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

Welcome to our next session. I'm really happy to have the team from Elastic here. Janesh, you just had like we recently reported very strong for your as Q2 results. Maybe we start off to bring everyone up to the same page with like what were the highlights from your perspective? And then we can go a little bit deeper, well, I will do anyway.

Yes, Raimo, happy to touch on that, and thank you for hosting us. It's great to be here and great to be able to talk to everyone. So on Q2, look, we are very pleased with our results. We did better than expected, and we had record results across the board in so many different ways. Revenue was $206 million, which was up 42% year-over-year. On the cloud revenue side, which was a real highlight for us, Elastic Cloud grew 84% year-over-year. And now that's 34% of total revenue, and it's been growing at a very strong rate for quite some time now. We had over 17,000 subscription customers. We clocked more than 830 customers that have a CV more than 100,000. And even our customer metrics, I would say, over the last, call it, 3 quarters or so have actually been growing at a very healthy rate. So we've been really encouraged to see that trend. One of the interesting data points for us, which we also shared was that if I look at our cohort of customers that have ACV of more than $1 million, we now have more than 100 of those customers, and that's growing at an increasing pace, if I compare us to where we were back in fiscal '20 and '21. So we've continued to see great opportunity. We're investing towards that. We expect that cloud will continue to grow significantly faster than the rest of the business. We provided an outlook that it will exceed 50% of revenue in the next 3 years. So we're super excited about the opportunity ahead of us and looking forward to the rest of the year.

Yes. Okay. Perfect. Yes, that's a good summary. Let's start like with my questions slightly on the bigger picture, like what are you seeing in terms of the growth drivers at the moment for the business?

Yes. I think one of the most significant growth drivers for us, as I mentioned, is cloud. We see that across customer sizes, across segments, across geographies. Customers still have some workloads running on-prem, but definitely new workloads are increasingly starting in the cloud. And then when they run on the cloud, especially for larger enterprises, they are looking for a multi-cloud strategy. And they see that we're running on all the various cloud hyperscalers. We've got strong integrations with them. We support existing workloads that they have on-prem as well. The features and functionality in Elastic Cloud are highly differentiated . So they're all very excited about that. And cloud is definitely a big driver. And again, we've been making significant investments there. The second piece I would call out, Raimo, is our 3 solutions around enterprise search, observability and security. So within enterprise search, the ability to add a search box to your website, or from an observability perspective to monitor workloads in the cloud as well as on-prem as well as from a security perspective to detect and prevent cyber threats. And all of these are our big markets. And there's actually convergence happening across some of these markets. And despite that convergence, there's expansion happening. So the TAM is already very large. We're very well positioned competitively. Data volumes are growing. And as that convergence happens, we're at the epicenter of that with a single stack and a unified pricing model. So that works really nicely to us. And the combination of the 3 solutions then delivered on cloud, it's a great cocktail and it makes us very optimistic about the future. So we don't feel demand constrained and that's a great place to be.

Yes. No, I can't imagine, yes. And you mentioned the 3 pillars already. It's -- like I hope it's okay if we double click on them individually. Like in terms of like the -- let's start maybe with like search and endurability et cetera, but the -- like what are you seeing on the search side? Like, I mean that was kind of, I think, your first business. That's for initially, you grew up. Like is that still growing? Like what's the scale there? Can you talk to that, please?

Yes. Enterprise Search has been growing quite nicely for us across the board. We've made significant progress. In many instances, when you think about a search box on a website or on an app, in many instances, chances are Elastic is the default technology choice underneath that. And that's worked really nicely for us. We expanded our offerings even further with our Workplace Search offering some time back. And so we've just seen significant momentum and growth just as more data gets created and people feel the need to derive insight from that data with that explosion in volume and people feeling the need to drive quicker insights in that data. Those are both pieces that play to our advantage from a service standpoint. So we've continued to see great traction in that -- in our earnings calls. We provide highlights of that as well. So Search has played out quite nicely for us. It's still just about under 1/3 of the business, but growing quite nicely.

And the -- let's talk the young ones, like so Observability, that's obviously a new area. Even if I look at the conference, a lot of vendors talk about it. How is it playing out for you there?

Yes, very well, again, Observability remains our largest solution. And if I think about our history there, it's -- so in terms of mix, I'd say it's a little bit more than 40% of the overall business. By the way, just one qualifier for those listening to the conversation, the mix that we have across Observability, enterprise search and security, it's generally self-reported by our field, so it's directional in nature because we sell unified SKUs for different subscription levels. So it's more directional in nature. But broadly speaking, it's, I think, a little bit more than 40% of the business. We've seen very strong traction and growth there. In our history, people used to often start with logging and then extend into APM as an example, and we've continued to see strong traction on APM where people increasingly are adopting us for APM as a starting point. And because of the way we see these markets coming together and because it's all in a single data store, we think of Observability as one solution. You mentioned that there are many vendors that talk about this. I think there are still people that talk about the different elements of observability as separate features or a separate products, and we don't look at them as separate products. For us, it's all just part of a single platform. And that, again, talks to where the industry is headed, and we feel like we're a step ahead in that area. So I think that's worked out very, very nicely. And maybe just to touch on security as well while we're at it. We've seen security increase in the mix quite nicely. It's the fastest-growing solution area for us. It's roughly 20% of the total. So it is a longer-term play for us, but we're seeing significant momentum there. And across the 3 solutions, Raimo, we had shared a statistic sometime back, which continues to be true even today. When I look at the 3 solutions and I look at our customer base, more than half of our customers who have more than 100,000 ACVs still have adopted only one solution. And if I look at our million dollar plus customers, a pool of more than 100 customers, over 75% of those have 2 or more solutions. So that's just an indication for us of the upsell potential. And as we drive greater solutions penetration across that customer base, it shows you what the revenue potential can be as those transactions get bigger and the wallet share with those customers get bigger. So it's a great indication of that upsell potential.

Yes. No, yes, exactly. That sounds good. And I guess I revisit that before I go there, like if you think about Observability, like it does -- it's real. On the one hand, it looks like a very competitive market. But then the real thing is all the vendors are doing actually pretty well. So I don't think it's kind of right. It seems more like that the market expanding is so fast in the more complexity of the application landscape, more cloud, et cetera. So going into this now from your perspective, if you look at -- as the CFO at your kind of deal ratios and where you're winning, where you're competing, et cetera, like what are you seeing there in real life?

Yes. I mean from a competitive position, I'm really excited about where we are. I think we're in a very strong position with the strength of the product portfolio and the go-to-market motions are starting to take hold quite nicely on the cloud as well as with all the investments we've been making in the field over the course of the past year. For us, it's more about how best do we prosecute that market opportunity. Because as you said, the markets are growing fast. And as these industry silos are breaking down, we're finding that the opportunity set is actually expanding, not shrinking. And more customers are seeing the benefits of having multiple solutions in a single platform. So all of that really plays to our advantage. If I think about how that's working on the ground, I see our strategy working very nicely, right? We've been executing very well. As we continue to move further up with our investments on the enterprise selling motion, we are continuing to participate in opportunities that we were not seeing before. We're seeing the strength in the recognition of our product portfolio in various industry analyst reports that get published as well. And that's a lot richer than it used to be earlier as well. If I think about it from the lens of pricing or other kinds of dynamics, we've actually been at the forefront of driving a unified pricing model. And it's great to see some of the other folks out there starting to endorse a pricing model that is very similar to Elastic's. And it's been a great positioning strength for us. So we've not seen any particular change I would -- that I would call out as some sort of step function change in the last 90 days, but it's really been progression as we continue to move further up as we continue to see more of these opportunities, and we continue to deliver well in the marketplace.

And is the fact that you kind of actually were able to do with a lot of clients like did on-premise, give you like an earlier entry as they go to the cloud, and you can now kind of deliver on both sides?

Yes. I think that's certainly part of it, right? Look, at the end of the day, customers are keen to adopt new workloads in the cloud, but there's a large amount of workloads that are sitting on-prem. And some customers may choose to move those workloads to the cloud, but different customers that are at different points in their journey. We've seen a number of customers who years ago told us that they're going to move all their workloads to the cloud and here we are in the present and those workloads are still sitting on-prem. So our promise to customers has been, we'll be there for them wherever they are. Usually, data has got a lot of gravity and data is quite heavy. So people will deploy us wherever the applications are, wherever their infrastructure resides, and they will deploy us next to that. So given that we don't want to be the reason that somebody can't move to cloud or can't stay on-prem. So we offer both options. And I think it's a great way for people to start to adopt us, particularly if they're using us on the on-prem side with a free and open version, I think that's a great way to get started. But if I look back over the last several quarters, we've added, call it, roughly 1,000 customers a quarter for several quarters now. I would say the vast majority of our new customer additions are all on cloud. And most of them are starting slow and they are starting in the monthly cloud format, and that's why you'll see that monthly cloud format has been increasing and mix gradually over a period of time. And so it's great that they are now starting off with us in cloud. And as their workloads continue to grow and as their consumption grows, that just provides a great tailwind for the cloud business overall.

Yes, yes, Okay. Yes, makes sense. And since you mentioned cloud quite a bit, like let's talk a little bit about it. To me, this sounds like a really nice potential mix effect. If you have like your cloud business growing at EV as you do, which is kind of a very, very great healthy run rate. It's greater scale. It's now 1/3 of total business, that kind of should help you on the overall growth of the company or not.

Yes, I think that's right. I mean, cloud has continued to grow very nicely for us. And as I mentioned, most of our new customers are now getting added on cloud. We've invested heavily in that part of the business. We've built strong partnerships with the hyper scalers. And those investments are actually starting to pay off. And that's both on the technical side as well as the go-to-market partnerships. So having delivered pretty strong growth for several quarters now, we do continue to expect that cloud will grow significantly faster than the overall business, and that's why we laid the goal out or the outlook of exceeding 50% of revenue in the next 3 years. And you're absolutely right. As the cloud business becomes bigger and it's continuing to grow faster, the averages and the numbers start to play into it and that becomes a tipping point as the momentum in cloud starts to drive just greater velocity for us overall in the business. So again, it's -- we feel we are very well positioned for the rest of this year and beyond.

Yes. And is there -- will that be at some point like a natural balance? Because if you have like guys like -- let's -- like Barclays were because of regulation, et cetera, some parts of the business will have to stay on-premise. So how do you see that -- you gave us a number in 3 years' time, you will be at 50 -- want to be at 50% and then go higher. Like is there a natural level that you think about? Or is it just like -- because the cloud is growing so much faster for so much longer, you just kind of make on-prem smaller and smaller?

Yes. So a couple of thoughts on that. One is the outlook that we provided, it reflects our history and our trajectory that we've experienced so far. And on the one hand, while we -- while I talked about the fact that we'll help customers be successful in whichever format they prefer. The reality is we prefer cloud, we think it's better for the customer. We think it's better for us. So we lead with cloud. And we emphasize cloud in our selling motions. But of course, the customer eventually choose us. So we're not forcing their hand in any way. But as I think about how that can eventually evolve, I do think it will be a majority of the business in 3 years, but I will point out also that, that 50% is -- that's not a destination. It's a milestone. And I can't tell you what a specific percentage will be in the future because as you said, some customers will continue to deploy on-premise, whether it's for regulatory reasons or otherwise. And we won't want to abandon those customers. But fundamentally, as I said, we prefer cloud, we're always looking at ways in which we can go faster and also go further. So I don't see us stopping at 50%. I do think that eventually it continues to grow in a meaningful way. And fundamentally, we are making all the investments now and continuing to drive all the motions now to get that both, as I said, faster and further.

Yes. Okay. Makes sense. So -- The -- if you look at that growth, we all kind of need to learn to think about it and put it into perspective on the car growth. So if you think like you are really happy with the 84% growth. If you look at the share price, we actually -- some of the guys in the market were kind of thinking well, but the quarter before, you were at 89%. And if I do normal sequential growth, you could have been maybe about there, about an 84%. Like could you talk a little bit about some of the puts and takes that we need to consider? Obviously, we're kind of the number, monkeys, we just kind of do sequential growth year-over-year growth than very much, and there is the outcome, like what are other things we should consider?

Give you a lot more credit for that, Raimo, a lot of the investment is obviously as well because people are actually quite thoughtful about the way they think about our business. But look if I think about the puts and takes of the factors that people should consider when thinking about our success in cloud, one is we've obviously looked back at our history, right? We've maintained a very high growth rate in cloud above 80% for a few years now as the business has grown. And obviously, as the base gets bigger, the growth rates in percentage terms become tougher. But fundamentally, the most important thing is that we continue to see significant demand, plenty of demand for our solutions, the differentiated and proprietary features that are only available in Elastic Cloud, nowhere else. And then, of course, the strong customer preference that I talked about to deploy cloud in general. And I think that strength in cloud continues, and that will be a significant tailwind for us. The investments will continue to pay off. I don't think of this as a one quarter game. If I look back at Q2, again, 84% growth was nothing to stop at. We were actually very pleased with that dynamic. And fundamentally, that trajectory continues to be up and to the right. So we feel very good about the rest of this year on cloud and the business overall.

And are there kind of factors within a certain quarter on the cloud, like consumption patterns or things like that, that could influence a given quarter?

Yes. I think it's a little bit too early to tell for that. The vast majority of our business now is consumption oriented on the cloud. And so it's a little too early to tell what some of those eventual patterns might look like. But fundamentally, what we've seen in the business is that people continue to deploy workloads and having a consumption model starts to eliminate friction in the process. So they don't have to worry about a capacity constraint. They don't have to worry about being on-demand rates. They don't have to worry about hitting some sort of ceiling. When you then combine that with some of the technical features that we had introduced in cloud that allow customers to continue to deploy a little bit more easily, I think that just continues to get better over time. I don't know that seasonality has necessarily played a role just yet because I think there are some customers that will see strong seasonality, some customers that want it really depends on the nature of their business. Infrastructure is always on and attackers out there in -- that are the bad actors. They don't rest over the holidays. So there's plenty of things going on already. And fundamentally, we just continue to see that as we drive the investments with our cloud partners, that we continue to drive more customers, and we monitor the cohorts of those customers and watch their consumption increase. And as I look at all of those trends, we've seen just great strength in that over the last several quarters. So we continue to be excited by that.

Yes. And then talk about another factor that -- well, I don't know if it's even a factor. That's why I'm asking is like what's the story of like a term customer like an on-premise customer coming to cloud? Or in terms of the asking slightly differently, is cloud for you like new customer business and existing customers' new workloads? Or is it people realizing, okay, I don't need to do this myself. I don't want to do it myself. I'd bring it over to the last day cloud rather than Elastic on-premise self-managed.

Yes. It's a great way to think about it, right? Look, fundamentally, most of the new customers, as I mentioned, that we acquire are starting off with cloud. So net new workloads, net new customers, that's all organic growth in cloud. As I think about existing customers and existing workloads, fundamentally, do we see people moving existing workloads to cloud. I see that anecdotally from time to time. But as we were talking about the size of the market earlier and the size of the deployments fundamentally, given a multibillion dollar TAM and given our size, we feel our penetration rates are really, really low at this point in time across both cloud and self-managed. So fundamentally, I don't view it as a substitution story. And I'll also point out that we've not really instigated a change in the customer base towards cloud. So as I mentioned, while we prefer cloud and leave Cloud, at the end of the day, we let the customer decide. So we've not been trying to actively transition our entire business model in the past like some other folks out there have customers just choose cloud or self-managed fundamentally based on their needs. So I think our opportunity is very large. Our penetration rates are low. So we've got plenty of room to grow both on the cloud and the self-managed business.

And the -- Are you totally neutral on the sales force in terms of like if they sell a cloud deal versus term deal? Or do you try to at least start with the sales force to kind of give them a little bit of notch?

Well, at this point, our sales plans are neutral, right? We treated dollars a dollar. Now for the same workload, a cloud deployment might be larger in size than an on-prem deployment. But fundamentally, a salesperson retires quota based on the dollars that they sell regardless of what they've sold. So we've actually kept it really quite neutral until now.

And is there any difference for you as the CFO, that needs to look at profitability, et cetera? Like is the dollar worth the seem for you? So in other words, I'm trying to get towards the gross margins on the cloud. Is there how does that play out for you?

Yes. I mean if you look back in time, Raimo, we've done a pretty good job at, say, managing the gross margins, right? I do think that gross margins cloud will be a little bit of a headwind to gross margin as it continues to increase in mix. But I think we've managed that very well so far, both with just greater operational efficiencies as we scale as well as improvements on the cost side and just really strict discounting from a field perspective. They've credit to our field, they've actually maintained our pricing quite nicely out there in the marketplace. So I think all of those factors have helped us. And as cloud continues to grow, I do think that will be a slight headwind to gross margins. But fundamentally, in the long run, I just think about us as an enterprise software company. So as we get even bigger scale, some of those things naturally get addressed. And honestly, a higher mix in cloud with a slight headwind in gross margin would be a first problem to have.

Yes, Okay. No, makes sense. I think it gives you also more visibility what the client is doing, how he's using the system and stuff like that. So there's also advantages, I guess, yes.

Yes, there are significant advantages, right? We get the visibility, we get the telemetry. It allows us to drive much more sophisticated motions in terms of upsell, in terms of driving expansion. And many of those customers that increase and move up to higher levels of subscription tiers as well, which also aids in the gross margin.

Yes, yes, yes. Okay. Perfect. And we talked a little bit about term. I wanted to kind of double click on that one. What have you seen there in terms of like the end demand situation throughout the pandemic as well because it is kind of obviously more on-premise and that kind of other players was a little bit more impacted. What did you see there?

Yes. What I'd point out is that fundamentally, the customer demand has been more towards cloud just because of that's where the momentum has been, that's where they choose to deploy. The way I think about what happened in the pandemic, like many in the industry, we saw a benefit because customers increase their spending in the cloud through the pandemic. And people just fundamentally couldn't physically access their servers or their IT infrastructure during the lockdowns. And so a lot of that -- those new workloads naturally went to cloud instead of going on-prem. But we've seen that momentum continue even as things have opened up. And as people have started to come back to work and have more access. So we've seen that momentum and preference for cloud continue. So in terms of our self-managed business, while we were happy with the numbers, there's nothing in particular that I would call out there other than customers continuing to express a preference for cloud, which again is a great place for us to be.

Yes, yes, yes. Okay. Perfect. And then shifting gear to the last couple of minutes. So the -- if you think about it last quarter, if you look at the results, so people maybe wanted a little bit higher cloud growth, which kind of, okay, we discussed it. The other one was the links, which kind of annoys me a little bit because it's actually not a good metrics for you. Can you just speak to a little bit about like the changing dynamics around metrics, especially as more cloud is coming in and more monthly is coming in and why we might really kind of stop doing this?

No, I understand and, in fact, largely agree with that view, right? Because at the end of the day, if I think back to when we were a younger company and had first gone public, our Cloud was a much smaller percentage of the business. The business looked a little bit different back then. Monthly cloud was a very small component of the business. If I think about billings overall and how to think about that and what the right metric is as we previously said, look, we expect a stronger second half in billings because of the investments that we had started to make over the past couple of quarters. And that should start to bear fruit in the back half of fiscal '22. So to start with the year is playing out exactly as we expected. We called this 6 months ago, we reiterated that 3 months ago. And here we are, we delivered and executed as we said we would. So no real change or surprise there from our perspective. And in terms of thinking about the metrics, I do believe for the reasons that you outlined that revenue is fundamentally a better indicator of business performance for us. Calculated billings can obviously fluctuate based on timing and duration and so forth, but also the billing arrangements with the customers. But the other piece I'll also highlight, Raimo, is that it's also -- billings is less correlated with revenue in a consumption model. If you think about the consumption model, the revenue that we recognize in any period is variable based on the customers' actual consumption patterns. So it's not like you've got some deferred revenue rolling off the balance sheet on some predefined time-based runoff. So it's a much more current measure of actual customer behavior, which is why we continue to focus on revenue. And then -- and of course, from a -- if you look at the revenue, it also normalizes with time, right, in the sense that it includes a full 3 months regardless of whether you're on a monthly format or an annual format. And it includes the full effect of the adoption of our technology across all the different formats that we offer . And then monthly Cloud, of course, has no deferred revenue, no remaining performance obligations as well. So all of that makes revenue a superior measure, which is why I look at revenue primarily in the business.

Yes. And then -- you talked about that -- and why I'm asking if you just control billings doesn't matter. But like I do get the question because you said in the second half, things are getting a little bit better on the billing side, and you talked about the investment. What did you think about there? What is your confidence seems really high there, but what is it coming from?

Yes. I mean it's coming from the fact that we've been making investments in the business, as we said we would. We've executed to our plan so far. If I think about it, if you give you one data point, right, if I look at our headcount additions in Q2 organically holding the acquisitions aside, we added 280 people in the business. That's net adds, right, net of attrition. And that $280 million is significantly higher than what we've ever done before. All of our history is out there. And it's higher than what we've done before by a wide margin. And a big chunk of those investments have gone into sales and marketing. So those investments as people start to ramp will start to bear visible results in the back half, right? So that's the internal view around the confidence. And then externally, we talked about how customer priorities are shifting towards areas where our solutions are well positioned. We talked about cloud, we talked about the benefits of a single stack. All of those external factors continue to present great transitions that are playing in our favor and represent net tailwinds to us. So I think you combine all of that, it gives me pretty good confidence for the back half of the year.

Yes, yes. Okay. Perfect. Okay. Makes sense. And then the last couple of minutes, I wanted to talk with you, Janesh, because you're starting to get a real good track record because you were kind of very sober and kind of honest about like what you're seeing out in the field you didn't want to give us what we wanted to hear in terms of end demand has been amazing, and you've always kind of kept a more conservative approach around guidance, et cetera. So from that perspective, it's -- and I guess it goes back to your old boss, Pak Gelsinger VMware that always had that track record as well as you just say how -- what he sees. So from your perspective, like what do you see in terms of current market environment and how that has a port over the last few months?

Yes. Happy to talk about that, Raimo. So first off, I do think that we're in very exciting times, right? In terms of the evolution of the market, I think customers are continuing to increase their investments in digital transformation efforts, solutions we talked about, just a number of different market trends we've talked about already in this conversation. And we've been investing towards capturing that growth. So I do see that opportunity play out. If I think about our philosophy on how we've managed expectations. If I think back to fiscal '21, when we first laid out expectations for that year, going back to June of 2020 now, that was, if you recall, the very early stages of the pandemic, and there was lots of uncertainty in the market environment back then. So we guided extremely conservatively for fiscal '21, and we were quite transparent about the posture that we are taking because no one knew how COVID would really play out. And then as we entered this fiscal year, again, I was quite transparent to let people know that we obviously had much better visibility in fiscal '22 compared to the prior year. And so we would reflect that in our guidance philosophy. Fundamentally, the approach remains unchanged, right? We guide based on what we know and haircut for the things that we don't. But we leaned into that a little bit more. Q1 for us was a pretty big upside surprise because of the rate of customer consumption that we saw. We also had some benefit from professional services. But Q2, I would say, played out as predicted and as expected. And fundamentally, nothing has changed in that philosophy. We continue to be very excited about the outlook. We continue to have better visibility and confidence in the investments that we've made playing out in the back half. So that's how we would characterize it.

Perfect. Hey, Janesh, that was a great fully statement as well in my time also. So I'll let you go with that one. To continue to work with you. It's a great story, and I continue to like -- really like it.

Of course. Likewise.

Thank you.

Thank you for the support.

Thank you.

Bye.

Bye.