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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen, and welcome to the Splunk Incorporated Second Quarter 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded.
I would now like to turn the call over to Ken Tinsley, Corporate Treasurer and Vice President of Investor Relations. You may begin.
Fabulous. Thank you, Mark, and good afternoon, everyone. With me on the call today as usual are Doug Merritt and Dave Conte. We issued a press release after close of market today and it is posted on our website. Additionally, this conference call is being broadcast live via webcast and following the call an audio replay will be available also on our website.
On this call, we will be making forward-looking statements, including financial guidance and expectations, including our forecast for our third quarter and full-year of fiscal 2019, trends and expectations regarding partners, customers, markets, strategies, revenue and bookings mix and predictability and our expectations regarding our investments, acquisitions, products and technologies.
These statements reflect our best judgment based on factors currently known to us and actual events or 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 information.
We will also discuss non-GAAP financial measures, which are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of GAAP and non-GAAP results is provided in the press release and on our website.
With that, let me turn it over to Doug.
Thank you, Ken. Hello, everyone, and welcome to the call. A strong execution in the field drove great results in Q2 delivering $388 million in total revenue, up 39% over last year. Our success comes from new and existing customers, expanding their adoption Splunk as a platform for data analytics and machine learning of course both on-prem and in the cloud.
I'm on the road visiting with customers on a regular basis and the questions they ask revolve around leveraging their data to improve their customer engagement, secure their enterprises, deliver IT and app dev resiliency, and drive business results. All of their questions highlight the fact that if you don't know your data, you don't know your business. The real power of Splunk, what we do that no other technology does, is enable organizations to get answers from their data without having to know all the questions to ask beforehand. The answers come together as real insights to help them know their business
Data problems or requirements are constantly evolving, so our customers need a solution that can adapt with them. The ability to investigate, monitor and analyze all of their data across all of their technology in a continuous way that is constantly improving makes that possible.
Our growth strategy of build by partner aligns this concept and we are investing to enable customers to effectively and quickly make decisions and to take actions real time.
In June, we announced our acquisition of VictorOps, a leader in DevOps incident management. By applying artificial intelligence and machine learning to monitoring event management and incident management data, Splunk and VictorOps will enable development and DevOps teams to more rapidly resolve incidents and learn from past actions to make proactive recommendations.
We are thrilled to work in the VictorOps team and to add another official Splunk site in Boulder, Colorado.
Technology such as VictorOps and Phantom play a big role as part of our broader Splunk story, empowering customers to detect a critical issue, alert the appropriate team and take action automatically. I am pleased with the progress about both companies are integrating into Splunk.
Both the Phantom and VictorOps teams are a great cultural fit. They are talented, passionate about data and focused on customer success. To make it easier to use Splunk and improve the time to value for our customers, we released several updates to our Insights and Essentials offerings. Insights and Essentials; decrease time to value for our customers as they address specific revenue or operating needs of an organization.
And now they cover more than 200 specific used cases and they have resulted in over 25,000 downloads from Splunk base. Our goal remains the same which is to become the ubiquitous machine data platform, the standard in every organization solving our customer’s 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 challenge and deliver for our customers.
It is increasingly apparent that Splunk’s platform is the best solution for end-to-end investigations which enable customers to gain operational intelligence by asking different questions of the same data across multiple used cases. I’m excited about the innovation that Tim and the product teams are working on. Stay tuned for more product and solution announcements at our upcoming user conference.com.
In Q2, we saw a continued momentum with our customers getting value from both our Splunk platform and market group focus. Starting with ITOps and App Delivery. Wins in the quarter include ADP, a longtime customer who expands their use of Splunk and Splunk IT service intelligence or ITSI to enable end-to-end business service visibility on key applications to streamline product delivery, and to strengthen their overall offering.
SMSGlobal, an Australian mobile messaging solution provider is using ITSI to help get full visibility into what their customers need and want, as well as understand system health. SMSGlobal is also using Splunk enterprise security areas to support IT operations, improve security and for PCI compliance.
Moving to security, where we continue to help our customers migrate to an analytics-based approach. Security wins include California Public utilities commission to expanded Splunk use by purchasing user behavior analytics. With UBA, the information technology staff expects to have better insight into known and unknown threats within their network.
Grab, a Singapore based ride-sharing service is a new, Splunk and ES customer. Grab purchased Splunk for security monitoring and plans to expand its used cases in the future.
University of North Carolina, Greensboro has significantly expanded with Splunk, recently adding ES. We hope with increased operational and security intelligence and be a key part of media compliance and audit requirements.
Longtime customer, Worldpay brought ES and Phantom for the first time, while also significantly expand their use of Splunk Enterprise all through the AWS marketplace. Splunk helps Worldpay improve merchant on boarding, rapidly resolve incidents and better understand their customers by analyzing transactional data.
Highlighting a handful of customers who standardized on Splunk as a machine data platform. Laboratory Corporation of America or LabCorp, a leading healthcare diagnostics company expanded their use of ES and ITSI to help ensure that their clinical, laboratory network is always working, and protected.
With Splunk, LabCorp can keep their teams focused on innovation in key areas like patient testing for oncology, HIV genotyping and more, and then the company can consolidate their 130 plus tools they use today.
The U.K. Ministry of Defense signed an enterprise adoption agreement for Splunk Enterprise, ES and ITSI. The Splunk platform provides a Ministry of Defense, one method of access to real-time protected and performance monitoring as part of its enterprise, security and service management program.
We also saw our cloud business continue its momentum. A sampling of our cloud wins in the quarter include Dartmouth College, who is a new Splunk cloud customer. They have replaced their previous data analytics tool because Splunk cloud provides a platform that scales and can analyze data across their entire security and technology footprint.
While Big Green will initially be using Splunk to improve their security analytics and stock efficiency, they also plan to utilize the platform and IT as well as institutional research used cases.
One of Australia’s largest department store brought Splunk Cloud to help protect their customers and their online shopping applications and cyber threats. Use cases include real-time study monitoring, advanced threat detection, forensics and incident management.
We also had some great wins in IoT. Belkin purchased Splunk in the quarter, as well as VicRoads, who is an Australian customer developing and managing the road network across Queensland. Splunk Enterprise and UBA help VicRoads protect their critical internet-connected road and infrastructure assets, including thousands of Bluetooth sensors that provide real time monitoring and information on traffic congestion and throughput. The new expansion will enable VicRoads to help keep those IoT assets secure.
Moving onto ecosystem, longtime customer and partner, Amazon signed an enterprise agreement with Splunk. And our global partner, Accenture expanded their use of Splunk by implementing our Phantom Solution and piloting machine learning capabilities for their own operations as well as for their myWizard, intelligent automation platform.
I'm excited about the momentum around our strategic partnerships and also by the success of our reseller partners. Optiv, one of our top partners focused globally on cybersecurity, continued to experience accelerating growth at better than 5x the market growth rate for this segment. This growth is also a reflection of investments Optiv is making in their Splunk practice and the investments we are making in our partner ecosystem.
SecureWare, one of the key channel partners in Australia, had a strong quarter, closing more than a dozen Splunk opportunities, including a new customer in the South Australian government. One of our top partner wins in the quarter was in South Asia by Bluesify Solutions, who won an opportunity with a large electric utility company in Malaysia.
Bluesify replaced a legacy SIM by showing off the platform nature of Splunk and proving that Splunk goes far beyond security. Future potential used cases that this customer include ITOps and IoT.
In summary, I'm proud of our first half performance and how we continue to deliver value to our customers who as always remain our source of energy and inspiration. We are counting down to our biggest event of the year, conf18, which runs from October 1st through the 4th in Orlando, Florida. We are really excited about the innovation our product teams will be announcing as welcoming our guest keynote speaker, Steve Wozniak. We hope to see all of you there.
Again, thanks to all of our customers and partners and special thanks to all of our Splunkers. Now, let’s turn the call over to our CFO, Dave Conte.
All right. Thanks Doug. Good afternoon, everyone. Thanks for joining the call. I'm pleased to report that our momentum from the start of the year continued into the second quarter with strong performance globally. I’m equally pleased to pass along that our transition to a mostly subscription or renewable model is accelerating faster than planned. Now more about that in a minute.
On results, in Q2, total revenues were $388 million a 39% increase over last year. Software revenues which is the total of licensing cloud were up 43% from Q2 of last year, totaling $240 million.
Cloud revenues was $39 million up 90% over last year. Educational and professional services represented 9% of total revenues and international operations contributed 31% of total Q2 revenues, and we added over 550 new customers and recorded 61 seven figure orders during the quarter.
Now turning to profitability and other results, which were all non-GAAP. Operating income was $11.4 million, representing a positive margin of 3% better than our plan, driven by our solid topline performance.
Q2 overall gross margin was 82% comparable on a year-over-year basis. Net income was $11.7 million or $0.08 per share using a weighted average share count of 151 million shares.
Operating cash flow in Q2 was $34 million, while free cash flow was $28 million, and we ended the period with about $900 million in cash and investments reflecting the cash consideration paid for the VictorOps purchase during the quarter.
As it relates to our go-to-market, since the beginning of the year, we’ve continued our shift to a predominantly subscription or renewable model. Prior to fiscal 2019, we realized between 40% and 50% of our software bookings from renewable or term and cloud contracts.
As you know, we have been targeting the move to 65% renewable this fiscal year and 75% next year, driven by customer buying patterns and adjustments in our GTM and field incentive programs.
Our efforts through the first half of the year have been more successful than we’d expected. Our year-to-date mix is already ahead of our full year target and is in fact nearing next year's target. Specifically, for the first half of this year, our renewable mix for term and cloud transactions was 72% of total software bookings.
Now looking at the composition of our forecast, I expect this first half success will continue through the second half of the year and expect we will achieve our 75% renewable target a year early.
Important to note that our customers are typically invoiced annually under our renewable contract versus upfront for perpetual transactions, consistent with our expectations for FY 2019 cash flows as we have discussed on prior calls.
Now a key benefit of mix overachievement is a more rapid build of a pool of cloud and renewable term contracts, which as you know, provides higher predictability going forward. More importantly, these contract structures enable us to deliver on another one corporate priority around customer success by enabling our customers to ramp their use of Splunk in an efficient and predictable manner.
So, with all the moving parts, what’s the best way to evaluate our execution under 606? As I’ve mentioned before, software revenue, i.e. the combo of license and cloud revenue, and RPO, or Remaining Performance Obligation, are the best indicators of business momentum. Because RPO includes backlog, the total of revenue plus the change in RPO should provide a better estimate of in period bookings than the traditional billings calculation.
Now on the RPO front, we ended Q2 with total RPO of $841 million, up from $525 million for Q2 of last year. For comparability, as we move into the second half of the current year, RPO in Q3 and Q4 of last year, fiscal 2018 was $602 million, and $801 million respectively.
RPO for Q1 of fiscal 2018 last year, totaled $493 million. And as you can see on the balance sheet, FY 2018 ROP with about 20% higher than total deferred revenue, which is a good way to think about it.
To provide additional 606 comparability, earlier this week we filed an 8K, which contains full income statement, balance sheet and cash flow detail by quarter for all of last year, all of which has been recast under 606.
Okay, enough of 606. Turning to guidance, we expect Q3 revenues are between $430 million and $432 million and non-GAAP operating margin of approximately 13%. For the full year, we are now expecting total revenues of approximately $1.685 billion up from $1.645 billion, and we maintain our non-GAAP margin target of 11.5%.
Since we expect to be non-GAAP profitable for the remaining quarters and for the full year, you should use fully weighted average share counts of 153 million in Q3, 155 million in Q4 and 152 million for the full year.
In closing, the first half of the year was transformational, in terms of our move to a highly predictable, renewable model on the back of solid execution from Susan and the field and the company overall.
As Doug mentioned, Tim and the product teams have been working aggressively on product innovations. I’m looking forward to having you all attend our upcoming corporate team where we’ll showcase much of their work.
Thanks much for your time and interest. With that, we will open it up for questions.
[Operator Instructions] And our first question comes from the line of Michael Turits of Raymond James. Your line is now open.
Hey guys, good afternoon, strong quarter. Among other things you did increase the -- slight increase in the number of net adds. What are you doing in terms of go-to-market starting to work now?
Hey Michael thanks for the question. As we've said over and over that whole framework of net news was a three year cycle. And as we talked about over and over and over, coverage is the number one thing that keeps me focused day in and day out. And what we've been doing on coverage, we've got this tough tension of the contribution from existing customers continues to be strong, and we want to maintain coverage within those customers but we also have to free up coverage so that we can go after net news more effectively.
And as I said, I think in the Q4 or Q1 call, Susan has been moving for the past year and a half, and definitively at the start of this year, to carve out a true commercial segment that is predominantly, if not completely, focused on net news.
And so I think a chunk of that is we're seeing some of those field investments start to pay off, but we also have been working the product angle with Splunk Essentials, Splunk Insights, enhancements to Cloud, so that it becomes easier and more intuitive for customers that are not quite the deep dive experts that our current customers are to see value from Splunk.
So I think the whole three year framework was, we know it takes time to shift field and field coverage. That's not something that is immediate, you can spring up business development teams, commercial teams, but they've got to come up to the productivity curve. And it takes time for the product enhancements to actually come to market and be tested and be adopted.
So I think both of those, we saw the first light of that here this quarter and ideally we'll see that continued momentum as we continue to make those investments and learn and fine tune.
Thanks, David. And excuse me, thanks, Doug. And Dave, I got a follow up on – you talked and obviously you did talk about the mix shift happening faster than expected. What should we be cautious at all about the impact on cash flow, and/or that thing we don't talk anymore about numerical [ph] billings?
Well, when we started the year and we thought about our objective around getting to a higher level of mix 65%, we expressly said we think fiscal 2019 to be a cash trough as a result. Again, because the multiyear contracts are typically billed annually versus a perpetual contract, which is billed upfront.
Now, we still feel the same way about fiscal 2019 and what we think the ultimate cash flow yield will be, knowing we still have six months of the year to go. But that's based on yes, we're getting to the mix rate higher but the delivery that Susan and the rest of the business gave us for the first half of the year support our full year cash flow objective.
Okay, thanks very much Dave.
All right, thanks Michael.
Thanks, Michael.
And our next question comes from the line of Raimo Lenschow of Barclays. Your line is now open.
Hey Doug, Dave thanks for taking our questions. It’s actually David [ph] on for Raimo today. Also thanks for the disclosure on RPO, that’s going to really helpful to comp against last year. You mentioned Splunk Insights earlier in the call saying that you had already 25K download even though it’s early days. I’m just wondering what are you guys hearing from customers and maybe more precisely from competitors to the response to this new lower price Insights here?
So thanks, David. This is Doug. And just for clarity, that 25,000 downloads is a combo of Essentials and Insights. And again, just a reminder I know that we kind of complicate things sometimes here at Splunk because of our multiple categories, but the way to think about Essentials is they are recipes or cookbooks for how to use the underlying Splunk Enterprise platform across a broader set of use cases and should, because of that, simplify the interface for some of our end users and customers and more importantly allow them to rip out a new use case more quickly and reduce time-to-value.
Insights are smaller premium apps. They tend to be targeted to departmental leaders, managers and narrow the aperture and what they are focused on. Splunk Insights for infrastructure for example, was really initially targeted at monitoring, detecting problems around server infrastructure, which will be a subset of a premium app like ITSI, the IT services intelligence app that is providing a dash board across the entire network operations IT operation center and helping that, all that broad based organization understand and conceptualize these services hops across usually hundreds or thousands of software and hardware components, that is the end-to-end journey that an end user actually experiences or expects.
And as I said, there is between Essentials which are free and just recipes and our few Insights right now with more to come. We now cover over 200 used cases out of box for our customers. And what we are hearing – and the Essentials have a little bit more volume of download right now given that the security Essentials have been out for about a year, and we’ve got a really robust set of ITOps and app dev Insights that we rolled out the past quarter and half.
It was, [Indiscernible] huge value for me and you’re helping me prove within my account that, while I bought Splunk for X or Y, it really is a platform that can help me with a whole multitude of use cases. So that whole point of customer success is our number one priority. How do we make sure that we help customers on their success journey? I’m getting more data into Splunk to cover more use cases, but do that as rapidly as humanly possible..
That makes sense. Thanks for the clarification. And maybe just quick follow-up, when you're looking at the bookings for the overall quarter, anything that stands out in terms of verticals, geographies that that's worth pointing out here?
As we said over and over, we are such a horizontal technology that we're broadly distributed across verticals. And I don’t think that we saw any meaningful move acquired as part of verticals go. I was really pleased to once again see that the international team perform well and specifically as we were talking about a number of quarters, EMEA continue to lean in and gain strength from that really strong sub-theater leadership team we're talking about. And I think Richard Timperlake, as the head of that segment continues to add strength, consistency and leadership capability. So that I would call as a standout right now.
All right. Thank you, congrats again.
Thanks David.
Thank you. And our next question comes from the line of Phil Winslow of Wells Fargo
Hey thanks guys for tasking my question and congrats on a great start to the year here. [Indiscernible] One of the things that really stood out to me again was the large deal metrics. I think David talked 61 seven-figure deals, obviously continued momentum there. Help us kind of think through just the big deals here. You've talked about the $10 million deals last year. You've talked the growth in the million dollar deals this year and last year. What is driving this momentum in large deals? Have you figure out sort of just the pricing versus volume schema negotiation there for these larger customers. Is it these curated experiences so you can get up and running faster and into more use cases? Kind of help us think through that and how you're thinking about the second half of the year, particularly from the mega deal perspective.
Yes, hey Phil, it’s Dave. I’ll give a brief response now and turn it over to Doug. Our model is not driven by the size of the customer order. So we reported it as a metric because we think it indicative of the success we’re having around adoption, and are ultimately how much value we actually can deliver to the customer. There are lots of initiatives that we've done over time around pricing and EAA's and all those things. I think the desire for us to offer renewable contracts is really beneficial in terms of aiding the customer on their success journey and deployment of the product in a predictable way. So there are many things going into it, but from a product portfolio perspective, I think a lot of the -- a lot of the work that Doug has mentioned and Doug maybe you can comment on that again for Phil.
Yeah. Absolutely. I think we've been wrestling with this predictability element and I think that these term contracts really help organizations with predictability. And as we are able to give them a reasonable and ample swath [ph] of usage -- when you combine what we're doing with Insights, what Tim and the core platform-oriented folks are doing to enhance the investigative capabilities and monitoring and detection capabilities, more predictive ML capabilities and some of the new stuff that will be coming out to really, really make it easier to consume and respond, especially when you add in some of the characteristics of Phantom and VictorOps.
I think all of those combine to illustrate the power to companies that the value and the total cost of ownership that they get from a very, very complete solution that covers investigation, monitoring, analysis, is simple to use, integrated, and broad based, is a really effective investment. And the more that they use that platform, including the more data they put to that platform, the more rapid and expansive the value is back out to that account.
Awesome, thanks guys.
Thanks.
And our next question comes from the line of Fatima Boolani of UBS. Your line is now open.
Good afternoon, thank you for taking the question. Doug, a question for you. Just a comment you made in your prepared remarks around the implementation of Phantom at Accenture, it sounds like a very strategic implementation they have there. So I’m curious, what sort of go-to-market motions you formalized around Phantom and if you can give us a sense of sort of contribution to the business and sort of pricing models that are settling out and a follow up for David if I may.
Yes, when I think about Phantom, and I put VictorOps in the same category as far as how we are trying to enhance the platform capabilities. There are two aspects to broker’s acquisitions. One is, they would for sure give an immediate boost to the security or ITOps and app dev market groups. But the other aspect is when you think about the overall journey, data journey that customers take, the ultimate goal is to take some type of action based on the aha moments and the Insights that they get. And they get those Insights by having gathered much different data which is difficult to do and then making those correlations across the data.
Where Phantom and VictorOps really play -- they play in a number of areas across find, transform, store, interrogate, and take action. But I think they're strongest on the take action front.
And what we're seeing within many of our customers is we've been evangelizing this nerve center concept within security of Phantom, let's say. And have a group of partners that have integrated through now Phantom but that have integrated with Splunk and the capability, so that the brain can signal activity and then understands what that activity and action was and how effective and efficient that activity was.
For a strategic partner like Accenture to add Phantom to the fold, I think it was a statement to the benefit that that capability and team adds to that Splunk backbone and capability and characteristics. And I think you'll see that – you'll see Phantom being added to many of our partnership -- partnerships here already as people understand that acting at the pace of machine action is important to their health and effectiveness.
That's really helpful. And Dave, just a question for you on seasonality in the business and appreciate the ratability of the business in on the up. The full year guidance implies back half seasonality that's actually lower than what we felt last year. So can you help us sort of understand some of the puts and takes with respect of seasonality as you walk into the back half of the year and appreciating the great ratable mix and with doing more term and EAA type business? And that's it from me. Thank you.
Sure, Fatima, you bet. Our business has been pretty consistent in terms of at least to where we think about first half, second half. We know last year under either standard 605 or 606, we had a really strong second half of the year. And as Doug mentioned earlier, we were quite pleased to see the best strength and the performance in Europe, Q2, Q3 and Q4 of last year, and I think again that was feathered in to our the results. But if you look at this year, we're certainly very pleased with our momentum for the first half. And we're on top of our own expectations and it's been really nice execution in the field.
Now we've got some big numbers from last year in the back half. I think we've got a pretty strong forecast for Q3. It's indicative in terms of our guide for both the third quarter and the fourth quarter and we got a lot of work to do. So, we're looking forward to talking you guys in three months and see how we did on the print and what bottom-up outlook is for Q4.
Thank you.
Thanks, Fatima.
And our next question comes from the line of John Difucci of Jefferies. Your line is now open.
Thank you very much for taking my questions. I had a question for Dave and then follow-up for Doug. Dave, so listen, the results look really strong here. License grew 36% the last two quarters and that's under 606, and we're still trying to figure this out, right, and you've been really helpful on the way. The last year license grew 27% for the year under 605. So I'm just trying to make sure I understand what's going on here, because the last two quarters reflection of a positive inflection point and momentum for the company? Or is it simply more on accounting effect of 606 where you're recognizing that the on-prime license upfront versus 605? I mean regardless these numbers look really good, but I'm just trying to make sure I understand what happened?
No. It’s a good question. I think at the end of the day the momentum in the business for the first half of this year certainly feels -- and is stronger than the momentum we had in the first half last year. And of course we were very transparent about not liking Q1 so much in Europe where we had some inconsistent spots, a good bounce back in Q2 last year. We look at the body of work for six months this year like really strong execution by the field and it's reflected in the results and in terms of the large orders that we're closing.
In terms of comparability there is the headwinds and the tailwinds, okay. And the tailwind, oh, look, you're moving up your number of renewable terms contracts and you recognize that revenue upfront. Well, we did the same thing last year. The headwind is the percentage of our business that is now perpetual has gone down materially and on a faster pace. And the absolute size of a perpetual order tends to be a bit larger than that of a term order and that all has to with duration.
So just as a reference for everybody, our benchmark is for a term transaction to equal the same contract value of a perpetual transaction that has to be 36 months in duration. Now our duration is been moving up. We were about 33 months between term and cloud for the first half of the fiscal year, but that still represents a headwind on a comparative basis. So as the percentage of renewables goes up, ultimately it would be great if it was all 36 month, but until it is, it does create a headwind.
Okay, Dave. Thank you for that detail and for the topline conclusion. The momentum sounds like its improving, term are already strength. And I guess, Doug, if I could follow-up on Fatima's question about Phantom, this is an area like orchestration. This is an area that makes a ton of sense, right. And to me in anyway it seems like a nature progression of the SIM or SIM market, I heard it pronounced both ways, but it’s always made sense though, right. It just been really hard to do, because you talk about as the brain senses activity, but it also like ideally will respond across disparate vendors, and I think that's a really tough part, like why do you think it will work now or today? Like why are we ready for today versus -- it made sense like three years ago, but no one’s ever really been that successful with it?
Yes. And again, I think there are two dimensions to Phantom. One, is that orchestration automation continue build -- continue to build-out on the security front, but IT, business analytics, IoT ultimately have almost identical patterns, needs and usages, the content is different, some of the UIs are different, but our capability across those four broad segments is because of the similarities in core underline technology. I think what is helping make some type of orchestration automation more effective you see in the IT side as well is the amount of silicon across the business process continues to increase and the general programming standards today are to make sure if there's clear APIs and service level addressability for each one of those different components.
And phantom I think has been very well architected. There's Oliver and Sourabh and the entire Phantom team, I think did a really, really nice job on the thoughtfulness and the way they approach the problem overall, so that you have layers to the technology and the metadata that instruction set that tell a pallet of firewall what to do or helps to inform pallet of firewall and they've got the APIs and hooks to be able to receive that set of information is -- that type of integration could be done with a lower effort given that you understand the demand. And it has a degree of isolation from the movement of the underlying technology both on the Splunk side and the third-party product side.
So I think as an industry we're just getting better at layering our solutions and everyone is getting much better at and making sure there's clear communications in phases with the components that they put out. And then underlying all that, because everything is now machine addressable, when you got confidence that it’s time to take action, you want it done incredibly quickly, that's really where the orchestration automation response framework comes in to play. And you still need humans involved in many aspects of that response and that's where there's a break and hold-up until you wait for humans to evaluate and decide what the next step should be.
Great. That's helpful and it's logical and it will be breakthrough when this all starts to really come together. So thank you.
Thanks John. I think the world need this type of capability from Splunk and others. And we need to get much better at sense to respond, as all of the processes become more digital, and for me, it really goes to the core thesis of Splunk and we're largely in the data world we're doing with a set of manual processes and historical evaluation of what happened with sparse data where we sit with the lot of processes now is a flood of data coming in and going back out, a lot of that being much more real time based and they need to have more instantaneous processing, understanding and then action and that's a foundation, that's really what's driving the need and pull for a Splunk like set of solutions.
Great. Thanks guys.
Thanks, John.
Thanks, John.
And our next question comes from the line of Brian White of Monness, Crespi. Your line is now open.
Great. Doug, and maybe if you could elaborate a little bit on the Amazon deal that you announced this quarter. And also I noticed last week BAE systems came out and announced plans to integrate Splunk Enterprise into its government cloud solution? So I don't know if this is new way deals are being done. It sounds like your machine data fabric in the cloud, maybe you could touch on that also? Thank you.
Thanks for the question. Yes, we were really honored and thrilled to see that Enterprise agreement with Amazon. We've been working with different pieces of Amazon little bit more on the piecemeal basis, but I think seen good success, at least they told us we're seeing good success in the different pockets of the company, AWS to other parts of the company and over the past few years. And their willingness to lean forward as many of us know they are really competent engineering organization and wherever possible they choose to build versus buy. So I'm really very proud of the fact that they found the value in Splunk that they thought that would be usable tool set across all aspect of Amazon, but I think a lot of that speak to partnership as well, why we've been so effective together in helping organizations that are joint customers or joint prospects to get better visibility on these really complex systems environment to security environment they try to manage.
And those leaders, those early leaders, the Accentures, the Amazons or AWS that understood the Splunk value proposition, I think, are helping others understand the value as well and fore sure given the complexity of most cloud environment, we expect to see more examples like BAE where -- and we've seen those to the years where a large number of SaaS providers are really effective partners and customers of Splunk so that they can meet their SLAs and have the cyber and noncyber visibility across our landscapes. So that was nice to see as a win as well.
Okay. And just Dave, revenues are beating significantly, and you've had a couple of phenomenal quarters this year and operating margins are staying the same. Is that simply you brought on a couple of deals, VictorOps and Phantom and that impact OpEx or why not raise in the operating margins as well?
Well, the insertion of the headcount from the transaction certainly is embedded in the OpEx, that's for sure. But we still have the back half of the year to go and we expect the back half to be seasonally larger, so we'll see how that plays out in terms of the op margin. I think importantly Brian, the opportunity for us in terms of our investment philosophy and Doug talked about it early as it relates to the customer adds, it just critical for us to continue to ensure that we got the right coverage in the field as well as all the innovation that we're working on extremely hard in term of the product portfolio. So when you look at this type of revenue delivery and we think about how large the TAM is for us. I think the long term benefit from the way we're investing is really going to pay off.
Great. Thank you and congrats.
Thanks.
Thank you, Brian.
And our next question comes from the line of Kash Rangan of Bank of America Merrill Lynch. Your line is now open.
Hey, guys. Looks like the needle is finally turning towards the red zone on the red bar chatter.
Yes. That wind in my hair in this one, Kash.
You go. It's only convertible, and it's been accelerating with three straight quarters. So congrats guys. One for Doug, how are you with sales capacity expansion. Are you going to be growing your sales capacity, growth faster and later what seem to be better attainment of quarters, but it still early in the game? And a couple of Conte, is the business model is stabilizing at 75% you're achieving your goals one year earlier.
So, is this mix is stable next year, shouldn't we start to see the real operating leverage in the business start to show up next year in a way that's going to be better than what you had anticipated earlier because you thought the mix would still be evolving, but it looks like the mix is going to settle down this year. So talk to us about the implications for cash flow and margin and earnings relative to your previous expectation given that the model is reaching that end goal? Thank you so much.
Hey, it's Dave. So I'll take that reverse. I'll turn it over to Doug. We were very pleased with the success we're having in terms of our transition to primarily renewable. Getting to 75% a year early is testament to all the work that company is doing. Now what I haven't declared is that our long-term objective. So that was our bogey for fiscal 2020. We're getting there early. We get through Q3. We look at Q4. And we start thinking about in more detail next year. I'll look to update everybody in terms of what they should expect a steady state should look like. Now, I agree with you philosophically that when we get to steady state then we're going to see the normalization of cash flow yield and margin delivery and all those types of elements, but I think we have to achieve that steady state and I'm not declaring that we're at it yet.
And then on overall headcount, at the beginning of the year and our whole budgeting approach, we are always trying to give the most that we can based on absorption rate and productivity levels and our margin guidance to both product and sales. Given the TAM, there is so much products that we can still build and drive to help our customers achieve what they want to achieve and there is so much coverage that we have to drive that those two are always incredibly important for us to fuel.
We're not changing our trajectory on either of those fronts over the course this year versus what we had outlined at the beginning of the year, but we are very pleased at the rate of hiring that the entire company is doing. And just to call out to our HR organization training programs and the absorption rate and our enablement teams and sales continues to be pressured and I think is responding very well. So that we able across all the other works, facilities, HR, enablement to make sure that we have happy Splunkers and productive Splunkers, but there was a high growth of people that has been forecasted in advance this year that goes along with the growth that we're expecting on the revenue and other performance side.
And cash, even I've talked about this over the year, the rate of adding capacity in the field is more art than science, and you have to be very thoughtful to not get sucked into the spreadsheet, the rate that Doug mentioned that you can absorb resources, it is very delicate in terms of balance to ensure that you setting all those folks up for success. So while it would be terrific when I think about how big is our opportunity. You've heard me say this, if I could snap my fingers, I will take the entire size of the company and that just be the field. But if we added them out at a rate that was too accelerated we would not be doing ourselves or those people justice. So the art of it is as Doug said, think about a continuous rate of growth from where we've been.
Thanks, Kash. Hope we go to next question please.
And our next question comes from the line of Matt Hedberg of RBC Capital Markets. Your line is now open.
Thanks. This is actually Matt Swanson for Matt. I eco my congratulations on the strong quarter especially again on the new customer adds. Looking kind of more to the opportunity within the base, though it seems like there's still significant opportunity that being under penetrated. You're doing a lot betters on EAA. Is there anything that could be done to accelerate the expansion on this side? And maybe one it might make sense to add a vertical sales overlay?
It's great, Matt. And I agree complete with your statements. As I said I am about the expansion within customers. We still – those numbers tend to weighted by the smaller numeric account of customers that are going all in with Splunk versus the larger numeric account that still are trying to figure out how broad to go with Splunk. We have a whole host of initiatives every year which we think require a ton of heavy lifting to really effectively execute and increase adoption rates, is number three in the list of nine for this year. There's a bunch of stuff that we're doing on a leverage and on a manual basis, leveraging meaning how do we increase the productivity of the human resources we apply to this, and a lot of that comes back to how do we use Splunk more effectively to understand patterns and usage et cetera within our customer base. But I am happy with the increasing rate of adoption, but I think there's so much more than we need to do to get there. Coverage is one of those elements. More solutions in ecosystem is another, so that you can get more rapid time to value and people understand what the next use case should be.
Product enhancement is certainly another, increasingly capability within cloud so that's easier to immediately turn on Splunk and get immediate value, so there is a host of investment that we're making so that -- and I think they also having a Splunk customer with net news, so they pay in multiple different dimensions and that is – it’s a strong focus for the company to keep those going in a very positive up into right direction.
Thanks. And then maybe just a shorter one, if you could give us any inside on how you're thinking about the government vertical heading into the second half of the year?
That was the second piece of vertical. Yes, we have started to cluster in a strategic arena reps around verticals. So in New York for example, there is that whole team that just dedicated to financial services. That's different than moving the sales organizational structural we vertical first. I think we're still a ways away from that happening, but that inevitability that most companies eventually get to and get a bigger and bigger scale. Public sector is a one standout where due to the unique dynamics of most governments and from the U.S. Government we formed that up a long time ago 2011, 2012.
They've been a really strong performer for us over the many years and we continue to see good penetration in growth rates within public sector much like the commercial segment and keep that into that team. As we all know that the Fed year in September, all the performance that we're expecting that team has been baked in on a year-over-year basis based on what we've seen in prior Fed year ends. And there's really more randomness that's happening now because all the changes are going on the government, but the teams remain excited and optimistic and focus on the execution they need to do through Q3 to make sure that we get the type of performance out of public sector that we know as possible.
Thanks for the time
Thanks Matt.
And our next question comes from the line of Steve Koenig of Wedbush Securities. Your line is now open.
Hi, gentlemen. Thanks for taking my question. I appreciate it. So, Doug, at the Analyst Day, you and Susan talked about driving change internally, being willing to disrupt how you do things. And by the way, I really want to try to outdo Kash here and make a reference to permanent waves. But anyway, that aside, let me ask you about in terms of disrupting how you do things and continuous improvement here, when it comes to -- two different things I want to ask about, maybe stepping back what can Splunk do better? The first one would be in the area of, say, product integration from acquisitions and new product introduction. And the second area, I'm curious, what do you want to improve in the area of marketing?
Hey, Steve, it' Dave. Before I let Doug answer, I'll just tell you, it’s all really key around the natural science what we're trying to do.
Okay.
I will admit that I've seen rush more in concert than any other band, but that's still sub 10 times versus Dave's plus 50. So totally appropriate that Dave gets all the rush accolades. So to your questions Steve, and so many of framework we have in this company are based around growth mindset, the willingness to experiment, the need to constantly rethink what we do given how big the opportunity is, how really evolutionary and emergency this whole data space is. And I'm excited to show how our – how do way that we have architected Splunk really fits the constant change that's necessary and adaptability of the data space as we get .conf [ph] and how we're accelerating and accentuating some of those characteristics.
And the two things you call out, I think are the two of the top elements that we have focused on. As a product team has really cranked up and it's driving a ton of innovation right now, new product introduction becomes more and more important thing for us to be effective with.
I think we've made good strides there. We learned a lot as we start with these new SKUs like ITSI on how to orchestrate and coordinate more effectively internally and externally and that is a strong focus area that principally Tim and Susan are driving, but really people within their teams to make sure that the volume of innovation is coming down. It is understandable to our customers and lands effectively.
And you'll hear us talk about limited availability releases, datas and lot of standard and some non-standard terminology that's really helping us assure that we can maintain the high quality bar and the customer success orientation that we have even it’s a brand new 1.0 product. And in marketing, same thing where we very explicitly and consciously knew that we're diving in to marketing transformation and lot of that transformation was to augment the really effective branding and high-level events that we're famous for T-Shirts, Splunk Lives with much more of an online presence, a much more aggressive demand gen orientation that was filling top of funnel and tracking through top of funnel. And then there's a bunch of enhancements we've been making and have got to continue to get better on this next generation of packaging, pricing, positioning that ties back to NPI but is a different set of competence that marketing needs.
We've been growing the team sizes and both promoting and attracting folks with some really good competencies in both those areas. And I'm really excited about what we're seeing. Then that small tick-up that we saw in net news this quarter hopefully is the beginning of a continuous trend. I think marketing has had a big help there and I think some of the Insights and Essentials, which were part of the product orientation, also are contributing as well.
Great. Thanks a lot Doug.
Thanks, Steve.
And our next question comes from the line of Alex Zukin of Piper Jaffray. Your line is now open.
Hey, guys, thanks for taking my question. So just maybe two quick ones for, Dave. You mentioned average term contract durations being about 33 months through the first half of the year. I'm curious what that was last year, maybe for the first half and how much are you seeing as a tailwind from durations on RPO. And then I've got a follow-up.
Yep. It's about 33 months for all of our renewable contracts first half. It was probably about 25 months at this time last year. And while that might seem like it's a tailwind for RPO, with the move from 50% renewable to 75%, there's still a drag. The loss in perpetual actually isn't being fully replaced even though the duration is elongating. So, if it gets to 36 months, it'll be apples to apples but it's not quite there yet.
Got it. That's helpful. And then maybe Dave, can you just maybe talk about how you're thinking about the guide for operating and free cash flow for balance of this year?
Well, I guess, in what context? We are certainly pleased with our first half performance. I think, as we look to the strength of Q3, that's reflected in the guide. I do think back to the comment that Doug and I made when I think Kash asked the question about the rate of hiring. We're certainly very disciplined about the rate that we look to add resources but also quite deliberate to ensure that we're continuing to invest in both coverage and product, primarily, so all of that is built in to the guide.
I think cash flow yield, which, when we started the year, we identified our expectations with the shift to primarily renewable that fiscal 2019 would be a cash trough. And I think that's still the case. We're still working on how much will cash flow be in the back half of the year but we think we'll hit our full-year target. And obviously there's work to be done when you're over-delivering on renewable contracts that tend to be billed annually. So we're really pleased with the success we're having in terms of getting to what we expect, full-year, 75%, a year early. But we do have to navigate what that means in terms of invoicing and what that cash flow yield will be.
Got it. Perfect. Maybe if I could just sneak one more in for Doug on -- and I apologize if this has been asked already -- on just the pace of EAA activity to your expectations. Clearly, on term, you guys have outperformed your expectations. I'm curious how you would categorize the EAA activity?
I think it's in line with what we were expecting and hoping for. Maybe slightly above, because -- and I think that's primarily because of the term orientation. I think that there are two elements to EAAs. One is the customer has got to be ready for it. There's been lots of questions about why can't you just give everyone these big, expansive pieces. And if you just don't understand yet the value -- they're not free. So there's a payment for the EAA and it's got to be correlated with value. And that usually means that there's enough use cases, enough end users, and enough value that they get why they would really want a more broad-based and end-to-end multidepartment type platform.
And the other piece is the rep's willingness to lean forward and really try and drive an EAA. I think that the term approach has given a lot more comfort for the reps to move with these EAAs, because they know there's a renewal at some point in time and as long as the product engine keeps coming, there's always a reason to go back and talk to the customers about adding to their term contract and/or thinking about an early renewal. So I think the rep issue has kind of naturally started to go in our favor with that. But we always will still be dealing with the customer issue and that's where, again, the product portfolio is so important. How do we continue to make it easier to understand the value of Splunk? How do we get more and more ecosystem participation and use cases and applications? Given that people still wrestle with, I get that big data is important. I read it about it every single day. I know that data is growing. But what do I do with it? How do I get value out of it? It's still one of their biggest issues. And that, I think, also, over time, people are getting better with data so that's helping a little bit as well.
Great. Thanks guys.
Thanks Alex.
And our final question comes from the line of Jesse Hulsing of Goldman Sachs. Your line is now open.
Yes. Thanks guys. Yeah. Dave, I know that you haven't revised that 75% and you're getting there a year early, but I guess, in the conversations that you've had with customers, has there been any friction? And I guess is there any reason why that 75% can't go to 85% or 90% over time? Is there kind of a barrier that you're seeing as you have these types of discussions??
I don't know, Jesse, that there's necessarily a barrier. But when you're coming from a company born on-prem with perpetual licensing and you have very high adoption rates in the install base, it's a bit more work to change the composition as you go forward. So I do think, in fairness to everybody out there -- again, we're really happy and proud of our performance to get there early. But we do need to get through the back half of this year and get into some of the details, in terms of how we're thinking about next year, before I want to set any expectation about what should everybody think it's going to be next fiscal year. In summary, do I believe that that rate could and should go higher? Yes. Am I setting that expectation today? No.
That's totally fair. Thank you.
Thanks, Jess, appreciate that.
And I'm showing no further questions at this time. I would now like to turn the call back to Ken Tinsley for closing remarks.
Perfect. Thank you, Mark. Appreciate your help today and thanks for everybody's participation. Have a good night and we'll see you at conf.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.