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

Welcome back, everyone, to the Software Conference. My name is Brent Thill. I want to welcome in Janesh, CFO of Elastic. He's been at the company since 2018, was previously CFO at Infoblox and held senior finance roles at VMware and Cisco. Janesh, welcome. You're coming off of the second quarter in a row of the constant currency revenue acceleration. Maybe talk us through the end market in user and drivers that are driving this type of adoption.

Yes, happy to, Brent, and thanks for hosting us. We appreciate it. A few different things, as there's a lot of strength that we are seeing out there with respect to end users and the end market. Our solutions are resonating really well. We started off on this journey of focusing on 3 main solution areas: Observability; Security; and Enterprise Search some time ago. And I think that customer spending is generally lining up quite nicely. And as customers think about their shifting priorities, our solutions are very well aligned in all of those different areas. So I think that's clearly one of the things that's helped us over the course of the past several quarters. The other piece that I would call out that I think is increasingly starting to happen is that we are starting to become this platform across the 3 solutions. And as customers adopt us for any of these areas, they're realizing the benefits of extending across solutions into different areas, so from Observability into Security or vice versa. And we are starting to see that trend emerge a little bit more strongly. So I think that's another piece that has really helped us in one of the aspects of end user behavior that we are starting to see out there. And maybe the final thing I'll call out is the momentum that we've enjoyed on cloud. We've invested quite heavily in that area in terms of the physical build out and presence in so many different locations around the world on public cloud providers. We've invested heavily in our marketplace partnerships with the likes of Azure and Google. We've invested heavily in terms of our own go-to-market efforts. I think all of those have been starting to provide pretty good returns. And we are pleased to see the momentum there, and I think that momentum continues.

You've got a $78 billion TAM. You mentioned '23 revenue target of the bill. When you talk about the confidence of getting to that goal, clearly, you've got enough runway to get to $1 billion, let alone you had $78 billion or $77 million more in front of you. But when you think of -- just what's giving you this confidence around what you're seeing in your market?

Yes. I think a few things. One is some of these end user behaviors that I talked about, right, with our solutions resonating so well, I think that's really encouraging. The investments we've made on the product side to see those get translated into customer demand and fulfilling that demand, I think, is really encouraging. The other couple of things that I'll point out, maybe one tied out to -- tied to that is that we're continuing to invest in the business. Against a $78 billion TAM, to your point, where today, sub-$1 billion, we've got $1 billion revenue target for FY '23, that's still relatively small. And the way I think about that compared to the overall market opportunity and the demand set is that we've got plenty of headroom to grow, so we're investing. We started to accelerate our investments in the business really in the latter part of fiscal '21 and starting -- and continuing that acceleration here in the early part of fiscal '22. And I think as we make more of those investments, which are across the board, more -- a little bit more oriented towards the go-to-market side, but generally across the board, including product and the support functions that help both product and go-to-market, those investments start to take a greater hold in the back half of this year. And that gives us even greater momentum going into fiscal '23 from a revenue standpoint. And then, maybe the other piece I'll just touch on because I know it's top of mind for so many people is just the broader macro environment. We -- because of our history and our roots, we actually have a fairly diversified business model across geography. A significant portion of our business comes from outside of the United States. And as the global economy continues to recover from the pandemic, we're obviously seeing much earlier recovery here in the U.S. with things opening up a lot more. There's many other parts of the world that are still facing the effects of the pandemic. And I think, as those continue to get better with time, I think that will just provide more natural momentum going into fiscal '23 for us as well.

One of the debates investors have been having is after last year, the digital throttle got thrown down. And the question is, can you continue to redline on the throttle before the engine pressure starts to build and passengers start to feel like, hey, are we going too fast and the drink cart starts to shake? Is your sense, we're still full throttle, or have you seen any sign, hey, like we had this initial surge, and now people are kind of dialing back a little bit. We're still at a great altitude. We're still moving quick. But what's your sense on the behavior of -- or how would you characterize what you're seeing?

Yes. There's a couple of ways to think about it: one is velocity; and the second is acceleration. And what we're seeing, to your point, to borrow your analogy, I think we've been moving full throttle forward in the market more broadly, particularly around the areas, around Observability and Security and Enterprise Search. Again, that's been really, really encouraging for us. We saw significantly higher usage, even on our cloud business, and that was part of what drove the upside for us in Q1. We saw -- I was, certainly myself, modeling increased usage as the year progressed. But we saw even more of that than I expected, which was an upside surprise, even to me, but I'm happy that it was an upside surprise. I'll take it every day of the week.

We like how you're framing that. Thank you for beating even your own bar.

Yes. Its -- it really reflects the strength of the investments and the partnerships that we've got out there. It was really encouraging to see that usage come in so strong. So from our perspective, we continue to be really excited about the rest of the year. As I said, I baked a lot of that into my own thinking for the rest of the year already. So we'll see how Q2 and future quarters play out. But from the standpoint of what we're seeing in the demand in the marketplace and the reception to our solutions, I think that momentum continues. And we're investing towards that, which is what's giving us the confidence to make all these investments in the business.

Just a friendly reminder, if you guys have questions, you can ask on the online portal. [Operator Instructions] But when you think about turning to cloud versus the traditional business, cloud has been a real standout. When you were at VMware, when you think about kind of managing a traditional business and the cloud business, it's not easy. How are you doing this so well?

Well, I think to start with, it helps significantly that our approach to customers is just to be there wherever they are. And from a technology standpoint, the development team over here at Elastic, the engineering team, we're really focused on making sure that we build all of those capabilities into a single stack and that we can deliver features on cloud and on-prem really at the same time. And so, what it really comes down to then is on the go-to-market side, working with partners out there, the likes of Google and Azure as well as our own direct sales team, engaging with customers in those conversations, we're not trying to drive some sort of transition in the business. I think transitions are always difficult. For us, our view is simply that we will be there for customers wherever they are, and customers will tend to deploy us wherever their applications and infrastructure reside. And so we won't be the reason that they can't move to the cloud. If they want to deploy us in the cloud, we will say, great. We -- as an example, we don't give customers or even our salespeople any particular incentives to shift a workload to the cloud versus keeping it self-managed or on-prem. We really want that to be customer-led behavior. And I think just doing it quite naturally means that the demand signals that we see in the business are reflective more broadly of what customers are seeing and doing in their own environments. When you look at the IT industry broadly, I think this is a well-known fact, the vast majority of workloads still sit on-prem, but all of the growth is happening in the cloud. And I think that's what you see reflected in our business as well. It's just a reflection of underlying customer demand.

I believe that Observability is one of the largest parts of the business. I believe it's over 40% of your bookings mix.

Yes.

Can you just maybe drill-in a little around this category? And what's happening? What's forcing this to drive such great growth? What are you seeing from what your customers are telling you?

Yes. Observability really has grown quite nicely for us, to your point. In fact, when we went public about 3 years ago, Observability was a concept that we were just starting to talk about and the industry was just starting to talk about. Back then, it was still the independent pieces around logging and APM and monitoring. And I think what's happened over these last few years is that businesses, just as a natural matter, have become a lot more data dependent, a lot more data-driven, dealing with many larger data sets and really using that data to drive their own strategies and their own execution. And when that happens and when businesses have become so much more dependent, as a result of that, IT has become so much more mission-critical to the success of those businesses because they rely on tools. They rely on automation. They rely on so many emerging technologies to make them successful and leverage the value in that data. And both of those play very well to the Observability theme. The other thing that also helped to a degree is obviously the pandemic as people have realized that work is something that can happen in a very distributed way. A lot of interactions that previously were much more siloed or centralized have become decentralized. You think about some of the technology shifts that are happening as we've moved -- you referenced VMware earlier. As you think about some of the shifts happening on the infrastructure side as we've gone to much more micro services-based architectures, all of those machines, all of those applications are generating far more data than they did before. And all of that data needs to be searched. It needs to be indexed. It needs to be analyzed. And it needs to be used to make sure that the infrastructure is up and running and that user experiences are what you would expect them to be. So those are some of, I think, the underlying trends that have driven the importance of Observability. The other pieces, as these different silos have come together, I think customers are really seeing the benefits of having all of their observability data in a single place and a single platform, and that really plays to our advantage as well. So that's another benefit for us.

When you think about APM, can you just talk about what you're seeing there today on the application side?

Yes, happy to do that. So as I said, initially, it was all about the different stools of -- or the different legs of the stool of Observability, logging APM and monitoring. And initially, when Observability started to come together, we -- a lot of customers started to adopt us for APM as an initial extension of logging. And we got into the APM space a few years ago. So we were already building the APM capabilities into the stack. And our logging customers, initially when they logged into Kibana, they had a bunch of tools, a bunch of buttons. They could -- they have the APM features already included in their subscription. That's part of the value of having a unified pricing model and the subscription model that we have with the tiered subscription levels. And so they started to use us for APM really as an extension of logging in the initial days. In many instances, what we've now seen is that as our APM capabilities have gotten a lot better over the last several years, in many instances, customers are leading with APM. Customers that didn't even use us for logging are starting off with APM. They are pulling logging together with APM. We've highlighted examples of those from time to time on earnings calls and in other forums. So we are definitely starting to land with APM as a use case. And in many of those instances, customers pick us because they see the benefit of having logging and APM and monitoring all built into a single stack. If you think about the example of somebody whose job it is to wake up every morning and keep the infrastructure up and running the entire day for a fantastic user experience, if they have to log into a separate tool for logging, a separate tool for APM, separate tool for monitoring, in many instances, those tools are giving them conflicting signals, it makes their jobs difficult. So we've seen significant benefit from the idea that we're this -- that we are a platform and you can do all of that on a single stack. It's helped us win many APM deals as well. We've got more than 1,000 APM customers now, and that's a statistic we're quite proud of.

Turning to Security, I believe your fastest-growing business, about 20% of the mix, some really interesting momentum. And maybe just touch on kind of what you're most proud of and ultimately kind of what you think about over the next year and how you're unlocking some of this Security TAM.

Yes. I think Security is one area where I'm really, really keen to see how this all plays out because our view on Security is that we've got a great portfolio. Fundamentally, we view Security as a data problem. We started with threat hunting capabilities and Security across large data sets well many years ago, even before we had a SIEM product. And our users started to use us for those kinds of capabilities. So we built SIEM into the product back in 2019. We added endpoint into the mix. That gave us a much better view and give customers a much better view with -- when you've got more data, more sources of data, you get a much better sense of fidelity on the underlying trends that you're seeing in that data. And as we moved from detection to also take action and protect the customers' environment, we added many new capabilities. You saw that now in the Elastic Agent that we launched in 7.14. We acquired Bill.Security and CMD, which now allows us to also to protect cloud native workloads at bill time and runtime. So that completed the XDR picture for us. But when we launched our capabilities, we called it Limitless XCR, which I think is one of the core differentiators for us because when you really think about the value of data in Security, data is very heavy. Data is also very expensive. So a lot of companies don't store the data for very long. They might store a few weeks, maybe a month of data at most. And that's why when you have these kinds of breaches and attacks and the ransomware attacks and so forth that happened, it takes a significant effort to figure out what really was happening, how long were those bad actors in the infrastructure because companies don't retain the data for very long. But with limitless XDR, because we can combine that with stack level features that we have when we talk about capabilities like searchable snapshots or storing data on object storage or storing it in frozen tiers, customers can store literally years' worth of data without breaking the bank. And that's just one aspect of how it becomes Limitless. They can also open up the analysis to a lot more than just a security group. Every DevOps operator can also be a threat hunter. So there's many different avenues that it opens up, but really allowing for significantly richer outcomes with a lot more data and a lot more history, I think that sets us apart. So I'm really quite proud of the portfolio we've built, and keen to see how that all plays out over the course of the next year or so.

There's been a lot of excitement around the pricing changes, and maybe there's some misperception. And so I'm just curious, if you could clear air. I think there's a lot of confusion around what change went in, like what are you doing. Can you just revisit that again and what you're seeing on the pricing side?

Yes, happy to touch on it. To your point, I think it was not a very significant change from our perspective. But back in the January timeframe, we changed the pricing of one of our subscription tiers, the enterprise tier. So by way of context, for those that might not be familiar with it, when we price our offerings, we've got a Gold, Platinum and an Enterprise tier. On cloud, we also have a standard tier. So we've got that tiered level of pricing, we introduced the Enterprise subscription tier on cloud back in 2019 when we acquired Endgame, and we started to put endpoints in that tier. And then, more recently in -- back in January of this year, when we launched our searchable snapshots feature, we put that into the Enterprise tier as well and we increased the price of the Enterprise tier. The reason for the price increase was that we are delivering significant value to customers. And with the searchable snapshots, they can actually drop their spending on third-party hardware and third-party infrastructure by a significant portion. And to us, that felt like it was an opportunity for us to participate in that value creation. And if we're delivering that much value, then to get some portion of that by way of revenue in that subscription tier. And so it was a great example. It demonstrated our ability to raise prices as we deliver value to customers. And that's the approach that we took. Now the Enterprise tier, as I mentioned, is a relatively small portion of the overall business. The price increase was also not very significant. And then, when you essentially apply both of those together, it really had no meaningful impact at all on the overall numbers for us just yet. I think over time, as the Enterprise subscription tier becomes more meaningful and becomes a bigger portion of the business, that becomes one more vector in which we can drive growth over time.

Is there an easy way to bracket what percent are on Gold, platinum and Enterprise? Is it...

There's -- the way I think about it is that the majority of customers that we have today will be on Platinum because it was the tier that had some of the more popular features. Enterprise is a relatively smaller portion of the business as is Gold. And I think over time, we will just see more of a shift. But beyond that, we haven't described the specifics in terms of those breakdowns.

I didn't think you would, but that's great color. You've been pretty clear, you expect the billings acceleration. Can you walk through what you're seeing in the second half that you've been seeing in the front half?

Yes, happy to. So as I mentioned earlier, right, there's a couple of drivers that are underway in the business. One is the pace of investments that we started to make in the back half and that we've continued to make here in the first half of this year, and I think those will start to bear fruit in the back half of this fiscal year as salespeople ramp up to productivity and so forth. And the second is just the broadening macro environment. I think those are -- and the improving macro environment. Those are sort of the to factors that were really underlying the thought process around why second half billings growth would be stronger than the first half as we built out our own internal models. Beyond that, there was nothing particularly unique to call out. So we're looking forward to executing to that model. We obviously had a great Q1, and looking forward to the rest of the year here as well.

Any -- a lot of questions around the hyperscalers, specifically AWS. Just curious kind of your thoughts on what's happening there. I know you had a little bit of a divorce from some of the business model, but a lot of questions around that. Can you maybe comment on what's going on with Amazon?

Yes, happy to. I think just by way of context, everyone knows that we first made our licensing changes all the way back in 2018 as we took most of the benefits of an open-source business model or distribution model in the form of free code, open code, the ability to interact with developers. And we put all of that under a proprietary license and then expanded the proprietary feature set quite significantly over the last 3 years. And then in January, when we announced the licensing change, we didn't expect it would have any impact on existing customers of ours. A vast majority of users were also unaffected. And it played out quite nicely. Amazon, as expected, said that they're going to [indiscernible] the older version of Elastic Search, which was the pure open-source version, and not even all of it. It was only the open-source features within that set of capabilities. And that's what they did. And they recently launched Open Search. I think over time, that actually gives us a net benefit because there's less confusion in the marketplace, and people are very clear that Amazon's offering is not the true Elastic Search offering. And I think that plays to our advantage over time. So we've seen good reaction from our customers. We've obviously enjoyed good cloud momentum here over the past couple of quarters, and I think that continues to play out over time.

Janesh, always good to see you. Thanks for your time today, and looking forward to staying in touch.

Yes. Likewise. Thank you, Brent. Thanks again for hosting us.

Thank you.