Why Splunk Shares Fell 9% After Earnings

Artificial intelligence is defined incredibly broadly at the moment. It has evolved from early visions of smart hardware to an ever-growing presence in software services. In our interconnected world, it's possible to use data to analyze almost anything, and Splunk (SPLK) has developed tools to do this quickly and efficiently -- now serving 91 of the Fortune 100 companies. 

Splunk has a history of generating really lumpy operating income (meaning there are swings from big losses in some quarters to profits in others). However, net losses are a consistent theme. It just announced earnings for the first quarter of the 2022 fiscal year, and while it beat analyst expectations on revenue growth, it lost $471 million -- over 54% more than the same quarter last year. That wasn't the only concerning metric in the report, and investors have responded by selling the stock. 

Image source: Getty Images.

Big data, big business

With each passing year, more of the economy shifts online. Companies that you would never have thought needed extensive data analysis are using Splunk to generate exponential growth. Take Domino's Pizza (DPZ -1.68%) for example, which now generates 65% of its U.S. sales through 15 digital channels. It feeds its data through to Splunk, which analyzes security, operations, and even the performance of new product releases. It informs Domino's of trends in the data and allows the company to make adjustments in real time -- and that's extremely powerful.

This phenomenon is probably best displayed through Splunk's partnership with the McLaren Formula 1 racing team. In development, practice, qualifying, and on race day, McLaren feeds data through Splunk's platform to get instant feedback on a multitude of points. Artificial intelligence is applied to rapidly analyze the data, allowing the team to change the dynamics of the car, or offer feedback to the driver, during a live race. 

Splunk charges for its platforms using a few different pricing models. It uses ''entity pricing'' for comprehensive organizations that need the full suite of products. Users can also adapt ''workload pricing'' to fit their needs -- a more tailored solution that charges based on usage across the different products. Individuals can also use ''ingest pricing,'' which simply charges based on the gigabytes per day of data Splunk is fed. 

A lack of earnings

Financially speaking, Splunk's performance isn't quite up to the standard of its innovative platforms and services. So far it has struggled to deliver profits on an annual basis, and in the quarter just reported, it lost 54% more than in the same quarter last year. 

The company experienced a revenue drop in the 2021 financial year, and lost more money than ever. The recent quarterly report suggests the size of those losses could persist. 

Data source: Splunk.

Splunk has a really high gross margin. Its licensing segment, for example, generated $143 million in Q1 revenue, booking just $4.2 million in costs for that revenue. Blended gross margin (the average gross margin across all products and services) came in at 72%. The majority of the company's spend is in sales and marketing, where in Q1 it spent $356 million, an increase of 11.6% year over year, driven by sales representatives earning more commissions. 

The company also ramped up its research and development spend, which increased 28.6% year over year, attributable to the deployment of new cloud products -- expenses management expects will not recur. 

Combined with a near-doubling of general administrative expenses, Splunk's Q1 revenue (and then some) was completely exhausted. 

Looking forward

Overall, Splunk's costs appear to have risen much faster than revenue in recent years. There's a possibility it expected stronger revenue growth to offset some of the expenses, but so far it hasn't come. 

For investors, when paying an $18 billion valuation for a company that is making losses of Splunk's magnitude, you don't want to see falling or stagnant revenue. In fiscal year 2021 this was definitely the case, and in the first quarter of fiscal year 2022 revenue grew a modest 15.6% year over year. More concerning, the company saw a 16% drop in total contract duration to 23.4 months in Q1, which could signal a future reduction in earnings. 

Cloud services is where most of the company's growth comes from, and it clearly recognizes this given the extra investments in research and development spend in that area. Going forward, the company would likely benefit from continuing to focus its attention there. 

Given the overall Q1 result, it's not a total shock that investors responded negatively.