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Splunk Inc. (SPLK - Snapshot Report) reported first-quarter 2014 loss of 16 cents per share, which was wider than the Zacks Consensus Estimate of a loss of 12 cents and the previous-quarter loss of 6 cents per share. However, first-quarter loss was narrower than 71 cents reported in the year-ago quarter.

Revenues

Revenues surged 53.8% year over year but plunged 12.3% sequentially to $57.2 million and were within management’s guided range of $52.0 to $54.0 million. Revenues beat the Zacks Consensus Estimate of $53.0 million. International operations represented 21.0% of revenues.

Strong license sales and maintenance & services revenues primarily drove the better-than-expected year-over-year result. License sales (63.2% of revenues) jumped 48.3% year over year to $36.2 million. Maintenance and services revenues (36.8% of revenues) increased 64.3% from the year-ago quarter to $21.0 million.

The sequential decline was primarily due to lower license revenues, which fell 22.7% in the quarter. The sharp decline was partially offset by 14.0% sequential growth in maintenance and services revenues.

Splunk continues to generate majority of its revenues from core markets, which include App management, infrastructure and operations, and security compliance. Splunk introduced a number of new products during the quarter that include Splunk App for Enterprise Security 2.4, App for Palo Alto Networks 3.0, general version of Splunk DB , Splunk App for Microsoft (MSFT - Analyst Report) Windows 5.0 and many more.

These new products are expected to boost Splunk’s market share in the emerging fields of web intelligence, business analytics and industrial data. The company’s cloud and Storm platform added more than 70 new customers to reach 200 at the end of first quarter.

During the quarter, Splunk signed deals with more than 350 new customers, which include the likes of The Bank of New York Mellon Corp (BK - Analyst Report) and Level 3 Communications (LVLT - Snapshot Report). Splunk’s total customer base was approximately 5,600 at the end of the first quarter.

In the first quarter, Splunk signed 132 orders, worth more than $100K, compared with 73 in the year-ago quarter and 171 in the previous quarter. Term-base and perpetual license sales mix was 16.0% in the quarter compared with 13.0% in the previous quarter and within the historical range of 10.0% to 20.0%. Maintenance renewal rate was 93% in the reported quarter.

Margins

Gross margin contracted 20 basis points (“bps”) from the year-ago quarter and 150 bps sequentially. This was primarily due to unfavorable product mix.  

Splunk continues to invest in research & development (“R&D”), which jumped 78.5% year over year and 8.9% sequentially to $14.5 million in the quarter. Sales & marketing (“S&M”) expense surged 71.0% from the prior-year quarter and 2.4% from the previous quarter to $41.3 million. General & administrative expense (“G&A”) increased 52.6% year over year but decreased 4.0% quarter over quarter to $10.4 million.

The sharp jump in operating expenses (up 69.3% year over year and 2.6% sequentially) negatively hurt profitability in the quarter. Operating loss was $15.7 million compared with a loss of $6.2 million in the prior-year quarter and a loss of $5.9 million in the previous quarter.

Net loss was $16.1 million compared with a loss of $20.5 million in the prior-year quarter and a loss of $6.2 million in the previous quarter.

Balance Sheet and Cash Flow

Splunk exited the first quarter with $331.3 million in cash & cash equivalents compared with $305.9 million in the previous quarter.

Cash flow from operations was $19.9 million compared with $24.8 million in the previous quarter and $11.6 million in the year-ago quarter. Free cash flow was $18.6 million compared with $21.4 million in the previous quarter and $9.7 million in the year-ago quarter.

Guidance

Splunk expect revenues in the range of $266.0 to $274.0 million (up from prior guided range of $260.0 to $270.0 million) and break-even operational result for fiscal 2014. For second quarter of 2014, revenues are likely to be in the range of $61.0 to $63.0 million. Operating margin is expected to be negative 4.0% to 6.0% in the second quarter.

Our Take

Splunk’s revenue growth is expected to benefit from a strong growth in user base, higher renewal rates and expansions into new markets. We believe that Splunk’s strong product pipeline will also boost top-line growth going forward.

However, increasing investments for product development are expected to drag profitability in the near term. As Splunk continues to explore and expand into new markets, sales & marketing expenditure is expected to increase significantly, thereby hurting margins in the near term.

Currently, Splunk has a Zacks Rank #3 (Hold).

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