Good day and welcome to the Elastic Third Quarter Fiscal Year 2022 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. And I would now like to turn the conference over to Janice Oh. Please go ahead..

Thank you. Good afternoon and thank you for joining us on today’s conference call to discuss Elastic’s third quarter fiscal 2022 financial results. On the call, we have Ash Kulkarni, Chief Executive Officer and Janesh Moorjani, Chief Financial Officer. Following their prepared remarks, we will take questions.

Our press release was issued today after the close of market and is posted on our website. Slides which accompany this webcast can be viewed in conjunction with live remarks and can also be downloaded at the conclusion of the webcast on the Elastic Investor Relations website, ir.elastic.co.

Our discussion will include forward-looking statements, which may include predictions, estimates or expectations regarding the demand for our products and solutions and our future revenue and other information.

These forward-looking statements are based on factors currently known to us speak only as of the date of this call and are subject to risks and uncertainties that could cause actual results to differ materially. We disclaim any obligation to update or revise these forward-looking statements unless required by law.

Please refer to the risks and uncertainties included in the press release that we issued earlier today included in the slides accompanying this webcast and those are fully described in our filings with the Securities and Exchange Commission. We will also discuss certain non-GAAP financial measures.

Disclosures regarding these non-GAAP measures, including reconciliations with the most comparable GAAP measures can be found in the press release and slides. The webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link.

Our fourth quarter fiscal 2022 quiet period begins at the close of business, Friday, April 15, 2022. With that, I will turn it over to Ash..

Thank you, Janice. Hello and welcome everyone. I am honored to join you on my first earnings call as Elastic’s CEO. Since assuming the CEO role in January, I have spent time with many of our teams across the company, learning, understanding and speaking with as many Elasticians as I possibly could.

It has been tremendous to be welcomed so warmly by them. I am continually impressed with the passion of our organization, the knowledge of the team, and most importantly, their commitment and dedication to serving our users and customers.

I would also like to thank Shay Banon for building an amazing foundation here at Elastic, a foundation that we will continue to grow and expand upon, especially as we accelerate our opportunity in the cloud, a growth area where I have strong conviction.

I am very excited about the contributions that Shay is already making in his return to the role of Elastic’s CTO, driving even greater innovation as we continue to increase our cloud focus. Q3 was a strong quarter. We delivered revenue of $223.9 million, up 43% year-over-year.

I am very pleased about our performance in cloud, where increasing consumption trends, fueled cloud revenue of $80.4 million, up 79% year-over-year. We will spend a fair bit of time talking about our Q3 results and business momentum. And there are three key messages to take away from today’s discussion.

First, the markets we operate in are immense and growing, a $78 billion opportunity and we are well-positioned to succeed. Second, our focus in Elastic Cloud will be a major driver of growth for our business as more organizations embrace the cloud.

Third, our team has both the drive for innovation and the operational expertise needed for success and that will continue to show in our results. I joined Elastic a little over a year ago as its Chief Product Officer.

I had been a big fan of the Elastic platform even before that, having used it in the past for implementing various search powered solutions for observability and security. So, the size of our market opportunity and the breadth of use cases was clear to me.

Whether it’s the complexity of modern cloud-native applications, the sophistication of cyber threats or the explosion of customer-facing services that rely on data, organizations are constantly being challenged to extract value from data with speed, at scale and with relevance. This is where search comes in.

It’s the most intuitive and attractive way to approach data and therein lies our biggest strength and differentiator. Elasticsearch. It’s the best foundation for addressing modern observability, security and enterprise search needs.

When our customers bring their log data, their trace data, their metrics data, their threat data, all of this data into Elasticsearch, they can use our advanced machine learning algorithms to correlate across logs, traces and metrics to quickly identify performance issues for observability.

They can use a rich set of behavior detection rules for identifying threats across their entire environment. They can seamlessly adopt Elastic for more and more of their observability, security and enterprise search use cases. They can do this at scale, with great speed and all in a single unified data store with a unified pricing model.

This foundation of Elasticsearch enables our many innovations across our platform and solutions. As data continues to grow in volume and importance, we believe Elastic will be essential to our customers’ success. Very recently, I met with several of our customers in Europe, including BMW, Deutsche Telekom, SAP and several others.

When I speak with customers, there are three universal themes and takeaways from our conversations. First, customers are unconditional invoicing their reliance, on using Elastic for observability, security and enterprise search every single day to extract value from their massive amounts of enterprise data.

I especially heard significant interest in using Elastic for SIM in security and for log analytics and observability, where customers are looking to displace incumbent offerings with Elastic.

Second, they value Elastic as a unified platform within and across observability and security, especially with our resource-based pricing model, which allows them to scale their costs in more manageable ways, even as their data volumes explode.

This is something that our competitors often struggle with, where their costs tend to become prohibitive as data volumes grow. Our strategy is resonating with our customers. Many of whom now use us for more than one solution.

And third, our investments in Elastic Cloud are positioning us better than ever to address the large market opportunity across our three solution areas. And our opportunity in the cloud is significant. Growing Elastic Cloud is a top priority and our performance in Q3 is a testament to that focus.

36% of our total revenue is cloud compared to 29% a year ago. The majority of our customers are already in the cloud and new and existing customers are universally driving more workloads rapidly to the cloud. Elastic Cloud is ready for them today and will get even better in the future.

We continue to expect that over 50% of our revenue to be driven by Elastic Cloud in the next 3 years and we will not stop there.

With our deepening technical and go-to-market partnerships with cloud hyperscalers, frictionless onboarding experience with Elastic agent, pre-built integrations and so much more, we are incredibly optimistic about Elastic’s future in cloud. There is no better indicator of our progress in the cloud than the success we are seeing with customers.

In the third quarter, we expanded business with our customer, Barclays, who is using Elastic observability on Elastic Cloud to power their global internal center of excellence that supports hundreds of use cases across their business. Barclays uses all three Elastic solutions.

Their new deployment of Elastic observability on Elastic Cloud creates a single pane of glass to monitor their data across the bank. Now, they can spend time serving their internal stakeholders instead of infrastructure maintenance. Similarly, one of the world’s leading digital travel companies also expanded business with us in Q3.

They use Elastic security on Elastic Cloud for SIM, threat hunting and fraud detection and analytics throughout their organization.

Elastic enables them to significantly increase the efficiency of their security team and they are also seeing immense value from searchable snapshots, which allows them to store a year or more of security data for compliance requirements and future analysis in low cost object storage in the cloud.

We also signed on a new customer, Canvas, the global visual communications platform and one of the world’s fastest growing tech companies with over 75 million monthly active users. Canvas is using Elastic Cloud to deepen their security capabilities and enable more effective threat hunting and detection at scale.

A leading online retail delivery service in North America continued to expand their business with us in Q3 using Elastic Cloud for their enterprise search use case.

The customer uses Elastic Cloud to power their searches you type experience as well as their real-time text matching ads offering, making it easier than ever for their users to find what they are looking for.

I am also inspired by the outstanding work done by our teams across all functions and their passion for operational excellence and continued innovation.

We recently launched Elastic 8.0, a game-changing release that featured capabilities like native vector search, enhanced machine learning, natural language processing capabilities, simplified data onboarding and streamlined security.

The native vector search capabilities empower users to search and receive highly relevant results using their own words and language.

With the natural language processing feature, users can now perform named entity recognition, sentiment analysis, text classification, and more directly in Elasticsearch without requiring additional components or coding. We introduced new observability tooling for continuous integration and continuous delivery pipelines.

We also delivered more than 30 out-of-the-box integrations, including new ServiceNow connectors as well as new integrations with AWS and a more simplified Elastic Cloud on AWS onboarding experience.

Our continued focus on the cloud marketplaces, AWS, Google Cloud and Microsoft Azure remains a source of strength for us and will continue to help drive future growth. Also, we are grateful for our robust elastic community and all the engagement we see from them everyday.

In fact, our Second Annual Elastic Community Conference in February had more than 2,000 global attendees who joined more than 60 sessions in six different languages. Looking ahead, we are focused on delivering a strong Q4, while actively planning for FY ‘23.

We remain confident that our prioritization of cloud, our dedicated innovation in observability, security and enterprise search, and our large total addressable market will yield durable growth for many years to come.

We have the mission and the demonstrated capabilities to capture the large market opportunity ahead of us and to become a generational company whose offerings are synonymous with the markets in which we operate. I look forward to sharing more with you when we lay out our plan for next year.

I will now pass it over to Janesh to talk more about our Q3 financials and our fourth quarter outlook. Over to you, Janesh..

Thanks, Ash. We were very pleased with our third quarter results, and in particular, with the momentum in Elastic Cloud. We are building a great long-term business in the cloud and are still early in our journey. Total revenue in the third quarter was $223.9 million, up 43% year-over-year.

We performed better than expected with robust consumption in Elastic Cloud. 44% of our revenue was outside of the United States. Subscription revenue in Q3 totaled $209.6 million, comprising 94% of total revenue.

Within subscriptions, revenue from Elastic Cloud was again strong at $80.4 million growing 79% year-over-year, driven by customer growth and usage. And as Ash said, Elastic Cloud comprised approximately 36% of total revenue, up from 29% a year ago.

As a reminder, the vast majority of Elastic Cloud revenue is now derived from consumption-based arrangements in which a customer can bring unlimited data into our platform. They can consume resources flexibly as needed.

And in terms of the commercial model, they can either go month-to-month and simply be invoiced for actual consumption at the end of a month or they can purchase credits upfront and consume those over time.

These three factors, the scalability of the platform, the flexibility of consuming resources as needed, and the choice of the commercial model all reduce customer friction. We believe this makes the consumption business model superior to a traditional ratable model.

Also in the consumption model, we recognize revenue based on the actual consumption in a period and not based on a preset time-based schedule. This makes revenue a more current measure of customer activity and business performance.

Revenue grows as consumption ramps for new and existing customers and we believe this sets us up nicely for durable long-term growth. Accordingly, going forward, it is important to focus on revenue as the measure most representative of our business growth. Within Elastic Cloud, we saw continued strength in both the annual and monthly formats.

Monthly cloud revenue was approximately 17% of total revenue in Q3 versus 16% in Q2, continuing a trend we have seen for some time now. The monthly cloud format continues to be a great way to acquire new customers.

The vast majority of our new customers start on monthly cloud and as they scale up and ramp their spending, they can move to an annual subscription. Professional services revenue in Q3 was $14.3 million, growing 45% year-over-year.

As I have said before, this revenue stream can fluctuate across quarters depending on the timing of projects and delivery. Professional services remains mainly a product adoption enabler and we do not expect professional services to increase significantly in mix.

The quarter’s strength in terms of deal flow was broad-based across our three solutions driven by new and existing customer growth across segments and geographies. APJ grew the fastest, followed by the Americas and then EMEA. The U.S. federal business performed well in the quarter.

Looking at customer metrics, we ended Q3 with over 17,900 total subscription customers. We once again saw significant strength in customer additions, driven by new customer momentum for Elastic Cloud.

We also ended the quarter with more than 890 customers, with annual contract values above $100,000 compared to more than 830 such customers at the end of Q2, reflecting continued strong expansion trends. Our net expansion rate was slightly up compared to Q2 and remained just under 130%.

As you know, this is a trailing 12-month measure and therefore a bit slower moving. We continue to expect the net expansion rate to remain around the current level in Q4. Now, turning to profitability for which I will discuss non-GAAP measures. Gross profit in the quarter was approximately $170 million, representing a gross margin of 75.8%.

We continue to track well relative to our expectations. Looking ahead, Elastic Cloud will remain a modest headwind to gross margin overall as it increases in mix and as we continue to invest to drive growth. Looking at operating expenses in Q3, we continue to invest in the business as we laid out in prior calls.

A significant portion of these investments were in sales and marketing, where our core strategy of driving initial adoption, particularly on cloud and then scaling up through the enterprise remains unchanged. We added sales capacity in various roles across the geos. In terms of operating income and operating margin, we achieved breakeven.

This was significantly better than expected primarily due to the strong revenue performance in the quarter, once again demonstrating the operating leverage inherent in our business model. We also continue to benefit as expected from lower travel and event spending given the pandemic.

Loss per share in Q3 was $0.12 using 93 million weighted average shares outstanding. Turning to free cash flow. Free cash flow was $15.8 million in Q3 on an unlevered basis. As we have said before, quarterly cash flow can be affected by both timing issues and seasonal variation. So, we look at cash flow primarily for the full fiscal year.

Although we expect free cash flow to be negative in Q4, we continue to expect our free cash flow margin to remain slightly positive on an un-levered basis for the full fiscal year. We ended Q3 with a strong balance sheet, Cash and cash equivalents totaled approximately $864 million.

We remain comfortable with our cash position from an operating perspective. Turning to guidance. The year is playing out as we expected for Elastic. We have executed well so far and our customers’ consumption patterns on Elastic Cloud have been robust. We expect this trend to continue.

We are therefore raising our revenue and profitability outlook for the year. The increase in the revenue outlook reflects not only the outperformance for Q3, but also a healthy increase relative to what we previously expected for Q4.

This is more than our typical increase and there is less conservatism built into our revenue guidance than in prior quarters. Further, for those of you that look at quarter-over-quarter growth rates, I’ll remind you that our fiscal fourth quarter has only 89 days compared to 92 days in the third quarter.

With that background for Q4, we expect revenue in the range of $230 million to $232 million, representing a growth rate of 30% year-over-year at the midpoint.

We expect non-GAAP operating margin in the range of negative 5.5% to negative 4.5% and non-GAAP net loss per share in the range of $0.24 to $0.20 using between 93.1 million and 94.1 million ordinary shares outstanding.

For full fiscal ‘22, we expect revenue in the range of $853 million to $855 million, representing a growth rate of 40% year-over-year at the midpoint.

We expect non-GAAP operating margin in the range of negative 0.4% to negative 0.2% and non-GAAP net loss per share in the range of $0.42 to $0.38 using between 92 million and 93 million ordinary shares outstanding. Looking ahead to fiscal ‘23, we are in the middle of our planning process.

While it’s too early to provide specifics I will share some thoughts on how we are approaching next year. First, we are focused on delivering durable long-term revenue growth as we build a multibillion-dollar revenue business. We are confident that we are still in the early stages of this growth journey.

We also expect to comfortably meet our stated goal of exceeding $1 billion in revenue next year. Second, we expect cloud will remain a powerful revenue growth driver for us and continue to increase meaningfully in terms of mix. Although incremental in gross profit dollars, Elastic Cloud will create transitory pressure on gross margin for fiscal ‘23.

Third, we will continue to invest in the business with discipline in support of our drive to durable long-term growth. This discipline is visible in our results. We expect to continue to make targeted investments in all functions in fiscal ‘23 to drive growth. We also expect travel and in-person events to come back into the model in a meaningful way.

Additionally, we are keeping a close eye on wage inflation in the talent markets in which we operate. Despite these near-term considerations on gross margin, the return of travel and wage inflation, we expect to be operating margin breakeven in fiscal ‘23.

Some of these expenses will come into the model early in the year, while revenue will ramp, so we expect Q1 to be the low point on operating margin. Longer term, we expect to demonstrate leverage in the operating model as we have done previously. We also expect to have slightly positive free cash flow on an unlevered basis in fiscal ‘23.

In summary, we’ve had a great year so far and are looking forward to successfully finishing out Q4 as we ready ourselves for next year. And with that, let’s go ahead and take questions.

Operator?.

[Operator Instructions] Pardon me, thank you for standing by. The first question comes from Tyler Radke with Citi. Please go ahead..

Hi, good afternoon. Thanks for taking my question. Maybe first question for you, Ash and congrats on the first earnings call as CEO here. How are you thinking a little bit more about the go-to-market strategy here? Obviously, that was a huge focus for you. It’s one of your priorities taking over the top seat here.

And especially, how are you thinking about organizing the sales force into FY ‘23 as you’re really focusing on cloud, just any thoughts since you taking over? Thank you..

Thank you very much for that question, Tyler, and good afternoon to everyone. So it’s been wonderful to see the team execute very strongly in Q3. And in the last couple of months, I’ve been spending a lot of time traveling in regions, meeting with customers, meeting with our teams.

And fundamentally, what I have developed even stronger conviction in is that from a fundamental strategy standpoint, the markets that we are in are absolutely the right markets for us. The opportunity in these markets is massive.

And specifically in areas like log analytics for observability for SIM in security, there are tremendous opportunities to displace incumbents.

So as we think about what we are doing today, we are continuing to make sure that from a go-to-market standpoint, we focus, first and foremost, on cloud, where there is demand in our customer base new customers are coming to us on cloud, existing customers as they increase workloads, they are tending to increase them disproportionately on the cloud, and that’s good for customers, and it’s something that we absolutely are leaning into.

In terms of FY ‘23, you should expect that we will continue the intentional bias towards cloud that we have been doing for a while. We see that as a growth engine.

We see that as something that’s good for customers, that’s good for our business, and we’re going to continue that, not only in the go-to-market side but also in the relationships that we formed with the cloud hyperscalers and also on the R&D side, of course.

And organizationally, as I’ve spent time immersing myself with the go-to-market teams, I’ve been very excited to see the depth and strength that we have in the teams – and as I have explained at the time when I spoke to several of you around the CEO transition, all our selling teams report to Michael Kremin.

And Mike and the teams have done a fantastic job in Q3. They are focused on driving Q4 to a strong year-end. And we’re going to continue on that journey. And in terms of organization, I’m loving what I see in the team, and we’re just going to continue that drive..

Great. And maybe a follow-up for Janesh. So obviously, it sounds like you’re focusing investors on total revenue, just kind of given the moving parts between billings and monthly staff. I guess, maybe two questions.

First, if we look at the monthly SaaS revenue line, was there anything to call out from a seasonality usage impacts, some others in the space have kind of called out longer holiday period.

Did that have any impact on the quarter? And then secondly, on billings, just anything to help us think about that metric, both for the quarter in Q4, just some of the moving pieces given the cloud kind of consumption model that doesn’t always get billed in advance. Thank you..

Hey, Tyler, happy to answer those. So on the consumption side, we did not see any particular trends around demand patterns over the holidays. We were not expecting any unusual trends either. So the quarter played out as we expected. And when you think about our solutions overall, particularly for observability and security, those are persistent.

Security threats don’t vanish over the holidays as an example. So we did not see any significant variations around those. And then with respect to billings, look, as you saw, we’re very pleased with the numbers we posted here in Q3. It was a strong print we had many successes across the business.

You see that reflected in all the numbers, the revenue numbers as well as the customer metrics. So there is a lot for us to be pleased about in that.

And as I said in my remarks earlier, revenue, I think, is a better indicator of business performance for us since it is a much more current measure of customer usage of our technology and particularly in the consumption model. In terms of order flows, I’d say the quarter played out as expected.

We did provide the details on billings in the press release for those folks that want to look at that, but we did deliver a strong growth. It was stronger than the first half as we said it would be. And so we did deliver against that expectation.

And if you think about it in constant currency terms, it was even stronger than the numbers we had posted in the first half.

So if I think about the business going forward, we will continue to focus on revenue, particularly because when you look at the monthly cloud business, which is now 17% of revenue, that has no deferred revenue, and that’s a significant enough portion of the business that it just makes the calculated billings conversation less relevant.

So I don’t expect us to talk about billings going forward. Again, we will focus on revenue. We had a really strong result here, and we feel very good about the business looking at fiscal ‘22 and beyond, and you see that confidence reflected in the raised revenue guidance for the year..

Thanks so much..

Thank you..

The next question comes from Raimo Lenschow with Barclays. Please go ahead..

Thank you. Two questions, if I may. One for Ash.

Ash if you look at the big guys like us like Barclays signing up and being in the cloud with you observability, etcetera, as well, can you maybe talk a little bit about like what is – kind of what’s the message there in terms of how comprehensive your stack is because you obviously, you were known for good lock and log management.

But obviously, there is more aspects here like infrastructure monitoring, APM, etcetera, that need to be fulfilled as well. So maybe talk a little bit about how comprehensive your portfolio is and by now. And then one for Janesh, in terms of like the customer adds on the over $100,000, that was kind of a very strong number.

I haven’t seen that for quite a few quarters now. Was there anything particular that was driving it? Are you focusing a little bit more on kind of expansion, et cetera? What drove that number? Thank you and congrats from me as well..

Thank you, Raimo, and most importantly, thank you for the continued business and the trust in Elastic. We appreciate it. So let me maybe touch upon the question on absorbability and the completeness of the stack. And this is one of our core strengths.

The fact that all the data that we bring in, whether it’s log data, APM TRACE data, metrics, infrastructure metrics data, CICD monitoring data.

All of that comes into Elasticserach and I can’t talk about this in my prepared remarks but fundamentally one of our greatest strengths, that when all of that data into Elasticsearch, our ability to run very advanced machine learning rules, our ability to run all kinds of correlations and advanced queries is very powerful.

And we can do that at tremendous scale. And when you think about large organizations like Barclays that have very large amounts of data, you are talking about in – for many of our customers, many perabytes of data, that becomes a difficult problem.

And that’s where given our roots and given that our core foundation is Elasticsearch, we have a tremendous advantage – and over the years, although we started with log analytics, we’ve been building out our portfolio. Today, we have over 2,000 customers that are using our APM capabilities just on Elastic Cloud. And that’s been growing.

Similarly, we’ve introduced capabilities around metrics and infrastructure monitoring. We’ve talked about the work that we’ve done in our ability to monitor CICD pipelines, the integrations that we’ve done with Maven and Ansible and other technologies that form part of the CICD process. Last calendar year, we acquired Optimize.

This was an acquisition, a small technology acquisition that really gave us tremendous capabilities in the area of EBPF, which is a new technology that really allows us to look deep into Linux-based systems, and the visibility that we can provide with all of this in the cloud in a very fast, frictionless manner, it’s a big source of our strength.

So although we might have started from logging as we see the expansion – and also here, our natural our pricing model, which works very well in allowing a more viral motion has been playing to our strength.

So that’s what gives me a lot of confidence and optimism in the overall strength – And then obviously, as many of you know, this convergence as we are seeing between observability and security, which also helps us as customers continue to expand their usage..

Hi, Raimo, this is Janesh. I’ll follow-up on the question about the customers. And look, we are very happy with the metrics on customer accounts. We’ve got, as you saw, more than 890 customers now with more than 100k ACV. And fundamentally, our strategy is working as customers start to use us for one use case or one solution.

Their data volumes grow, their needs grow, they ingest data from more sources, they extend into additional solutions and all of this drives significant expansion for us over time. So it’s great to see that customers that start small expand to become customers more than 100k and eventually even larger than that.

The other piece I’d call out there is that we’re also calling higher within the enterprise, which, as you know, is an area that we’ve been investing. And our strategy is playing out quite nicely over there, too.

We are continuing to see greater awareness beyond departmental buyers, calling on C-level executives and now routinely taking down transactions more than $1 million in size.

So with all of that, that’s – those are some of the pieces that I would call out that I think are the highlights that indicate the opportunity ahead of us and the success we’ve had.

And if I try and offer another way to think about that opportunity ahead of us, you will recall that we previously shared a stat that if I look at that pool of customers more than 100k ACV, more than half of those customers have still adopted us for only one solution.

And if I look at our pool of million dollar plus customers, more than 75% of those have adopted us for two or all three solutions. So that’s just an indication of the room that we have to continue to drive upsell. So we’ve been executing quite well, and we are excited about the opportunity ahead of us..

Okay, perfect. Makes sense. Thank you..

The next question comes from Brent Thill with Jefferies. Please go ahead..

Janesh, I just want to follow-up on the comment you met on the guide. And I think you’d said there is less conservatism in the guide.

Can you explain why that is?.

Yes, happy to, Brent. So look, obviously, we had very strong results here in Q3. We’ve talked about that quite a bit. Consumption has been stronger than we expected so far this year, and that’s all been reflected quite nicely in the results we posted for the first three quarters.

So when I look at the guide that we’ve provided now, we’ve raised the full year by $9 million more than the Q3 outperformance. And if you look at that in terms of quarter-over-quarter growth, typically the way we’ve guided, our guidance increase this time is more than it’s usually been.

Typically, for any quarter in the past, the way we’ve guided is just slightly above the prior quarter. And this time, it’s $7 million higher than the prior quarter. And that’s despite the fact that on a quarter-over-quarter basis, we’ve got a headwind of 3 fewer days in the quarter.

That headwind in itself is a little bit over 3%, so despite that headwind, we’ve got a nice sequential increase that we are guiding to here. So we are continuing to take a prudent approach, but it’s far less conservative than it was before. We feel really good about Q4 and the full year.

Brent, are you still there?.

Yes. And can I – just as a quick follow-up on the DR on the current DR, came down considerably, so I just wanted to drill in on the dynamics between current and long term – and I’m sorry, the non-current piece drop more.

What’s happening? Is that just the shift to cloud, Janesh?.

Yes. I think there is always dynamics associated just with deal flow. And for the most part in our business, we invoice customers only annually in advance. From time to time, when customers request us to have an entire transaction, the full TCV invoice, we will accommodate that request.

We saw some of those kinds of transactions last year in Q3, and I think what you’re just seeing now is some of that bleed over from long-term to short term as we lap that year. So as you know, in deferred revenue or in billings more broadly, timing can always be a factor.

I think short-term deferred revenue adjust for some of those timing issues quite naturally. And as you noted, that grew 25% Currency is another piece. And if you adjust for currency, it would have been – short-term deferred revenue growth would have been several percentage points even higher.

But more importantly, Brent, as I step back, as I said, the monthly cloud business fundamentally does not have any deferred revenue, that’s now 17% of the business. So that starts to make deferred revenue overall, just a lot less meaningful to look at.

So that’s why we continue to stay focused on revenue as the most current indicator of spending patterns in the consumption model..

Thanks, Janesh..

Thank you..

The next question comes from Matt Hedberg with RBC Capital Markets. Please go ahead..

Hi, guys. Great. Thanks for taking my question. Congrats, Ash, on the promotion here. I’m curious on the CRO front, obviously, you guys are operating well as is with I think Michael taking on more responsibility.

But just wondering sort of what are the thoughts on sort of that role, timing, etcetera?.

Yes. Thanks for the question.

So from my perspective, I’m really actually enjoying spending time with the teams because to me, as I think about our go-to-market and the fact that we’ve got this massive opportunity in cloud, it’s really important to make sure that I understand and continue to drive the cloud motion, the solution motions that we have that are working so well throughout the organization and define the plan for FY ‘23 that’s going to allow us to make sure that, that bias in the cloud is even greater than what it has been.

Now in terms of the sales teams, as I have called out, the selling teams today already report to our Chief Sales Officer, Michael is doing a wonderful job. In the future, it’s – I can imagine a time where we would have a single person leading all of field operations. But honestly, at this point in time, I’m – things are working incredibly well.

I’m enjoying working with the team. And I’m not seeing any reason for any immediate changes because we have got such a great working engine and the team is executing wonderfully..

Got it. That makes a lot of sense.

And then, Janesh, you maybe I missed it, but did you talk about RPO growth in the quarter?.

Hey, Matt, no, I didn’t mention that specifically, but I’m happy to touch on it here. As you saw again just strength overall on the business side on so many different metrics, on RPO specifically, again, just like deferred revenue, you know that the monthly cloud business does not have any RPO either.

And so again, RPO just becomes less meaningful for us. But the other important piece in a consumption model, as you realize, is that if a customer is ramping their usage faster and burning down their backlog, that’s actually a good thing. And that’s a big chunk of what we saw.

So that will allow us to go back to those customers sooner than expected in the future to increase their commitments based on their higher usage, and that’s obviously not reflected in the RPO today. So that’s just another piece why RPO has been less of a focus area for us. If I look at the reported numbers, RPO growth was 22%.

But again, you can normalize that for things like FX, which was several points in terms of a headwind and would have been higher on a constant currency basis.

But the main piece, as I said, is as we shift towards the consumption model, there is significant opportunity for us to drive growth with these customers over time, whether they are on the monthly format, or whether they make commitments to us in the future.

So for us, we are continuing to stay focused on revenue as a primary indicator of the business..

Got it. Thanks a lot. Best of luck guys..

The next question comes from Kash Rangan with Goldman Sachs. Please go ahead..

Hello. Thank you very much. Congratulations to Ash and Janesh. Ash, a question for you.

You want to pivot to the cloud as quickly as you can, right? From a product perspective, what are the things that you are looking to invest in the cloud platform that would make it a no-brainer for an initial customer who might otherwise be predisposed to the on-prem Elastic question because it’s got such a rich legacy.

But how do you ensure that the cloud platform is not just on parity, which it probably is, but it’s actually heads and shoulders above the on-prem version that it becomes a no-brainer.

And one for Janesh is that as you move to a consumption model, when you look at consumption models like Snowflake and Datadog, they have been able to put up CRPO, RPO growth.

So, do you envision when you cut over to the – whatever the optimal point of your consumption oriented cloud business is that you can also see the benefit of RPO, CRPO growth like the other consumption models have? Thank you so much..

Yes. Thank you for the question Kash. So, I want to sort of step back a little bit and talk about the journey that the team has already been on when it comes to cloud. So, we have been on the R&D side, very intentionally driving a lot of investment into our cloud platform.

Elastic Cloud, there are lots of advantages of Elastic Cloud, just given the fact that you don’t have to worry about the management aspects and the monitoring aspects, the way you typically would need to if you were doing everything in self-managed.

We have delivered capabilities like searchable snapshots that work incredibly well, especially in the cloud. We have got auto scaling that we have already delivered on, that’s true for Elasticsearch and several of the other components.

And what all of that has meant over the years is Kash the point that you made not only is it on par, but in fact, Elastic Cloud already is significantly at a stage where it is even less friction kind of way to get started. You can get going faster. You can adopt the technology and all the capabilities in there better.

And that’s just a natural reason why we are seeing some of the advantages today in the cloud. We are not having to pivot in the sense that we are not really forcing customers, customers are naturally choosing Elastic Cloud.

What we are doing is making sure that we enable our field teams and we educate our customers, and that’s what’s resulting in customers like Barclays that have been traditionally a self-managed customer.

And you are talking about a very large organization here at Barclays that has depended on Elastic for a very long time in this self-managed mode, recognizing that all of these investments over the years have actually made Elastic Cloud an incredibly compelling platform.

And when I joined Elastic last year as the Chief Product Officer, I saw that this was the trajectory. I had confidence in this trajectory. And I continue to invest more. And now as we sort of not only on the product side, but also on the go-to-market and the partnership side continue to work the cloud focus, I personally am very excited.

The organization i s very excited about the future in the cloud. And our customers are very excited about everything that we are doing there. Let me turn it to Janesh for the other question..

We have Cloud 9, right?.

Well, we – like I said, we appreciate all our customers, and definitely, Barclays has been – it’s been a wonderful relationship. But Kash, there is no reason why we can’t have the same relationship and continue. I would love to be able to thank all of you in the future for similar reasons..

On that note, Kash, on the remaining performance obligations, look, I think one of the important distinctions between us and some of the other consumption-oriented business models out there, is that customers actually have the choice of signing up on a monthly basis and being invoiced at the end of the month based on that actual consumption or making an annual commitment.

And so they can opt for either model, and that’s the monthly cloud piece, which is now, as you know, 17% of the business. And there is no RPO at all in that.

So, depending on what form that takes, and how customers on board, which is primarily on the monthly cloud side and when they convert over to annual, you can have a lot of dynamics that come into that RPO number. That’s why it’s perhaps a little bit less meaningful for us at this stage of where we are.

And I look more at the revenue number, which is – it’s really the equalizer, right. Revenue measures, the consumption across all the different formats, it adjusts for duration, and it’s the most current measure of how customers are using our technology. So, that’s why, in my mind, that’s a stronger measure..

Wonderful. Thank you so much..

Your next question comes from Mark Murphy with JPMorgan. Please go ahead..

Thank you very much. So Ash, Amazon has been removing the term Elasticsearch from its website. I think as part of the trademark infringement resolution. And you still seem to have a very strong momentum in the AWS partnership. You mentioned it several times here today.

Is there a feeling that everyone has kind of made their piece or buried to hatch it? And do you sense a benefit from kind of clarifying your linkage to the term Elasticsearch?.

Yes. Thank you very much for the question. So, the relationship and the partnership with AWS is continuing to strengthen. And this is an area where we have intentionally put a lot of effort in making sure that we work with them on tighter product integration.

In the press release, you must have seen some of the work that we have done to make it easier for prospects when they come to the AWS marketplace to start a trial for Elastic Cloud and the integrations that we have done for cloud-native data coming from AWS directly into Elastic Cloud, that’s really very valuable to our joint customers, and that’s really helping strengthen that partnership.

And as you mentioned, the resolution of the trademark, but even before that, the license change that we made last year, those things have been helping clarify things in the market, and customers see that now. There is only one Elasticsearch, and it’s from Elastic.

And as I have been having conversations with customers, it’s becoming more and more apparent that this is helping create clarity in the market. In the long-term, I can see that that’s going to definitely be a tailwind, but even in the near-term, it’s helping AWS and us partner better, which is immediately apparent to us.

And I am particularly excited about that..

Excellent. And as a follow-up for Janesh, we have had this unique situation where investors have been assuming that the slowdown in billings in the first half would foreshadow a slowdown in revenue. And yet we look at what happened, it’s the opposite where revenue growth accelerated both sequentially and year-over-year at 43%.

And so I am wondering, would you ever consider shifting to an ARR metric or some other type of metric to help us, or is there some approximation to help normalize.

For instance, if we see billings growth at 35%, maybe there is a mental model where we could tack on 5 points to 10 points to that, right, if we want to try to account for the shift to consumption.

Just kind of wondering if you have any thoughts along those lines?.

Yes, Mark, it’s a great question. In terms of – I will answer the second part first. In terms of just thinking about monthly and annual and an apples-to-apples way, it’s still probably best just to look at revenue, particularly since the vast majority of our cloud business is now consumption-based.

And revenue reflects just a full three months of current consumption regardless of whether it’s monthly or annual business. So, it addresses the duration quite naturally. It reflects the current consumption patterns rather than a time-based runoff of historical deals.

And it’s got the full effect of the adoption of our technology across all the different formats that we offer. So, that’s why I think that’s probably the more meaningful measure for us to focus on looking ahead.

And then with respect to ARR, look, there isn’t a perfect measure out there that addresses all the aspects of the business model differences and timing. We think revenue is probably the best of the measures at this point in time.

And again, even in a consumption model, keep in mind that it’s harder to use ARR as a revenue predictor just given the variability of consumption patterns and the ramp in consumption that we are seeing, particularly when customers first join. So, cloud is a big portion of that, and that’s largely consumption.

So, I don’t want to put a metric out there that’s not reflective of the full business and that may have a short shelf life as the consumption format continues to increase in mix. So, that’s part of the reason why we are staying focused on revenue. I think it’s still the best indicator of our overall business..

Thank you..

The next question comes from Brad Reback with Stifel. Please go ahead..

Great. Thanks very much. Janesh, I know billings isn’t necessarily the best way to look at the business, and we have talked about that a lot this afternoon. That being said, I don’t think you guys reiterated the commentary from last quarter about 2H being ahead of 1H. And it was only 90 days ago.

So, I am just trying to figure out if anything has changed on that front and if so, why?.

Yes. Great question, Brad. And look, we have spent quite a bit of time talking about billings, as you said, and why it’s a less relevant measure in the business. The way I think about it is in Q3 here, we delivered 35% year-over-year growth compared to 26% in constant currency terms in the first half. So, I think that’s the indication enough.

And the way I think about it in the future is, we are pivoting to revenue. It is the best measure. We really aren’t going to focus much on billings going forward..

Great. Thanks very much..

The next question comes from Koji Ikeda with Bank of America. Please go ahead..

Hey Ash and Janesh. Thanks for taking my questions. Apologies if you guys went into this in detail on the prepared remarks, hopping on here a little bit late. But I noticed in the press release with the Elastic 8.0 announcement, the natural language processing is really highlighted there.

So, I guess could you help me understand why is this such a big deal? And more importantly, what could this mean from a use case expansion or maybe a usage expansion from the end market? Thanks guys..

Yes. Thanks for the question, Koji, and let me address that. So, first and foremost, 8.0 is truly a fundamental release because we typically have always delivered a lot of innovations, not just in the major release, but in all the minor releases that come on top of it.

And so you can expect us to continue to deliver innovations as we always have, in a continuous manner, not only through this calendar year, but beyond. Now with 8.0, one of the big advances is the capabilities that we have introduced in the area of vector search.

And there are a whole bunch of other capabilities surrounding it, like natural language processing.

And when you take all of those capabilities together, what that really lets you do is for your enterprise search kinds of applications use more natural query more natural language query techniques to get the results that you are looking for, the applicability for enterprise search, both in app search and in workplace search, which are the two kinds of use cases for customer-centric applications and employee-centric applications are tremendous – and this is where we obviously are expecting to continue to drive a lot of momentum.

Also, when it comes to vector search, it allows you to do additional more interesting custom search use cases that also depend upon the vector search functionality and all the machine learning that you can apply on top of it. But that’s just for enterprise search.

Beyond that, the announcements that we made in terms of additional integrations, cloud-centric integrations, the work that we are doing for observability to make it easy to bring in data into advanced analytics on top of it. All of that benefits from what is inherently in 8.0.

So, a lot more to come in observability, security and enterprise search on this platform..

Thanks Ash. I appreciate it..

The next question comes from Rob Owens with Piper Sandler. Please go ahead..

Yes. Thanks for taking my question. I was wondering if you could speak to net new customer adds, which were kind of flattish year-over-year and flat to down a little bit quarter-over-quarter, realizing it’s a rounded number.

But with cloud providing more of a frictionless on-boarding motion, why aren’t we seeing an inflection here, or will we see an inflection here in the near future? Thanks..

Hey Rob, this is Janesh. I will take that. So, we were actually quite happy with the pace of new customer additions in the quarter. We have seen a consistently strong rate of new customer additions for many quarters now, and Q3 continued that trend.

The majority of our new customer adds – as I mentioned, are on monthly cloud where, again, we saw strong trends from a revenue perspective as well. We have invested quite heavily in cloud, in marketing, in partnerships, in the product. So, it’s actually great to see the results of these investments. And thinking about how we see that growth.

I think about average deal sizes in annual subscriptions deal sizes were slightly up year-over-year. So, we are pleased to see that as well. And when I look at the overall data for all of our customer metrics in Q3, I think it was actually quite strong across the board. So, we are happy with the results..

Thank you..

The next question comes from Steven Koenig with SMBC Nikko. Please go ahead..

Hey, great. Thanks for squeezing me in. I wondered if you guys could give us any color on kind of self-managed customers converting to cloud and especially the larger customers.

Can that be lumpy at all? And are you able to kind of anticipate their choice of deployment options, and kind of what are the factors that drive them to convert either in part or in whole to cloud? Thank you very much..

Yes. Hey Steve, this is Janesh. And maybe I will start and then see if Ash would like to add anything. But fundamentally, when I think about the business and when I look at self-managed customers, everyone has got their own strategy.

It’s not like we are driving some sort of substitution in the business by trying to move customers to the cloud people, move at their own pace. And every customer is unique in that regard. Everyone has got their own story behind it.

But when I look at the self-managed business overall or even the cloud business, obviously, very happy with both of those with the growth that we posted. Most of our net new customer additions, as I mentioned, were on cloud. So, the cloud strength was not necessarily from transitions in the customer base.

A lot of that is just organic strength that we have driven with the new customers and as those continue to expand. So, cloud is a significant opportunity for new customer growth as well as for expansion. Customers are just spending more in cloud, and that’s what we are seeing.

So, we expect that cloud will continue to grow faster for us because that’s where customers are driving their spending pattern. And so it’s more of the opportunity rather than some sort of transition. I think our opportunity is large. Our penetration rates are low, and so we have plenty of room to grow in both formats.

Ash, anything you would add to that?.

Yes. The only thing that I would add, as I look at all the customers that are continuing to expand, several of them are expanding into the cloud. Others are new into the cloud.

But the one thing that is important to understand is the way we have architected our offerings, it makes it very simple for somebody who might have started on-prem in a self-managed environment to start to sort of expand in the cloud and run their queries, create their applications in such a way that they are able to seamlessly take advantage of them.

And as they see the frictionless, easier to use, easier to manage, easier to monitor capability and natural attribute to the cloud, that’s where the growth becomes even faster. So, to Janesh’s point, we are not forcing any behavioral patterns in our customers.

We are showing them the advantages of cloud and then letting them naturally just make those choices. And we find that to be a much better model than anything else..

Super helpful. Thank you very much..

The next question comes from Blair Abernethy with Rosenblatt. Please go ahead..

Thanks. Thanks for squeezing me in guys and congratulations, Ash. Just a quick question on the security space, the Elastic security solution, you have added a lot of functionality, acquired functionality on that over the last year or so.

Just wondering how you see your competitive positioning with that solution? Now how do you go to market and differentiate yourself in the security side of things? And what’s the security demand environment looking like today versus the beginning of the quarter?.

Yes. So, the security continues to be a very strong demand driver. If you look at our security business today, security now accounts for over 25% of our overall business. And over the last couple of years, the investments that we have made, both organically and inorganically have set us up very nicely.

So, in my prepared remarks, I talked about the fact that we are actively seeing opportunities and involved in opportunities where we are displacing incumbents in SIM. SIM is the most mature part of our security portfolio, and we have expanded from there.

And it’s a natural area of strength for us because a SIM effectively requires you to be able to pull in data from all kinds of different sources, run analytics against it, find the patterns that indicate attacks and then take actions on it.

And that’s enabled us to expand to XDR, the investments and acquisitions that we made in the area of cloud security. I expect that to start showing up in the product in the next couple of quarters. And most importantly, we have been investing a lot in threat research.

So, just as an example, earlier this week, our threat research team detected and started protecting endpoints in Ukraine against a new data wiper, effectively a form of malware that wipes and destroys data on your end systems that we started to observe in Ukraine, and we were able to protect end points there.

And we were very proud of that kind of work that we are doing. In December, we discovered a new malware type called blister that was, again, attributed to some Russian crime groups. So, we are doing a tremendous amount of work. I personally could not be happier about the quality and the strength of our teams.

And starting with this core strength in Elastic SIM and expanding from there, I see a tremendous amount of potential..

Great. Thanks very much for the extra color..

This concludes our question-and-answer session. I will turn the conference back over to Ash Kulkarni for any closing remarks..

Well, thank you, everyone, for joining us today. As you can tell, we remain very excited about the opportunity ahead. I am also looking forward to meeting many of you in the coming weeks and months. Thanks again, and have a great evening..

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect..