market leadership as the ubiquitous platform for our customers' data.

Now, back to our report. Before I detail actual results and discuss guidance, I want to clarify a few things regarding the strength and growth of our business. I've said the best measure of our overall business momentum is software revenue, which is the combination of on-prem license and cloud revenues. When looking at the mix of transactions on prem, there is both a tailwind from longer duration and a headwind from fewer perpetual contracts.

When aggregating these, we estimate we've recognized tailwinds of about $40 million for the last nine months, i.e. year to date. However, as we said, the strategic shift to renewable contracts includes delivering more of our software via the cloud, which we all know is recognized. So, obviously, this represents a headwind to overall revenue.

Consistent with overachieving our mix shift a year early, it follows that we realized more cloud transactions than originally anticipated. Specifically, year to date, the growing contribution from cloud to total software sales has resulted in a headwind of about $43 million. So, as we've said, we believe the shift in both mix and duration has a net neutral impact on total software revenue as they generally offset one another and are therefore not material.

To give you a sense of just how rapidly our Cloud business is growing, the current ARR of Cloud-only is about $200 million, which is nearly double from a year ago. For simplicity, something we always strive for here, our outlook in Fiscal 20 is based on a consistent mix and duration level that we're realizing in Fiscal 19. We expect any deltas resulting from head and tailwinds to be immaterial at this level of scale.

Now, more on FY20 in a minute. Let's move on to the current period results. Q3 total revenues were $481 million, a 40% increase over last year. Software revenues, again, the total of license and cloud were up 49% from Q3 of last year, totaling $325 million. Cloud revenue was $45 million, up 87% over last year. Education and professional services represented 8% of total revenues, international operations contributed 24% of total Q3 revenues, and we added over 500 new customers and recorded 111 seven-figure orders during the quarter.

Now, turning to profitability and other results which are all non-GAAP, operating income was $65.4 million, representing a positive margin of 13.6%. Q3 overall gross margin was 85%, comparable on a year over year basis. Net income was $57.6 million or $0.38 per share using a weighted average share count of $153 million shares. Operating cash flow in Q3 was $59 million, while free cash flow was $52 million. And we ended the period with about $2.8 billion in cash and investments, reflecting the net proceeds of about $1.8 billion from our convertible debt offering we closed during the quarter.

Again, the best indicators of our business momentum are software revenues and also RPO. Recall that RPO includes backlog, so the total of revenues plus the change in RPO should provide a better estimate of in-period bookings in the traditional billings calculation. With that, we ended Q3 with total RPO of $950 million versus $602 million for Q3 of last year, up 58% and reflective of our bookings achievement thus far this year.

Okay. Turning to guidance -- we expect Q4 revenues of approximately $560 million and non-GAAP operating margin of a positive 25% to 26%. For the full year, we are now expecting total revenues of approximately $1.74 billion, up from the $1.685 billion, and we are increasing our FY19 non-GAAP op margin target to range between 11.5% and 12% positive.

For EPS purposes, since we expect to be non-GAAP profitable for Q4 and the full year, you should use fully diluted weighted average share counts of $155 million in Q4 and $152 million for the full year. Looking forward to next year, the investments we're making in product and field continue to fuel our growth. We expect our momentum this year will translate into next year, with FY20 total revenues of $2.15 billion, exceeding the $2 billion expectation I set two years ago.

Again, to be clear, this revenue target is based on a target mix and duration assumption for software contracts as compared this year, with any deltas expected to be immaterial. For your models, please remember that just as we saw this year, 606 causes a steeper revenue ramp during the year than we've seen historically. As such, I expect total revenues in 2020, Fiscal 20, will be weighted 40-60 first half to second half, with the largest seasonal impact visible in Q1.

In closing, Q3 execution was outstanding and I expect a very strong finish to the year. I'm extremely proud of everything we've accomplished thus far, transitioning from a $100 million private company to a public company targeting well above $2 billion in total revenue. It's been terrific contributing for such a long time and I've had the pleasure and honor of working for so many great people at the company and all of you on the call. I'd like to thank all the current and former Splunkers and all the folks on the finance team. I'm looking forward to the next year here and making sure we continue to deliver in Fiscal 20 and beyond.

On that note, thanks so much and we'll open up for questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, if you have a question at this time, press * and the number 1 key of your touchstone telephone. If your question has been answered or you wish to remove yourself form the queue, press the # key. Again, to get in the queue, just press * and 1.

Our first question is from John DiFucci with Jefferies. Please go ahead.

John DiFucci -- Jefferies -- Analyst

Thank you. Dave, we appreciate the long runway you're giving your team here. It truly has been a great pleasure working with you. It really has. We're going to miss you. It looks like we've got you for a while.

David Conte -- Senior Vice President and Chief Financial Officer

Thanks, John.

John DiFucci -- Jefferies -- Analyst

These results look really strong here, but as you guys know, there's a question of how much of that strength is because of ASC 606 and props expanding duration of on prem term license. Dave, thanks for that $40 million of tailwind over the first three quarters of the year. We can look at it three quarters over three quarters. Could you tell us what it was this quarter? It's probably not dividing by three. Could you break it out per quarter?

David Conte -- Senior Vice President and Chief Financial Officer

John, thanks for the question. Thanks for acknowledging we quantified our estimated at $40 million for nine months, but don't forget I was explicit to point out the shift to renewable includes a shift to routable cloud. That was about a $43 million headwind for the same period.

Now, in terms of quarter impact -- John, you've been with us since the IPO and we've talked about mix for so long and it was really frustrating because it would jump up and down every 90 days. That remains the case today. The best way to think about it is over not a 90-period but a nine-month period.

More importantly, if you think about the size and scale in Fiscal 20 and look comparably between Fiscal 19, now $1.740 billion, growing $2.150 billion, our model has consistent assumptions for both duration and mix. Even if there are gyrations between the two categories, it's going to be immaterial at that level of scale.

John DiFucci -- Jefferies -- Analyst

Okay. This is something for us to chew on tonight. Thanks. That's helpful.

Operator

Our next question comes from Michael Turits with Raymond James. Please go ahead.

Michael Turits -- Raymond James -- Managing Director

Hey, guys. Good evening. Dave, congrats on the long-term outlook for retirement but retirement nevertheless. You gave us a sense of what the duration was last quarter. I was wondering if you could update us in terms of where we are now with this quarter and year to date and also what impact that extension and duration might have as we come in terms of the renewal period a couple years out since we're signing longer deals now.

David Conte -- Senior Vice President and Chief Financial Officer

Sure, Michael. Our year to date duration remains consistent for the year, which is about 33 months. That's the blended duration for all of our renewable contracts, both on prem term and our subscription cloud contracts. In terms of our outlook going forward, we were modeling and setting the objective to get to 75% renewable. We thought of course, we're going to have a recurring stable of contracts that will come up for renewal. As we've been accelerating toward that goal, we're seeing that group of contracts grow beyond our original expectations based on really strong execution in the field.

When we model forward and think about the foundation that provides from a model perspective, it's really strong and stronger than when we first set the objective originally. All that's great on the financial model side. But more important strategically, we've learned it's by far the best way to enable our customers to deploy and adopt our solutions. Customer success is number one for us. Everything that we do from the investment portfolio that we manage here is all focused on that as the prime directive. Having these kinds of contracts out in the market for our customers to leverage really puts them in great position to consume our products.

Michael Turits -- Raymond James -- Managing Director

Thanks very much, Dave. Doug, you made a couple comments about IoT becoming a hotter area. Can you talk a little bit more specifically about the investments you're making in IoT and business non-IT analytics in general and where that money is going and what we should expect in terms of your strategy?

Douglas Merritt -- President and Chief Executive Officer

Absolutely. The key IoT announcement we made at .conf was the release of industrial asset intelligence, which is a collection of dashboards, queries, alerts focused specifically on predictive maintenance in industrial shops. However, the biggest issue we've talked about for a number of years on extending beyond the technical footprint within IT and cybersecurity is making it easier for less technical people to play with the data in Splunk and then take actions on that data as well.

There were a host of announcements we made at .conf to help lower that bar, from our new mobile platform to augmented reality in a future virtual reality framework that makes it far easier for people to visualize what's happening in the environment around them, the demo that Jesse, the leader of that product gave. We introduced a product called Business Flow, which represents the data within Splunk through a process journey.

That is, I think, a much more approachable interface for anyone that's involved in marketing, operations, manufacturing to see how their reality of their environment is performing. That was prompted by one of our customers to help them see customer interaction patterns through the machine data. We introduced natural language processing as an application so that you can actually have a verbal interaction with Splunk.

So, we're attacking it from a multitude of angles so that we can continue to broaden or allow our customers to broaden from their more technical personnel.

Operator

Thank you. Our next question comes from the line of Raimo Lenschow with Barclays. Please go ahead.

Raimo Lenschow -- Barclays -- Analyst

Thank you. Dave, congrats from me as well, although I'm slightly confused because you've just done 606 and you're done with the subscription transition and now you ride off. You should have done it the other way. Doug, you've been at AWS. Most of us were at re:Invent. Can you talk about the changing nature of competition you see from cloud that are all popping up there? What are you seeing from the market on that one?

Douglas Merritt -- President and Chief Executive Officer

From a day in, day out basis, we haven't seen a change in competitive dynamics. We continue with really impressive win rates. We continue to work within accounts to allow them to understand the power that Splunk provides. That winds up helping us a lot in the competitive landscape.

Within AWS and the cloud vendors, those are really complex environments, as we all just got to see, so many different services and capabilities can be online all the time, every one of those exuding different kinds of data. They've got different attempts within AWS to help capture that data so AWS customers can make sense of it. We integrate with all those different services and different data capture devices.

We were first to the table with Cloud Watch to have our integration ready. We were right there with them with their latest announcement related to the insights capability released in Cloud Watch as well as Security Hub. Our focus and why that innovation agenda is so important at .conf and why we're pushing hard on the product front is to stay in front based on customer needs and customer feedback the different capabilities being released around us.

Raimo Lenschow -- Barclays -- Analyst

I might have missed it, but did you talk to the mix on security and other use cases this quarter?

Douglas Merritt -- President and Chief Executive Officer

No, we didn't talk about it because it was uneventful and consistent with what we've been experiencing over the last handful of quarters.

Operator

Thank you. Our next question comes from Philip Winslow with Wells Fargo.

Philip Winslow -- Wells Fargo Securities -- Managing Director

Two quick questions, one a quick housekeeping item for you, Dave -- you mentioned duration of 33 months for the nine months this year. What was that metric for the nine months last year? Also, for the team, just a broader question on pricing and particularly larger deals, any update that you have on pricing, particularly as you get to these larger deals that Doug highlighted on the call, it seems like you were talking about multiple different use cases here, way more data volume, how is that impacting the pricing conversation when you're talking about going down the pricing curve?

David Conte -- Senior Vice President and Chief Financial Officer

First, as it relates to duration, let's just say unlike the Raiders, Splunk is leading the league and we're putting up a lot of points on the scoreboard. I'd love if the Raiders could replicate that. Duration again for the nine months this fiscal year was 33, the comparable nine-month prior year was about 26. Then as it relates to pricing, Doug?

Douglas Merritt -- President and Chief Executive Officer

My favorite initial lead-in for pricing is folks are never happy with the price, but the one thing I hear from our customers is they're always happy with the value. The question for pricing continues to be how do we provide predictability to our customers. I think we've done a better job over the past couple years of making customers aware of the possibility of unlimited contracts and other buying vehicles that lock down their perspective and how much they're going to owe Splunk.

The biggest impact the last nine months has been that shift to term. Customers can lock in a three-year perspective of either consistent data usage or in many cases escalating data usage. It's a little bit easier to give them a little bit more than they might need without the permanent impact you'd have on a perpetual contract we had in the past. I think some of that pricing noise is going down. We're never done. We are always focused on making it more transparent and easier for customers. Stay tuned for additional focus areas to help there.

Operator

Thank you. Our next question comes from Kash Rangan from Bank of America Merrill Lynch. Please go ahead.

Kash Rangan -- Bank of America Merrill Lynch -- Analyst

Congratulations, this is spectacular. You guys are accelerating at scale while cancelling out the headwinds versus the tailwinds. My question for you is as you look at the use case, clearly, the option is there to grow to be much larger, $5 billion, $6 billion, who knows? But you look at successful companies like a Salesforce.com or Workday, they always had a second act, third act, or fourth act.

Is there going to be a fourth use case, fifth use case that could end up being a big hundred-million opportunity or billion-dollar opportunity? It's hard to think of Splunk going from $2 billion to $6 billion while maintaining the same mix of use cases such as security, operations, SIM, if you will, and IT operations. There's got to be something, a third act, a fourth act. How do you envision the future for Splunk four to five years from now? That's it for me. Thank you.

Douglas Merritt -- President and Chief Executive Officer

First of all, it's hard to believe how we get to $5 billion to $6 billion with security and IT. I think we can get to $5 billion to $6 billion with security and IT. We do have lots of other plans.

When I look at the installs that we have across our existing customer base and how broadly we are being used, what data sources we're ingesting across the IT set of use cases and how much utilization we have at ITSI and how many additional apps we've deployed they've built themselves or they've downloaded from Splunk just within IT, we are a fraction of what is necessary for the vast majority of the customer base. I'd say 95% of the customer base is still not getting the full analytics and monitoring detection and investigation capability they could or should just within security and IT.

That said, the power of Splunk, we talk about a percentage of business every quarter, where a sales rep has said they bought this solution for a security use case or IT use case or non-security use case. We know that's the beginning of the journey. If we're successful, they're implementing a whole host of use cases outside of IT and security.

As we see patterns emerge, we'll start to facilitate the ecosystem to release apps we'll highlight or build these apps ourselves. We do believe at Splunk there's a huge opportunity -- again, probably tens of thousands to hundreds of thousands of potential applications to recover the needs of the functional users and the different industrial use cases in the industrial IoT or IoT segment.

Operator

Our next question is from Fatima Boolani with UBS. Please go ahead.

Fatima Boolani -- UBS Securities -- Analyst

Good afternoon. Thank you for taking my question. Doug, you mentioned again this quarter you have a ton of IT ops use cases in your prepared remarks and to Dave's point around the business mix being consistent from a use case perspective, I wanted to understand from your view what you need to do either from the technical or go to market perspective to replicate the type of success you've had in the security arena. As we think about DevOps becoming the more influential buyer in the enterprise, how are you positioned from that standpoint?

Douglas Merritt -- President and Chief Executive Officer

Thanks, Fatima. A lot of the quick rise in security was two things. One, obviously, cyber is becoming a critical component for everyone to understand and address, so that alone with the board scrutiny has become a heavy drumbeat to make sure you've got the degree of insight you need in your landscape and two, there was a clear replacement category. There's this whole SIM market and the way Splunk approaches that problem because of the flexible underpinnings of Splunk Enterprise was pretty differentiated.

In the IT ops arena, ITSI, the whole orientation around ITSI was to provide that same degree of flexibility in that IT operations side. It took ES five years to get significant foothold and traction. I think the first coding on that was done in '09 and '10. So, it takes a while for these products to mature and right now, we're in the third year with ITSI.

We are starting to see more completeness with ITSI and more situations where a 20-40-year old systems management framework is now being replaced with ITSI. So, my hope and Rick's orientation is that with continued investment and focus, we can be talking in a future call about the replacement cycle opportunity on the IT ops side.

The other piece that's equally important -- replacement within that heavyweight IT ops segment, a lot of the energy of new workloads is going to next gen DevOps. We have a whole host of different insights, the lighter weight applications was really primarily focused on DevOps, a true next gen environment where every developer owns their code end to end without that handoff. Stay tuned for more releases in that category. In addition to the SOC and NOC, the next gen DevOps portfolio is one we're really excited about and developing aggressively toward and in the strategic landscape is something we're looking toward as well.

Fatima Boolani -- UBS Securities -- Analyst

Dave, a quick follow-up for you. You talked about the accelerated shift toward more the routable business being a pretty big drag on your cash flow profile this year. If you could, give us an update on how that should shake out as we barrel through the end of the year. At a very high level, what does that trajectory for cash flow from operations look like next year as we think about that and also internalize the headquarters-related CapEx you're going to be doing next year. That's it for me. Thank you so much.

David Conte -- Senior Vice President and Chief Financial Officer

So, as we mentioned at the beginning of the fiscal year, we expected Fiscal 19 to be a cash flow trough as we made a material shift toward renewable. As we know, those are billed typically on an annual basis versus the full contract value. With the over-achievement on that objective in terms of renewable, that would add additional pressure form a cash flow perspective, but that's been offset by strong over-delivery of our plan in the field.

Obviously, the fourth quarter is our largest quarter of the year and we have plenty of execution that we have to go nail down and that is going to ultimately translate to the amount of cash flow that we generate for Fiscal 19 but I'm confident we're on the right direction and '19 will be that trough year.

When you look forward, what about cash flow going forward? When you see stability in the percentage of our business that is renewable and stability or consistency in terms of duration, then the business starts to normalize form a cash flow yield perspective. That's what we expect to see for Fiscal 20.

As it relates to CapEx, we are a fairly light capital expenditure-consuming company, outside of the facility work that we do in terms of global footprint. We're excited about many of the spaces we're developing around the world and of late, we've made some significant investments in terms of creating the right footprint for Splunk in the Bay Area.

But like we did a couple years back when we expanded in San Francisco and South Bay at the same time, we quantified what we expected the incremental or total cash flow or capital expenditures and therefore, the impact of free cash flow would be from those facility buildouts and we'll do the exact same thing as we finalize our plans for our latest phase of facility expansions.

Operator

Our next question comes from Walter Pritchard with Citi. Please go ahead.

Walter Pritchard -- Citigroup -- Analyst

A couple questions, Dave, for you -- on the duration impacts, a lot of us focus on the license impact. Can you help us understand how you're getting to the cloud impact and if there's any impact as it relates to the amount of booking you're deferring into maintenance and how that may come back in any way?

David Conte -- Senior Vice President and Chief Financial Officer

Thanks, Water. There's been focus on license, which makes a lot of sense. Candidly, the reason I have been very deliberate over the last how many periods to point out software revenue as the best way to look at our growth, you have to contemplate how much of our software is being delivered in the cloud that doesn't hit the license line.

So, when we look at the drag or the headwinds from the routability of cloud, we look at it in terms of how much is it growing as a percentage of our business that is in lieu of what would otherwise in our model be on prem, i.e. the on prem hits the license line, cloud hits service line, you've got to look at those two sides of the equation together.

Walter Pritchard -- Citigroup -- Analyst

On the margins for next year, I know you didn't give an explicit -- I think at analyst day, you talked about a 14% operating margin in 2020. Is that still the way we should think about profitability next year?

David Conte -- Senior Vice President and Chief Financial Officer

We didn't explicitly update what we provided at analyst day. As is consistent with our cadence on this call, we focus on the visibility we have and making sure we give that to all your folks in terms of the revenue. We've got to get to the end of the fiscal year, measure up the beans and look at the investments we have on the table and we'll provide an update at that time.

Walter Pritchard -- Citigroup -- Analyst

Thank you.

Operator

Thank you. Our final question will come from Steve Koenig with Wedbush. Please go ahead.

Steve Koenig -- Wedbush Securities -- Managing Director

Thanks for squeezing me in. What I'd love to ask you guys about is if you can, give us a little color -- do you have a playbook for converting perpetual customers and what does that playbook consist of and how do the mechanics of that work? Also, I'm curious to know are there any incentives for cloud sales this year over and above any incentives for recurring sales? What's driving the strong Splunk Cloud adoption and execution this year beyond any sales incentives.

David Conte -- Senior Vice President and Chief Financial Officer

Let me talk about sales incentives for a second -- we've been very transparent that we've been on this multi-year journey having been born as a perpetual company to one that wants to deliver our solutions, obviously, on prem, but also in the cloud in leveraging the renewable structure. I think we were pretty clear that as we looked to accelerate our move in terms of that shift, we had this multi-year adjustment to how we align incentives in the field, moving where perpetual was the first-class citizen to now having renewable be the first-class citizen.

As it relates to Cloud, what we experience in the field, it is absolutely most relevant around use case, customer preparedness, the needs and requirements in terms of how they want to leverage our technology, ultimately differentiates between are they going to use a renewable term contract on prem, are they going to use a cloud instance for that particular data source?

We continue to see a very high percentage of customers that are with us in the cloud are also on prem customers. But unlike the incentive plan where we say perpetual shouldn't be first class, we don't go into that level of specificity on cloud because it's so customer-driven.

Steve Koenig -- Wedbush Securities -- Managing Director

I'll leave it there. Thanks again.

Operator

Thank you. Ladies and gentlemen, this concludes our Q&A session today. I would like to turn the call over to Ken Tinsley for any final remarks.

Ken Tinsley -- Corporate Treasurer and Vice President of Investor Relations

Thank you, Carmen, I appreciate that. Thanks, everybody for joining us. Have a great evening and enjoy the holidays.

Operator

Ladies and gentlemen, with that, we thank you for participating in today's conference. This concludes the program and you may all disconnect. Have a wonderful night.

Duration: 65 minutes

Call participants:

Ken Tinsley -- Corporate Treasurer and Vice President of Investor Relations

Douglas Merritt -- President and Chief Executive Officer

David Conte -- Senior Vice President and Chief Financial Officer

John DiFucci -- Jefferies -- Analyst

Michael Turits -- Raymond James -- Managing Director

Raimo Lenschow -- Barclays -- Analyst

Philip Winslow -- Wells Fargo Securities -- Managing Director

Kash Rangan -- Bank of America Merrill Lynch -- Analyst

Fatima Boolani -- UBS Securities -- Analyst

Walter Pritchard -- Citigroup -- Analyst

Steve Koenig -- Wedbush Securities -- Managing Director

More SPLK analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

10 stocks we like better than Splunk
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Splunk wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of November 14, 2018

Motley Fool Transcription has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Splunk. The Motley Fool has a disclosure policy.