Elastic N.V. (ESTC) Earnings Call Transcript & Summary

Good afternoon, and good morning to the West Coast viewers. My name is Joel Fishbein. I'm the host today. I want to welcome you to the Truist Tech Conference 2021. Before we begin, I need to read the following disclaimer. This call is arranged by Truist Securities for research for institutional investors and issuer clients as defined by FINRA. If you're not an institutional investor or issuer, please disconnect at this time. For required disclosures, please see our website at trustsecurities.com or our equity research library. I am very pleased today to have with me the Elastic team, including Janesh Moorjani, who's the CFO. Janesh, previously, she served as CFO of Infoblox, and was a Senior Vice President of VMware and had various sales and finance positions at Cisco. He's also worked at Goldman Sachs, and was a Vice President of the Merchant Banking division there. And welcome, Janesh, to the call today. I'm really excited to have you here.

I'd like to start off by talking about the fact that we launched coverage, so we're new to coverage on Elastic. We launched on January 19 with a buy rating and $175 price target. You're coming off of very strong results ahead of estimates. Your subscription offerings were part of the beat, making up 94% of the overall business. You outperformed on the operating margin side. Your dollar-based net retention stays at a significantly high level. And you provided strong guidance. So I'm going to just ask you a general question, tell us what's happening at Elastic and what's driving the great performance?

Yes. Joel, great question, and thank you for hosting us. It's great to be here today, and thank you for arranging this conference. I will point out, similar to your disclaimer that statements that I make here are forward-looking statements. There will be some of those covered by the SEC safe harbor, and I'd point people to our regulatory filings on the SEC's website for more information. But with respect to the question, it's a great time at Elastic. It's where -- we had a really successful Q3 to your point. It was a clean print across the board. We fired on all metrics. The business performed really well across all dimensions. When I think about some of the highlights around the cloud business, in particular, that was something that we are proud of. We've seen great traction in our SaaS business for quite some time now and seen a good mix shift towards the cloud in terms of the composition of our overall customer base and revenue base. So I think that all played out quite nicely. We've seen good strength and traction across our different solution areas. The demand environment, I think, stayed relatively consistent as well, which allowed the team to execute really well over the course of Q3. So when I think about this fiscal year. It's been a tough fiscal year, just given all of the effects of COVID, but I'm really proud of the way the team has executed over the last 9 months and certainly, in Q3 as well. If I think about some of the exciting things happening for us, it really revolve around our solution areas around security and observability and enterprise search. And how we're investing in each of those solution areas as well as on the go-to-market side to capture the future growth opportunity ahead of us. So folks are excited, and it's been a good year so far.

That's fantastic. Just as a follow-up on the COVID, right, obviously, it was a headwind in the beginning of last year.

Yes.

Did it turn into a tailwind at all? And I'm trying to -- the question I'm trying to get to is, are we in a normalized environment? Or we in an accelerated environment? And what are budgets? And what are your customers telling you about next -- or this year, I should say?

Yes. It's a great question. I'd say that we -- through the course of the entire fiscal year, so far, the first 3 quarters, we've actually been in what I would characterize as a mixed environment. There's obviously some headwinds associated with COVID as customers think about their spending patterns and where they are spending their money, in some cases, deals are going to higher levels for approval, which meant they took longer to get done. In some cases, people who were thinking back about their budgets. But what we've also seen are several tailwinds because as customers step back and think about what their real business priorities are and they think about all of the digital transformation efforts that they need to drive in their business. So they just think about the risks in their business, but with cyber threats and so forth. What we saw is that customers are increasingly shifting the composition of their spending towards areas where our solutions are very well positioned. All 3 of our solutions, Enterprise Search, Observability and Security. So I think we had both put and takes from that perspective. And I think that played out as we expected over the course of the last 9 months. The team executed relatively well, as I said, across all these dimensions, despite this mixed environment. In terms of what we are seeing out there now, just a couple of thoughts. One is, in terms of actual customer behavior, where people are still thinking about how they write check. So when things went up to higher levels of authority in the organization for approvals, we haven't seen those come down yet. It's not like CFOs have started to delegate authority down again or they've loosened the strings in any way. What's different is that the tone of the conversations. If I think back to 9 months ago, there was all of this talk about 30% to 40% GDP reduction and how many millions of jobs will be lost. And how bad is the downturn going to be and people were likening it to crises and not seen since, I don't know, the '70s or '80s. In the '70s, you have the oil crisis or World War II. There was sort of this doomsday scenario that people were talking about back then. And now the tone of the conversation has shifted, where people are talking about what happens when things get better in the future, what happens when there's enough shots and arms, what happens when things start to open up. So I think people are planning for a different future and a better future, but we haven't actually seen them take actions. It's not like budgets have suddenly increased overnight. It's not like CFOs have loosened the burst strings any. So we are watching that quite cautiously. We'll see how we execute here in Q4, and we're just taking it 1 quarter at a time. But we are looking forward to an eventual recovery, whatever shape that takes.

That's great. So you do have 14,000 or close to 14,000 customers. You get -- you still had 20 net new $100,000 deals in the last quarter. How do you view the environment relative to mix of new versus existing? You obviously have a lot of cross-sell opportunity, which we're going to get to a little bit, but I want to just think about how you're thinking about the net new customers while 14,000 sounds like it's a lot, you still have a lot of market penetration to hit.

Yes. It's a very large market in which we play across our solution areas. And so that's something that we are quite excited about. To your point, we've got relatively low TAM penetration compared to the overall opportunity, which is a big reason why we are focusing on investments, which we can touch on as well, if you like. But as I think about the new versus testing customer dynamic, we've actually been quite pleased with the rate of new customer additions. I think as we went into the pandemic, which really coincided with the start of our of fiscal Q1 is when we started to first see the effects play out in the business beyond that short 2-week period back in March of last year. You will see that we've continuously maintained a good pace of customer additions throughout the course of the pandemic adding 800 to 900 customers every quarter. So that's something that we were quite pleased about despite pandemic continuing to add customers at a pretty good rate. And then even in terms of the customers more than $100,000 ACV in size, I think that continued to play out quite nicely year in Q3 relative to what we saw in Q1 or at the start of the year as well. To your point, I think as customers continue to adopt Elastic and continue to grow with us, their spend with us naturally increases over time. So we've seen strength in all of our metrics, whether you're talking about new or expansion and growth. I think the other thing I'll point doubt there is as customers continue to grow with us and continue to spend, I think there continues to be significant opportunity for us in the marketplace externally. We do continue to see more customers shift towards cloud. We tend to be relatively agnostic ourselves. Customers can deploy us wherever they like. But we have seen strong traction on cloud. It's been growing quite nicely for us, 79% revenue growth here in the past quarter. And we do continue to think that it will be a bigger portion of the business looking ahead.

That's great. So I want to shift over to your areas of coverage that you do. And I've got multiple questions with regard to it. Because you play in 3 very, very big markets, right? So you're dominant in the search market and security and observability, our 2, obviously, very big markets. Can you give us how Elastic thinks about those 3 end markets strategically? And do you -- I guess, do you care -- I know you care, but does it matter where the companies are deploying? And is there a different go to markets in each of those segments? I know those are many questions, but I just want to dig a little bit deeper into those end markets. And they each have their own idiosyncrasies to say the least. And I want to get your take on it.

It's a great question, Joel, because it also highlights the way we continue to stay focused and continue to drive success in these 3 areas, which do some folks might seem like they are disparate areas. But I sort of boil it down to first principles. When I think about the core idea behind Elastic, it's that you can ingest large volumes of data, index that data and return near real-time search results on that data. And to do that with the speed and power of a search engine, if you think about your experience as a consumer when you're running a search and a web browser, how quick that result is. To think about that speed, to think about that scale and that relevance, those are the kinds of use cases or solutions where Elastic really shines. And if I think about what that means from the standpoint of our investment philosophy in areas like R&D or engineering and product. We think of these as power plays, things that we can build into the stack that can actually provide benefit across all of these solution areas. Searchable snapshots is a great example of that because it enables much better outcomes in all those solution areas. Similarly, from a go-to-market perspective, because we leverage this free and open distribution model, very often when our salespeople engage with customers, they are not having to explain the product to a customer. They are not having to talk about features and benefits. They're not having to tell the customer, "Hey, why don't you stand up at BOC to learn and experience of product." Customers are already were very familiar with the product. They're using us in all these creative ways across these 3 solutions and then some. And so the nature of the conversation that the salesperson has with the customer, it's a very warm conversation from the beginning. And they tend to be very focused on driving the right outcomes for customers. So we've had a uniform approach to investing from a product perspective as well as a general sales force. And in some cases, we'll bring in the right level of expertise or the right technical focus to speak to certain kinds of buyers for certain kinds of use cases or problems. But by and large, as we focused on first principles and what allows Elastic to go faster and what allows us to scale faster and how do we help our customers go faster, that's really what underlies our overall investment philosophy. And as you mentioned, we focus on these 3 big markets. Each of them is unique, but we bring the same underlying principles to each one of them that allows us and has allowed us so far to succeed really well in each of these 3 solution areas.

That's great. So maybe digging down a level deeper, security market opportunity, $27 billion. Maybe you can share maybe a use case there and maybe what the competitive dynamics look like?

Yes. Happy to. So when we started off in security -- and by the way, this informs a lot of our product development and go to market, many of our existing customers had already started to use security-related use cases even before we declared that we wanted to be a player in security and even before we declared that we wanted to build the same product. And based on what our customers are telling us, and that's one of the powers of free and open that it makes for a very efficient R&D model because you don't waste your time building features that no one will use because you're listening to your customers time and you are listening to your users. And so over time as we built and launched our SIEM product a little over 1.5 years ago now. And we've seen great traction on that. And then we acquired Endgame for endpoints back in October of 2019. And to us, we saw the coming together of endpoint and SIEM as really a very compelling story in security endpoints are a great way to not only ship data into Elasticsearch, but also eventually enforce action and enforce policy on an endpoint. But that was a great opportunity for us, and we saw endpoints and SIM coming together. You've seen some other players now start to follow in our footsteps and make moves in that space as well. But that's one way. So we get used. If I think about either endpoints only or SIEM-only or earlier a combination of the 2, we get used in those kinds of use cases in a variety of settings, everywhere from government settings to think about security at a national scale to large enterprises that have used us. In our past earnings call, we provided some examples of how customers are using us. We also believe that as these technologies come together, the value actually lies in the data itself, it's not in the endpoint. And so when we acquired Endgame, and we folded endpoints into the Elastic stack, we said endpoints are free, if you buy an enterprise subscription tier with Elastic, you can get the endpoints with it. It's a very robust product. By the way, on a stand-alone basis, when you look at some of the third-party independent research, the Endgame product compares very well to existing endpoints. But we said endpoints are free, you don't have to pay for endpoints because that's not how you get value from them. We folded it into the Elastic stack, and we monetize the underlying data, which is a great, great place to be and it's a great way for us to help customers think through it as well.

So can you talk a little bit about the competitive dynamics there before we move over to Observability?

Yes. Happy to. So the company that we find ourselves competing the most with in the past would be a company like Splunk, one of the largest SIEM players. There are other SIEM players as well. From the standpoint of product maturity and readiness, we've always maintained that the SIEM product, because it's a relatively new product for us, I think there's more work we need to do on that front. But competitively, in the situations where we've got users that are comfortable with it, I think we've done relatively well competitively speaking. And even from the stand -- if I think about endpoints as well, the interesting thing about endpoints is we don't necessarily need other companies to lose for us to win as I said, the value is in the data, and we happily take the data from third-party endpoints, we'll happily take the data from Elastic endpoint. Of course, we prefer that it's elastic endpoints rather than third party, but it doesn't prevent us from monetizing the underlying data if it comes from some other sources.

Not to put you in the spot, but do you have any reference customers that you can point to?

Well, a number of them. I think you'll see some names on the website in terms of customer cases. We didn't name specific customers on the earnings call. But if I give you the profiles there, large brand name customers would recognize immediately.

Okay. I'll do some follow-up there. All right. Let's move over to the Observability side. Same question can you give us the use case, it's a $12 billion market, highly, highly fragmented. Everybody is using Observability in their marketing line. What makes Elastic unique there? And how are customers using the products? And I love to understand the competitive dynamics there as well.

Yes. Happy to. So Observability got coined as an industry term, as you said a few years ago. We were actually quite pleased with the rate at which it's gotten traction and adoption because, again, I think that's one of the trends that plays in our favor. In our history, as we started out as a company, we didn't intend to ever say we're going to be a particular -- we're going to solve a particular problem in logging or observability. People, 5, 6, 7 years ago, started to use us for logging. And when they started to use us for logging, we started to see more use cases there, and we continue to improve our product along the way, and we became a fairly popular tool for the logging specific use case. And then a few years ago, we acquired a company called Opbeat, which was based in Denmark, and they were building a set of APM tools on top of Elastic. And we acquired that technology, and we put that out into the open and as part of our free and open model. And we then build -- continue to build further on that and build APM capabilities natively into the Elastic stack. And we've had monitoring for quite some time as well. And those are the 3 legs of the Observability. So for the longest time when customers would talk to us about a particular feature, given that we were a relatively newer entrant in APM and that even for logging, there was already an existing market. When folks would talked to us about a particular feature, our view always was that, look, you got to step back and think about where the industry is headed. And because the value is in the data, it becomes incredibly powerful to have the data all stored in a single data store and all these capabilities built into a single stack. So we always up lever the positioning to Observability to begin with. So this whole industry trend towards Observability has actually played quite nicely in our favor because we've been very well positioned from the standpoint of being a native stack. And by the way, you look at that and you look at the pricing model, typically, when you look at a company's pricing model, it gives you a pretty good view into how their stack is actually built. So we have a single pricing model across all the solution areas Observability as well as the others, and it's a resource-based pricing model. So that just shows you that it's purpose for that, and it's played very well to our advantage. In terms of the competitive dynamics, I think, as you might expect, when observability started to gain traction, the first thing that happened was those competitive walls started to come down. So if you had 2 or 3 companies competing and logging or 2 or 3 companies competing in monitoring a handful of players in APM. When you start to look at Observability to begin with suddenly, all the names come on the list. But obviously, not everybody has got the right products. And you can see over the last 24 months, some people have tried to cobble together Observability solutions with bolt-on acquisitions, and they've had sort of mixed success in the marketplace. Others are still struggling and lagging further behind. We feel really good about how we are positioned and the traction we are seeing. In terms of some of the names that we see from time to time, we still see a number of point solution players. So we will still run into Splunk with respect to logging or we will still run into a Datadog with respect to monitoring only or what have you. But generally speaking, when you step back and think about the overall competitive dynamics in the space, they haven't changed much. What we've been really proud about is that previously, I'd say, a year ago, maybe 1.5 years ago, we used to win deals based on logging and then customers would from their extend into something like APM. And what we've been seeing increasingly is that very often, we will now win deals on as APM being the tip of the spear, even though the customer may not have already adopted us for logging yet, and they'll adopt us for APM first and then extend into other areas. So we've now got hundreds of solutions, hundreds of customers that are using us for APM as an example. So we've seen really good traction on the Observability side, and we are quite impressed with the progress that we've made there with even if say so myself.

That's great. So crown jewel, and that's not to belittle Security or Observability. But the crown jewel of the organization is search. We live in a data world, you know it, you live it every day, datable useful if you can search it and use it, right? So talk about the search market, what's going on there? And used cases, competitive dynamics, same as you did. So love to hear that.

Yes. Happy to. So I'll draw a distinction between search as the technology and the enterprise search use case or solution. Search as a technology is really the crown jewels for us. And for us, enterprise search was just the very logical and first set of use cases around our technology. And people would use us for all kinds of creative ways. When I joined the company a little over 3.5 years ago now, people are using us for all kinds of just novel ways I wouldn't have even imagined when you think about even things like a dating application, it's one human being searching for another and Elastic would power those kinds of experiences as well behind the scenes. So a variety of experiences that you would experience as a consumer that you would experience as a business user, powering a number of e-commerce-related applications. I think what we've seen over the last year or so, particularly in light of COVID is that enterprise search has been a net beneficiary in many of those areas as like e-commerce have picked up quite a bit. And then the other piece within enterprise search that we were really excited about was the launch of our workplace search product, which also happened a few quarters ago. And if you think about the traditional workplace search concepts, when you had the old legacy companies, in many instances, they fail because they didn't recognize that the value is in the data. And even if they try to -- the data was all in disparate sources and cobble together differently and had different levels of integration that you would need to build in order to get real benefit from that. And what we've seen over the last several years is with the shift towards cloud. So much enterprise data is stored outside of the 4 walls of the enterprise. When you think about all the SaaS assets that you've got out there, Box, Dropbox, Salesforce for CRM, ERP systems in the cloud, developer tools in the cloud and so forth. There's so much enterprise data that sits outside the enterprise. And so for us, Workplace Search became the mechanism where you could search across multiple SaaS assets including things like e-mail and so forth, all with a single search box, and that becomes an incredibly difficult problem to solve when you think about both the distributed nature of those applications, you think about the security models associated with that, you think about the privileges that you as a user have across all of those different applications. And the ability to take all that complexity and simplify it into a single search in a single text box for a user, it's a fairly complex set of problems and it's, again, been received very well by customers that have been using that product. From the standpoint of competitive dynamics, that's a bit tricky. I mean there's no obvious names that come to mind that I would call out as sort of direct competitors. I think it really just depends on use case and how people are using us for that -- for all of these different use cases within enterprise search.

Just a follow-up there. Is there an OEM component to this where you're OEM-ing to search capability to other companies to be able to use it in their products?

Yes. So a number of companies will embed Elastic into their products, and we power the search behind a number of different experiences. Some of them are paid because they are using commercial features that are paid features. Some of them may be unpaid. I'll give you a simple example, the search behind Wikipedia is powered by Elastic. And you wouldn't know that if I didn't tell you that.

That's great. All right. I'm going to shift gears, we only have a few more minutes. I'll get 2 more questions. Just any changes in the go-to-market and how customers are buying? And how are they handling your single pricing?

Yes. We touched on what customers are doing right now in the context of the demand environment a little bit earlier. But in terms of pricing and go-to-market overall, so no significant changes from a go-to-market perspective. We are really happy with the addition of Paul Appleby to the team. He joined back in August of last year. So he's been here about 6 or 7 months now. And he's been a great addition to the team and a great partner for me personally in the business as well as my peers and for Shay, of course. And so as we think about the future and where we need to make investments in the business, we will continue to invest in all aspects of go-to-market coverage and scale is really important for us. You mentioned the TAM numbers as we were going through each of those areas and you look at the size of Elastic today relative to that TAM, it's a relatively low TAM penetration. And so given that, we're continuing to make significant investments across the board from a go-to-market standpoint. The pricing model is one where customers have actually told us that becomes a significant advantage for us. It's liberating for customers not to have to talk about all the different modes of pricing that they are devoured to just because a vendor adopted that particular approach. Resource-based pricing that is in the hands of the customer, and they control how much they spend based on the resources that they use. It's an incredibly powerful pricing model and the fact that it's a uniform model across our solutions makes it that much more powerful for us.

Have you disclosed what your hiring plans are for this coming year?

Not specifically. What we said on the prior earnings call was that given the investments we are making, folks should expect that the op margin should be a few points -- the non-GAAP op margin should be a few points lower than that fiscal '21, which is the year we're in right now. But we didn't disclose that specifically, Joel, has yet because they're still working through our plans, and it's a little bit too early.

Okay. And I've been asking this question pervasively because it's been a recurring theme, and that is finding talent has been pretty hard. Have you found that to be the same case to hire and retain the quality level talent that you're accustomed to?

We haven't found it particularly hard. I think it's been relatively consistent, I would say, over the course of the last 9 months or so. One of the advantages of Elastic is we're just a distributed company. By the way, distributor doesn't mean 100% remote. It doesn't mean that everybody is working from home naturally. Distributed just means we are distributed, we didn't have a particular concentration in any one location. I think part of that is our roots in open source, and sales and marketing tends to be fairly distributed anyway. So as a company, we were just very comfortable with this concept that work is something you do. It's not a place that you go. Work is -- it's an activity, not a location. And given that, we always, throughout our history, have invested heavily in making sure that we can be very inclusive for people who are either not in the same physical location or just in -- may not have the same physical presence as certain other people do. And it's just embedded into our culture in many ways. And people see that and they look for that, and they appreciate that in the hiring process. So we've actually found that our ability to recruit has remained, I'd say, relatively consistent in terms of our ability to attract good talent. There's always seasonality to hiring given the holidays and so forth. But in terms of the experience that we've had and our candidate experience, it's been fantastic.

That's great. So last question for me is what's in-store for calendar 2021? And what are some milestones that investors should be thinking about when they're thinking about Elastic?

Yes. If I had to summarize it, I would say, investing for growth in fiscal 2022. So our fiscal year will end here in April year. We'll start fiscal '22. Some of that growth and some of those investments are geared towards the near term, but a lot of those will be longer-term oriented. If you think about all of the investments we make on the product side or just investing for scale or investments, a big belief we have is to make a consistent base of investments over the course of the year. And so investments that we made in the back half of fiscal '22, for example, won't return results in the same year. So that's the approach we are taking. I think those investments will be across the board, as I touched on earlier. In terms of what the specifics around that mean and what markers for success people should look for. Those are the kinds of things we are working through right now as we build our internal plans over the course of the next couple of months. And so I'll spell out the specific numbers for fiscal '22 when we get to our next earnings call. But the underlying team is continuing to invest for growth.

That's helpful. And that's a teaser. So you're going to have to follow-up on that. Last question, just a follow-up to the last one, is -- are there any major holes in the portfolio that right now? I mean, you have a broad breadth of product in areas that you're focused on.

Yes. I think we've got -- we are very happy with the quality of the portfolio. I think, particularly when I think about the breadth we've got on Observability. When I think about the progress we've made with the full integration on the Endgame side into the security mix. I think we've actually got a fair amount on our plates. And I think we've been quite pleased with the breadth of the portfolio. I think there's always more to do. For example, we've been quite transparent about features and road map and so forth that we still need to work towards on the security side, as an example. And we'll always be continuing to look for ways in which we can accelerate that future even faster. So there's no such thing as a perfect product. It's always going to be an never-ending journey.

That's a great place to end the conversation. I really appreciate your time. This is highly informative and look forward to speaking to you again soon, and thanks for your time.

Likewise, and thanks again for hosting us, Joel. Appreciate it very much.

Take care.

Take care. Bye-bye.