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

Great. Thanks, everyone, for joining us. My name is Mike Cikos, I'm the lead analyst here covering Elastic. With me, I'm pleased to say we have a fireside scheduled with Elastic's Management, Interim CFO, Eric Prengel as well as, I know Anthony Luscri and Janice Oh from the IR team are here with us as well. We have 40 minutes set aside for this fireside, but I just want to flag to the folks who are sitting in the audience, there should be some sort of Q&A function on your side, please if you have questions, your questions are way more interesting than mine, make sure you get those in, and we'll do our best to get to it while we have Eric here. With that out of the way, Eric and the team, thank you again for the participation. We really do appreciate it here.

I think, super basic, easiest question you'll get all day. But for people who are maybe newer to the name or dusting it off, just a quick refresher who are Elastic, what do they do?

Yes. At a high level, Elastic is a broad search platform and that search platform can be used for 3 different functionalities. We've got the core search where you can use Elastic in your enterprise for search, we can power the search bar that you might have either in enterprise on a website, et cetera. Elastic can also be used for security, where we predominantly play in the SIEM space, and then we can also be used in observability where we play across all the different capabilities and observability, but historically, a lot of our strength is in logging. The one thing I'd add is that Elastic has evolved over the course of the last 2 years as generative AI has become a bigger and bigger part of the ecosystem. Our core search functionalities are really critical to generative AI and well before it was becoming part of the everyday vernacular of software investors. And before ChatGPT became big, we've been working on Vector database capabilities, on Vectorization. And so for us now, generative AI is becoming a much bigger part of what we do. And that really plays across all 3 of our capabilities. If you think about security, we're infusing AI across everything we do in security with our -- a lot of the capabilities that we have, the SIEM and observability, and that's interesting. It makes us more competitive in those spaces. But where it's really most compelling for us is that when you think about the search capabilities, we really are now having a whole expansion to our TAM as people are building their generative AI applications on top of our search capabilities and that's a really compelling and exciting thing for us. So we're getting more competitive because of the generative AI that's infused in our platform in both security and observability, but in search, it's really a massive TAM expansion for us as you think about what that creates for us as an opportunity.

Excellent. Excellent. And two things before we go into it as well. Interesting, and I appreciate you calling out Vector at the store, just a quick sound bite from like probably a year ago, there was a private database vendor that I was talking to when the market was still going through this debate of whether or not Vector needed to be a stand-alone offering versus maybe more of a feature capability as part of another broader offering and the private company, no skin in the game, not necessarily competitive, but volunteered on their own. They're just like, "hey, everyone's trying to featurize or add this capability, Elastic had Vector now for a handful of years." So kudos to them for being able to see that. So good on you guys for going to where the puck was going before it was actually there.

Thanks for putting that out there because it's something that we've been saying, but it's nice to hear it coming from someone else. The other thing I'd say is that 1 year, 1.5 years ago, I'd say that there was a lot of noise in the market. People didn't know who was going to be winning share. And now more and more, I think it's -- you're hearing third parties as you talk to some of our customers, as you talk to people in the marketplace, I think that Elastic's name is coming up more and more. And there's -- it's clear there's a lot of demand for what we're doing and that we have a differentiated solution as you think about the Vector Database functionality and all the other capabilities that are used to build a generative AI application.

That's great. And I know I definitely want to hit on the technology while we have you here. I think one thing, again, in the interest of just setting the table for the audience, I know the October quarter earnings feel like forever, though, but there were some interesting things that I think are probably worth highlighting. So maybe from a -- for a quick 30-second pitch, like what were some of the highlights. I know like third consecutive quarter where you guys cited that search continues to accelerate now. But what else would you be pointing investors to from that quarter?

Yes. At a high level, what I'd say is that Q2 was a really strong quarter for us, and it was driven by solid sales execution. We saw a lot of customer commitments come in. We exceeded guidance on revenue and profitability. And Q1, obviously, you are aware, we had some issues with our customer commitments and our go-to market. And I'm sure we'll talk about that later, so I won't belabor the point. But Q2, we really saw that get back on track, which was great. We saw key wins across all of our solution areas. So where search continues to be the part of our business that grew the fastest. We also saw really strong wins in observability and security. So that was really positive. And we talked about this a little bit on the call, but those new commitments with generative AI almost doubled in dollar volume compared to what we saw in Q1. And we actually had 3 deals that were over $1 million on a commitment basis for generative AI. And that was hugely positive and a really strong trajectory for us. So we're very excited about that. We're really seeing a lot of increasing commitments that are tied to generative AI and that are tied to people wanting to bring our platform on to use generative AI or to use generative AI on our platform that they're already using. And while we're seeing a lot of these commitments and we're seeing a lot of trajectory, it still is early days from a revenue perspective, and that's going to take time to ramp along with these commitments. Revenue is going to trail a little bit. Generative AI is clearly the fastest-growing part of our business. And we think that as it continues to grow, as you see more of those commitments, you'll see revenue in the future years continue to have a bigger and bigger role associated with it. We also saw -- in addition to generative AI, we saw customers continue to consolidate onto the Elastic platform on both security and observability. So we saw a nice momentum in those businesses. And we continue to be focused on displacing incumbents and really migrating people over on to our platform. The consumption trends in the second quarter were positive, both enterprise and commercial generally did what we hope they would do, and we actually saw a little bit stronger-than-expected consumption from some of our larger customers, which was obviously a huge positive. So overall, I'd say that Q2 really was a reaffirmation of our strategy that our go-to-market is functioning the way we'd want it to. And our hope and expectation and what we're seeing in the business is that we're well on our way to getting back to the pace of sales execution that we've demonstrated in the past. So a very positive quarter.

It's great because I know that you guys also talk about customers, whether it's the -- as a mark on the total customer base or as a mark on your higher spend cohort, who is actually using Elastic from a GenAI perspective. I'm curious when you're having customers sign these commitments, are we at a point now where we can say like, hey, Cikos is going to come in and sign a commitment for $100. If GenAI attached to that, that commitment now is maybe above 10 or above 20, like are we getting that? Or can we pinpoint it to that level of granularity or not necessarily?

No, it's a great question, and it's something that we look at a lot. So as you think about the commitments that we're getting. People -- we don't have a separate SKU for generative AI. So when people are buying our products, they're not buying x amount of search, x amount of observability. They're buying ECUs, which they can use across our platform. And so we don't have a separate SKU where we can measure the dollars that are coming from GenAI specifically. What's really interesting though is that we're seeing so much more momentum, so much more interest around deals that are tied to generative AI, and that's really where we're seeing some traction, and we're seeing a lot of positivity. And to a degree, it's not even that it's 10% uplift or 20% uplift, it's the deals that we might not have otherwise seen happen could be happening because of generative AI and because we're getting that engagement with -- even if they're not buying us purely for generative AI, there's a level of engagement, a level of interest on up-leveling and who we're getting access to in their organization that's helping us move deals forward in addition to all the generative AI interest that we're seeing.

It's great to hear. And from a demand perspective, again, I know we're all into the new year here. I think people are trying to get a sense of what you're hearing from customers, how are conversations tracking. I mean, obviously, there's a lot of enthusiasm behind GenAI, but if I compare where we are now versus where we were a year ago, is there reason to be maybe more optimistic? Or are you hearing anything on budgets as an example? Can you comment on that?

Yes. No -- I can. I wouldn't say that there's been a change in the macro as you think about the last couple of months. There's certainly nothing that we're willing to commit to at this stage. It feels like it remains stable. We're seeing customers remain cost-conscious and they really want to get value as they are deploying their dollars. To your point, there is a lot of interest in generative AI. And while we're not seeing IT budgets growing as a whole, what we are seeing is that there could be some shifts or some specific carve-outs for AI within existing budgets. So it's not that the budgets are growing, but people are more focused on generative AI in terms of where they're deploying their spend. And so as we think about the acceleration in search, and we talked about this a little bit, that really is a generative AI-driven thing for us. And so that remains positive. One thing that we've talked about a little bit is the SMB segment. And so far, we haven't really seen that come back. That part of our business, which is what we call monthly cloud. And every quarter, we report on where that is as a percentage of our total business. That has been much flat -- more flat, a little bit flattish is how I describe it. And we've disclosed that each quarter and at a high, it was something like 17% of our total revenue, and it's come down to be more like 13% of our total revenue, where you've seen the subscription revenue that we have outside of the SMB monthly cloud business grow really nicely that SMB monthly cloud has been a lot flatter in our business.

And just to make sure we're doing our proper diligence here that flattish type behavior we're seeing out of SMB and maybe we can lead this into a broader conversation. But is that in any way related to competition or new entrants or change in win rates or is that really just a function of potentially the more -- the greater macro sensitivity that those SMB type organizations have.

Yes. The way we think about it is, I think it's much more of the macro and the sensitivity that the SMB has. As we talk to some of our peer organizations who have similar go-to-market motions, I don't think that they -- I know that they haven't seen something different than what we're seeing. They tend to say that pay-as-you-go or the SMB portion of their business is a little bit slower to recover than some of the more enterprise side. And I think what we're seeing is really consistent with what others have been seeing. And we've seen it really since some of the changes that happened in the economy a couple of years back now, and it's just been consistent since then. As you think about the competition, we haven't really seen any changes in the competitive environment. Across the board, we think there's an ongoing opportunity for us, and we think that we can continue to gain share. As you think about our win rates, they haven't really changed much. It's been pretty consistent. And if you think about it from a solutions-specific perspective, in security, it feels like SIEM is evolving to this 3.0 version, that's going to be a lot more AI based. And we think that given all of what we do in AI, that's a place that really favors us and that we have an opportunity. And we've come to market with something called Attack Discovery, which is a product that we have where we leverage LLMs to analyze the alerts and do a lot of triage work. So what a SOC analyst used to have to do and was a very manual process, they can now use large language models and our platform to do. And we've really gotten tremendous positive response around that and it's something that we think is a big opportunity for us. In observability, it feels like customers are demanding a lot of these similar AI-based innovations and observability. Obviously, there's been a move over multiple quarters and even multiple years away from these siloed tools and more in favor of this end-to-end observability platform with a multi-signal approach. And I think that we're at the forefront of that trend. And then in search, we talked about this quite a bit, but that's where we really see ourselves an established leader in this space and over the last couple of quarters. There's something that our founder Shay said, at a meeting that gets quoted internally at Elastic a ton, and he says, "search has a budget again." And it really is true. As you think about the opportunity with generative AI and how so many companies are so focused on this, search does have a budget and search's a market that we're really strong in. And so this interest in generative AI, coupled with our differentiated technology has been hugely positive for us and has helped us grow our TAM and we've seen that search business really accelerate nicely.

If I could just continue on that search piece, right? So if you have a customer that comes to you, maybe they wouldn't have come to you otherwise, right? Forget the ASP -- potential ASP outlook for a second. But like are you hearing anecdotally from customers as far as the ROI that they're achieving or what kind of -- are they citing to you specific gains or enhancements that they wouldn't have gotten otherwise, do you have a better feel or anything to quantify what the customers are receiving from that perspective.

Yes. In terms of ROI, it's a tough question because a lot of things are still early days. We have some customers and what they've said to us is they've kind of seen a massive decrease in the hours that are needed from some of their employees in terms of their ability to service, like the call centers, chats that they've been more efficient. They've been able to do more. We've got 1 customer. It's a large bank, and they're using us for some of their wealth management capabilities, where they're enabling their wealth management employees to engage with customers to have insight into the customers in a different way than they had previously. And there's a ton of value in that. So it's not just that they're spending less, it's also that they're able to do more, and that's creating this tremendous opportunity as you think about what our customers can get. And I think it's early days still. This whole generative AI phenomenon is still in the works on an earlier days basis. But as we think about it evolving, as we think about the opportunities that some of our customers have talked to us about some use cases that they can see. And even though they're preliminary, some of the use cases that they already have in place, there's definitely an ROI that can be really strong with the capabilities.

And for those customers as well, is there anything notable as far as what kind of companies are coming to the platform? Like in any way is the customer profile changing as you see -- again, it's like self-selecting, right? They're telling you they're coming for GenAI, but like based on that, are they more tech-focused? Or are they more manufacturing background? Is there anything vertical-specific or size employee base? Or it's really just across the gamut.

It's a great question. it feels like just geographically, and I know this isn't the question you asked, but I'll give it to you anyway and maybe and I'll keep going. It does feel like America is ahead of -- the Americas are ahead of the broader geographies in terms of their adoption of generative AI. They're a couple of quarters ahead. And that's not atypical for the Americas to be a little bit ahead of some of the other regions when you think about technology adoption. It does feel like they're a little bit ahead. And even the public sector in the U.S. is probably a little bit behind the private sector in terms of adoption. Interestingly, we are seeing large financial institutions spend a lot of time on this and different institutions are adopting things at different rates similar to the way you think about the cloud. And so we'll see how that all plays out. But it doesn't feel yet that there is 1 industry that we've seen really spring ahead of others in some of the external customer-facing, digital markets. If you think about a consumer-facing company, they might be doing something to help with the search on their website where you'd be going from traditional search to semantic search. So they are making things a little easier in that respect. But we're all seeing financial institutions think of a lot of different use cases across the board, whether it be some of the things we talked about earlier with that wealth management use case to fraud detection or what have you. There's -- it really does feel across the board, Mike. And maybe as we get further along a couple of quarters from now, I'll say, oh, this industry is using it more than this other industry, but right now, it feels pretty broad-based.

Understood. Okay. And again, you guys have a couple of different solutions here and a couple of different factors. So I don't want to over index the search even though it is an exciting part of the story for sure, if we just look at security and observability for a second, right? There have been some announcements from other vendors on the competitive front. I would be interested in hearing how has that competitive landscape changed for Elastic more recently?

Yes. I'd say broadly, there has been a huge change to the competitive landscape. The consolidation trends that are in play today have been going on for a while. And to a degree it started when the economy really shifted. I think that with some of the consolidation, we've been more focused on it, and we're continuing to pull on that thread. But it's been here for a while. As you think about our strength, it's being able to ingest unstructured data from any source in observability. It's logging in security, it's SIEM. But what we're seeing, and we talked about this a little bit before, is that AI is really transforming both those spaces. And I think that if you think about our business, it's 3 solutions built on top of the core platform and our core platform is where a lot of the engineering work happens. And so a lot of our core platform is being infused with this generative AI DNA and with our company being very focused on generative AI in terms of the platform and the search opportunity, that plays into how our products are evolving in both security and observability and our platform getting that -- those AI capabilities in it really lends itself to the strength that we're seeing in those other portions of the business where we think that even though the TAM might not necessarily be growing for those 2 businesses, we think that we do have an opportunity to win more in security and to win more in observability than we might have before. And we talked a little bit about Attack Discovery where you can automate those investigations and triage. And that really came about because of all the time that we're spending in generative AI and all the capabilities we have there. And we've been investing in features like that in features like our AI assistants that are in observability and security, the ESQL, Express Migrations, a lot of things that we're doing that -- where we're really leveraging AI to make it easier for customers to adopt Elastic and to get more value out of us. And that really makes us more competitive in those 2 spaces.

Awesome. And if I just think out loud again, you guys have had this competitive dynamic for some time. But again, just given some of the changes out there, the characters that we're up against, is there a reason to think that the pipeline building that's going on for security, observability in any way, like I would imagine that it's accelerating in some way based on that competitive dynamic, but is that fair? Or is that still too early, need more evidence building?

We've continued to build pipeline. We're super focused on it. it's an important thing for us. I'd say that there's -- it's probably a little -- it's still early days to say that there's been a massive change. I think that we've built pipeline nicely. We're happy with what we've been doing with pipeline in the last -- since Q1, we obviously had some issues with execution. We've put a lot more emphasis and rigor into how we think about building pipeline. We have weekly call that we go through where we work through the pipeline, not only for Q3, obviously, which we're deep into, but for Q4 and even into Q1, and there's a focus on that that's even more intense than what we had prior to Q1, and I think that's helped us not only build pipeline but make sure that we're building the right type of pipeline and the pipeline that we're building is moving through is progressing through the pipeline in the right way. And I'd say, to bring that back to your question about security and observability, I'd say that we're seeing it build in those spaces as well as others as well as search obviously, and that we talk a lot about search, there's a lot of excitement for search, but observability and security are key parts of our business, and we continue to be focused on building pipeline there. And our goal is that in security and observability, we continue to grow the business really nicely, and we view ourselves as a market share taker in those businesses.

Got it. And I want to shift to the tech for a second. Just because it really does feel like over the last year, the number of product announcements or enhancements, seemingly just -- it just feels like it's accelerated, right? And so as we exited calendar '24, go back to the November-December time frame, there were a couple of different announcements that I wanted to hit on. The first is the company had announced Elasticsearch, the Logsdb index mode that went GA in mid-December. And just as a reminder for folks, what are the anticipated benefits for customers from this Logsdb index mode?

Well, before I get to that, I just want to say something else. You say we've been making a bunch of product announcements. An investor once said it to me, he said, Eric, we probably see more press releases from you around product announcements than we do from most of your peer companies. And I'd say, yes, we've been very focused on technology and on innovation. And hopefully, that shows up in terms of some of the things that we're adding to our platform, some of the things that we're doing to differentiate ourselves. So -- and he was like, no, it's a good thing, definitely. So I just wanted to call that out since you mentioned, it pulled on that string in my mind. So back to the Logsdb point. What we've done with Logsdb is we've really used it to optimize storage and query performance for log data. And as you think about log data, it's really the foundation to visibility into the IT environment. And these growing log volumes are generating by infrastructure and applications, and that's creating more cost and forcing customers to limit how much they collect and retain. And they want to retain more, they want to collect more. But at some point, they have to make a choice between what is the value to retaining these incremental logs for this additional time and what is the value of collecting these additional logs in our system, and they have to make value choice. Is it worth the dollars to do that? With Logsdb, we intend to address this challenge by reducing the cost to retain their logs in their system. So obviously, we wanted to be the leading data store for a logging data. And I think with Logsdb, we make that even more clear as we're going to reduce the storage footprint significantly to enable customers to store and retain just much more data and enable them to get more meaningful insights by having that data in their system for a longer amount of time. And as you think about it, the full capability of Logsdb is something that we're going to hold off for the enterprise tier. And what we've seen from customers is that as we provide them with features like this, it's going to help them upgrade to enterprise because they're going to have more value out of it. And then once they've upgraded to enterprise, they're going to be able to put more data into our platform and get more value out of our platform. So it really plays to the benefit of our customers in a lot of ways.