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

Okay. Good afternoon. I am Jonathan Ruykhaver. I'm responsible for infrastructure and security software coverage here at Baird. Very pleased to introduce Elastic. From the company, we have Janesh Moorjani, the CFO; and Anthony Luscri, who is VP of IR. This is a fireside chat format. [Operator Instructions] We do have a breakout session for Elastic, 5 minutes after this session ends, and that will give an opportunity for additional Q&A.

So before we get into some of the questions, Janesh, I wonder if you could just hit on the high points from the fourth quarter results from last week. I mean numbers were very strong, pretty much an acceleration, I think, from what we had seen before, cloud growth, RPO, SaaS growth. I think for me, personally, it was the customer growth, the large customer growth that really improved sequentially. So maybe you could just talk about -- last year, some of those macro headwinds that were an issue and kind of put that into context relative to the fundamental drivers that you're seeing, and it seemed to be outweighing the -- those macro headwinds as we exit last year and go into this year. How do you think that progresses as we move through '22?

Yes, it's a great question. As I sort of step back and think about it, Jonathan, you're right, Q4 was just a very strong quarter for us. And I'm really proud of the way we executed collectively here at Elastic as a team. And you see that in a number of different metrics, whether it's the customer account that you said, cloud growth that sit at 77%. And all of the expansion metrics and reflected really across the board in all the P&L and balance sheet metrics that you see as well. So just strong results from the team. As I step back and think about what happened in the quarter or in the environment more broadly -- and maybe I'll actually take us back to the start of fiscal '21 when we were first guiding for the full year for fiscal '21. And we were just entering the pandemic. There was all of this talk externally about 30% and 40% GDP reductions and millions of job losses, and people didn't know how to interpret that because I mean we just -- there was no recent experience on a pandemic. And so we guided at that point quite cautiously. We were initiating guidance for the full year when companies were withdrawing guidance left, right and center. And we set a view out for a full 4 quarters to provide a view on our business and how we see it unfolding. And rightfully so back then, we guided extremely conservatively just because there was far less visibility in the environment. And it turns out that over the course of fiscal '17, customers actually continue to spend through the pandemic, which was really encouraging to see. We saw some of that in the first couple of quarters. We saw some of that here in the back half as well as customers just pull forward their future into their present and continue to accelerate the additional transformation initiatives. And we've been the net beneficiary of that with the way our solutions align to their spending priorities. And that's what we saw play out in Q4. And I think that's a structural shift that's happening where we are very well positioned from the standpoint of those areas of investment from customers. So as I think about fiscal '22 and how that plays into fiscal '22, I think there's a couple of pieces. One is the broad macro, I think, will just continue to get better. Fortunately, the U.S. is making significant progress with opening up. We get almost half of our business from outside of the U.S., and the rest of the world is a little bit behind. I think that diversification, generally, over the long term, is a good thing for our business. It's a strength that we have. But I think that just from a global perspective, when I think about it, my sense is the global economy will continue to improve and will improve as we are progressing through this fiscal year. And then the second piece is, we've just given some of the customer signals and given the market opportunity that we see for ourselves, we're investing quite heavily in the business, and we started to do that more recently. And we're going to accelerate those investments even further in -- here in fiscal '22. So by the time those investments start to take hold, we should see some effect from those in the back half of '22, which is why, as I think about how fiscal '22 might unfold, I think the second half is actually going to be stronger than the first half. But overall, we are quite optimistic about the market opportunity and the outlook we've provided, and we're investing towards that.

That's helpful, Janesh. Can you talk about those dynamics, as it relates to the 3 specific buckets of Search, Observability and Security? Are you seeing the same trends across those areas? Or are there differences?

Yes. I think we are seeing good momentum across all 3 areas, as we've talked about, and we provide examples of those on the earnings call every time. So you've got a good sense of the progression we are seeing. One way to think about it objectively is in terms of the product mix that we've seen. And as you know, Jonathan, we sell Gold, Platinum and Enterprise subscriptions. And across those solutions, we have very fine grain features across all of those 3. So the solutions mix information is a little bit directional in nature because it's just self-reported by the field in terms of what they think the customer is using the -- this -- the platform for. But as I think about those, Observability today is a little bit more than 40% of the business, and it's been growing quite nicely. Back at the time of the IPO in late 2018, early 2019, before Observability was even a thing, we used to talk about logging, and logging back then was a bit more than 1/3 of the business. So as Observability has come together, it's actually created even greater momentum for us. We've seen great success on the APM side, for instance, where we've got more than 1,000 customers. We always had monitoring natively built into the stack. Security has grown quite nicely for us as well. And a few years ago, it was not a very significant part of the business. And today, it's grown to be roughly 20% of the business already. So within a high-growth company, when you've got that much of a mix shift, it gives you a sense of the momentum we're enjoying on the Security side. And that's through a combination of SIEM and endpoint. When we acquired Endgame back at the end of 2019, we ended up folding endpoints into the stack right away. So we don't sell endpoints separately. Just as a matter of general principle, it's all -- when you buy the Elastic stack, you get endpoints with it at the Enterprise level because the value is in the data. So I think that's actually been working quite nicely for us and just very strong adoption by customers of our Security solution. And Enterprise Search has actually also seen some great momentum and tailwinds with the Workplace Search solution that we launched sometime back. And then in the context of COVID, there's just more businesses have shifted to being online. There's greater e-commerce. There's more content that's getting created that's searchable, whether it's recorded meetings like this one or others. And so that's just been -- it's been great for Enterprise Search. And Enterprise Search, it continues to be under 1/3 of the business.

Right. So within that Security category, 20% overall, I understand that you include both Endgame endpoint with the SIEM offering. But talk about the use case. Is the majority of that around the SIEM application? And is the endpoint -- or use case still relatively new and that will take longer to really contribute to that bucket?

Yes. I think the core of our strategy is that at the end of the day, we see the value in the data. And so initially, a lot of the deployments that customers had for Security were for SIEM-related use cases and then we went out and we built our own SIEM product and that was built into the stack. And we are certainly seeing pretty strong traction on the SIEM side. With respect to endpoints, because our goal is -- we're -- at the end of the day, we're not selling endpoint separately. The way we see it is data has got a lot of gravity to it. And for Security-related use cases where people are looking at -- looking for trends, anomalies or hunting for threats, the value is in the data rather than in the endpoint itself. So endpoints are a great way to ship data into Elasticsearch and eventually a great enforcement point for actions that may need to be taken, which is why we don't -- we just don't sell them separately. But in terms of what motivates the customer to adopt Elastic, in many instances, it's SIEM. In many instances, they see the value of the data and they'll deploy us in place of -- or sometimes side by side with another endpoint provider. And we're happy to coexist with other endpoint providers because we care more about the data coming into Elasticsearch regardless of where it comes from.

Yes. So I wanted to touch on the -- I don't really view it as an issue. It feels like it's noise more than anything else. But the [ fore game ] on the part of Amazon to their own version of Elastic, I think they call it OpenSearch. But there are a couple of other vendors out there as well who have taken the free version of Elastic and they're trying to monetize on top of it. Maybe you can talk to that in terms of the feature functionality that those offerings deliver and whether or not you actually see them in the enterprise that you go after. For me, I tend to think that Amazon has a lot of work to do to catch up. But just what are you seeing? What are you hearing along those lines?

Yes. I think you're right, Amazon does have a lot of work to do. And for folks that might not be as familiar with the history, back in 2018, we started to expand what we used to call the Basic subscription tier, which was our proprietary but free subscription tier. So if you think -- when people normally think about open source or free, usually, they think of a few characteristics, right? One is, is it free? The second, can I inspect the code? Is the code open? Can I look for bugs and those kinds of things. The third is, can I have a rich interaction model with the people that are behind the project? So can I interact with the developers? Can I think about feature requests and so forth in that interaction model? And the fourth is, what's the governing license for the software? Most people don't really care about the fourth piece. They care about the business benefits and they care about the value and the open code. So what we did back in 2018, was we've said, "Let's give the users the benefits of all of those things," but we just put it under a proprietary license. And so our default distribution became the Elastic License. And so if I -- if you think about all of the innovation that we've had over the past few years, the vast majority of that has actually been proprietary features. Everything we've done on SIEM, on APM with endpoints with some really foundational, low-level features in the stack as well, none of that was in the pure open source category. So at one level, that competitive moat has been widening for the past 3 years. And back what -- in January, what we announced was that in the future, we will only distribute under the Elastic License. Or if a customer wants to use -- a user wants to use SSPL, which is another popular industry license, we said you can use that, too. It's their choice. So that did not affect any of our existing customers because they were already with us and under an Elastic License. It also did not affect the vast majority of our users because, again, they are on an Elastic License anyway. That was our default distribution. We saw a little bit of noise on social media, which is what you would expect. There tends to be a noisy minority, and there's some selection bias there. And of course, as we expected, Amazon announced that they're going to fork the pure open source version, which was, at that point, version 7.10. And if you think about the distinction, what they were able to fork was only the pure open source features that were in 7.10, whereas what we had was the entire stack, including all the proprietary features. And since then, we've launched 7.11, 7.12, 7.13. 7.14 is soon to come. And you just look at the velocity of innovation that we've had, it's really encouraging. So from our perspective, it's really -- the Amazon announcement has not had any significant impact in terms of the way we think about the business. We've really not seen any change in terms of our momentum, as you saw in our Q4 results. I think this will actually just play out over time as more workloads shift to the cloud and folks recognize that the Elastic Cloud offering is very different than what Amazon offers in search.

Yes. No, that's very helpful. So we talked about the 3 main categories. And I'm wondering if you can talk about some of the statistics that you shared around adoption of the broader platform at the Analyst Day. I think at that point, it's still a fairly small percentage of large customers using all 3 families. But anything to update on that dynamic?

No. As I mentioned, there's a bit more than 40% of the folks that are using Observability now and roughly 20% on Security. If I think about the solutions mix and how large customers have adopted us, what we said back at the analyst meeting was that more than half of our customers that have more than 100,000 ACVs still have only 1 solution. And then the $1 million-plus customers, over 75% of them had 2 or 3 solutions. So it was really a way for us to indicate the headroom that we see for growth and the opportunity as we drive more solutions to drive customer expansion and increase the number of million-dollar customers quite significantly. And we've done that over the course of this year with now 75 customers, more than 1 million ACV compared to more than 50 customers a year ago. I still think that same headroom for growth exists. Those percentages in terms of penetration have not changed. If I look at the 75 $1 million-plus customers, I'd say 75% of those still have 2 or more solutions. And if I look at the 730 $100,000 ACV customers, over half of those customers still have only 1 solution. The one thing I'll point out that sometimes does get lost in translation is that when we think about a solution, we think about Observability as just one solution. So there are features within Observability, logging is a feature, APM is a feature, monitoring is a feature. Those are just capabilities within Observability. So if I've got a customer who was a logging customer then adopts APM, to me, that will always be just one solution. I don't count that as, "Hey, this customer had 1 and now has 2." I know that some folks think about it that way, but from our standpoint, we just say the customer's an Observability customer.

Right. Okay. That -- I mean that model to me seems like it can facilitate or smooth the sales and the consumption motion as long as the product is competitive. And the company has really demonstrated this strong innovation, like you've already mentioned. And so I'm wondering about the introduction of the frozen tier for search in S3. I believe that just went fully GA, so congrats. But any color around customer usage for that solution and what that is trying to address from a problem standpoint?

Yes. I think it's an interesting question because we've been on this journey for some time now where if you sort of think about the temperature of storage, some years ago, all storage was only hot storage, and then we said now you can have hot warm architectures and then we introduced the gold tier and now the frozen tier. I don't know what comes beyond frozen. But the -- it just gives customers a lot more choice in terms of where they want to deploy. And being able to deploy Elasticsearch and put their data where it already exists in object storage, S3 is 1 example of that. And to keep that on frozen tier where they can -- they get much more choice in terms of the storage performance relative to the infrastructure costs that they are paying for -- paying to those third parties while not really compromising on the performance that they are getting from Elastic. So to be able to go deploy Elastic on a frozen tier means for those customers, they can reduce their spending on third-party infrastructure. They don't have to always be using hot storage. They don't have to make any significant compromises on the overall performance in terms of the Elastic performance. And it just unlocks more value. It unlocks more use cases for them. It allows them to store a lot more data. Somebody who is storing a week of hot data can now store many, many weeks of data in frozen. And then when you combine that with searchable snapshots and the ability to search across snapshots, across object storage, across those tiers of storage, it just gives the customer that much more value because, in combination, searchable snapshots and frozen tier just allows customers to get significant more benefit by reducing third-party costs while continuing to actually increase their spend with Elastic. So that's something that we're quite excited about.

Yes. No, it sounds like it. It's just another reflection of how you've been able to monetize that innovation. So look forward to hearing more updates on customer adoption going forward. Observability, as a word, is relatively new. And I'm wondering, you guys have always been very, very strong around the logging capability. But when you think about infrastructure and application monitoring, how do you think about your maturity there? And how well do you think you're positioned relative to some of the other vendors that have been in the market longer?

Yes. So we actually feel very well positioned from a competitive standpoint for a few reasons, right? Logging, as you said, is relatively mature. We've been in it for several years. Historically, if I think back 4 or 5 years ago, there used to be sort of a critique about things like ease of use and logging. All of that's been addressed. That's history. On the APM side, when people would initially start to use us for APM, some of the early adopters, they would use us because they were already using us for logging and wanted to extend into APM. And because the technology is built natively into a single stack, it was very easy for them to, right there in Kibana, click a few buttons and start using us for APM. Of course, they have to instrument their applications and so forth. So the adoption was relatively easy. And APM, to your point, it's come a long way where, in many instances, people that want to -- that -- people that want to adopt us for an Observability solution, the entry point may not be logging. In many instances now, the entry point is APM, where we'll happily compete from a functionality standpoint against existing APM vendors. I think what customers are increasingly looking for is the fullness of the solution and the vision and where we are going. And the idea that you can get the benefits of logging an APM and monitoring all from a single stack that was natively built and doesn't have clunky integrations and complex pricing models, we've got a single unified pricing model across all of those. That resonates really nicely with customers. And with respect to monitoring, we've always had monitoring capabilities embedded into the stack organically for many years. So that's -- in some senses, the least complex of the 3 legs of the stool. And it's just -- it's something that we've always had. So when customers look at where we play and just think about the fullness of the solution, what they -- what really appeals to them is the fact that it is, in fact, a unified solution all on a single stack with a single pricing model.

So when I look at Observability, to me, the biggest challenge is really around APM. I think understanding the interactions of an application with other elements of your environment and being able to map that and recognize where performance issues are occurring. And so I -- so when I look at that category, to me, it's obvious that logging is going to be a big part of it. But you're suggesting that the APM capabilities are being valued in the marketplace. Can you talk to competitive situations, large customers that have seen that value and have chosen to go with you as opposed to some of those other vendors?

Yes. Happy to. In fact, we provided an example recently where there was a very large telecom company in the U.S. And they were a customer of a logging company and what they were looking for was to extend beyond logging and they wanted logging and APM without compromising on the performance of logging and without compromising in terms of speed and the feeds that they were getting and so forth. And as they considered the alternatives that they had out there, they elected to go with Elastic because we brought logging and APM, again, natively built into a single stack. And it just made their lives that much easier from the standpoint of their adoption and the business goals that they were trying to meet. So that's one very powerful example. There are a number of others like that, that we routinely have every quarter.

Okay. So I wanted to ask about pricing. Pricing always comes up in this market -- well, these markets, across Observability, Security, even Search. And I'm wondering, so the company just had a shift in your License structure. And I'm wondering if there's been any change in customer conversations. I know prior to the shift, I think most customers are already choosing the Elastic License. But curious if there's anything worth calling out there in terms of progression over the last couple of quarters.

Yes. No, nothing specific that I would call out. In fact, to your point, it's always -- it's always a little bit flattering when you see other companies change their pricing models to mimic yours, which means you got something right. And they saw a benefit in that. So I think that's -- that always brings a smile to my face. But when I generally think about pricing, our goal out there is to make sure that we're delivering the strongest value to customers and eliminating friction, making adoption easy, that's why a single pricing model is incredibly powerful. And that's why the pricing model that allows customers to choose the size of their deployments and control their costs is also incredibly powerful. And that's what we had with respect to our pricing model. And we've continued to see that, that is an advantage for us in the marketplace. We will continue to see, I think, competitors try to evolve and keep up with us, but we feel pretty good about how we're positioned right now from a pricing perspective.

Okay. Yes, it seems like it is helping to drive that ease of consumption. It's a very simple pricing model, and that's key. So Janesh, you touched on some of the heightened investments the company is making in fiscal '22. Can you just lay out where you see those investments going? And why now?

Yes. So in terms of where we see ourselves investing, it's in all functions to continue to accelerate the innovation engine on the R&D side, significant investments on the go-to-market side as well as in the teams that support both product and field as we scale. So on the go-to-market side, in particular, we'll invest across segments, across geographies, across the different sales motions that we have. We've got a multimodal go-to-market model. So there's the traditional enterprise account executive or sales rep and we'll hire more of those, and we will surround them with the people that make them successful on the technical presales side and other functions and so forth. And all the way down to the velocity motion, where essentially we're trying to drive in the lower customer segment, smaller transactions, but moving at a much higher velocity. So given that we've got all of those different motions, we're investing in all of them. And in terms of why now, I mean, to us, it seems fairly clear that the market opportunity is so large. When I think about the TAM that we outlined, it's a $78 billion TAM, and you put out guidance for fiscal '22 against that, and it's basically [ zero point one tenth percent ] penetration. And so when you've got that much opportunity ahead of you, it just feels natural to make the investments, especially since we've got a pretty good track record that we've now built of executing against our plans and delivering well even in the face of a pandemic. So I feel like we bought the right foundational elements in place and now it's a question of adding more fuel to the engine so that we can continue to scale rapidly, which is what we are doing. The unit economics are incredibly powerful in the business, and we know that as we invest, first, on the product side and then in sales and salespeople ramp to productivity, we see the returns on the other side. And I think the operating leverage becomes inherent in the model going forward as well.

Yes. So in the 1.5 minutes we have left, Janesh, the developer has been a focus in terms of buyer historically. And I think that's helped you in terms of identifying where you need to innovate and what kind of features, functions the market is looking for. But as you look at these larger-dollar opportunities and the need to be able to get a bigger part of the budget, sometimes that means also touching the C level. Just what are the challenges you've seen as you've gone after more dollars for the bigger portfolio? And does that same motion aimed at the developer work? Or do you need to change that at all?

Yes. I think the language is a little bit different as you move further up, but the positioning is the same. Because a big part of the value that we provide in terms of business relevance, in terms of architectural relevance to our customers is the fact that we have this forward-looking vision of data being the center of gravity, and some call it convergence. But the way we think about it is the values and the data and all the data sits in one place. So how powerful is that system for you and how relevant is that to your business? And every time we have to compete on a specific bell or whistle or a specific feature we have or don't have, at the more senior levels in the organization, when we help them understand the vision of where we are going and how it's relevant to their businesses, individual features become less relevant. And so there's great alignment. So for us, we've had pretty good success in moving further up within the enterprise. I think it's just a question of doing more and continuing to invest towards that, but without compromising the base. At the end of the day, we can position the vision, but there's still a product to sell, and you've still got practitioners and frontline users that have been great champions for us, and we will be forever grateful to them, and we want to continue to serve them as well.

Understood. That does make sense. Okay. Well, we have hit our time limit. Janesh, Anthony, thank you very much for presenting. Everyone online, thank you for participating. And just a reminder, we do have a breakout for additional Q&A in 5 minutes. The next presentation to take place in this session is Medallia. Everybody, have a great day.

Thank you, Jonathan.

Yes. See you again soon.

Yes.