Elastic N.V.

Good day and welcome to Elastic's second quarter fiscal 2022 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Anthony Luskri, Vice President of Investor Relations. Please go ahead.

Thank you. Good afternoon, and thank you for joining us on today's conference call to discuss Elastic's second quarter fiscal 2022 financial results. On the call, we have Shai Bannon, Founder and Chief Executive Officer, and Janesh Morjani, 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 to 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 the date of this call, and are subject to risk 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 more 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 third quarter fiscal 2022 quiet period begins at the close of business Friday, January 14th, 2022. On December 8th, we will be participating in the Barclays Global TMT Conference. That'll turn it over to Shai.

Thank you, Anthony. Hello and welcome, everyone. I'm happy to be here with all of you today to share our second quarter results. We once again delivered strong performance driven by broad adoption of our offerings and the continued growth of Elastic Cloud. In Q2, total revenue grew 42% year-over-year. Revenue from Elastic Cloud grew 84% year-over-year. And we once again saw robust customer acquisition and expansion metrics. We ended the quarter with more than 17,000 subscription customers, including over 830 with annual contract value of more than $100,000. The strong performance was fueled by continued adoption of our differentiated solutions, reflecting our increased strategic relevance across our customer base. Organizations across the world continue to accelerate their digital transformation plans, creating massive volume of data. IDC estimates that by 2025, we will be generating 480 exabytes of data per day, and as much as 90% of that data is unstructured. And with endless data comes endless possibilities. At Elastic, we use the power of search to help people and organizations turn these possibilities into results. With our leading platform for search-powered solutions, we help everyone, organizations, their employees, and their customers accelerate the results that matter. Our solutions for enterprise search, observability, and security help people find what they need faster, keep mission-critical applications running smoothly, and protect against cyber threats. As I get back to spending time in person with customers, something I'm hearing again and again is that for many organizations, their business strategy heavily relies on their cloud strategy. As organizations embrace the cloud to drive business agility and flexibility, IT systems also become more distributed and heterogeneous. This is because as new workloads are deployed on the cloud, many times across clouds, existing workloads might still run on . And with data having gravity to it, deploying search-powered solutions next to it while working seamlessly across it is critical. Our investments in Elastic Cloud are geared to address exactly these needs, and it is resonating with our customers. And we continue to invest in Elastic Cloud, which we expect will exceed 50% of our revenue in the next three years. We are expanding our strategic partnerships with the cloud hyperscalers, and we are seeing significant traction in the cloud marketplaces. This is happening thanks to our investments with each cloud provider, in product, marketing, and the field. In Q2, we announced new integrations with Google Dataflow that allows customers to leverage the powerful search and analysis capabilities of Elastic from within the Google Cloud Console. We also added support for Amazon ARM-based EC2 instances, and we expanded it to three new AWS regions and now have 48 regions across Azure, AWS, and Google Cloud. We also release major enhancements that improve data resiliency and reduce network latency across all cloud providers, enabling customers to deliver results fast while reducing data transfer costs. Elastic Cloud is the best, easiest, and only way to access all of our innovations across all of our solutions. For example, a longtime free and open user, one of the world's leading online job sites, migrated their free on-prem clusters to our enterprise tier on Elastic Cloud. The customer is using Elastic to power the global job search functionality on the website and to monitor logs for suspicious or illegal activity. They moved to Elastic Cloud to access these innovations while lowering their overall costs. Managing risk is another reason global organizations are turning to Elastic. And with increasing sophistication and scale of cybersecurity threats across an ever-growing attack surface area, Elastic Security helps our customers quickly find the data they need to prevent, detect, and respond to complex cyber threats at scale, minimizing risk and protecting your organization's reputation. Because cyber risk is business risk. One of the core and unique pillars in Elastic Security is openness. from open data to open architecture to open content to open collaboration. Openness is something we believe is deeply missing in the cybersecurity space, and we are actively working to change that. Security starts with data. That's why we invest in integrations to extend our customers' ability to protect their data and use it to prevent, detect, and respond to cyber threats. we announce integrations with products from CarboBlack, CrowdStrike, CloudFlare, HashiCorp, and Palo Alto Networks. When customers get started with Elastic, we often see a natural evolution as they expand their adoption of Elastic across SIEM, endpoint protection, cloud security, and XDR. In fact, Forrester recognized a strong, customizable, free and open SIEM, naming Elastic a contender in the industry's first analysis of XDR vendors. And this analysis was done even before we launched our SDR offering. We believe this was driven partially by the power of our open search platform, including capabilities such as searchable snapshots and machine learning, which we believe are game changers for security use cases. Typically, our security customers start to use our same use cases. For example, in Q2, we closed new business with a global leader in commercial electronic document management and operations. They chose our SIEM to replace their legacy product because they were looking for an open and innovative data-driven SIEM that is an easy-to-deploy, cost-effective option to manage their growing data volumes while meeting data retention requirements. Other times, customers start with security and add observability. while they continue to expand their security use cases. For example, we closed business during the quarter with a major U.S. public research university. They had first adopted our endpoint security solution and then expanded to observability. In Q2, the customer expanded with us yet again, choosing our SIM to replace a legacy product for their security operations center. They currently deploy Elastic on devices across the university system, and leverage searchable snapshots and frozen data tier to better manage their high volume logging data and storage needs. Which leads me to another trend we are seeing, the continued convergence and adoption of a unified platform within and across observability and security. On one hand, customers are bringing together logs, metrics, and application traces with unified observability. At the same time, we're seeing a similar convergence in security with SIM, endpoint, and cloud security coming together with XDR. And because customers rely on the same data across security, operations, and development, they are choosing Elastic as their unified platform, growing from one to another and laying the foundations for new DevSecOps workflows. We are investing heavily in this major evolution in the market. For example, we joined forces with Optimize to further enhance the ability for customers to gain insight into the entire IT ecosystem and eliminate blind spots in complex distributed environments. This will allow customers to have always-on continuous profiling capabilities without needing to explicitly instrument applications. Along with CMD and Build.Security, which I spoke about last time, The addition of Optimize furthers our vision to enable customers to both observe and protect their cloud-native workloads. One of the world's largest internet domain registration and web hosting companies is a great example of this. They wanted a single pane of glass across DevOps, network operations, and security. They previously chose Elastic Cloud for observability to achieve faster mean time to respond and have implemented logging, metrics, and APM. With our unified resource-based pricing and features like searchable snapshots, the customer is able to bring in more data and instrument more applications than with other vendors. But the story doesn't stop there. In Q2, the customer expanded to security, displacing another vendor with our SIEM. Because, as we say, while you observe, why not protect? And within Elastic Observability, our APM capabilities continue to grow. In Q2, we GA'd trace correlations to help organizations overcome complex dependencies to keep modern cloud applications running. While logging is still the most common use case for new customers to adopt Elastic Observability, APM customer use cases are growing in both land and expand. A leading telehealth platform provider expanded business with us so they can gain insight into their overall operating environment. Demand for their platform skyrocketed over the last 18 months. Already an Elastic Observability customer for logging, in Q2, they added APM to better understand and improve the user experience of patients and providers. User experience can be a competitive differentiator for enterprises. Our customers use our observability solution to monitor user experience, and they use Elastic Enterprise Search to empower their customers and employees to find what they need when they need it. In Q2, we announced the general availability of our native web caller, offering a fast and efficient way for users to ingest content directly from publicly accessible websites. Customers turn to our enterprise search solution for our out-of-the-box capabilities like WebCaller and Workplace Search, as well as the flexibility to develop search apps with Elasticsearch. A wonderful example of this is the business we disclosed with one of the largest diversified financial services institutions in the United States. The customer uses Workplace Search to centralize search across their multiple data sources to promote efficiency across the organization. In Q2, the customer added a new use case, developing a custom application to reliably search, audit, and report on ATM data using Elasticsearch as a central repository. Retail customers are taking a cloud-first approach as they look to retool their traditional brick-and-mortar businesses to meet the continuing demand for online shopping and curbside pickup. one of the world's largest home improvement speciality retailers expanded business with us in Q2. Their online business has nearly doubled over the last three years, and the existing search functionality on their website was not able to keep up with their scalability and availability requirements. With Elastic Cloud on Google Cloud, The customer is able to leverage the speed and scale of Elasticsearch without having to invest in additional people and infrastructure to manage the deployment. And with our machine learning capabilities, they are able to provide more relevant search results and product suggestions for their customers. Elastic is at the epicenter of all of these digital transformation trends. The possibilities for us are endless. That's why we are making significant investments in our business, in all functions, and particularly in the field. We are expanding coverage in all geographies and also expanding our global cloud inside sales, which supports our scalable programmatic approach to revenue generation, which focuses on Elastic Cloud. And we continue to invest in our partnerships. Azure and Google Cloud were marquee sponsors at our Elasticon Global User Conference. Scott Guthrie, Microsoft's Executive Vice President of Cloud and AI, joined me on the virtual stage at Elastic on Global. And customers, including Adobe, General Motors, IBM, SAP, and Twitter, showed how Elastic is helping them solve their data challenges. As we scale towards becoming a multi-billion dollar company in the future, we welcomed Shelly Labovitch to the Elastic Board of Directors. Shelly was the CIO at Morgan Stanley and the World Bank, and she brings 30 years of real-world security domain expertise and extensive corporate board and advisory experience. And for the second year in a row, we were honored to be named as the best technology company for women, a best overall company for women, and best company where CEOs support gender diversity by workplace review site Ferry Godboss. It's humbling to see that wherever and however our community, customers, and partners are putting Elastic to work, we are helping them search, solve, and succeed at scale and on a single platform. Now, over to you, Ganesh.

Thanks, Chai. Q2 was another great quarter, continuing our momentum of strong execution and investments to capture the large market opportunity ahead of us. Elastic Cloud was once again the highlight, with strong new customer additions and robust consumption trends. We continue to expect that Cloud will remain a tailwind for the longer term. More broadly, our solutions continue to resonate with customers, and we are capitalizing on the clear secular tailwinds both around the volume of data and how enterprises more effectively use that data. Let's get into the numbers. Total revenue in the second quarter was $206 million, up 42% year-over-year, reflecting the continued successful execution of our strategy. We are very pleased with our performance, which was better than expected, with stronger than expected consumption rates in Elastic Cloud. 44% of our revenue came from outside the United States. We continue to view this geographic distribution as a long-term strength of our business model. Subscription revenue in Q2 totaled $190.3 million, comprising 92% of total revenue. Within subscriptions, revenue from Elastic Cloud was again strong at $69 million, growing 84% year-over-year, driven by strong customer growth and usage. Elastic Cloud was approximately 34% of total revenue, up from 26% a year ago. The vast majority of Elastic Cloud revenue is now derived from consumption-based arrangements, As you may know, the consumption model places no limits on how much data a customer can bring into our platform. Additionally, customers have the flexibility to purchase credits based on the amount they plan on using or purchase purely on demand each month. They also have the flexibility to consume credits on actual usage without wasting credits until they are up and running at full capacity and without being penalized with higher rates if they consume credits faster than they expected. The limitless consumption and customer flexibility considerably reduce friction and make it a superior business model compared to a traditional Rattable model. Also, we recognize revenue based on the actual consumption. Revenue grows as consumption ramps, so we believe this sets us up nicely for strong revenue and expansion metrics in the future. Within Elastic Cloud, we once again saw strength in both our annual cloud business as well as our monthly cloud business. More specifically, our monthly cloud business exhibited ongoing momentum in both new customer additions and increased consumption. This route to market continues to be a great way to acquire and onboard new customers as they quickly find value in our paid features and support. Monthly cloud revenue was approximately 16% of total revenue in Q2 versus 15% in Q1. Professional services revenue in Q2 was $15.7 million, growing 47% year-over-year. This revenue stream can fluctuate across quarters depending on the timing of projects and delivery. Professional services remains mainly a product in APA, and we do not expect professional services to increase significantly in mix over the year. 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. The Americas grew the fastest, followed by APJ and then EMEA. Federal business performed well in the quarter. Calculated billings in the quarter grew 30% year-over-year to approximately $231 million. At the end of Q2, total deferred revenue was approximately $390 million, up 26% year-over-year. Maining performance obligations totaled approximately $832 million, up 29% year-over-year. Customers continue to make multi-year commitments to us, reflecting the increasing strategic relevance we bring to their businesses. Contract length remains slightly over 1.5 years on average. As a reminder, we do not actively manage the business to a target contract length, so this can fluctuate across quarters. Also, our monthly cloud business has no deferred revenue or remaining performance obligations. Turning to customer metrics, the end of Q2 was over 17,000 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 830 customers with annual contract values above $100,000, compared to more than 780 such customers at the end of Q1, reflecting continued strong expansion trends. This marks the third quarter in a row of strong momentum in this category. We also crossed another important milestone and now have over 100 customers with ACD over $1 million, compared to over 50 such customers at the end of fiscal The pace of customer additions and growth in both the greater than 100k ACV and greater than 1 million ACV categories reflects the success of our enterprise selling motion. And we believe we are still only in the early stages of unlocking the opportunity in the enterprise segment. Our net expansion rate was roughly flat compared to Q1, remaining slightly below 130%. As you know, this was a trailing 12 months measure and therefore a bit slower moving. We continue to expect the net expansion rate to remain at current level, give or take a few percentage points in Cisco 22. Now turning to profitability, which is non-GAAP. Gross profit in the quarter was approximately $158 million, representing a gross margin of 76.8%. We managed our overall gross margin well during the quarter, despite the increase in the cloud mix. Looking ahead, Elastic Cloud will remain a modest headwind to gross margin overall as it increases in mix and we continue to invest to drive growth. Looking at operating expenses in Q2, we increased our investments in the business as we laid out in the prior call. We added 341 people to the company, which included 61 from recent acquisitions. A significant portion of these investments were in sales and marketing, where our core strategy of driving initial adoption and then scaling up through the enterprise remains unchanged. We're also expanding our capacity across geographies and segments, as well as scaling our velocity sales motion to further drive our cloud business. At the same time, we are continuing to focus on moving further up within the enterprise with field investments that support our solution strategy. We expect these investments to continue in Cisco 22 across all functions as we look to capture the market opportunity ahead. Our operating profit in the quarter was $1.4 million, with an operating margin of 0.7%, which was significantly better than expected, primarily due to the strong revenue performance in the quarter. This reflects the operating leverage inherent in our business model. We also continued to benefit, as expected, from lower travel and event spending given the pandemic. Loss per share in Q2 was $0.09, using 92.2 million weighted average shares outstanding. Turning to free cash flow. Free cash flow was negative $12.2 million in Q2. As we've said before, quarterly cash flow can be lumpy and affected by timing issues and seasonal variation, so we look at cash flow primarily for the full fiscal year. We continue to expect our free cash flow margin to remain slightly positive on an unlevered basis in fiscal 22. We ended Q2 with a strong balance sheet. Cash and cash equivalents totaled approximately $876 million after the recent acquisitions of Build.Security and CMD. Turning to guidance. The year is playing out as we expected, both from an execution and business environment perspective. Specifically on Elastic Cloud, our customers' consumption patterns have been robust through the first half of the fiscal year, and we expect this trend to continue. We remain confident that Elastic Cloud will continue to grow faster than the overall business, and as Shai mentioned, we expect Elastic Cloud revenue to exceed 50% of total revenue in the next three years. We also continue to expect our calculated billings growth in the second half to be greater than the first half as our recent investments gain traction. That said, we continue to believe that revenue is a better indicator of our business trends than calculated billings in RPO, as those can fluctuate based on timing and the duration of customer contracts. In a consumption model, these metrics are also less correlated to revenue due to the variability associated with customer consumption patterns. Also, as I mentioned previously, our monthly cloud business, which has been gradually increasing in mix, has no deferred revenue or remaining performance obligations. Additionally, as you know, the U.S. dollar has been strengthening recently. At current spot rates, we expect FX to be roughly a 1% headwind to reported revenue in the second half of the year. Looking ahead, we remain very excited about the long-term opportunity ahead of us and will continue to invest aggressively in the second half against that opportunity. As the business environment continues to improve, we also expect increased expenses related to travel and events. Even with these investments, we will continue to demonstrate the operating leverage in the model for the full fiscal year. With that background, for Q3, we expect revenue in the range of $207 million to $209 million, representing a growth rate of 32% year-over-year at the midpoint. We expect non-GAAP operating margin in the range of negative 6% to negative 5%, and non-GAAP net loss per share in the range of $0.24 to $0.20, using between 92.5 and 93.5 million ordinary shares outstanding. For full fiscal 2022, we expect revenue in the range of $826 million to $832 million, representing a growth rate of 36% year-over-year at the midpoint. We expect non-GAAP operating margin in the range of negative 3% to negative 2%, and non-GAAP net loss per share in the range of 61 cents to 51 cents, using between 92 and 93 million ordinary shares outstanding. In summary, we had a great first half of the fiscal year, and our strategy is working nicely. We remain excited about the long-term market opportunity ahead of us, and we are investing towards that. And with that, let's go ahead and take questions. Operator?

We will now begin the question-and-answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. Our first question today comes from Raimo Linchao with Barclays.

Thank you, and congrats on a strong quarter. If you think, Shai, can you talk a little bit about the cloud adoption patterns that you're seeing there? Because if I look out into the industry, it seems like all of the vendors are seeing very, very strong growth. Can you talk a little bit about that whole notion of competition versus actually a broadening of the market and what's driving that broadening of the market at this scale? And then I had one follow-up for Janusz after. Sure.

Yeah, of course. Thanks. Thanks for the question. Happy to answer it. I will answer it in at least two parts on my end. The first part is the move to the cloud. You know, I traveled and visited customers in Europe and in the U.S., and I see more and more both small companies but many large enterprises obviously moving to the cloud. They still have some workloads running on-prem, but definitely new workloads are running on the cloud. And when they run on the cloud, especially for large enterprises, they're looking for multi-cloud strategy. This is when we talk to them about our strategy and our investments in running on all the various cloud hyperscalers, our integrations with them, and the support for existing workloads that they have on on-prem. They're very excited about the opportunity that presented them. But cloud is the delivery model, which obviously we're investing in and making sure that we have a best in class offering. Our three solutions are well integrated, obviously, and delivered best on our cloud offering. And those three solutions are the ones that I think are growing the most when it comes to the opportunity that we have in front of us. Enterprise search, the ability to add a search box to your website, observability, the ability to monitor your cloud workloads, as well as your on-prem workloads and infrastructure. and security to the ability to detect and prevent cyber threats. All of them are markets that in the midst of convergence yet expansion that I, to be honest, haven't seen over the last few years that I've been, you know, engaging in them. So that I remain very excited. And the combination of these three highly applicable solutions across verticals and across geographies delivered by cloud makes me optimistic about the future.

Yeah, perfect. And Janusz, as we think about your business with more cloud in the mix, I think billings will be less and less relevant. Can you kind of, what's your thought going forward in terms of what you should really talk to in terms of CRPO, billings, maybe an ARR metrics, revenue? Because a lot of the cloud doesn't get captured, well, none of the cloud gets really captured in billings and stuff.

Yeah, it's a great question, Raimo. And at the end of the day, there's no perfect measure in these kinds of businesses, which is why, as I've indicated before, I think revenue is the best measure for us to reflect the performance of our business. It includes the full effect of the adoption of our technology across all the different formats that we offer. It's also the best measure to look at, particularly since now the vast majority of our cloud business is based on consumption-based arrangements. And As you know, in a consumption model, revenue reflects customers' current consumption patterns. It's not a time-based runoff of historical deals. So revenue, in fact, in a consumption business is a very current measure of customer activity. And calculated billings in RPO provide a bit of a view of billings and backlog, but they are affected by the various factors that you talked about, especially because the monthly cloud business does not have any deferred revenue or RPO. So given that, I continue to look at revenue as a primary measure when I look at the business internally. Perfect. Makes sense. Thank you. Congrats. Thank you.

Our next question comes from Brent Till with Jefferies.

Janesh, I think everyone's curious. I know you mentioned don't focus on billings or DR, but you did have a pretty sharp decel year on year on current DR. Was there anything that You take away from that. I think you had mentioned you expected the second half billing to be higher than the first half. Are you still anticipating that?

Yeah, we are, Brent. So, you know, as I reflect back on the quarter and the performance in Q2, we are very pleased with the outcome. I think the team did really well on many different fronts. Obviously, the headline numbers that you see in terms of revenue growth and cloud revenue growth at 84%, but there were many successes across the business. When you look at the customer metrics and the expansion metrics, So there was a lot for us to be pleased about in the quarter. We had already shared previously that we expected a stronger second half in billings, given that the investments that we started to make in the past couple of quarters should start to bear fruit in the back half of this fiscal year. And that continues to be our expectation. So the year is playing out just as we expected, and we're looking forward to the rest of the year. We feel really good about the business looking ahead, and you see that confidence reflected in the raised guidance for the year.

And maybe for Shai, just when you think about the commitment to the platform, it seems like you have numerous engines of growth and this kind of commitment to the Elastic platform versus, you know, taking one area for security or another area for search. Are you seeing these bigger enterprise-wide commitments where you're seeing standardization and bigger enterprise license agreements? Talk to us about just the adoption pattern, what you're seeing as it relates to the platform adoption.

Yeah, of course. Happy to. So first of all, I'll start that our focus is on our three main solutions, enterprise search, observability, and security. We've been playing in the observability space for almost 10 years now. And through observability, specifically through logging, we're starting to be using one more within the security space, even before we invested actively to build user experiences that are curated for security professionals. So all of them are very natural evolution of our product line. The benefit that I believe we have is the fact that all of them are developed into a single unified platform. That means that we can implement certain capabilities in one area and then have them immediately impact the other. I mentioned, for example, our ability to reduce latency, compress network, and reduce data storage costs And those suddenly, once we implemented them, apply to all of our cloud customers across enterprise search, observability, and security. That platform play also helps us with our ambitions and efforts to become the first or second player in each market, like we did, by the way, from my perspective, at least, in the enterprise search market, which was our first solution. So we continue to invest heavily there. Great. Thank you.

Our next question comes from Matt Hedberg with RBC Capital Markets.

Great. This is Anisha for Matt Hedberg. Thanks for taking my questions. Maybe could you start by talking about the macro environment and the health of your end markets? And secondarily, although the details on the new COVID variant are limited, are you assuming any additional conservatism in your model?

Yeah, maybe I'll take that. So just in terms of the Go ahead, Shai.

I'll talk about the market environment, happy to. So first of all, the three solutions that we work through that works into the single platform, and by the way, I'll talk a bit about the examples of customers that I didn't get a chance to mention before. They help us really address the needs of our customers. Our total addressable market is north of $70 billion today. and we think it reflects the expansion and applicability of our software, and we're very, very excited about it. Together with our cloud growth, we think that we're solving our customers' needs every single day, and that's very exciting. As I speak to customers every single day, we help solve their challenges of today's and also of the next few years. We'll just help a home improvement company with their supply chain challenges in observing it and making sure that they can optimize it and serve their customers. That's very exciting. We help one of our largest customers start with us in the logging use case, expand to APM, and then adopt our full breadth of observability use cases. And then from there, thanks to their usage and wonderful experience that they had with us, they've expanded and now use us for SIM, displacing their existing incumbent vendor within the security space. And I'm excited to also offer them down the road our endpoint security and cloud security offering. So all of that makes me very excited about what we build. At the end of the day, you know, as companies become more digital, as they move to the cloud, they end up generating large and massive volumes of data. And we, I consider us to be the leader in providing search experiences across any type of data. And I think that represents a huge opportunity ahead of us. When it comes to COVID and market conditions, obviously, this is a very volatile situation. We have new variants coming on, countries changing their rules. What we remain focused on is, first of all, making sure that we serve our customers as they go through these difficult times and sometimes turbulent times. We keep our employees safe and focus on the applicability of our solutions. It doesn't change during COVID or hopefully soon when COVID passes. The ability to find what you're looking for addresses secular trends that are there, whether COVID exists or not.

And then maybe just to round that out in terms of how we've modeled COVID specifically into the guidance, we are continuing to see a slightly better environment, as Shai said. That was the expectation when we laid out our plan at the start of the year. And we expect that in the back half, things will continue to improve gradually over the course of fiscal 22. Got it.

And then you've reported strong customer net ads for three consecutive quarters now. Could you talk about the drivers of that trend? And then how durable are this level of net ads? And then one last question from you. How is the licensing change from a few quarters ago positively impacting new customer adoption? Thank you.

Sure, so I can take those. And to start with, in terms of the customer metrics, we've been very pleased with our customer metrics. I think fundamentally our strategy is working. As customers start to use us for one solution, their data volumes grow, their needs grow, they ingest data from more sources, they then extend into additional solutions, and all of that drives significant expansion for us. So we're also calling higher within the enterprise, which is an area where we've been investing quite meaningfully. and our strategy is working quite nicely there as well. We talked about metrics not just in terms of total customer count, a lot of which come on the monthly cloud format to us, but also the expansion that we've seen in the greater than $100K and greater than million-dollar ACV categories. So the opportunity for us is large, and we are continuing to invest, and it's the motions that we've been driving historically, including the cloud partnerships that we have, the investments we've been making internally in the business that are helping us drive that sustained growth in terms of new customer additions, both in terms of total customers as well as the expansion for the greater than $100K and greater than million-dollar categories. And then, you know, as I think about the other part of your question, in terms of the sustainability of that, again, it comes back to the investments we're making. As we've talked about before, the opportunity is really rich out there. We're investing heavily in the business. We feel pretty good about the motions that we have in terms of customer acquisition and customer expansion, and we're looking forward to the rest of this fiscal year.

Wait, thank you.

Yeah, maybe I can chime in for the license change quickly. I think it's a very relevant question. So first of all, the license change, we've been very happy with the license change. The first and most important part is that our community of users is all the way from practitioners, developers, operations, SREs, continue to adopt our software based on every single metric that we track. Actually, it's increasing in some areas like our download numbers, which makes me very excited. And also, when I end up talking to CIOs and CISOs out there, they take it very naturally and think that that makes total sense. When it comes to how it plays out in the markets, one of the wonderful things that happen with the license change is that there's more clarity in the market. This type of clarity is clarity that we deserve. The fact that the only way to access our innovations and our products is by working with us as a company in a collaborative way. And obviously, when you become a cloud customer, you have access to all of it. And this clarity is now showing over the last few quarters, and I expect this additional clarity to be a tailwind for us over the next few years. especially for a cloud business.

Thanks. Our next question comes from Yichun Wang with Citi. Hello. Again, that's Yichun Wang. Your line is open.

Hi, guys. Can you guys hear me all right? Yeah, we can. Go ahead, please. Oh, sorry. Hey, thanks for taking the question. Yeah, I'm just curious on some of the Elastic Cloud. It looks like it decelerated slightly on constant currency, which is kind of slightly surprising given the strength we've seen on some of the competitors. And could you provide some of the colors as to the numbers? What do you see there, some of your competitors? new customers' momentum or expansion trends from current customers. And I guess the follow-up to that is we actually saw a blog post regarding the TLS certificate change on Elasticsearch website that was completed in the end of October. And I was just wondering if you guys think there would be any effect on your usage trend that we've seen seems to be slowing down a little bit. Yeah, there we are.

Thanks. Yeah, maybe I can take the first part of your question, and I'll let Shai touch on the second part. In terms of the cloud revenue outlook, you know, at 84% growth in cloud in Q2, we were actually very pleased with that performance, both in terms of as reported as well as constant currency change, the growth rates. So, you know, I think that was a very positive outcome from our perspective. We executed very well on many fronts. We had a large number of net new customer additions and also expansion, as I just talked about. The investments that we've made, the partnerships, the go-to-market investments that we're driving, the integrations with the hyperscalers, I think all of that is working very nicely for us. So looking at the cloud business overall, we've delivered robust growth now for several quarters in a row. Given our focus and our customers' preference as they adopt Elastic Cloud and start to expand in Elastic Cloud, we do continue to expect that cloud will grow significantly faster than the overall business. And as we laid out, it will exceed 50% of revenue over the course of the next few years. Shai, do you want to touch on the bit about the blog posts?

Yeah, of course. I believe that what you refer to is our license change, which I answered in the previous question. We remain excited about it. And you asked about how we look at it as a future driver for our business. We all believe and are excited about the clarity that it drives in the market as we speak. And we think that it's going to be a tailwind for our cloud business over the next few years.

Not the licensing change. I know there's like a TLS certification change for the Elasticsearch website that comes in October. I think it was for the Elastic Cloud or Elasticsearch website. There was a certificate change and then because we saw some of the web traffic, it kind of decelerated meaningfully and we just figured it might be a coincidence that it just tracks just as you guys doing the certification change on your website, on the server.

Oh, I see. There's really no change in our business or our web traffic as a company. We continue to monitor it and we haven't seen any change on our end. Okay, thanks.

Our next question comes from Mark Murphy with JP Morgan.

Oh, great. Hey, thank you for taking the questions. This is Bindulam sitting on behalf of Mark. Shai, I wanted to ask you about Optimize. Seems like it takes you into the observability of cloud-native slash microservices-based workloads. Is that entirely a cloud solution, and how does that compare with competitive products like Datadog and SignalFX from Splunk? Yeah, of course.

So first of all, we're very excited about the Optimize acquisition. It's the investments that we'll make not only on the expected of what our customers need today, like APM and logging and infrastructure monitoring and metrics, but also on emerging technologies. Optimize is built on top of a technology that is continuously evolving and emerging called eBPF that allows to do continuous profiling at very low overhead without explicit profiling of the application. This technology is Linux operating system technology, so it applies to any server that runs Linux and runs containers on top of it. And obviously, it's heavily used in cloud-native workloads that revolve around tools called Kubernetes and container workloads. So, yes, we expect most of the usage of it to happen on cloud-native workloads. especially as it can peer into containers, workloads, and help people continuously profile it at low overhead. It's a technology that evolves as we speak at a very rapid pace, and we're excited about the ability to adopt it, integrate it into our platform, and offer it to our users under the same proxy model that we already have over the next year.

Understood. Does that kind of take you to parity versus some of the competitive products?

I think that the whole technology around continuous profiling is something that is in the very, very early beginning, so it's hard to say whether there's parity or not. This is one of the newer aspects of observability, and I think the thing that I'm excited about is the fact that we're building the foundation for us to use that technology because we believe it's going to be a core foundational aspect of observability moving forward.

Understood. And one for Janesh. Janesh, when I look at the sequential subscription revenue growth, it seems like about 7%. It seems a bit lower if I look at previous Q2s in prior year. Is there anything unusual in terms of linearity in the quarter, or maybe your higher consumption-based mix now doesn't even make sense to compare versus prior year? I mean, any color would be helpful.

Yeah, happy to talk about that, Bijal. Fundamentally, nothing unusual in terms of the mix of business or the linearity or things as they played out. I look at the quarter-over-quarter growth, but also look at the year-over-year growth where as the business gets a lot bigger, obviously the growth rates are hardest to sustain. But when you look at the year-over-year growth at 84%, I think that's been remarkable for us in terms of the results of the investments that we've made. So we were actually very pleased with the performance As I mentioned, the usage or consumption on the platform was even higher than we expected at the start of the quarter. And so that played out quite nicely, and it sets us up very nicely for the back half of the year.

Understood. Thank you.

Our next question comes from Brad Reback with Stiefel.

Great. Excuse me. Thanks very much. Shai, during the prepared remarks, you talked about a free-to-pay conversion approach. a fairly large customer that moved from a self-managed free to your cloud, your SaaS product. Is this going to be something you see as a long-term opportunity or more as a one-off?

I deeply believe that this is a long-term opportunity for us. Yes, especially with our cloud business. There's a few factors playing into it. The first one is that companies are realizing that it's much better to let the people that develop and build the products to run them as well so they can focus on their business. And obviously that is a driver for our cloud business. And, you know, we're very proud of our bottom-up adoption and the vast, vast community that we have of users that, you know, started with downloading the software and running it themselves. And I think there's an opportunity to tap into that and have them move to us as they move to the cloud and run on the cloud. The other part that I would say is, you know, and that was a part of the reasons why we changed our license is that I expect the license change to help drive clarity in the market that I'm already seeing when it comes to customers that, or users, free users that use Elasticsearch on-prem. And then as they want to go and move to the cloud, there is very, very clear company and only company that provides Elasticsearch as a service, and that's us, with the full breadth of capabilities of our solutions as well. So that's something that I remain excited about. I think that this is going to play out over the next few years, but definitely as good as a tailwind for our business.

Excellent. Thanks very much.

Our next question comes from Koji Ikeda with Bank of America.

Oh, hey, Shai. Hey, Janesh. Thanks for taking my questions. I've got a couple for you. The first one on the Elastic App Search web crawler announcement, you know, with it becoming GA in the 7.15 release. I was wondering if you could talk a little bit about how fast that can get enterprise search up and running versus how it was done in the past. And when I first saw the release, you know, back at the end of September, reading the blog post, I thought that there could be many different use cases for this type of crawler within an organization. I was wondering if if that thought process was right. You know, could this crawler be used for anywhere within an organization where data is being updated continuously, like an e-commerce search or maybe in an internal workplace or a self-service type knowledge base? And then I have one follow-up.

Yeah, of course. We're excited about our web hauler technology. This ties into our efforts to continuously simplify and ease data onboarding and usage of our products across our three solutions. And that's a great example of our investments that we do in the enterprise search space. Definitely also on our cloud businesses, we, as customers that do adopt and use our web hauler, tend to stick around and convert from trials to paid customers significantly more compared to customers that haven't used the web crawler. So that's just a great indication that as we invest in simplicity and ease of use of our products, it means that we will be able to increase the number of customers that we have and increase the consumption that they have over time. It's all about ease of use when it comes to a company that thrives on the ability to build search experiences on data. And a big part of the early part of the interaction with Elastic is the ability to onboard data. And that was a big focus for us over the last few releases, including 7.15, and it's one of the biggest focuses that we have in 7.16 in our upcoming release.

Got it, got it. Thank you. And then just one follow-up for Janesh. Looking at the numbers here on the second quarter results, it looked like it was about a 5% revenue upside against the high end of the guide, whereas the last two quarters were maybe double digits, I believe, against the high end of the guide. Just was curious, anything to note in the quarter, maybe back-end loaded bookings or anything else in the revenue that we should be aware of? Thank you.

Hey, so nothing specific to call out. You know, I will point out, though, that as we enter the year, we did talk about the fact that we have better visibility, and so we were going to lean into that a little bit more. So I think it played out as we expected it would, and a little bit better than we expected, given the strong consumption patterns that we saw on cloud with respect to the consumption and usage trends for customers. So that's really what you saw here in the numbers. And if I compare that to Q1, you'll recall that in Q1 we had some other benefits in professional services and so forth that helped the number. But this was really the strength of Elastic Cloud consumption that we saw reflected in the numbers in Q2.

Got it. Thanks, Janesh. Appreciate it. I appreciate you guys taking my questions. Thank you. Thank you.

Our next question comes from Kingsley Crane with Barenburg Capital Markets.

Hi, our questions have been answered. This is Ed Maggi on Kingsley Crane. So we'll see you at the floor. Thanks.

And our next question will come from Steve Koenig with SMBC.

Hi, thank you, Elastic. Steve Koenig here. I appreciate you squeezing me in. You know, you've got this goal of getting Elastic Cloud to exceed 50% of total revenue in the next three years, which looks imminently doable. I'm wondering, when you look ahead to those next three years, what are going to be the key operational challenges or initiatives that you'll need to undertake or changes that you'll have to make, whether it's in product go-to-market, pricing, et cetera, to make that goal a reality? Thank you very much.

Yeah, I'm happy to take it. Our cloud journey started in 2015, and we've been investing in cloud since then, but definitely over the past year, two years, we've invested significantly more, and we mentioned that this year is a year of investment for us. I'll start with the product side. The first part is around the effort of running Elastic Cloud natively on all the cloud hyperscalers, Amazon AWS, Google Cloud, and Microsoft Azure. That's a lot of work on the product side, from integrations with the marketplaces, billing engines, various data sources that they provide, and providing a single pane of glass across all of those data sources, all of these cloud providers, sorry, with our cross-cluster search capabilities and the ability to search across all of them from a single location. That really resonates with our customer base, and that's not an easy thing to implement, especially with large enterprises. The other part is continue to invest in more and more ease of use in terms of onboarding data to Elastic. We shine when there's data in Elastic itself. We have such advanced capabilities when more and more data exists in Elastic, like searchable snapshots, the ability to store data over long term, and being able to still search it using the same APIs and same UIs. So the more data comes into Elastic, the more consumption is driven in our cloud, which is great, but the more value our customers see. So we continue to invest in ease of use of onboarding data into our cloud service. The other part is our, you know, and then, you know, tons of other aspects that we spoke about, some of them when it comes to our various solutions and making sure that we continue to innovate, invest, and lead there. When it comes to our go-to market, A few things that I can mention. The first part is continuing investments in our cloud partners, all the three cloud hyperscalers that I mentioned. We love working well with them. We think that a business that goes through the marketplace is additive to both of us, and we love having a joint offering and joint solution as a result of it. We make significant investments across all three. Our investments that we mentioned in our inside sales function, A big part of our sales service, increased consumption, product-led growth is heavily helped by inside sales function that continue to take it and help our customers succeed over time as they continue to use our software and our products, which is exciting. But that also comes together with our investment in going up within enterprises, That's something that we've invested over the last year. A good example of it is our analyst relations that we only really kick-started about a year or a year and a half ago, and you already see the impact of it across the gardener and forester. Analyst relations that we have in the Magic Quadrant results and forester waves. But that also includes investments in our field when it comes to supporting C-level executives and going all the way up to customers that invest north of a million dollars with us and making sure that we support them. Those are just some of the investments that we're making. They're all tied together, and we think that together with just tailwind of companies becoming more digital, moving to the cloud, and our license change means that we're excited on going on this journey of increasing the capacity for our cloud business. Beyond that, I will just mention the simple fact that every customer that uses our cloud is in better hands and have better experience. So on a very natural level, we prefer our customers to run on our cloud versus not because we think that they get the best experience provided by Elastic.

Thanks very much, Shai. Sure.

This concludes our question and answer session. I'd like to turn the call back over to Shai Bannon for some closing remarks.

Thank you, everyone. Thank you for joining us today. Q2 was a great quarter for Elastic. We continue to see strong customer momentum for our differentiated solutions and a large market opportunity ahead of us. Appreciate you joining us. Ciao.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.