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What to Watch When Splunk, Inc. Reports Q4 Earnings

By Steve Symington – Feb 23, 2016 at 8:00AM

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The operational intelligence specialist is aiming for its fourth-consecutive quarterly beat; here's what to listen for this week.

Splunk (SPLK 1.73%) is set to release fiscal fourth-quarter 2016 results this Thursday, February 25, 2016 after the market close. With shares down more than 40% during the past three months despite its last beat and raise in November, investors in the operational-intelligence specialist could use a positive catalyst to end this questionable pullback.

After all, Splunk's recent plunge largely came with no company-specific news, but rather as the broader market dropped, punishing similar high-multiple, cloud-based enterprise software companies in the process. But that raises the question: What should investors be watching this time when Splunk's quarterly report hits the wires?

The headline numbers
First, Splunk's latest guidance calls for revenue between $200 million and $202 million, the midpoint of which represents roughly 36.4% growth from the same year-ago period. Splunk also told investors to expect adjusted operating margin between 5% and 6%, up sequentially from 3.8% last quarter.

By contrast -- and with the caveat that we don't typically lend much credence to Wall Street's short-term expectations -- analysts' consensus estimates call for higher revenue of $202.9 million, likely a byproduct of Splunk's knack for under promising and over delivering for each of its past three quarters.

On investing for growth, and winning customers
Next, look for Splunk to continue meeting or exceeding its full-fiscal year target for operating cash flow margin of 20%. Last quarter, Splunk generated operating cash flow of $36.4 million, or 20.9% of revenue, and free cash flow of $21.1 million.

Meanwhile, Splunk will almost certainly continue investing for growth in lieu of bottom-line profitability, piling cash into both sales and marketing (which rose 51.8% year over year last quarter), and research and development (up 42.1% YOY in Q3). These investments should yield fruit in the form of new products, collaborative agreements, and ultimately, new and expanded customer relationships. Last quarter, for example, Splunk added more than 500 new enterprise customers, struck a strategic alliance centered around predictive security analytics with Booz Allen Hamilton, and detailed half a dozen significant product updates, including huge performance increases with the latest versions of Splunk Enterprise, and the Splunk App for Amazon Web Services.

And its efforts appear to be enjoying continued success. In mid-December, the company revealed a new report from IDC naming Splunk the worldwide IT Operations Analytics (ITOA) market share leader, with a 28.7% share. At the same time, Splunk senior VP of IT markets, Rick Ritz added, "Splunk helped pioneer the ITOA market and we look forward to accelerating our ITOA leadership with the introduction of our newest solution -- Splunk IT Service Intelligence."

Perspective from "new" leadership
Splunk surprised investors last quarter by revealing that CEO Godfrey Sullivan was retiring from his post, effective immediately, to be replaced by then-senior VP of field operations, Doug Merritt. Merritt previously served in several executive roles, including CEO of Baynote, senior VP of product and solutions marketing at Cisco, and executive VP of global on-demand applications at SAP.

That doesn't mean everything will change for Splunk. Sullivan admitted during the subsequent conference call that he had worked with the board "for some time now" on a succession plan -- something he noted was "every CEO's responsibility" -- noting he had recruited Merritt to Splunk with an "eye to succession" two years earlier. Meanwhile, Sullivan remains on Splunk's board as non-executive board chairman, and promised to work with Merritt to ensure a smooth transition. 

Nonetheless, this will be Merritt's second conference call as Splunk's CEO, and investors will be watching closely to determine whether the company can continue to thrive and advance its customer-centric approach under his leadership.

Looking to the new year
Finally, with almost two months of fiscal 2017 already under Splunk's belt, listen for updates on the company's targets for the full year. Last quarter, management told investors to expect fiscal 2017 revenue of roughly $850 million, or roughly 30.8% year-over-year growth, assuming it meets expectations on revenue in fiscal 2016, with similar adjusted operating margin as compared to last year.

Noting that industry analysts had only recently increased the potential total addressable market for Splunk's products to $45 billion, management also insisted Splunk plans to "remain in investment mode," which almost certainly means continuing to forego bottom-line profits as measured by generally accepted accounting principles. While that might mean more volatility over the near term, however, it makes sense for Splunk to continue to invest in securing as much market share as possible in these early stages of growth.

Steve Symington has no position in any stocks mentioned. The Motley Fool owns shares of and recommends and Splunk. The Motley Fool recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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