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Why Splunk Stock Dropped 17.4% in August

What happened

Shares of Splunk (NASDAQ: SPLK) fell 17.4% in August, according to data from S&P Global Market Intelligence. The operational intelligence platform specialist absolutely crushed estimates for its fiscal second quarter, but followed by significantly reducing its cash flow expectations for the rest of this year.

Before you go tapping that sell button yourself, you should note that Splunk's quarterly results were just as incredible as they looked on paper: Revenue climbed 33% year over year to $516.6 million, translating to adjusted net income of $46.6 million, or $0.30 per share. Analysts on average were looking for earnings of only $0.12 per share, and Splunk's outlook called for revenue of just $485 million. 

Man in suit touching digital dollar signs next to a translucent chart.

Image source: Getty Images.

So what

Within Splunk's top line, license revenue grew 39.2% to $279.3 million, and maintenance & services revenue soared 26.5% to $237.3 million. Within those totals, however, management noted that cloud business grew an incredible 80% year over year and now commands over $300 million of annual recurring revenue (ARR). Splunk also announced it has agreed to acquire cloud-monitoring company SignalFX for $1.05 billion in a cash (60%) and stock (40%) deal -- a move that should significantly expand its reach and value proposition to clients.

If that wasn't enough, Splunk increased its full-year outlook for revenue to $2.3 billion -- up $50 million from its old target.

During the subsequent conference call, CEO Doug Merritt insisted Splunk is "firing on all cylinders," adding almost 500 new enterprise customers. And by the end of the year, he said, essentially all of Splunk's new software sales will be cloud- or term-license based as it transitions away from a perpetual license model. 

So what's the problem? That transition is happening much faster than Splunk expected -- it previously thought as much as 15% of total sales at the end of the year would be perpetual -- which hurts the timing of Splunk's cash collections as its perpetual-license sales base wanes.

Now what

To be fair, Splunk saw the exact same response in May, when it lowered its operating cash-flow expectation for this year by $100 million to "just" $350 million. But as renewable license sales continued to soar, as of last month's update Splunk now expects negative operating cash flow of $300 million this fiscal year. 

Over the long term, however, I'm intrigued by Splunk's potential as it begins to lap this jaw-dropping transition and collects more of the recurring revenue it's putting into place today. For investors willing to buy now and watch this growth story play out, I think the pullback is an enticing opportunity to open or add to a position.

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Steve Symington has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Splunk. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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