Splunk Inc (SPLK) Q1 2023 Earnings Call Transcript

Splunk Inc (NASDAQ:SPLK) Q1 2023 Earnings Call dated May. 24, 2023

Corporate Participants:

Katie White — Director of Investor Relations

Gary Steele — President & Chief Executive Officer

Brian Roberts — Senior Vice President & Chief Financial Officer

Analysts:

Raimo Lenschow — Barclays — Analyst

Brent Thill — Jefferies — Analyst

Brad Sills — Bank of America — Analyst

Matt Hedberg — RBC Capital Markets — Analyst

Andrew Nowinski — Wells Fargo — Analyst

Jake Roberge — William Blair — Analyst

Matthew Calitri — Needham & Company — Analyst

John DiFucci — Guggenheim — Analyst

Michael Turits — KeyBanc — Analyst

Keith Bachman — BMO — Analyst

Janet Zhang — BTIG — Analyst

Presentation:

Operator

Good afternoon, my name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Splunk First Quarter 2024 Financial Results Conference Call. [Operator Instructions] Thank you. Katie White, Director of Investor Relations, you may begin your conference.

Katie White — Director of Investor Relations

Thank you, Abby, good afternoon and thank you for joining today’s call. With me on the call are Gary Steele, President and CEO; and Brian Roberts, CFO. After-market close today, we issued our earnings press release, which is also posted on our Investor Relations website along with supplemental material. This conference call is being webcast live, and following the call, an audio replay will be available on our website.

On today’s call, we will be making forward-looking statements, including financial guidance and expectations, including our long-term growth and profitability, forecasts of our second quarter and full year of fiscal 2024 and our future expectations of revenues, total ARR, cloud mix, non-GAAP OpEx, non-GAAP operating margin, free cash flow, free cash flow margin, cloud growth margin and equity compensation usage. As well as trends in our markets and our business, our strategies, and our expectations regarding our business, AI, acquisitions products, technology, customers and demand.

These statements are subject to risks and uncertainties and are based on our assumptions as to the macroeconomic environment and reflect our best judgment based on factors currently known to us. Actual events or results may differ materially. Please refer to documents we file with the SEC, including our Form 10-K and 10-Qs, as well as 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 the 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.

So, with that, let me turn it over to Gary.

Gary Steele — President & Chief Executive Officer

Good afternoon and thank you for joining us today. To begin our call, I am pleased to share that Splunk delivered a solid start to our fiscal year. I am proud of our team’s hard work and dedication to helping our customers around the world, keep their digital systems safe and resilient. As we’ve discussed on these calls, since I joined Splunk just over a year-ago, we remain squarely focused on driving durable growth with increasing profitability and free-cash flow.

Our Q1 results demonstrate this focus, and action as we exceeded guidance across our top and bottom-line metrics. We grew annual recurring revenue percent Year-over-Year to $3.75 billion, $25 million above the guidance provided during our March call, total revenues were up 11% to $752 million, well-above our guidance. We delivered a 16% ARR growth while remaining tightly focused on our expense control strategy reducing non-GAAP OpEx by 1% Year-over-Year. At the same time, we delivered free-cash flow of $486 million in Q1, up 253% Year-over-Year and exceeding our guidance by $11 million. Given our progress on operational efficiency, we’re increasing our annual free-cash flow outlook.

As we discussed last quarter, we believe ARR and free-cash flow are the best top and bottom-line indicators at the health of our business and we’re pleased with what we’ve accomplished during the quarter. Brian will expand on our progress here during his prepared remarks. Our first-quarter results demonstrate the strength and momentum of our business, although we continue to see the late cloud migrations and expansions and increased deal scrutiny, consistent with last quarter, we exceeded our growth target as we focused on delivering compelling value and strong ROI to our customers. We ended Q1 with 810 customers with one million or more in ARR, up by 120 from this time last year and $0.20 last quarter. This includes 433 customers with cloud ARR over $1 million, up 32% Year-over-Year.

Looking at the year ahead and beyond, I remain confident that Splunk is well-positioned to continue to drive top-line growth while continuing to improve profitability and free-cash flow. Since joining Splunk 13 months ago, I have focused on the transformational initiatives needed for us to deepen our customer relationships and extend our market leadership. Today, the elements of our growth engine are primed and it is even clear to me that no other company can deliver the value we provide at enterprise scale, and what we believe is a $100 billion-dollar and growing addressable market.

I meet personally with four or five customers every week who consistently tell me that’s Splunk is more essential than ever in driving their digital resilience across cyber security and their entire digital footprint. CSOs, CTOs and CIOs are under a lot of pressure to make their organizations digital systems more resilient amidst the formidable cyber security landscape greater technology complexity, demands for better digital experiences and IT budgets that continued to be scrutinized.

Only Splunk has the enterprise scale unified product portfolio, industry maturity vision to meet these needs and our key growth drivers were on full display over the past quarter through many significant customer expansions and competitive wins. Our dedication to helping customers modernize and shift to cloud on their timeline was evident during the quarter with the signing of the largest public sector cloud agreement in Splunk history. This eight-figure deal added Splunk Cloud to an existing Splunk footprint at a major U.S. agency that already included compliance, cyber security and advanced threat hunting.

As its agency moves to a hybrid environment, adding Splunk Cloud will provide it with the visibility needs to monitor the mini applications and services, it has moved to the cloud. Our hybrid approach and the cost of ownership. Benefits of the cloud we’re critical to winning this particular deal. Splunk’s continued investment in meeting government compliance requirements illustrates our commitment to serving our public sector customers. In fact, over the past few months, we achieved two important designations.

The first is as in-process as we work towards FedRAMP High authorization, what are the most rigorous certifications a cloud service provider can achieve and the tier above our current FedRAMP Moderate authorized status. The second designation is as pending for StateRAMP. Achieving StateRAMP authorization assure state and local governments and higher-education institutions that our technology has achieved a heightened security standard.

Turning to Cyber Security our focused on enabling organizations to stay ahead of emerging cyber threats. It was evident in significant security deals during the quarter. In Q1 we expanded our footprint within our global IT services and consulting company with an eight-figure deal for the extended use of our core platform coupled with the addition of Splunk Enterprise Security. This deal underscores both the power of our continued partnership with this organization as well as the power of our relationships with CISA. Following the CISA directive for more stringent security we displaced a legacy SIEM and will address several use cases, including safeguarding personally identifiable information for the hundreds of thousands of employees worldwide. Our best-in class offering is in perfect alignment with the customer’s digital transformation efforts and this deployment will enable us to help drive a unified approach for resilience across the customers, IT and engineering to environments.

On the observability front, we are pleased to see further momentum during the quarter as we continued our strategy to bring the value of our observability offerings to our existing customers. In Q1 we secured an eight-figure deal with a leading financial information services provider. This company has grown from an on-premises account to a multimillion-dollar cloud customer, their need for greater resilience across their digital systems resulted in a multimillion-dollar observability deal during the first-quarter. This organization has made several acquisitions in recent years and plans to consolidate more than 20 costly observability tools that it has a math down to only Splunk. We were the only company that was able to demonstrate technical differentiation based on our commitment to open telemetry and then our observability solutions could manage that complexity across this organizations multiple business units.

We also made progress on international expansion during the quarter, with notable customer wins across security and observability. In Q1, we secured a significant deal in Europe for Splunk Cloud and Splunk IT Service Intelligence or ITSI with a multinational semiconductor manufacturing company. The organization has gained strong momentum recently due to the high global demand and they selected Splunk’s observability solutions over competitive offerings. Our proof-of-concept demonstrated that we were the only vendor with a unified observability products that could enable this customer to modernize its manufacturing and service monitoring to resolve incidents faster predict and prevent outages and improved resilience.

Turning to the Asia-Pacific region. During Q1, we secured a major cloud deal for a Japanese central government agency. Following a competitive selection process only Splunk was capable of meeting this agency’s need for flexible and efficient data management, rapid issue resolution and streamline operations. This Splunk Cloud and Enterprise Security deal is the latest in a series of successful contracts with this customer as well as the realization of the government’s overall Cloud First policy. We believe that our continued focused on our key growth drivers including cloud adoption, customer expansion, international growth, furthering our security leadership and accelerating our observability business, are staging Splunk for a solid year.

Since joining Splunk, one of my top priorities has been to accelerate our product innovation and I’m pleased that today we have a robust product roadmap well-aligned to our customers’ complex needs across multi-cloud and hybrid environments. At RSA, and in many customer conversations, one of the most important topics of discussion is how AI will transform our industry. I’d like to share how we’re thinking about AI and ML more broadly and where we believe there will be significant benefits for our customers and Splunk.

Let me start by saying that Splunk has been empowering security and IT teams with machine-learning for a long-time, including with over 200,000 downloads of our machine-learning toolkit, which we introduced in 2017. Earlier this year, we introduced the Splunk App for anomaly detection, which uses ML to detect seasonal patterns and finds anomalies in time series data in just a couple of clicks. In terms of AI, enterprises are just beginning to understand its promise and risks, but we view AI is a definite opportunity, one we’ve been working on since well before the most recent buzz. When immediate application is to help make our product easier to use without requiring deep knowledge of SPL or search processing language, allowing more of our customers to drive better outcomes faster.

SPL is what enables organizations to conduct complex analytics in a highly flexible language. This application of AI is table stakes and a clear path to value, in fact, we released a preview of and FPL assistant based on large language models back-in 2022 which helps users ask plain English questions to create data in Splunk, lowering the barrier-to-entry for more practitioners to drive outcomes with Splunk. We know that AI requires a contextually relevant rich dataset to be beneficial and Splunk, flexible and highly scalable data architecture, positions us to continue delivering the solutions that today’s enterprises need. We are enthusiastic that AI can help our customers get more value out of Splunk, improving security and observability outcomes around the areas of detection investigation and response.

We fundamentally believe that AI will transform the way the world’s largest and most complex organizations, keep their digital systems, secure and reliable, not only by augmenting mission-critical security and observability solutions, but also by helping to shore up the global talent started nearly 3.5 million workers in cyber security. We view AI as an accelerator to human decision-making not a replacement. But they can make understaffed teams more efficient.

Looking ahead, we believe AI will bring enormous value by automatically detecting anomalies, recommending actions and focusing users’ attention where it is most needed based on intelligent assessment of risk. AI can be a growth driver for Splunk as an enhances user experience and outcomes in both our core and premium products. As an example, we see significant opportunity to drive further automation [Indecipherable] through AI enhanced store and other premiums Splunk security products. At.conf23, we plan to share, how we’re advancing our AI strategy to help customers gain more value make Splunk, easier to use and accelerate security and observability outcomes.

Let me turn now to further innovation on the product front. During the quarter, we announced general availability of several products that will further augment the value customers get from Splunk. For example, our Enhanced Mission Control brings together security analytics, automation and orchestration and threat intelligence capabilities under one common work surface empowering security teams to stay ahead of cyber threats. Our 2023 state of security report found that nearly two-thirds of [Indecipherable] teams about switching between too many disparate security tools and management consoles with little if any integration, inhibiting comprehensive and timely investigations in response. Mission Control solves exactly that problem.

Splunk observability Cloud also got important upgrades during the quarter. We introduced Splunk Incident Intelligence to help incident response teams increase efficiency, so they can diagnose, remediate and restore services before their customers are impacted. Next new trace analyzer for APM helps easily identify problems from billions of traces and endless combinations of metadata and IM Network explorer enables teams to easily monitor and assess their cloud network health and resolve issues faster. Our continued investment in enterprise-grade observability solutions for monitoring across complex hybrid environments, further accelerates the value we deliver to customers, with comprehensive visibility and a more unified approach to incident response only Splunk is delivering the full stack observability solutions needed to help organizations improved digital resilience.

In Q1, we introduced Splunk Edge Processor to increase our customers visibility into and control over the volume of content of data before it leaves their network by supporting processing at the edge, customers can control the cost of data transfer and storage better ensure that sensitive the data does not leave their defined boundaries be confident that they are collecting all the data that they need and ensure that the data ends up at the right destination, in the right format, all with the flexibility to scale cost-effectively. We’re also driving ongoing innovation with our partners to make it easier for organizations to gain value from Splunk. Last week we announced Splunk’s SAP premiums certified endorsed app SAP’s industry cloud, which is expected to be available for purchase in the SAP store next month.

SAP environments contain business-critical information and one of the challenges have been to have the visibility needed to protect against risk and cyber threats. Through our strategic partnership with SAP [Indecipherable] bring security relevant SAP data into the fold of Splunk Security analytics and operations workflows enabling security teams to monitor detect and rapidly respond to threats impacting their SAP environments.

Looking ahead, we’re continuing to invest in ways to make it easier to get data into Splunk gain value and drive resilience. For example, we’re making good progress on integrating capabilities from our acquisition of TwinWave last year to strengthen our customers ability to quickly analyze and remediate attacks. At.conf23 in July, we’ll share more about our continued cross portfolio innovation and how we’re thinking about AI-powered premium Splunk Solutions.

Let me change gears from our technology to our talent, building the leadership team Splunk needs to steer us through the next chapter of opportunity and growth has been among my top priorities and we continue to invest in our people during the quarter. In Q1 we welcomed Min Wang as Splunk, Chief Technology Officer. Min brings over 20 years of experience in applied research and product development, with a focus on AI-ML, data analytics and the enterprise cloud. Most recently, she spent more than five years at Google, including three years leading the team responsible for critical components of the Company’s AI driven Google Assistant. I’m looking-forward to having further accelerate Splunk’s technical leadership and catalyze the development of more World-class technology.

In April, I appointed at Splunk, Toni Pavlovich as our new Chief Customer Officer. Tony’s three decades of industry experience and unrelenting focus on delivering for our customers, our already helping, ensure that organizations around the world continue to gain amazing value from our products while enjoying a best-in class customer experience every step of the way.

I’m pleased with the progress we’ve made, building out a World-class leadership team that is aligned behind our common purpose and efforts to deliver exceptional results for customers and shareholders alike. Outside of our management team, Splunk welcomes Yamini Rangan, President, CEO and Director of HubSpot to our Board of Directors. I’m looking-forward to partnering with Yamini and our directors to further accelerate Splunk’s market leadership and I’m enthusiastic that the changes we’ve made to our board composition, have positioned us for driving the business forward as we grow in scale over the coming years.

As I wrap-up, I want to reiterate my appreciation for Splunkers around the world for all the hard work and execution to deliver a strong Q1. Our team demonstrated once again that only Splunk has the deep industry partnerships operational rigor and unified security and observability solutions needed by the Global 2000 to help keep their digital systems resilient. Although, macroeconomic conditions continue to impact our customers’ buying behavior, we still delivered solid ARR growth along with a significant increase in free-cash flow.

I remain confident that the go-to-market organization and workforce changes we’ve implemented over the past year and our steadfast focus on efficiency, set the stage for Splunk to continue delivering the long-term durable growth and profitability, I am focused on since joining the company.

And with that, I’ll turn it over to Brian to share more about our Q1 results and outlook. Thank you.

Brian Roberts — Senior Vice President & Chief Financial Officer

Thanks, Gary. So, let’s get to Q1. As Gary mentioned, the macro environment remained challenging. We continue to see more scrutiny on expansions than deals. Additionally, cloud migrations remain sluggish. That said, we were able to successfully navigate this economic backdrop and close a solid quarter as we exceeded or met our outlook across all guided metrics. We grew total ARR by 16% year-over-year to $3.725 billion, which exceeded our most recent guidance by $25 million. Cloud ARR grew 29% year-over-year to $1.815 billion. Cloud DBNRR was 120%, which was in line with our expectations given delayed cloud expansions.

Q1 total revenue was $752 million, ahead of our guidance range of between $710 million and $725 million. Cloud revenue increased by 30% year-over-year to $419 million. In terms of sequential growth, we want to remind investors that our fiscal Q1 has three fewer calendar days than Q4, and three days equates to over $10 million of cloud revenue.

With regards to cloud gross margin, we continue to make progress on our expense initiatives. Cloud gross margin reached 73.6%, which is up nearly 600 basis points year-over-year and better than our outlook. In Q2, we expect cloud gross margin will decline towards 73% while we focus on improving service levels and customer experience. This would still represent a nearly 400 basis point improvement year-over-year. We continue to expect that we can achieve cloud gross margin of approximately 74% in Q4. Given our priority of increasing profitability, we remain laser-focused on managing expenses. We continue to identify initiatives and investments that could help us generate additional OpEx leverage.

In Q1, we were able to tightly manage headcount and contingent labor expenses. Ultimately, we were able to reduce non-GAAP OpEx by 1% year-over-year, even while driving 16% ARR growth. Our success leveraging OpEx, combined with our revenue beat, helped us exceed our guidance on non-GAAP operating margin. In Q1, we achieved a positive 3% non-GAAP operating margin, ahead of our guidance of negative 3% to negative 5%. Let’s move to free cash flow. In Q1, we generated $486 million of free cash flow, which is $11 million ahead of our guidance as we more than triple quarterly free cash flow year-over-year.

Q1 is annually our largest free cash flow quarter driven by the seasonally high bookings in Q4, which are mostly collected in Q1. For that reason, we recommend that investors evaluate free cash flow on a trailing 12-month basis which totaled $776 million at the end of Q1, more than quadruple the $179 million generated over the 12 months ending April 30, 2022.

Before I move to guidance, I want to reemphasize that Splunk software license revenue related to term contract volume is recognized upfront. Thus, GAAP revenue is highly subject to both bookings mix and contract duration. We believe ARR is an indicator of future free cash flow because we bill both cloud and term software license customers on an annual basis.

I want to be super-clear; we’re focused on ARR and free cash flow growth to create shareholder value. You will note that in the supplemental slides, we calculate the Rule of 40 metric based on ARR growth instead of revenue growth and free cash flow margin as a percentage of ARR. Now what may be less visible to investors are the long-term investments we’re making that we expect to translate into future growth. These investments span both the R&D and go-to-market organizations.

On the tech side, under new leadership, we’re focused on accelerating product road maps and amplifying value to customers. Additionally, we’re making investments in our field to deepen our international footprint, improve coverage ratios and position Splunk to win new global greenfield accounts. With these actions, we believe we are well positioned to accelerate ARR growth in fiscal ’25, assuming we see an economic recovery and a return to a more rapid pace of cloud migrations. And with that, let’s turn to guidance.

We continue to experience increased scrutiny on expansions and deals as well as delayed cloud migrations. Given we are still early in the fiscal year and based on the current market environment, we are maintaining our guidance range that we set last quarter for fiscal ’24 ARR of between $4.125 billion and $4.175 billion. Until we see a positive change in the macro environment, we believe it’s prudent to keep our ARR guidance unchanged despite our solid Q1.

In terms of revenue, in Q1, term duration trended slightly ahead of our expectations. We are updating our annual revenue guidance to the top end of our prior range of approximately $3.9 billion. As a reminder though, duration and mix of term contract volume could significantly impact reported revenue and associated growth rates. Given the current macro trends, we continue to expect that cloud mix of software bookings will range between 55% and 65% in fiscal ’24, but actual mix could vary from quarter-to-quarter just as we’ve seen historically.

In Q1, cloud represented 58% of software bookings, in line with these expectations. We continue to expect that cloud will begin to represent a majority of total ARR in the second half of this year. So, let’s move to expenses and the impact on free cash flow. It’s important to understand that in addition to looking for opportunities to leverage expenses, we will also make fiscal ’24 investments that we expect can accelerate growth during the economic recovery and beyond. Our objective is to drive long-term ARR and free cash flow growth.

We made solid progress in Q1 on our expense structure, and looking forward, we remain extremely focused on increasing our operating efficiency. As a result, we are updating our annual expense outlook as we now expect to manage annual non-GAAP OpEx growth below this prior 7% outlook. We expect that we can hold non-GAAP OpEx growth to roughly between 5% and 6%, a reduction of 100 to 200 basis points from our prior outlook. It’s worth noting that in the second half of the fiscal year, we will face more challenging OpEx growth comparisons as we begin to comp the cost actions we took last year. In terms of the impact on margins, we now expect fiscal ’24 non-GAAP operating margin to increase to between 18% and 18.5%, up 100 to 150 basis points from our prior guidance range.

Based on our successful expense management, we’re also increasing our annual free cash flow forecast by $30 million. We now expect to generate free cash flow between $805 million and $825 million in fiscal ’24, which represents an increase of between 89% and 93% year-over-year. As a percentage of ARR, this would represent a margin of between 19.5% and 19.8%, up from 11.6% in fiscal ’23.

Let’s move to equity. As I mentioned last quarter, we have taken and will continue to take deliberate steps to reduce our use of equity compensation, and over the next several years, get to a lower and sustainable dilution rate. Even though stock-based compensation expense is a lagging indicator, we are pleased with the double-digit percentage decline in Q1 year-over-year.

Looking forward, we will outline our capital allocation strategy at our Investor and Analyst Day later this fiscal year. It’s worth mentioning that we see potential scenarios to reduce the total share count in fiscal ’25 by being disciplined with our use of equity along with future capital allocation decisions.

Let’s move to near-term guidance. In Q2, we expect to grow ARR by approximately $100 million to $3.825 billion, which represents 15% growth year-over-year. From a GAAP perspective, we expect total revenue of between $880 million and $895 million. In terms of costs, we plan to manage non-GAAP OpEx growth to between 2% and 2.5% year-over-year. From a margins perspective, this translates into an expectation of a non-GAAP operating margin of between 10% and 12%.

In terms of free cash flow, Q2 follows our seasonally slowest bookings quarter, and as such, similar to prior years, we expect quarterly free cash flow to dip negative in Q2, which we estimate at negative $15 million. This implies free cash flow of approximately $785 million for the 12 months ending July 31, 2023, which is nearly quadruple the $260 million of free cash flow for the 12 months ending July 31, 2022. We then expect modest positive free cash flow in Q3 with further growth in Q4. Again, for the full year, we expect free cash flow between $805 million and $825 million, which is an increase of $30 million compared to our prior guidance range.

In closing, despite macroeconomic headwinds, execution in Q1 was solid, and we delivered strong operating expense leverage. We’re focused on driving durable long-term growth and increasing our free cash flow and free cash flow margin.

And with that, let’s open it up for questions.

Questions and Answers:

Brian Roberts — Senior Vice President & Chief Financial Officer

[Operator Instructions] Your first question comes from the line of Raimo Lenschow from Barclays. Your line is open.

Raimo Lenschow — Barclays — Analyst

Thank you and congrats for a very good start to the year. Gary, during the conference call, you mentioned quite a bit competitive wins where you kind of demonstrated that you can do cloud and on-premise as well and can do both. With the current situation that customers kind of kind of view the current environment to stay maybe a little bit longer in there, how much is that playing to your advantage? And how do you think about that as we’re coming out there? Do you think there’s a fundamental change in thinking and — wherein, like, how much is in cloud and how much is not cloud, and how much it is helping you? Or do you think it’s temporary, and how much is it helping you? Thank you, and congrats again.

Gary Steele — President & Chief Executive Officer

Yeah, thanks so much. I believe that our hybrid approach in supporting customers as they want to evolve the cloud on their time frame has been very important and strategic to us. What we — what I see when I speak to customers is I see more hesitation today and more thoughtfulness about what’s going into the cloud and what’s staying in their own data centers.

And so, I think from a strategic point of view, I think it’s been advantageous that we have the ability to deliver great value across hybrid environments, and I don’t see that changing anytime soon. I think that will continue to be a strategic advantage for the company.

Raimo Lenschow — Barclays — Analyst

Okay, congrats [Phonetic]. Thank you, well done.

Operator

Your next question comes from the line of Brent Thill from Jefferies. Your line is open.

Brent Thill — Jefferies — Analyst

Thanks Gary, for you to raise guidance for the year, can you just give us a sense of where the strength you’re seeing, the confidence to do that, what areas of the portfolio seem to be shining? And for Brian, really good expense discipline, good to see. Can you just give us a sense of kind of what you’re modeling and expecting in terms of the overall environment to continue the impressive margin improvement that you’re seeing going forward?

Gary Steele — President & Chief Executive Officer

Yeah, so a couple of things. So one is, we saw strength in cyber. And as we indicated in our prepared remarks, we see customers taking out legacy SIMs [Phonetic] as an example. That has been fueling growth. We see this opportunity, as we were talking previously, where customers know the cloud will play a role and they want to make that step, but they’re still leaving things on-prem to deliver a hybrid architecture. That’s been strategic and advantageous.

And then I think thematically, we’re seeing consolidation opportunities. And I would just reference back to the example we gave in the prepared remarks where customer chose our observability solution to consolidate down over 20 observability products to Splunk. That was — that’s been a play that we think is very repeatable and has been working well for us.

Brian Roberts — Senior Vice President & Chief Financial Officer

And I would just add that in terms of the bottom line, look, we are committed to increasing profitability and free cash flow. And so, we see multiple scenarios to achieve our new, increased free cash flow outlook across a range of different operating environments. And frankly, it’s just really a continuation of the work that we’ve already begun, and we will always be seeking opportunities to improve how we operate as we grow.

And as part of this, we’ll continue to seek more impactful and efficient ways of just operating, really, which includes changing sort of how we approach expenses, which is having a zero-based budgeting mindset, really driving better processes, looking for opportunities to flatten the organization which will save money but also just increase velocity, and then finally, growing our emerging talent centers.

Brent Thill — Jefferies — Analyst

Thank you.

Operator

Your next question comes from the line of Brad Sills from Bank of America. Your line is open.

Brad Sills — Bank of America — Analyst

Oh, wonderful. Thank you so much for taking my questions. I wanted to ask the question on operating efficiency here in another way. Obviously, you’re seeing real progress here with some efficiency gains, OpEx down 1%, ARR growth of 16%, better than your 15% guide. My question is, we know you’re still investing in the business. You’ve talked about some of those investments, but yet you’re generating this kind of leverage. So how are you able to kind of balance the investments that are going into the business while still delivering on this type of top line?

Brian Roberts — Senior Vice President & Chief Financial Officer

Sure. Look, we’re very pleased with the progress we made leveraging expenses in Q1, and we just — based on our progress, and we have a nice slide in the investor supplement where you can look at the focus areas of what we did in Q1. But we expect the success in Q1 will flow through now to the entire year.

So, to your point, we continue to make investments to leverage our cost, but it’s just offsetting a larger portion of the investments now. And so, when you look at the full year from a non-GAAP OpEx growth perspective, we think it could be now in the range of 5% to 6%, which is down from 7%, which is driving the increase in margins now up to, on a non-GAAP operating margin basis, 18% to 18.5%. So that’s up 100 to 150 basis points year-over-year.

Brad Sills — Bank of America — Analyst

Wonderful, thanks so much.

Brian Roberts — Senior Vice President & Chief Financial Officer

Sure.

Operator

Your next question is from the line of Matt Hedberg from RBC Capital Markets. Your line is open.

Matt Hedberg — RBC Capital Markets — Analyst

Great guys. Thanks for taking my questions. And I’ll offer my congrats on the consistency. Really good to see. Brian, you talked about accelerating growth in maybe fiscal ’25. Obviously, there’s probably a macro element to that, but sort of curious. Like, when you think about that acceleration in growth, do you think that can happen and sort of an unchanged macro? In other words, like company-specific drivers give you confidence in that sort of a trajectory?

Brian Roberts — Senior Vice President & Chief Financial Officer

Yeah, I mean, I think it’s important to look at the investments we’re making. If you look at last year on a GAAP basis, we invested $1 billion in R&D. And so, some of that is coming to fruition, so we really — we’re excited about the product portfolio and really trying to amplify the value for our customers.

Yes, an economic recovery will help. Obviously, it helps all. All boats will rise in that tide. But we feel really good about the product portfolio. And then as we discussed in the prepared remarks, we’re making a number of investments in our go-to-market that I think are really important to call out.

So, we are deepening our international footprint, we’re improving coverage ratios, and we’re trying to position Splunk now in new global greenfield accounts. And so all of these things will contribute a little bit this year, but it’s more about the multiyear growth opportunity.

Matt Hedberg — RBC Capital Markets — Analyst

Really good to hear. Thanks guys. Best of luck.

Brian Roberts — Senior Vice President & Chief Financial Officer

Sure.

Operator

Your next question comes from the line of Andrew Nowinski from Wells Fargo. Your line is open.

Andrew Nowinski — Wells Fargo — Analyst

Great, thank you. And congrats on a great quarter. I wanted to ask a follow-up question on the public sector cloud deal that you mentioned. So, I was wondering, how competitive was that deal? Is there an expansion opportunity with that specific agency? And then do you think there’s a way to leverage that very strategic win with other — some leverage with other agencies down the road?

Gary Steele — President & Chief Executive Officer

Absolutely. I think — so this was, they looked at all the alternatives out in the market when they made the decision, so it was a competitive deal. I think that this is really the starting point, though. We’ve really planted a flag and there’s plenty of opportunities for expansion. And we fundamentally believe that broadly, public sector represents a very interesting opportunity for us. And it’s why we’ve made the commitment to go to FedRAMP High, which opens the doors to different parts of the public sector, and I think it gives us access to more customer opportunities.

So, we feel very good about that particular win as being a key marquee account that we can then more broadly leverage. And the investments that we continue to make, we think are also critical to laying the foundation to drive long-term growth in public sector.

Andrew Nowinski — Wells Fargo — Analyst

That’s great. Thanks Gary and keep up the good work.

Gary Steele — President & Chief Executive Officer

You got it. Thank you.

Operator

Your next question comes from the line of Jake Roberge from William Blair. Your line is open.

Jake Roberge — William Blair — Analyst

Hey thanks for taking the questions and I’ll echo the congrats on the great results. Just on the generative AI front, I’m curious how you’re thinking internally about the magnitude of data and workloads that generative AI could create for Splunk to really secure and monitor over the next few years?

And then just as a follow-up there, how do you see AI playing into your migration journey with just maybe more customer willingness to move to the cloud to really get that type of technology?

Gary Steele — President & Chief Executive Officer

Yeah, great questions. One of the things that we’re very excited about is the advances in AI that are open to us given the rich data sets that we hold with customers. And one of the things that I’m particularly excited about is over the past couple of years, we’ve just seen some very good wins where customers have been able to leverage AI to get interesting outcomes, like in the area of fraud.

And so broadly speaking, we think that we’re at the very beginning of this journey which will open the door to many more use cases given the kind of data, the richness of data that Splunk holds and the opportunity there. So, we feel like we’re just at the very beginning of this, and this wave of generative AI just opens a lot of doors and accelerates a lot of activity for us.

Jake Roberge — William Blair — Analyst

Thanks. Congrats again on the great results.

Gary Steele — President & Chief Executive Officer

Thank you so much.

Operator

Your next question comes from the line of Mike Cikos from Needham & Company. Your line is open.

Matthew Calitri — Needham & Company — Analyst

This is Matt Calistri on for Mike Cikos from Needham & Company. Thanks for taking the question. I was wondering how the first quarter tracked versus your internal expectations? And if the top line outperformance was tied to a specific customer segment, geography or vertical?

Brian Roberts — Senior Vice President & Chief Financial Officer

Yeah, I would say in terms of Q1, I think across the verticals, we were quite pleased. I would say the — probably the strongest vertical would be U.S. public sector. We had really strong bookings strength there. I think in terms of — and actually, on Q1 as well, I just add, renewals performed very well, which we’re very pleased about. We are definitely ahead of our renewal plan.

Matthew Calitri — Needham & Company — Analyst

Awesome. I appreciate the color.

Operator

Your next question comes from the line of John DiFucci from Guggenheim. Your line is open.

John DiFucci — Guggenheim — Analyst

Yeah, thank you for taking my question. Actually, just a follow-up to the questions just asked. And Brian, we know — we realize that ARR is the most important top line metric, but we have to manage the revenue too, right? And being able to go from one to the other or at least model it is important. So, license was strong and you said renewals were strong, but we thought it could even be stronger.

So, I guess I’m just trying to understand for the on-prem subscription that, that renewal base, what that looks like for the rest of the year? And also, how would you expect contract duration, which you talked about in your prepared remarks, how that might trend?

Brian Roberts — Senior Vice President & Chief Financial Officer

Sure. So, what we’ve said in terms of the renewal opportunity this year, it’s going to grow roughly 20% to approximately $2 billion. In terms of just the duration — let me talk about duration, I’ll come back just again in terms of revenue. On duration, as you know, it’s impossible to perfectly forecast. We are expecting duration to be within a similar range to what we’ve seen in the last couple of quarters. But based on what we’ve seen, we’ve again raised guidance on revenue to the top end of our prior range, so now, $3.9 billion. As it relates to Q1, again, we came in well above the — our revenue outlook. So, we were quite pleased with that.

Trying — we have a lot of customers that as they approach renewals, they’re still trying to decide if they’re going to migrate to the cloud or not, and so that’s something that we’re going to continue to watch.

But again, we do expect that with an economic recovery, we’re going to see an acceleration of cloud migrations. And I think that’s something right now, I think the investors should realize as any company approaches this opportunity, it’s just a matter of when, not if, for a lot of these workloads. And it’s — in this environment, a lot of CFOs just do not want to take on additional costs this year, and there’s typically a cost to move to migrate to the cloud. And that’s why we expect with the economic recovery, we’re going to see an acceleration, or reacceleration.

John DiFucci — Guggenheim — Analyst

All right. That $2 billion, is that total renewals? Because I’m just curious about the on-prem subscription because that’s where — that’s the thing that can screw us up with the revenue recognition, right? The upfront portion there?

Brian Roberts — Senior Vice President & Chief Financial Officer

Yeah, the $2 billion is overall. And the other thing in terms of [Indecipherable], given 606, there is an increasing portion of cloud in that renewal mix. And so relative to — that’s what’s causing some of the drag on quoted accounting revenue versus true ARR.

John DiFucci — Guggenheim — Analyst

Got it. Thank you very much Brian.

Brian Roberts — Senior Vice President & Chief Financial Officer

Sure.

Operator

Your next question comes from the line of Michael Turits from KeyBanc. Your line is open.

Michael Turits — KeyBanc — Analyst

Hey guys, great job on efficiency. In the margins, the guide is like 18% on revenue for this year. I like the thought process of free cash flow relative to ARR as a percentage, which is getting towards 20%. So, I was wondering if you could just comment on how, you are, at least philosophically at this point, think about those margins longer term and about the relationship between the two of them?

Brian Roberts — Senior Vice President & Chief Financial Officer

Yeah, so I think it’s important to stay tuned for Investor Day, because we will provide the long-term expectations around growth as well as our entire margin, structure and free cash flow margins. But I think it is fair to assume we don’t see anything structurally in our business that prevents us from increasing our free cash flow. So again, we expect free cash flow margin to increase next year as well.

Michael Turits — KeyBanc — Analyst

If I could just sneak in one technical question on the [Technical Issues] what was the impact on revs, billings, bookings, etc., this ARR this quarter from that?

Brian Roberts — Senior Vice President & Chief Financial Officer

I’m sorry. Is the question around FedRAMP High?

Michael Turits — KeyBanc — Analyst

No, I think it was a large fed deal that you talked about.

Brian Roberts — Senior Vice President & Chief Financial Officer

We’re not getting into specifics on individual transactions.

Michael Turits — KeyBanc — Analyst

Okay, thanks very much.

Brian Roberts — Senior Vice President & Chief Financial Officer

Sure.

Operator

Your next question comes from the line of Keith Bachman from BMO. Your line is open.

Keith Bachman — BMO — Analyst

Hi, many thanks. I wanted to ask about the competitive landscape, and particularly with an orientation around your traditional business, not the observability business. And the context of the question is you did call out some new logo wins, and I think investors are candidly sort of surprised to hear about new logos with Splunk.

And I was wondering if you could just articulate, as you look out over the growth algorithm you had, I mean how much is actually driven buy new logos and which would presumably be largely competitive wins, since everything is competitive? But if you could just talk a little bit about the competitive landscape and how important are new logos?

And then secondarily, you also have — you’ve highlighted the SAP partnership, which is a bit different in terms of taking a deep dive with one particular software provider. What drew that conclusion? Is there other relationships that you think will come from — in competition in SAP? In other words, will you do more specific partnerships with other large software vendors? If you could just talk a little bit about the strategy there and what the implications are. That’s it for me. Many thanks.

Gary Steele — President & Chief Executive Officer

Great. I’ll let Brian start by talking just briefly about how much new logos represented in our ARR.

Brian Roberts — Senior Vice President & Chief Financial Officer

Yeah, so typically, when you look at net new ARR, it’s roughly 20%. We see that consistently. We tend to measure that on a trailing 12-month basis because you can see some volatility. But again, that’s something that is held now for multiple years.

Gary Steele — President & Chief Executive Officer

And then competitively, in accounts where we’re going in and looking broadly at competition, we’ve had very good success taking out incumbent legacy SIM solution, so that’s been a sales motion that’s been quite productive for us. In those circumstances, the customer will look at a variety of solutions. And I think we continue to demonstrate that we can meet the complex scale requirements that organizations have, that we offer more flexibility than our competitors out in the market. And just the broad set of security capabilities including orchestration and automation, threat intel, broad security analytics, all of these things integrated single product is a pretty unique offering that doesn’t exist in the market.

So, we — our win rate is quite high, and we do quite well in those new logo environments. And then going to your SAP portion, shifting gears. Going to the SAP portion, one of the things that’s super cool here is if you talk to CSOs today, they struggle with visibility into what’s happening with SAP. And so, what we’ve done basically with this app is it increases the level of visibility that security teams have relative to what’s happening within SAP, and they can bring that into the broader Splunk environment and drive broader correlations across their entire security footprint. And so, it provides visibility that frankly, they just haven’t had in the past. This is — we’re super excited about this. We’re happy to be engaged directly with SAP. They’re an important partner to us.

And could we do this with other vendors? That’s possible. But I think if you just look at the history of Splunk, which you obviously know well, we’ve always been a company that wanted these TAs or apps that allowed for integration of data into the broader Splunk environment.

I think in this particular case, it made a ton of sense to do a very strategic relationship and drive a combined go-to market. So, we feel really good about this and excited about the potential here.

Keith Bachman — BMO — Analyst

All right, many thanks.

Gary Steele — President & Chief Executive Officer

You got it.

Operator

Your last question comes from the line of Gray Powell from BTIG. Your line is open.

Janet Zhang — BTIG — Analyst

This is Janet Zhang on for Gray Powell. Thank you for taking the questions. My question is on the observability product set. I was wondering what are some of the things you do to improve the go-to-market motion on — with the observability product set over the next year? And how quickly could that have an impact on your ARR growth?

Gary Steele — President & Chief Executive Officer

It’s a great question. I think the — our go-to-market motion has been one where we’re taking the observability cloud and really working with our existing customers to drive those opportunities. And I think it — I think frankly, we’ve shown up in the last couple of earnings calls with some really interesting strategic wins which we saw again this quarter, and so that go-to-market motion is working well. And while we’re relatively early there, we’re seeing very big, very strategic wins coming from the go-to-market motion. So, we feel good about it.

Janet Zhang — BTIG — Analyst

Great.

Operator

[Speech Overlap] question and answer session. Mr. Gary Steele, I turn the call back over to you.

Gary Steele — President & Chief Executive Officer

Great. I want to thank you for joining us on the call today. We had a solid start to a year and feel great about the opportunity going forward. We look forward to seeing many of you at.dotcom23 in Las Vegas in July. Take care.

Brian Roberts — Senior Vice President & Chief Financial Officer

Thank you.

Operator

[Operator Closing Remarks]