A few years ago, IBM estimated we created 2.5 quintillion bytes of data every single day, and that 90% of all the data in the world at that time had been created in the previous two years. And data storage company Dell EMC forecast that between 2014 and 2020, the amount of data produced would grow from 4.4 trillion gigabytes to 44 trillion gigabytes, or 44 zettabytes.

Yeah, don't try wrapping your head around those kinds of numbers. It's not possible. Suffice it to say, we produce a lot of information, and big-data analytics -- the process of turning all of that data into a usable and actionable form -- has become big business. 

Data entering into a safe

Image source: Getty Images.

Rising to the occasion

Splunk (NASDAQ:SPLK) has emerged as one of the more innovative and dynamic players in the space, helping businesses capture, store, analyze, and curate the information generated. Over the past year, it has continuously beaten bullish analyst revenue estimates, but changes to its business model caused doubts about its ability to produce positive cash flow, resulting in its stock plummeting 10% in the second quarter.

It rebounded sharply in November after management reiterated its belief it will be able to produce some $1 billion in operating cash flow (OCF) for fiscal 2023. But is that a realistic scenario or merely a symbolic goal that ignores some of the realities of its business? 

Let's look at what's at play.

Throwing growth into reverse

There's no doubt Splunk's business is growing. Even in the second quarter, when it caused Wall Street bulls to get wobbly, revenue grew 33% to $517 million, well ahead of analyst forecasts of $488 million. It followed that up in the third quarter as revenue rose another 30% year over year to $626 million, and again ahead of projections of a $600 million gain.

Splunk is forecast to grow 26% in the fourth quarter to a consensus $783 million, while management has offered conservative guidance of $780 million. It's worth noting that the data analytics specialist handily surpasses its own guidance on a routine basis.

But it was Splunk's sudden reversal on OCF for fiscal 2020, which ends at the end of this month, that originally caused consternation. It had reported $296 million in OCF at the end of fiscal 2019 and had forecast $350 million this year. But in the second quarter, it surprised everyone by saying it now expected the year to end with OCF of negative $300 million, a $650 million reversal from just six months prior.

Even from the first quarter's outlook, where Splunk had eased back guidance to positive OCF of $250 million, it still caught everyone by surprise that things looked bad all of a sudden. But management did have a seemingly valid explanation for the change, though it took the company three more months to reassure everyone that $1 billion in operating cash flow was still an attainable goal.

A new way of doing business

As mentioned earlier, Splunk is changing its business model, or rather how it bills customers for its business. Beforehand, it offered perpetual licenses for its software-as-a-service technology, having customers pay up front for the software license with the right to use it indefinitely. But now it's changing to a subscription-based model, billing customers for the license that allows the software to be used for a specific length of time.

The latter is obviously a better model for Splunk because it gives it recurring revenue streams, but the changeover tends to be a bit chaotic. 

When Splunk was forecasting positive OCF for fiscal 2020, it had expected the changeover to happen more slowly, and that by the end of the year, 15% of its business would still be on a perpetual-license model. In the second quarter, however, it realized the pace of conversion was occurring far more rapidly than anticipated, and it now said just 1% of its business would be perpetual.

Since the average contract lasts about 33.5 months now, the transition is having a disproportionately negative impact on OCF during that time frame. Management is able to expect it to grow to $1 billion by fiscal 2023 because that is when the billing situation will have normalized.

A reasonable expectation

Splunk stock is not cheap on traditional metrics, trading at 65 times next year's earnings estimates and over 10 times sales. But the market also says it's worth about 23 times its $1 billion operating cash flow target, which makes it more reasonable, and it certainly seems the data analytics specialist ought to be able to hit the mark when the time comes.