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

Well, first of all, for the nth time welcome to the Goldman Sachs Communacopia and Technology Conference. This is a really big deal for us. We brought together 2 major conferences. We changed the timing, and we wondered how it's going to work out. It worked out magically. So record number of registrations, record number of companies, record number of requests for one on meetings. So off the charts and thanks to you for your support and it doesn't -- it's not possible unless we have the right content. So I think it's great that you guys were able to make it. And thanks for your continued support and showing up to meet with our clients. Ash you and I have never done a fireside chat before. It was great to me. I think I met you at one of these RSA-related security I think for the analysts, the sort of thing that Nikola hosted sitting all the way back there. So welcome to the conference.

Thank you and thanks to everybody for joining us.

I think you've already gotten the question what attracted you to Elastic. I'm not going to ask that question. That's a very old question already, although you do look extremely young. But I do -- I'm compelled to ask you, so what is it that you uncovered in your first few quarters as CEO, congratulations. You're now a $1 billion run rate company. It's no mean feat to accomplish in Silicon Valley. There's a high level of attrition from $100 million to $500 million, $500 million to $1 billion. So what have you uncovered? What are your key findings as you've done your work? And I also, as an adjunct to that, where would you like Elastic to be in the next 4 to 5 years? Let's say you came back to the Goldman Sachs conference in 2027, how would you -- how do you think Elastic -- nobody knows there's no crystal ball here, but what are your aspirations rather 5 years out?

Yes. So let me maybe start with the latter and talk a little bit about what we're -- what I sort of continued to learn because I've been with Elastic for at least a year before I took on the CEO role. So I had the opportunity to look at a lot of things that were working well that I felt we could do even better within the company. But what do we see as the aspirations for the company? We've already talked about our $2 billion goal for fiscal '25. But just generally, if I just look beyond that even, at the end of the day, what Elastic does incredibly well, what we are very, very strong at is being able to deal with all kinds of unstructured data and being able to provide an ability to search across all of that unstructured data at scale very quickly, and then allow you to derive all kinds of insights from it. And if you look at the areas that we play in, and we talk about security, observability and enterprise search and sometimes it's easy to get lost in some of these markets because they are so big. But if you look at security, our sweet spot where we always lead with or land, if you will, is almost always SIEM. And SIEM is all about security analytics. And when you think about SIEM, it's -- the whole problem is about bringing in all of your logs, whether it's network logs, your infrastructure logs, your application logs and then being able to correlate against all of that data to uncover issues. Whether it's indicators of compromise, it could be IP addresses, it could be domains, it could be pieces of malware, hashes of different sorts, seeing behavioral detections because of things that might have happened that don't make sense next to each other. But it all comes down to that ability to deal with unstructured data very, very quickly and then building all the security analytics through that area. When you look at observability, again, there, our biggest strength is in log analytics. And logs are the most common form of unstructured data that you'll ever find. And the reason why log analytics is so critical for observability is, at the end of the day, it's in the log files that you see all the details of what exactly was happening in any line of code that was executing that lets you understand the root cause of the problem. Why was my application slowing down? Why were certain transactions failing? Why was the experience that the customer was getting when they accessed their application to the browser slower than not? Log analytics is a very critical area in observability. And that's where we are absolutely fantastic because of our core strength. So if you ask me, what do I anticipate as being the business trajectory? It is absolutely to be #1 in SIEM and expanding in security from there. It is to be #1 in log analytics and expanding within observability from there. And it used to be #1 in enterprise search. And it all comes down to that core capability of dealing with unstructured data in a way that nobody else can. If you step back and then say, what did I uncover in the first few months and quarters that I have had this role, fundamentally, from a product standpoint, we have tremendous strengths because of this core competency that I talked about. And then when you think in terms of our go-to-market motion, we've always had a really efficient bottom-up adoption motion because of the open source heritage and just the wild popularity of Elasticsearch when it comes to dealing with unstructured data, but then we have had this top-down motion, the enterprise selling motion. And traditionally, in the past, our bottom-up motion was always on cloud, at least it has been for the last many years. But the top-down motion was often with self-managed because we had a lot of customers who traditionally purchased our license software, what we call self-manage. They would purchase it, licenses from us, they would run it either in their own data centers, or more often than not, they would run it in public cloud, but they would be effectively purchasing licenses, software from us. And the cloud motion changes all of that because when we focus in on cloud, that bottom-up motion gets nicely connected to the top-down motion. So everything that we've been doing more recently has been all about how do we make sure that our customers recognize that the cloud is the best way to consume everything related to Elastic? How do we make sure that all our sellers are incentivized to sort of position cloud first and foremost? Now by the way, we'll never stop a customer if a customer says, for whatever regulatory reasons, I cannot touch cloud. I want self-managed. Great. We'll send you self-managed, but we lead with cloud. So the comp plans are designed that way. Internally, we have created a lot of telemetry tools that allow every one of our -- not only our sellers and our technical presales experts, but also our customer success managers to take a look at what is the consumption of the customer. How is that consumption tracking? If the consumption is going faster than normal, we want to have a conversation because we want to understand what are you trying to do. How can we help you optimize it? If it's going slower than normal, we want to have a conversation, and understand, are you stuck somewhere? How can we unstuck you -- unstick you? But that's -- the cloud gives you that visibility and that ability to connect the dots between the bottom-up and the top-down better than anything else can. And that's why you see the focus on cloud. And a lot of what have been doubling in on is what I think I talked about very early when I took on the role that cloud is going to be the area of focus. And through that, play, we will achieve what I feel confident about achieving in the 3 markets that we are in.

Got it. Excellent. So search is the mother lode of the company, you were known for search, Elasticsearch, right? Now getting into security and absorbability, there's more than Elastic. There are other companies that are equally enticed by the market opportunity and the TAM seems to be growing ever since the first company go public, which is about 10 years back. People got a narrow TAM, but then keeps expanding. But in that view of the expanding TAM that there is more competition than before. How should we think about your critical differentiators? Is it the platform, the capabilities of the platform or the open source heritage or some combination, but how should we think about your competitive?

The open source heritage in the platform absolutely are big factors. But the #1 thing that I'll keep coming back to is, our ability to deal with unstructured data at scale is unparallel. And even other observability companies under the covers will often use the free version of Elasticsearch. Now the free version of Elasticsearch by design at a certain point, like is not as efficient because we want our customers to pay us for the higher-tier features that leverage object storage more effectively and allow you to sort of scale horizontally as much as you want. Like for that, you've got to pay us. But it's a testament to the fact that dealing with unstructured data is really hard, that we get massively used everywhere, including in -- often in other observability solutions under the covers for dealing with logs. That's our core landing point. That's our sweet spot, if you will. We land with log analytics, and then we expand from there. And we started that way. Today, we have thousands of customers who're using us for application performance monitoring. And the way we were able to expand into APM is basically with that lead motion of log analytics. We started with log analytics. You've already got your logs in Elastic. Logs tend to be the heaviest amount of data for all of your observability that you're ever going to deal with because as most people know, you can't throw away your logs. You can -- most people will retain metrics for 7 days, maybe 15 days, and then you toss it out. Logs, you need to retain for compliance reasons. And so logs tend to be the bulkiest data element of everything that you have for...

They log for a reason.

Exactly. And once you have that, then it becomes an easier explanation to say, look, you want to be able to correlate this with what's happening at your application layer and you want APM tracing. Well, we've got that same agent. We've got agents for APM tracing into all of your typical languages, and we support open telemetry. So if you have other agents, you can still pipe that data into us, and we can now start to deliver value on APM. And that's how we've been growing. We've been growing with that landing spot of logs. And even in security, that's how we've been sort of expanding. We start with SIEM. Once you're doing all your threat detections and your threat hunting in Elastic in our SIEM, then the conversation becomes, "Okay, if you're happy with it and you're like really using this as the primary tool for your security operations center, for your SOC analysts, well, do you know that, that same agent that's pulling in the data into your SIEM, that same agent also has capabilities for doing behavioral detection and ransomware blocking and anti-malware capabilities, You can just turn those on. If you are using CrowdStrike or you're using Microsoft Defender, that's fine. We'll coexist with them. But if you want to use our technology for doing a lot of those things, you can just turn it on and it's minimal expense because of our consumption-based pricing model." But we will never lead with endpoint security because endpoint security is a massively crowded market. There are lots of other vendors in there. And this is the core point that I'll come back to that our primary strength is in unstructured data, logs when it comes to both security and observability. And we will always start there. And then we'll expand from there to the extent that we can, but we want to be #1 in the areas of SIEM, in log analytics and enterprise search, like you've said, like we are pretty much the de facto standard there. So we are continuing to grow as that market is growing.

Got it. Ash, I was just curious, this past discussion, how has been your journey from CPO to CEO? All of a sudden, you're not just doing one thing, but doing like million different things. What has been that process like for you?

It's been fun, yes. It's always useful when you have an understanding of the company, the people, right? So for me, it wasn't having to drop in into an organization where I didn't know anybody and it makes it easier, I have to say. But it's -- look, it's a technology that I've used, purchased in my past.

you told me about your expense at McAfee that you deployed...

Both my last 2 companies, I used Elastic and loved Elastic, which is why I felt very excited about joining Elastic as the CPO. And the team is an incredibly innovative team, and it was -- it just made it easier from there. And this is -- everybody knows I am -- this is my first gig as a CEO. So you always want to have some things working well for you and my knowledge of the products and the customer space, having been a customer was very helpful without doubt.

What was it like when you got that call you that you've made CEO?

It wasn't a call, it was an in-person sit down and -- yeah. Look, it's always surreal. But yes, I'm enjoying myself. I didn't get to do this as much so -- I'm new at it. So hopefully, you'll all forgive me for my gaps, but...

You're doing great.

It's-- I believe in the markets. It's a wonderful problem that we solve for customers. We know our core strengths very well. What I focused most on is letting that innovation continue to thrive, while, at the same time, really being very sharp on execution. I think that's what I believe we can really help to accelerate the business. And I have conviction in the markets and the technology and having been a user helps.

Exactly, exactly. So you've set a target about $2 billion in fiscal '25. And I'm sure that life exists beyond fiscal '25 because fiscal '25, it's almost -- you can almost look at fiscal '25. So as you look to grow the company beyond the time frame, what should we be thinking about as the key drivers that will help you accomplish that goal? And also drivers are one thing, but then how do you see making changes to the go-to-market? Every company's strategy changes that $100 million in revenue is not the same as $500 million, $1 billion to $5 billion, things change, right? As you look ahead, the drivers that will get you to that revenue goal near term, longer term? And how do you plan to do things differently with GTM, scaling, partnerships, what does that road map look like?

So a lot of what we need to get to $2 billion -- I'd say all of what we need to get to $2 billion, we've already been -- we've started and been doing for some time. There is life past $2 billion, of course, and I'll talk about that. But the -- to me, the future for us is all driven through our focus on cloud. The markets that we are playing in, up to the $2 billion mark and even beyond that, the 3 market areas that we are in with the specialization that I talked about, those markets are big enough that we can easily cross the $2 billion market. The SIEM market is a huge market. Again, the log analytics market is a huge space given how big observability is. Same with enterprise search. When you add all of those up, the headroom for us is more than sufficient to cross the $2 billion mark. What we are focused on to ensure that we can get there effectively and efficiently is everything that we need to drive cloud. Our cloud net expansion rate, like we've talked about, has been higher than the net expansion rate for the overall company. It's been north of 140%. And it's stayed there, right? It stayed north of 140%. So we see that more efficient expansion because there's very little friction in the cloud. You can get started very quickly with Elastic Cloud. You can ingest in data very quickly. You can get to your first dashboards. You can start to see that value. And because you don't have to have any additional conversations with us as you're choosing to bring in more workloads for more capacity, the expansion also happens more gracefully and more naturally. As cloud was 39% of our overall business in the last quarter, as that continues to grow in the direction it's going in and crosses the 50% mark, the numbers start to kick in, that benefit starts to naturally come in. And our core competitive differentiation has held -- not only held very well, but continues to go in the right direction. And the marketplace partnerships, which is one of the reasons why we have spent so much time and energy in making sure that we clean up the situation with AWS. Like we've had a wonderful relationship with both GCP and Azure. Those have been very strong drivers for our growth. AWS, I think, everybody here, if any of you have been an investor in Elastic or looked at us, you know that it was a challenged relationship to say the least. They basically, until earlier this year, if you went on the AWS website, you basically saw 2 "Elasticsearch" services. One was the AWS Elasticsearch service and the other was Elastic. And that's a problem, when you have 2 offerings that both say Elasticsearch, like which one are you going to go with? And that's not easy to rationalize. You end up having to -- when you're having to explain, you're already behind. And it was really critical for me to clear the air on that. It was a multistep process. It was chess, not checkers. But we needed to get them to a point where we felt the competitive moat against their product was very strong. We felt that the opportunity in the market for creating that -- creating that distinction was good. And so last year, as you know, we changed the license terms. We fully expected them to fork, and that is exactly what they did, which was perfect. Once the fork happened, then the trademark resolution went through much faster. Because now their product is called Opensearch. They've got no defense for basically saying why they should be using Elasticsearch. And all of that kind of played out. Now if you go to AWS website, there's only one Elasticsearch that's from us. This other thing is called Opensearch. The product differentiation between these 2 products is significant. That is no different than what they've had with MongoDB and DocumentDB. Most people don't even remember that DocumentDB was an old fork of MongoDB. But it didn't -- it hasn't really affected MongoDB because the names were different. Most people don't realize how much confusion that name creates if you have the same name. So I feel really good. The partnering amongst the sales teams has improved. We are -- we've always had, in the last few years, Microsoft and GCP actively bringing us deals. And we are starting to see that on AWS now because -- and we expected that. Their sellers have always received quota credit. So those are the things that cash, we've got to -- we're really focusing on and it all -- like the tip of the spear is cloud.

You might run it to Thomas from TCP.

Yes. Great.

He starts talking at 1:15, minus 15 minutes before that, I think there's a pretty good chance to get spot them. Judson was here yesterday from Microsoft Chief Commercial Officer. We've talked a little bit about their partnerships, et cetera. And the commentary is they're very bullish on cloud Infrastructure as a Service, Platform as a Service. I want to come back to cloud transitions can be tough. It starts with the product functionalities, the cloud functionality on par with the on-prem. There's -- when your customers love you for your on-prem technology, it scales really well, searches really fast, and that's the one thing, lightning fast searches on Elastic, right? How do you convince the customer that that's like a thing of the past and so cloud is where we're going? Is it that all the functionality and the improvement and the innovation research and development engine is working overdrive on the cloud side so it becomes so obvious that you got to do this? Or is there something else? And how do you get these on-prem customers to -- I hate to use the word migration, but how do you migrate to the cloud? A lot of things there. Sorry for that question.

No. So we very intentionally, about 1.5 year or 2 years ago, started making sure that cloud became sort of the primary place for development in a way. And if you look at our cloud offering today, it is not only on par, but it's superior to our self-managed offering. And that's not because the code base is different or anything of that sort. The core base is actually the same, which makes it very easy for somebody if they have a cluster that they are self-managing to migrate it to Elastic Cloud. The difference, though, is when it comes to cloud, we are able to deal with cloud-native things more naturally and better. So as an example, in cloud, we have auto scaling. So you never need to worry about managing the size of your cluster, adding more capacity to it. In the cloud, we'll just natively scale it. You just need to literally turn on a toggle, configuration toggle that says auto-scale enabled. And once that's done, as the data that's being ingested as the workloads grow, we will automatically scale your instance size and manage it for you. Another typical value that customers will often get excited about is, in the cloud, we are able to take advantage of the latest and greatest hardware offerings. So support for Graviton, as an example, support for the latest AMD chipsets that GCP rolled out. Both Microsoft and GCP are also looking at what more can they do around ARM-based chips that tend to be more efficient. Like we just support all of that under the covers for you, and you don't need to worry about like having to change your infrastructure, your hardware. All of that we can do for you out of the box, searchable snapshots, the ability to deal with data that's -- rather than storing it on disk, storing it S3 or other object storage, which really reduces your cost of infrastructure very significantly. All of that started with Elastic Cloud. And those become natural reasons for customers to adopt Elastic Cloud. Migrations are very hard. And that's why...

Birds do it so easily but the cloud thing...

Yes. That's right. If you're a migratory bird, it's much easier. I suppose, I don't know I've never talked to it. But it is one of those things where, honestly, my experience has been that customers tend to cap and expand, right? In other words, like if I have a self-managed instance that's on-prem in my own data center, I'm going to let it grow because that use case is already there. The data is already there. Whatever additional data is coming in, we'll maintain it there. All my new development, I'll do in the cloud, right? And so we see a lot of that. And our model is not to force people to migrate. Like I would never want to do that. Like because I've been on the other side of that equation. And, as a user, like if somebody was forcing me to migrate to the cloud, I'd look at that excuse, I'd look at that and say, "Okay. If you're forcing me to migrate, I might as well look at what else is out there."

Yes. Yes...

And by the way, we are benefiting from that as others are trying to pull that stunt. To me, like the most important thing is how do we just make sure that our cloud offering is exceptional. And we make it easy for you. If you do have this model of, okay, I'm going to let these workloads run on-prem, and I'm going to now have all my new workloads in the cloud. I still want to have views across all of them. So we came out with cross-cluster search capabilities. I think it was like 1.5 year or 2 years ago. We then evolved it to allow cross-cluster search across multi-cloud environments. And then most recently, in June of this year, we allowed that for hybrid environment. So I can have an Elastic cluster on your own data center. I can have an Elastic cluster in GCP in Elastic Cloud, one in AWS, one in Azure. And I can make all of them in a federated way, look like it's one environment.

You know what Goldman Sachs would call that? Polycloud.

Polycloud? Okay.

George Lee, Chief Information Officer, who we met. He presented earlier this morning, and we talked about Polycloud business.

The private cloud makes it poly.

I think it's just the Federation of services across third-party hyperscalers and being able to have a service that runs through and pick the best of each of these hyperscalers with regards to functionality and deliver a service that can run across all 3. I think -- we shared the explanation by the way. That's not the way George had explained it, but...

But you would be amazed how many customers will come to us and say, "I want to purchase Elastic and I want to purchase half of the capacity that I need through the Azure marketplace, and I want to purchase half of it through the AWS marketplace." Like that is very common, like we have customers doing that all the time. And our model is, if I can ensure that all deals go through marketplaces, I would do it. Like it's -- marketplace partnerships reduced friction when it comes to the sales process because every major customer will have a precommitment that they've already made to cloud infrastructure providers. And so just us piggybacking off of that is wonderful.

We've got about 7 or 8 minutes and before I turn it over to our clients, the macro, any thoughts on the macro environment, demand picture, et cetera?

So we -- again, like this is something that I talked about even in our earnings call just under a month ago. But we haven't seen any change in the demand environment for us. I was actually in Europe just last week, I came back on Saturday, as I mentioned to you. And I was in Europe meeting with customers and the demand patterns that we are still seeing are the same. What I would say is that, clearly, when I was there last week, apart from the Queen's death, like the other thing that was in everybody's mind is a strengthening dollar. So the strengthening dollar is definitely on people's minds. And it seems like the considerations around the energy crisis, especially in Europe, everybody sort of already factored that in, and people are thinking about, we know there are certain critical areas that we need to spend in, and then it becomes a matter of how can we do more with the partners that we have. So they were all really good conversations, like there was nothing that looked different from what we've been seeing. And again, like part of what I believe it comes down to is where we specialize when you're dealing with security and observability and even that specifically on logs, which you can't stop storing and you can't stop analyzing, like that just gives us a degree of resilience. But yes, but I'm watching it carefully because I see the same things. I haven't seen the market today, but I...

You don't want to see.

I've been to I shouldn't look...

Inflation thing just crushed us. Any questions Sorry, there was a dark note. But I'm still hopeful that Jan's call for a soft landing.

There you go.

And if it does, please go ahead.

Can you talk about reinvesting in the business versus operating leverage?

So we've been very disciplined about how we invest in the business and where we invest in the business. When the pandemic hit, we had really slowed down all hiring. And that just meant that we had a need to sort of build up the capacity that we needed in terms of selling capacity. And we talked about the fact that we were going to have sort of an injection to catch up on that, that's sort of done and now we are back -- we sort of tapered back to a level that's more steady state. So the investments that we are making, primarily are in that selling capacity area. So you'll see that. And that efficiency plays out because there's a timing element, right? You're adding people, you're letting them onboard and ramp up. And once they ramp up, then that sort of catches up. In terms of R&D, our efficiency continues to get better. Even in the go-to-market, our efficiency continues to -- one of the factors that we focus on is the marketplace is like anything that we do to the marketplace ends up being a really good thing for us. On R&D, by the way, the big advantage that we have is, it's a vertically integrated stack. So all data, irrespective of whether we're dealing with logs, metrics, traces, security logs or endpoint data, it's all ending up in Elasticsearch. So we don't -- unlike most others, we don't have different data stores that we are managing. We are not putting logs in Elasticsearch and something else in Grafana -- sorry, [indiscernible] and something else in some other time series database, like we don't have that problem, which also means that it's not like a portfolio where I have a separate management console, 3 different management consoles and 4 different data back ends. Like it is just pretty efficient. And as we continue to scale, that sort of plays out better and better. It takes that scale to sort of truly build up. But we are going to continue to be disciplined. And we've talked about the fact that you should expect to see in FY '24 and FY '25, several points of margin expansion. And at scale in time, this is going to look like the margins of any software company.

Maybe a couple on the first one, just around enterprise cloud expansion. [indiscernible]

So what we typically see is like when you look at the cohorts and cohort-based analysis, obviously, when customers -- because it's a consumption-based model, when customers start, it takes them a little bit of time to ramp up. And then that ramp starts to build. And one of the things that we intend to talk about in our upcoming Investor Day is more of that insight into how the cohort-based expansion happens. But it takes a little bit of time. So if we sign up a new customer this quarter, it's going to take them some time to implement. And after the -- after 60 to 90 days, like you see that expansion starts to build up, next year gets even higher and then so on so. But that cohort-based analysis we'll show you. The thing that's important to understand is, our expansion motion is driven by multiples. It's not new use cases, but it's also just data growing, right? The third thing that is important is also the fact that customers can up level to higher additions of the product. So our enterprise tier, which is the highest tier. So we have enterprise platinum, gold and standard in the cloud. Standard is basically the equivalent of the free product and self-managed. In cloud, there's nothing like free because you're paying for even that basic layer. But enterprise, which is the topmost tier, which has a lot of these capabilities like searchable snapshots, capabilities like the federated hybrid search that I talked about, all of those are in the enterprise tier that's now our fastest-growing tier. So we've been successful in basically increasing the ASP from customers that way as well because the unit costs for that are higher in terms of what we charge the customer. So there're multiple ways in which that expansion happens, but it takes a little bit of time before a new customer that joins starts to contribute in that way.

And I guess I know we've touched on [indiscernible].

Yes. So there are -- there were several things that gave us a lot of confidence in that $2 billion number. One was the NER in the cloud that we talked about. The second is the -- our cloud growth. Today, cloud is 39% of our overall business. And if you then think about the fact that as our cloud business gets to the 50% mark, and we've talked about that, that we expect that to happen at the end of Q4 FY '24, fundamentally, the NER, along with the cloud motion, which is working very well, the numbers sort of give you that ability to get there. And we've sort of tested it in multiple ways. Like there were multiple paths to getting to the $2 billion that gave us a lot of confidence in that number. And that was the real reason. Like there was -- there's a lot of confidence internally about what the data is showing us.

Okay. That wraps it up. I think we're at the end of the session. Thank you, Ash.

Thank you very much. Thank you. Appreciate it.

Thank you as well for your questions and interactions.