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

Welcome to our next session I am really happy to have the team from Elastic here.

Since you had earnings last week, like maybe we start with a quick recap to get everyone on the same page, and then we can take it from there. Like -- so what were the highlights from you guys last quarter or from the quarter?

Yes. So maybe I can start and then I can ask Janesh to also add in. So in terms of the quarter itself, in terms of revenue and growth, obviously, we exceeded the guidance that we'd given and just stepping back, what I'd say is that even given the macro impact that we saw in October -- that we experienced in October, we feel really good about the overall strength of the business. In terms of our competitive environment, our win rates against competition, just the way we are seeing our customers continue to use our products and the strength there, we feel really good about the long-term prospects for the business and the strength in the business. Specifically, in October, we saw a couple of things play out that we had not seen until then. One was in the SMB segment and SMB typically tends to show up in monthly cloud. In the SMB segment, we saw a definite inspection -- a closer inspection of consumption. So we saw customers tightening their belts. The consumption was impacted. And we also saw an impact in terms of the number of net new customers in the SMB segment getting onto our cloud platform. So that was -- that was one thing that was very apparent. And you can best see it in our monthly cloud numbers because if you look at the month-over-month growth -- the quarter-over-quarter growth in cloud, you can see the direct correlation in what happened in SMB in monthly cloud. The second thing that we saw was in enterprise and especially in parts of Europe and parts of Asia, where the strengthening of the U.S. dollar had an impact on budgets and so on. We saw customers taking longer in terms of approval cycles. So more inspection, more approval cycles. Just -- CFO is getting involved at levels of deals that we had not seen in the past. And October is the last month of our quarter. So we definitely saw that impact. And just in terms of the deals themselves, a few deals slipped. Since then, several of those deals have closed. So we have not seen any change in the competitive dynamics or the deals going away. This has been a [ lengthening ] and some of these deals slipping. And the way we look at the future is we are conservatively looking at what happened in October and projecting that and saying that in the near term for the foreseeable future, we are not expecting the situation in SMB to get any better. We are also assuming that what we saw in October in terms of just the approval behavior and enterprise sales cycles and so on, that, that will continue. So we looked at all of those factors and guided appropriately. But again, coming back to where I started. In terms of just the ways in which customers use our products, the competitive environment and our ability to differentiate, our ability to land and then expand. All of those, we feel very good about. That strength continues. And that's what gives us confidence in the business.

I mean, the things like look it's a macro environment. It's got nothing to do with you. It's like everyone is going to have a slightly tougher time. In theory, you should have an advantage against the other guys just from your pricing model because -- and maybe, -- and Janesh maybe you can talk a little bit about like maybe how you price and then we can talk a little bit about the benefits that you should get from that?

Yes, happy to, Raimo. I think you're spot on that when people fundamentally think about the idea, particularly in this environment that people are looking -- no longer looking for best of breed in everything, but they're looking for the best of suite or the best platform and the fact that we have a unified platform in which you can bring data from multiple sources for multiple solutions, that's always been one of our core competitive strengths. And particularly when it comes to unstructured data and how you land with logging and SIM, which are really the 2 main entry points where a lot of our focus is in terms of landing new customers. But even from a pricing perspective, we give customers enormous flexibility because our pricing model is based on resources. And so what you actually consume, if you think about Elastic Cloud, which is now 39% of total revenue, that's consumption-based revenue. And you pay for what you use. If you think about it, there's no shelfware and for most other situations, the way people are used to buying software or selling software is that there's always some level of estimation that you need and you always usually end up over-provisioning and then you don't use some licenses or what have you. And that's just not true in the context of the cloud business. So that's a fantastic advantage in terms of our pricing model. I think that positions us very, very well from a competitive standpoint, looking ahead. When you think about TCO calculations, when you think about the power of this on a converged platform, that all plays to our advantage. I think the one thing I will call out, though, is that those kinds of shifts take a long time to happen. As Ash said, we haven't seen any significant change in competitive intensity against us from the -- in the near term. But you can clearly see in a lot of the customer conversations that we are having. People are increasingly focused on thinking about how best to consolidate their spend on to the Elastic platform. And I think that takes time to play out. You have to work through the mechanics of when their renewals of their existing contracts come up and so forth. But it's clearly a trend that plays to our advantage.

Yes, yes. And I mean, the -- I don't know if you have a cost analysis, but like from the conversations I have with people in the field, Barclays is a big customer, like the cost advantage is meaningful that you can offer that your kind of model. Is that like something that is -- continue to play out in terms of if you have customer conversations if other guys come up for renewal?

Yes. So -- go ahead.

Absolutely. So clearly, Barclays has seen that firsthand as a customer of ours, but the overall TCO argument works very well. I mean, obviously, as we project forward, that's an area, as you can imagine that we are leaning into because if that's an advantage and that's what customers are going to be looking to do, we definitely believe that it's going to be something that works well for us and for our customers. One of the examples I talked about in the earnings call was a large 8-figure deal with a financial services customer, that consolidated all of their APM, their application performance monitoring on to Elastic. And that customer had traditionally used us for log analytics. And what's interesting about that use case was not just the broad usage of APM, but the fact that they consolidated on Elastic displacing other technologies and what really worked very well for us, which continues to be a big strength is the open platform that we have. And just to give you some sense of what that means. They have close to 3,000 applications. It's a bank, so they haven't traditionally leveraged the cloud much, but they are starting to, in a pretty significant way. And as they're moving those applications to the cloud, they want to rethink how they do observability. And what really attracted them to Elastic was the fact that they have multiple different use cases. There are people who need that APM telemetry for retail banking to make sure that an application, both on mobile and on the web, is appropriately fast and responsive. They've got use cases around risk management. They want to build risk models to understand the kind of activity that they're seeing. They have use cases around interbank commerce and making sure that they can do fraud analytics on the transactions that are going through, and they have a lot of requirements where different groups want to not only look at the APM data but correlated with other data sources. So for example, wanting to understand and make sure that they were able to deliver the best possible response on the largest and most valuable transactions. Now to be able to do that, you need to pull in business data. You need to be able to pull in business transaction data, and that's completely a different type of data. It's got nothing to do with traditional observability or APM and other platforms you would not be able to do it in just 1 particular tool because most of these APM tools, observability tools have been built specifically as observability tools. That's all they do you can't think of it as a way to bring in additional sources of data and get other kinds of insights into it. And for them, it would have meant either investing in multiple different technologies or doing everything with 1 thing, which is Elastic because of our open platform. So it was a consolidation play from a cost perspective, but it was also just this notion of the thinking about it as a platform, more than just a tool, and we're seeing more and more of that.

You kind of raised a good point there now because the thing that -- the next question that comes out of that is like where I'm looking very surprised like do APM that well that you can take an APM guy out. Like talk a little bit about the evolution of your products in terms of like being able to handle that now? Because like I remember like I remember when the -- who did you buy on the APM side like years ago. That was like the first foray, and it was like a small business now. And I hear from my guys as well that they kind of look at you at APM, like very closely, you have the capabilities to be able to do that. Like can you talk a little bit about the evolution of like the product outside of [ logs ]?

Our focus has always been on this notion of getting behind open technologies. So open telemetry, which has been a pretty significant driving force in the overall observability space. That's something that we are seeing a lot of traction on. Just to put it in terms of numbers, about 30% of our customer clusters that run observability also have APM in them. So about 30% of our customers are using us for observability, are also using us for APM. That's a really interesting statistic, right? Because -- if you think about where we started and even now, what is our land motion, our land motion is almost always on log analytics because that's where we have had the most experience, that's where we've had the most mature capabilities, if you will. And so when we lead with log analytics, our win rates are very strong. But once we are in and once somebody is using us for logs, then having that conversation of "hey have you looked at what we have for APM." And the value proposition of the pricing model lets us basically tell the customer just try it for a few applications. You don't have to make an all-in purchase. You don't have to go all in. Just try it for a couple, see what it feels like. The incremental cost to you is going to be negligible, if you're just doing it in a couple see what that looks like. And once you've got that experience, then you can decide if you're getting everything that you need and more from Elastic and then you can make that decision on where you take it from here. Obviously, most customers do not want to make a complete switch until renewals are due for whatever the incumbent might be. But we -- that's the way we lead into it. So from a product standpoint, I'd say that for APM now, we see a lot of great wins, like some of these examples that I talked about, we've been investing in areas like metrics for infrastructure monitoring. One of the things that I talked about in the earnings call was the work that we are doing on being able to treat time series data, especially metrics data in more efficient ways that will allow us to reduce the overall storage efficiency -- to improve the storage efficiency, and that's going to make us that much more appealing for metrics use cases. So on observability, we feel very good about the road map. And then on security, again, some of the stats that I shared, we've seen now very good traction on our XDR use cases. So going beyond just detection because SIM is where we almost always start with, but then getting more into being able to protect and being able to do some endpoint protection or some cloud workload protection that's starting to take traction. About 20% of our customers are using some XDR use case where you're going beyond just detections. And then we now have 30 customers for our Kubernetes CSPM. CSPM, cloud security posture management, I mean it's brand new, but the fact that we are getting that kind of adoption, I think just speaks to even what Janesh was talking about earlier, in this climate, there's going to be a greater interest in customers to consolidate, to do more with fewer platforms and platforms, especially that give them better total cost of ownership.

Yes, yes, yes. Okay. Shifting gear a little bit, Ash like you're our now CEO for a while. If you think about like when you joined like what were your action points? We obviously have Shay still in there now as the CTO, so he's kind of focused back more on the R&D side. Like what were your action points and where are we on that journey?

Yes. So to me, the most important thing that I wanted to ensure that our entire organization is focused on was on cloud. And it's not just about products, but sales and go-to-market and how do we optimize the way we go to market in terms of looking at customers by segment, looking at the cost of customer acquisition and how do we optimize that, both in terms of the self-service motion as well as leveraging marketplaces. So if you see the continued traction with our cloud partners, that's been a big area of focus for us. Historically, we had great relationships with Microsoft Azure and with Google Cloud, but we did not have that same kind of setup with AWS. So ensuring that we could improve our relationship with AWS and get it to a point where it became a -- just like Azure and GCP, a key area of growth for us. That's been a priority. And then cloud. And all of this sort of -- if I were to describe it in one word, it's effectively cloud, the focus on cloud. So where we are on that journey? I think I feel good about the progress that we're making on all fronts. In terms of the go-to-market, we changed -- not only did we drive more focus in the org, but we also changed the compensation plans at the beginning of our fiscal year on May 1. So we are seeing the field really lean into it. In terms of the products, we clearly are doing a lot more in terms of cloud. We talked about serverless and what we're doing there. I'm very excited about that work. In terms of just the overall view on consumption. Even from a back office standpoint, what that means in terms of making sure that we think about consumption as being the primary thing that everybody works around, customer success, support, et cetera. And then the last thing that I'd say is just in terms of being very focused on not just growth but profitability. And some of those things obviously require some difficult decisions which we made last week in terms of how we went to market for supporting SMB. That's going to be all self-service now. In the past, it used to be sales assisted, which meant that we had an SMB sales team that would try and convert monthly customers into annual customers. And we did not feel that, that was getting us the right kind of return because SMB was still largely monthly cloud. And when you have a monthly customer who's using us on a monthly basis, converting them to an annual contract -- there's some value in that annual commitment. But at the end of the day, it's not changing the ARR, it's not changing the trajectory of the business. And servicing that segment through that high-cost model does not make sense. So we made some difficult decisions. These are never easy, as you can imagine, but they are the right decisions to make. And that has allowed us to both get more focused in terms of enterprise and commercial, where we see the greatest opportunity, in terms of cloud where we see continued opportunity and make sure that we are being disciplined in spend everywhere else.

I mean, staying on that subject a little bit, like it's interesting like the go-to-market over the last year has really changed from what I can see in the -- from the field, et cetera. And it almost feels like you still could do more in terms of getting closer to the customers, like in terms of like more outbound rather than kind of inbound, et cetera. Like where are you on that journey in terms of like kind of selling to enterprises with a number of accounts per sales rep that he's serving, et cetera, where are we on that journey?

So in terms of the capacity, the selling capacity for enterprise and commercial that's unaffected, right? So in the actions that we took last week, none of that was changed. If anything, you're going to continue to invest in that area because we see...

I think you'll see opportunity there. Yes. So my point was more than you probably need more [ gas ]...

I mean part of what lets you do that is when you see opportunity for growth in certain segments, you want to invest there, but you don't want to do that across the board if you're not getting the right ROI, right? So stopping spend where that spend is not helping you is as important as then redirecting that spend to where it is giving you the right kind of returns. So we feel really good about just the capacity that we have now in the teams. And obviously, as we go forward in FY '24, like I would expect that we will continue to look at what the growth opportunity is and invest appropriately in terms of selling capacity. From a productivity standpoint, look, we added a lot of sales reps in the last, I would say, 12 to 18 months. And they've been ramping nicely. So as that -- the reps continue to ramp, the productivity, you continue to see the benefits. You see us focused a lot on our CSP partnerships. That gives us some advantages. The growth of cloud through our cloud marketplace partners, through cloud marketplaces. Once again, even in Q2 grew over 100% year-over-year. So that just shows that there is a lot of momentum and potential in the work that we are doing with our cloud partners, and we're going to continue focusing on that. So I think you should -- as you look forward, just to be very blunt about it, like we see us as continuing to be a growth company, but we are going to be making sure that we are not chasing growth at any cost. It's going to be much more disciplined as you've seen from some of the things that we've done. We are going to be focusing on growth where growth is possible and then ensuring that we are driving profitability and continue to drive that in the business.

Janesh, it's a question for you then on that subject. It does feel a little bit like the -- I had MongoDB here who kind of talked about the -- with interest rates higher, you need to have a higher ROI hurdle for investment, and it does feel a little bit like you guys kind of using that kind of approach as well, to kind of revisit a little bit like how did I spend my money? It's like -- is that a fair -- like maybe talk a little bit about what's going on internally for you?

Yes, I think that's a fair way to think about it, Raimo. Look, there was a point in time in the past where we never -- as a company, never prioritized growth at all costs, but we definitely leaned in and took a little bit more risk with some of the investments that we were willing to make to see if they actually play out over time and whether they return the results that they were expected to return. And if they didn't, we tried to cost correct a little bit, but maybe let those experiments run a little bit longer than we should have. The whole sales-assisted motion in SMB is a great example of that, that we've talked about. And I think the current philosophy continues to be that we will continue to drive for growth, but it's never been about growth at all costs. It's about disciplined and profitable growth. And we will be much more selective in terms of where we're investing. And look for those signals much faster, take corrective actions much faster as needed and set the internal bar a lot higher in terms of what kinds of returns we expect on the investments that we are making. As Ash mentioned as part of all of these actions, we've maintained enterprise selling capacity. In fact, our intent is to continue to increase that further. As we move further up in the enterprise, particularly with cloud, those transaction sizes get larger as well, that helps us move further up, it helps people be more productive. I think those are all the right investments for us to make. But we're being much more vigilant about how and where we invest the dollars. And that's true across all the functions.

And then I mean you talked about profitability. You gave us a little bit of an outlook about maybe kind of remind us like where you think profitability is evolving for you guys?

Yes, happy to. So look, in the past, we've talked about several points of margin expansion in fiscal '24 and '25. And we didn't put a number out there, but the way most people interpreted that it was a, call it, a few points of expansion. So a lot of people had [ expect ] for the low to mid-single digits for the next fiscal year. And with the actions we've taken, that leverage model does not change fundamentally. Our intent is to continue to invest in the business, but at a rate of expense growth and investment growth that is slower than the rate of overall revenue growth. So we will still have operating leverage in the model every year. And the way I think about that is essentially, it hasn't changed the trajectory of the slope of the margin improvement, but it's lifted the whole line up with the actions that we've taken. So we feel very good that the actions that we have taken will help us get to the 10% operating margin number for next year. There's no additional action that we need to take to get there. So I feel very good about that, but we did took the action once, we went deeper than we needed to so that we could keep some room to reinvest. And beyond this, it's a question of investing in a pace that's consistent with the pace of growth and opportunity that we see.

Because the one question I got from investors there -- and that's my follow-up here on that one is like that 10% for next year is a quite significant step up. And so then the question that you get is like, "well, gee, like you kind of want to keep talking about growth, but then now we're just kind of getting -- ramping up the margins." But it's more like a reset in a way like an internal reset and we move from there? Is that kind of the better way to think about it?

Yes, that is the way to think about it. So it's not that we would expect 10 points of operating margin expansion every year. That would be too much. but we will have some consistent rate of operating margin expansion every year that's inherent in the business. Again, I'd call that several percentage points.

Yes, yes. Okay. Okay. Makes sense. And then peak -- Sorry, I could say then, well, does that mean you were running quite inefficiently before? Sorry.

Well, it's not that we are running inefficiently, right. But when you're investing for growth in a certain way. And as I said, you take more risks. Not all of those investments necessarily play out. You give people a little bit more latitude to cost correct. And I think in the current environment, particularly as we look ahead, it's important for us to invest for growth, but it's important for us also to learn faster and fail faster where those experiments aren't working and redirect resources faster where needed. Also, there's some just natural efficiencies that we get with scale. The G&A organizations, for example, don't need to grow at the same rate at which they've grown before. As the business continues to grow 30%, 40%, 50% in the past and at a slower rate of growth in the future, some of the investments that are more fixed in nature, don't need to necessarily scale at the same rate. So that's the way I think about it. And we're still focused on driving growth, but just thinking about the bar as being much higher internally in terms of how and where we invest.

And Ash, for you, is it partly also a function of like now that the product has reached a maturity -- scalability, you see how some enterprises are using it that you kind of -- the path is much clearer because it's like, yes, we're an enterprise play. Yes, we do SMB, but it's going to be like a self-serve or like if you want to work with us is, more low cost. So you kind of -- you don't have to experiment as much because you know this is the path we want to go. Is that also kind of part of that?

I think you look at innovation and making sure that you're continuing to keep that competitive gap that you have, that edge that you have over the competition is very, very important. So I don't think that's ever going to change, right? And we'll keep focusing on that. I think what is very clarifying is the clear focus on cloud. We've talked about that. The other thing that we're also looking at is what are the right long-term bets to make to make sure that we can improve the overall efficiency, not just the customer experience, but also of the business. So when we talk about investing. So we talked about the go-to-market piece, which is the SMB and how we service it and so on. But there are other areas of investment like serverless. And what serverless lets us do, and I've talked about this in the past, but the work that we are doing to come up with the severeless service, that effectively lets users not only use Elastic for different kinds of use cases, but it will also allow us over time to improve our gross margins. Because today, when you think about how we price for Elastic Cloud, we let you pick the specific instance type on EC2 or the equivalent services on Azure or GCP, the underlying compute, we let you pick the instance type. And every customer can go and see what the cost is of renting that instance type from AWS, Azure or GCP. So that complete transparency just means that when you're selling value on top, that's always a harder conversation because then customers look at it and go, "hey, can I -- if I just purchased software from you and go and rent my own EC2 instance, what is the delta." So there is a lot of nuances that we need to work through. When we move to the serverless model, fundamentally, what it does is it just completely decouples the way you perceive and use our service from the underlying infrastructure. And that correlation just goes away. And that allows us to then, as we continue to improve the underlying usage of infrastructure under the covers, use the infrastructure more efficiently, more of that, some of it we can pass on to customers, but some of it can accrue to improve our gross margins. That is -- so effectively, this move to -- the work that we're doing on serverless is not only important for how customers will experience the service and what they'll be able to use it for, but also internally for our gross margins. And that's the kind of work that we are continuing to focus on.

Yes. That's actually a great closing statement because I see my time's up.

As always extremely efficient.

Yes, exactly. German efficiency, yes. Ash and Janesh thank you, thanks for joining me. Thank you.

Thank you.

Thanks for hosting us Raimo.