Elastic N.V. (ESTC) Q3 2020 Earnings Report, Transcript and Summary

Good day, and welcome to the Elastic Fiscal Third Quarter 2020 Financial Results Conference call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Anthony Luscri, Vice President, Investor Relations. 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 2020 financial results. On the call we have Shay Banon, Founder and Chief Executive Officer; and Janesh Moorjani, Chief Financial Officer. Following their prepared remarks, we will take questions. Our press release was issued after the close of market and is posted on our website, where this call is being simultaneously webcast. 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. On this call today, our discussion may include predictions, estimates, or other information that might be considered forward-looking statements within the safe harbor provisions of the U.S. federal securities laws. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties include those set forth in the press release that we issued earlier today as well as those more fully described in our filings with the Securities and Exchange Commission, including our Forms 10-K, 10-Q and 8-K and other filings made with the SEC from time-to-time. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this presentation. Please keep in mind that we are not assuming any obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events unless required by law. In addition during today's call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to not as a substitute for or in isolation from GAAP measures. Our non-GAAP measures exclude the effect on our GAAP results' of stock-based compensation, employer payroll taxes on employee stock transactions, amortization of acquired intangible assets, acquisition-related expenses and non-GAAP tax rate adjustments. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures in the press release and on our Investor Relations website and the slides accompanying this webcast. The webcast replay of this call and slides will be available for two months on our company website under the Investor Relations link. With that, I'll turn it over to Shay.

Thank you Anthony. Welcome everybody to another Elastic earnings call. It's great to be here today and talk about the third fiscal quarter results. We once again delivered strong performance, driven by broad adoption of our offerings. Our results underscore the widespread and rapid adoption of the Elastic Stack in solving mission-critical problems for customers across segments and geographies. We believe our market opportunity across enterprise search, observability and security is enormous and that we are well positioned to capture the long-term opportunity and deliver better outcomes for customers and users. In Q3, revenue grew 60% year-over-year and we once again saw robust customer acquisition and expansion metrics. We ended the quarter with more than 10,500 subscription customers, including over 570 with annual contract values of more than $100,000 and our net expansion rate continues to be over 130%. I commented on a recent company all-hands meeting that I'm amazed on how much the team accomplishes in between calls. I feel the same way in this forum and I'm super excited to share some of our Q3 highlights with you. For us, everything ties back to first principles. Why do we do the things that we do? How do they continue to make our company and our customers successful? Our free and open distribution model fuels rapid adoption and innovation. Our business model leverages proprietary features to drive product differentiation and customer growth. Our strong innovation delivers value to our customers and our unified pricing model helps them grow with flexibility not friction. All of this is realized through our focus on building enterprise search, observability and security solutions on a single technology stack that can be deployed anywhere. Search is foundational to many experiences, finding documents, monitoring logs and infrastructure, protecting against security threats and beyond. And because Elastic is a search company, we're able to power a multitude of solutions in large markets that drive results for our customers in a way that other companies can't. This is because we engineer a search box you can put on just about anything. In the enterprise search space, we believe that putting a fast and scalable search box on your website, application or workplace data should be simple. This contrasts with what you're probably used to with other vendors and lack of scalability, for relevant capabilities, insufficient connectivity and long setup times that involve heavy integration services. The landscape has changed. With the tremendous proliferation of SaaS services from Slack to Google G-Suite, Office 365, ServiceNow and Salesforce, enterprise search solutions need to meet customer expectations for searching across these services easily. They need to be fast, scalable, and relevant. They need to be simple. We're delivering on this. Our investments in the enterprise search space continued in the quarter. We delivered highly requested platinum-level features like meta engines for our app search product. This helps enterprises better scale and manage multiple search deployments. We made our proprietary app search offering natively available through our Elasticsearch Service on Elastic Cloud. This is yet another step towards our vision of Elastic Cloud being the single SaaS platform on which customers can deploy all of our solutions. For us, the innovation hasn't stopped in the enterprise search world and continues to unfold on top of Elasticsearch one of the most popular search engines in the world, in order to deliver on the speed, scale, and relevance capabilities our customers need and deserve. For example materials science company, Dow closed new business with us in the quarter for enterprise search. They're replacing a previous search product with Elastic to ultimately drive a better employee search experience by connecting to more data sources and delivering more relevant results. Another example from Q3 is international real estate franchiser RE/MAX they closed new business with us for enterprise search moving from a monthly Elastic Cloud subscription to an annual subscription. This gives them the flexibility to be more cost-effective, while generating additional revenue and gaining a competitive edge for their business. Because our search technology is flexible and built on a single stack, it's easy and seamless for us to take a search box for full text and documents and apply it to log, metric, and APM data with our observability solution. As the amount of infrastructure, websites, and applications needed to support today's enterprises increases, so does need to monitor and observe it. We deliver a unified approach to our customers with a single stack and curated observability solution. When all the data lives in one place under one UI, it's easy to go from analyzing infrastructure metrics to analyzing server logs and application phases. This simplicity resonates with our customers. For example, in the quarter, we renewed and expanded business with a leading global investment bank. They use Elastic to get 360-degree visibility into their log, metric, and APM data. As a result, they can power multiple use cases that track customer activity on the website, back-end API consumption, and fraud detection. When all the data lives in one place, it's easy to apply our new platinum-level machine learning capabilities introduced in the quarter to observability workloads. Currently, millions of unstructured logs can be automatically categorized helping practitioners get to root cause quickly and efficiently. When all the data lives in one place, it's easy to expand cloud monitoring and unlock more visibility into billing and usage metrics to help customers run more efficiently. But why stop there? While you observe, why not protect? Which leads me to our security solution. Here we've made it easy to go from log analysis to threat hunting in a single click and also integrate with superior endpoint protection. In a market that is overrun with unintegrated single-purpose legacy offering, we are redrawing the lines. Our security solution already offers a unified approach that reduces investigations from hours to minutes, but we continue to innovate on it. In the quarter, we deepened visibility for securing Windows endpoints, a popular choice for many enterprises. And when practitioners paired the new capability with our highly requested SIEM detection engine that we released in this quarter, they now have enhanced layered prevention. This is exciting for a few reasons. First, practitioners are armed with a curated list of nearly 100 prepackaged rules that automate threat detection, reduce dwell time, and align with minor attack industry standards. Second, because our SIEM is open, we have a wonderful opportunity with our community to further build out a rich library of detection rules. This creates a network effect for us that amplifies our ability to reach more users and use cases. I'm incredibly proud of the team's effort here. We've come a long way from the middle of last year when we previewed our SIEM product which is now generally available under the proprietary Elastic license and it will just keep getting better and better with each iteration. The excitement with each release is not only present in the developer world. I see it continue to get traction as we move up the enterprise as well. From hands-on practitioners and decision-makers visiting our booth at RSA this week to the CSO at a major financial institution I met with recently. They're hungry for something different. They're weary of the unintegrated tooling, restrictive pricing model and the need for specialized expertise to operate. Our approach to security is different and it's resonated with users across various industries and sizes of business. We had several strong security customer wins in the quarter from the public sector in the U.S. and globally as well as in the banking, telecommunications and higher education technology sectors. Across all our solution areas, customers are coming to us asking for the tools and resources to migrate their workloads to Elastic. And because data has gravity to it it's important that they have the freedom to deploy where they choose in the cloud on-prem or hybrid environments. We provide that With Elastic Cloud customers can get access to our proprietary offerings like our SIEM and machine learning capabilities on their preferred cloud provider AWS, GCP, Azure, Tencent Cloud or Alibaba Cloud. And we continue to invest in a growing number of regions each quarter, which included GCP in Montreal, Virginia in Mumbai and Azure in Tokyo in Q3. It's worth highlighting our partnership with Microsoft Cloud platform. They've been a great supporters of our technology and community. They've committed to sponsoring our Elastic on tour events in the U.S., APAC and South America and we've sponsored several of their Ignite conferences. It's been really fantastic to watch this relationship grow. For customers that choose an on-prem or hybrid approach we continued to make investments in the quarter to help customers orchestrate their Elastic deployments with ease. We continued to see strong customer adoption for our Elastic Cloud Enterprise product. For example, we closed new business with Switzerland's leading telco provider Swisscom. A few years ago they were running a few nodes of Elastic for logging. Today they've grown to 40 instances of Elastic Cloud Enterprise to on-demand logging solutions. It's exciting to see them build out a strong foundation that sets up a path for even more growth. For users who prefer to run Kubernetes, I'm excited to share that our Elastic Cloud on Kubernetes product became generally available and I'm happy to share it's already driving more adoption. For example, Japanese collaboration software company Cybozu is a knowledgeable user of Kubernetes. They adopted our Elastic Cloud on Kubernetes product when we first previewed it last year. It will be important to Cybozu to orchestrate their observability workloads with Elastic. As a result, they've closed new business with us in the quarter. Everything I've covered so far is very validating of our strategy. It is also very humbling as I think about the people who make it possible from employees to our community, customers, partners and beyond and I'm excited to welcome two more people to the team as of this quarter Alison Gleeson and Sally Jenkins. Alison officially joined our Board this quarter bringing with her 20-plus years of strong experience at Cisco where she led a successful go-to-market team of over 9,000 people. Sally joined us as our Chief Marketing Officer as we scale our marketing function for strong future growth. She is a result-driven marketing leader with many years of experience at companies like Informatica, VMware and Symantec. They are both great additions to our company and I look forward to the impact they will have on our growth. Similar to the addition of Alison and Sally looking ahead I see an opportunity to bring in a seasoned go-to-market leader who has built and seen multibillion-dollar scale as we address the large and exciting market opportunity ahead of us. Accordingly, Aaron Katz will step down from his current role as Chief Revenue Officer and immediately move to an advisory role. I would like to thank Aaron for his many contributions to Elastic over the years. During his tenure we have delivered rapid growth and laid a strong foundation for the future. In the near-term Justin Hoffman will step in to lead our global sales efforts. I expect this to be a smooth transition since Justin has already been successfully running sales for the Americas and EMEA since he joined us almost seven years ago and those two regions made up the vast majority of our global business. We remain focused on our efforts to provide more customer value through making solutions that are easy and enjoyable to use, delivering on differentiated product innovation and a strong go-to-market strategy through our sales force and partnership. And with that I'll hand it over to Janesh to cover the details of our financial performance.

Thanks, Shay. We are pleased with our strong performance in the third quarter, which reflects continued execution against our large market opportunity. As Shay mentioned the quarter's strength was broad-based across enterprise search observability and security driven by strong new and existing customer growth across segments and geographies. I'll cover our Q3 performance first and then provide an outlook for Q4 and the full fiscal year. Total revenue for the third quarter was $113.2 million, growing 60% year-over-year as reported, or 61% on a constant currency basis. 44% of our revenue came from outside the United States, reflecting the strength of our bottom-up community-based adoption model. As I've mentioned before, we view this geographic distribution as a long-term strength of our business model. Subscription revenue totaled $104.2 million, an increase of 61% year-over-year as reported, or 63% on a constant currency basis and comprised 92% of our total revenue. We continue to benefit from a robust product offering, underpinned by a single technology stack and a unified pricing model, which we believe positions us well for the long term. Within subscriptions, the rapid adoption of our SaaS offerings continues to be the largest driver of our overall growth. Revenue from Elastic Cloud, which is our family of SaaS products, was strong at $25.1 million, growing 114% year-over-year as reported or 118% on a constant currency basis. We saw strength in both our annual SaaS business as well as our monthly SaaS business. Our rapid growth and increasing scale in SaaS, reflect the success of our strategy to widen our future advantages over competitive offerings and leverage our partnerships. Customers of all sizes are demonstrating a preference for Elastic Cloud. We are confident that these customer trends, combined with our continued investments in our SaaS business, can drive fast growth faster than our overall business growth in the future. Professional services revenue was $9 million, an increase of 44% over the same period last year. As a reminder, professional services revenue can fluctuate from quarter-to-quarter based on projects and delivery timing. Overall, we've seen strong adoption of our training and consulting offerings, which continue to be enablers of subscription growth. Moving on to calculated billings. Calculated billings in Q3 grew 54% year-over-year or 56% on a constant currency basis to $122.9 million. To provide a bit of geographic color APJ was once again the fastest-growing region, followed by the America and then EMEA. Within the United States we successfully closed a portion of the Fed deals that were delayed in Q2. At the end of Q3 total deferred revenue was approximately $209.8 million, up 52% year-over-year. Remaining performance obligations totaled approximately $426 million, up 40% year-over-year. Although, we do not actively manage the business to a target contract length, contract lengths were slightly shorter compared to a year ago, but continue to be roughly one-and-a-half years on average. As a reminder, our monthly SaaS business has no deferred revenue or remaining performance obligations. Turning to customer metrics, as of the end of Q3, we had over 10,500 total subscription customers compared to over 9,700 such customers at the end of Q2. We saw similar strength in new customer additions in Q3, as we have seen in prior quarters. The majority of the growth in total subscription customers came from Elastic Cloud, reflecting the product and market strengths I referenced earlier. We also ended the quarter with more than 570 customers, with annual contract values of $100,000 compared to more than 525 such customers at the end of Q2. Our existing customers continue to expand their relationships with us, reflecting increased spend for existing use cases and adoption of new use cases. In Q3, our net expansion rate remained over 130%. Overall, we were pleased with our customer metrics as we continue to execute against the significant market opportunity ahead of us. Now turning to profitability, which is non-GAAP. Gross profit in the third quarter was $84.7 million, representing a gross margin of 74.8%. We are tracking well relative to our expectations. In the near term, we will continue to invest in our SaaS business, which will remain a modest headwind to gross margin overall. Looking at operating expenses in Q3, we managed our investments and spending well, as we remained focused on driving top line growth, while scaling our investments with discipline. Our operating loss in the quarter was $20.2 million, with an operating margin of negative 17.8%, which was better than expected, primarily due to the strong revenue performance in the quarter. This reflects the strength of our underlying business model. The FX impact on operating margin was insignificant, since we have natural hedges as we incur expenses globally as a distributed company. Net loss per share in Q3 was $0.28, using 80.7 million weighted average shares outstanding, this compares to a net loss per share in Q3 of last year of $0.16. Turning to free cash flow. Free cash flow was negative $24.2 million in Q3, compared to negative $9.9 million in the same period a year ago, reflecting timing differences of certain inflows and outflows. As a reminder, we look at free cash flow and free cash flow margin primarily on an annual basis, since there are both seasonal and timing effects in any quarter, making quarterly cash flow inherently lumpy. We continue to expect modest improvement in free cash flow margin for the fiscal year. We ended the third quarter with approximately $294.1 million in cash and cash equivalents. We remain comfortable with our cash position from an operating perspective. Turning to guidance for the fourth quarter and the full year fiscal 2020. At the start of the year, we laid out our investment strategy of driving revenue growth and accelerating organic headcount-related investments and reinvesting the operating leverage inherent in our business model back into R&D to drive longer-term growth. The acquisition of Endgame in Q2 bolstered our investments further. We've executed well according to that plan so far. For the fourth quarter of fiscal 2020, we expect revenue in the range of $119 million to $120 million, representing 48% year-over-year growth at midpoint. We expect non-GAAP operating margin to be in the range of negative 20.5% to negative 19.5% and non-GAAP net loss per share in the range of $0.32 to $0.30 using between 82 million and 83 million weighted average ordinary shares outstanding. For the full year fiscal 2020, we expect revenue in the range of $423 million to $424 million, representing 56% year-over-year growth at the midpoint. We expect non-GAAP operating margin to be approximately negative 20.5% and non-GAAP net loss per share in the range of $1.13 to $1.12, using approximately 79 million weighted average ordinary shares outstanding. In closing, I'm pleased that we delivered yet another strong quarter. We remain excited about our long-term market opportunity and competitive positioning as we prepare to close out the year. With that, let's open it up for questions. Operator?

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brent Thill with Jefferies.

Thank you, and good afternoon. Curious, if you could just give an update on some of the federal deals from last quarter, the status of those transactions? And just secondarily, Microsoft pre-announced negatively due to the coronavirus. Curious, if you're hearing any change in tone on the overall IT environment, what you're seeing with the current situation. Thank you.

Hey, Brent, it's Janesh. Maybe I'll take the first part of that question, and then let Shay talk about the impact of coronavirus. So, overall as I look back on the quarter, we were actually quite pleased with the performance that we delivered. Obviously, strong performance across many different fronts in Q3 across revenue, and not just total revenue but also in terms of SaaS revenue where we more than doubled year-over-year. As I mentioned in my prepared remarks, a portion of the Fed deals did close, which helped the billings growth a little bit. But we had many successes more broadly through the rest of the business as well and those are reflected in the rest of the metrics that we talk about. So, there's quite a bit for us to be pleased about in terms of the performance in the quarter. And in terms of any remaining deals, I'll touch on that as well. As I mentioned, in Q2 there were a handful of deals that had slipped and we closed some of those here. So, there are still a few deals in the pipeline. But I will point out that the timing continues to just remain unpredictable on those. So, I don't see any significant risk or upside in Q4 from those remaining deals. Also recall that Q4 is seasonally our largest quarter. So at this point, I'm looking at the remaining deals just like any other deals in our overall pipeline, and I don't expect it to cover those in future quarters.

Yeah. Maybe I can take the coronavirus question. So first of all, our hearts go to everybody who are affected by the virus and their near and dear ones. The situation changes by the minute it seems. Obviously, we're paying very, very close attention to it as a company. Specifically when it comes to China, our exposure there is very small. Most of our business come -- the vast majority of our business comes from outside of China. And when it comes to the rest of the world, obviously we're paying very close attention to it. We are a very distributed company as a team, which helps a bit when it comes internally as a company to continue and operate, but the effect that it has on the global market is something that we're paying close attention to.

Great, thank you.

Our next question comes from Mark Murphy with JPMorgan.

Thank you. I'll add my congrats, and Aaron, you will be missed and best of luck on all your future endeavors. Shay, we've heard a couple of suggestions recently that companies are putting about 10% of new cloud budgets into this category of logging, monitoring metrics, et cetera. And it seems like a surprisingly large percentage that would be directed toward Elastic and a few other companies focused on that area. Does that align with your inputs? Or is that -- is the range kind of too variable across different customers to try to pinpoint it?

Yeah. I'm not familiar with the numbers specifically that you mentioned. But, I mean we've seen companies adopt our logging solution for many years. And the need to be able to go now and observe your whole infrastructure your application and your deployment is only increasing. Observability is relatively new, but it has become a term if you will very quickly. And I think it maps to the need that companies have whether it's on cloud or on-prem to be able to better observe their infrastructure. That involves not only logging, but that involves APM and infrastructure monitoring. And I think maybe what you see is what's something that I believe in, which is the opportunity that you have in the observability space is actually bigger than the summation of these other spaces combined. I do think that also, if I may, I mentioned on the call, I think as companies build on-prem and they move to cloud the need to be able to obviously observe their infrastructure and their deployment only increases. And the need to secure this infrastructure also increases which makes me excited about our security investments. And also the fact that our strategy is to be there for our customers wherever they are. I mentioned on the call that data has gravity to it and our ability to go and deploy our solutions next to where the customers are whether it's on a sales manager on-prem basis or whether it's on various cloud providers resonates with our users.

Thank you Shay. And Janesh just a quick follow-up, is anything else holding back the RPO growth sequentially and year-over-year other than the contract duration? And I guess I'm just wondering could you normalize that RPO number at all for the duration? Anything you can do there to help us understand the impact?

Yes, Mark. So as I think about RPO you mentioned both the RPO growth as well as billing sort of calculation based on that RPO growth. In terms of the RPO I think the primary factor is the contract duration that was slightly shorter. As I mentioned they still hover around the 1.5-year mark. And in any particular quarter they can always bounce around by a couple of months up or down. And so that's a little bit of what we saw over here. In terms of quantifying that we haven't done that discretely. And on RPO billings, specifically that's a metric that I've mentioned before it's less meaningful for us because we don't actually manage the business actively to a particular duration. We manage primarily based on ACV. And as I talk to our sales teams and as we think about the overall economics of a transaction we try and maximize the overall economics for ourselves rather than providing concessions for long-term contracts that are beyond what we ordinarily tried. So that's why we focus mainly on the calculated billings and revenue as the primary metrics that we look at when we measure the business. But broadly we've not seen any big changes in our overall deal metrics and we just continue to be quite happy with the way we've executed here in Q3 and are looking forward to Q4.

Thank you.

Our next question comes from Heather Bellini with Goldman Sachs.

Great. Thank you so much. I have two questions, one for Janesh and one for Shay. I guess Janesh just following up I think a little bit to Mark's question. Just trying to get a sense for – even for the percentage of your contracts that might be less than one year. Because if we look at the current balance of unearned revenue, I mean that's been coming kind of in line with expectations but I'm just wondering if there's anything to the current number that's getting impacted by contract duration maybe for a certain percentage of your installed base being less if there's been any changes in that amount? And then secondly for Janesh. I was just wondering when with Endpoint, given obviously that's a relatively recent acquisition just wondering – and I know you gave some highlights in your prepared remarks kind of who are you seeing most often when you're competing for business? And can you talk about maybe the competitive advantages that you're seeing versus your primary competitors? Thanks.

Heather it's Janesh. So I'll take the first part of that. In terms of the nature of the business that's less than one year in duration the primary piece there is the monthly SaaS component of the overall SaaS business. And there again we were quite pleased with the performance of that part of SaaS and in fact obviously SaaS as a whole as well. The monthly SaaS component continued to be roughly 10% of total revenue and it continued to grow quite rapidly. The way we think about it is that the web self-service option it's a great way for us to acquire new customers and then nurture them and watch them grow over time and that's all net new business. I'll quickly point out that the monthly Saas by the way also includes the on-demand usage that's above the contracted rate for annual SaaS customers. So as I think about the impacts there again it grew at a pretty healthy pace consistent with the overall rate of SaaS growth. And it's hard to predict the growth rate in that monthly SaaS component because customers might move to annual contracts might move to different kinds of models that better accommodate their uneven consumption. So that's why I prefer to look at the SaaS business as a whole and we do see the total SaaS business continuing to grow faster than the rate of the overall business.

Yes. And maybe I can touch on the Endpoint question. So first of all we closed the transaction only recently. The Endgame team has joined us and I will mention how impressive I have been with the team joining us. We have more than 100 engineers joining our security solution team now and they've already shown their capabilities that we can deliver not only when it comes to Endpoint but also to our – for our SIEM solution. We just GA-ed our SIEM solution this quarter and together with that we delivered one of the highly requested features that we had in the road map which is our detection engine. But together with that as well we had our protection team now that came from Endgame that delivered more than 100 prepackaged rules for it. As I look forward towards the opportunity that we have around Endpoint, we're making significant investments to fold the Endpoint product into our own Elastic Stack to really align with our vision that there's a single technology stack that delivers all of the various solutions that we provide. We've done the same thing three years ago with APM and we're seeing the results now. When it comes to competition, I'll mention that, Endgame developed one of the best endpoint protection solutions today and, obviously, we provide the ability for customers to engage with us commercially on it. And the competition varies across your usual players in this space from the legacy vendors like McAfee and Symantec to new ones like Carbon Black and CrowdStrike and others.

Great. Thank you so much.

Our next question comes from Raimo Lenschow with Barclays.

Hey. Congrats on a great quarter for a start. I was wondering, like the -- your cloud business has been doing well and we have now -- we've seen now like four quarters of accelerating growth there, which is really nice to see. But can you talk, like, how is that impacting your total customer addition? Will you kind of over time kind of start signing more customers, because they are coming on the lower price point? Or how do we have to think about that?

Hey, Raimo, it's Janesh. I'll take that. So, broadly, the SaaS business, as you noted, has been performing really well. Even in the past quarter we had a large number of net new customers that came in to Saas and we also saw significant expansion. We've invested quite heavily in the SaaS business, expanding availability across hosting providers as well as geographically and Shay touched on some of those investments and regions. And we've also started to add more marketing resources that focus on Saas. So the strength that we are seeing in SaaS really is a result of all of these factors. From the standpoint of customers, the Elastic Cloud piece and monthly SaaS components continue to attract a large number of customers. A lot of the net new customers that we added in Q3 and that we've added in prior quarters start with us on cloud. It's a really easy on-ramp. It's pretty easy to get started and from there, they continue to grow with us. But, obviously, as the numbers get bigger, it gets harder to sustain triple-digit growth, but we do expect that the SaaS business will grow nicely for us. And over time those customers will continue to expand their spend with us. The averages can be a little bit misleading, because you can have very wide ranges. I've got customers in that mix that started spending a few hundred dollars with us and have expanded to be multimillion-dollar customers. And we've got some customers in there that started at a few hundred dollars and are still today only a few hundred dollars. So it can be a very wide range, but overall we continue to see pretty strong expansion dynamics in that part of the business as well.

Perfect. And then one follow-up for Shay. If you look at observability, like, everyone is competing, but you guys are going to bring the message together of like having it all in one place, including also security. But on some of the -- the points part of that, you're probably starting from a -- slightly from behind. What's the customer thinking in there in terms of having best-of-breed in some of those solutions versus kind of actually seeing the benefit of one platform? And is there like a tipping point coming at some point? Or how do you think about that dynamic?

Yes. So a few points about that. First of all, we've been one of the most popular logging solution out there for many years now. So, I think, when it comes to the full observability spaces around various companies in various areas, or other solutions like APM and infrastructure monitoring, realizing that and also acting and trying to address the observability opportunity that is in front of them. I will mention that we have been seeing this trend happening for more than three years. We acquired an APM company about three years ago, seeing the need to provide what is now called observability. We worked and invested quite hard on R&D efforts to try to fold it into a single technology stack, because we truly believe that if markets fold and if products fold and they become features then it means that, a strong technology stack and a single experience triumph. We're also taking that to market in how we package and price our products, so we don't have different SKUs for the different solutions. And that really, really resonates with our customer base. And we're doing the same thing now with security. I think as I mentioned before, I think, the observability opportunity in front of us is bigger than the summation of logging infrastructure monitoring, or APM, because more workloads are moving to cloud more infrastructure needs to be monitored and observed and we're well positioned to be able to go and address that.

Okay. Perfect. Thank you. Well done.

Our next question comes from Kash Rangan with Bank of America.

Hey, guys. Thank you for taking my question. Congratulations on the quarter. Shay, I would love to get your perspective on the single platform that you're detecting the product set around. That strategy, I suppose, will play really well at the grassroots level, at the developer level. But as these deal sizes become larger, your competition in your industry is still fragmented, in that you have an observability vendor, a meter and security leader in logging. Is there a risk that you're ahead of the curve and that you're waiting for the convergence to happen, but the buying centers are still very separate and that they might complicate sales cycles for the foreseeable future, while being very respectful of the fact that you're building this all-in-one platform? In that context, what are you looking for with the new Chief Revenue Officer that you're looking for? What kind of qualities and what kind of experience are you looking for, especially as these buying centers, which are silos today that may converge in the future? What does it take to succeed from a go-to-market standpoint? Thank you.

Yes. Thanks, Kash. So maybe I can start. The fact that we're building our solution on a single platform, first of all manifests itself in our ability to have power plays or compounding results on our investments. So, for example, when we go and add drag-and-drop visualization called Kibana Lens into our core stack, it means that suddenly every single DevOps person or security practitioner becomes a business analyst if you will in their ability to go and visualize it. And so that I believe manifests itself in our ability to go and have an efficient R&D when it comes to trying to address all of the various solutions that we have. We don't necessarily want to force organization lines to break. We'll happily sell within the observability space into one division that needs logging and another one that needs APM. And definitely when it comes to the differentiation between observability and security we'll happily engage with the various buying centers in order to provide them the solutions that they need. I am encouraged by the fact that we have two promising factors from my perspective. The first one is that any logging users suddenly get exposed with very little effort into the rest of the observability paradigm. And as you see that market matures and people realize that that's needed then that resonates with them. And as you go up into the enterprise, the CIOs and the CSOs that I'm talking to, our packaging and pricing ease of use the fact that users don't have to train on multiple various products even when a single company delivers it, it might be multiple products really resonates with them. So they see the ability to actually bet on a single company that can see them through in this vision of observability and then security also as abroad. To your second question around what we're looking for in a CRO, we just had Sally join us to be our CMO and I already see the effect of someone that has seen scale bring to our company. We had a strong -- very strong foundation in our marketing team already but as I think about how do we position our company to capture the opportunity that we have in front of us and really the road to get to a multibillion-dollar company in revenue, I'm looking for someone that can come in and have the similar effect and set the next set of foundations and make sure that we go and address structurally the opportunity that we have in front of us especially as you mentioned across various business lines and across various solutions.

Best wishes guys. Congratulations.

Thank you very much, Kash.

Thanks, Kash.

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

Hey guys, congrats on the quarter. Thanks for taking my questions. A lot of us are at RSA this week and I'm wondering Shay when you look at your progress on becoming more of a vendor in the security space from a customer market perception standpoint, what are other things that you need to do to have people think of you guys in that light?

So we're -- it's a great question. First of all, I spent the whole day yesterday at RSA. It was a great event from our perspective. We actually had two booths at RSA. Endgame had a booth before and we had a pretty big presence there. Even with RSA, which is a more business-oriented conference, you could see people getting drawn. I think we had full capacity in every single demo and every single time that we showed our products. The excitement is contagious when it comes to our efforts in the security space. And that's practitioners. That also resonated really well with our recent release, the excitement that the practitioners themselves have around our detection engine and the SIEM improvements that we've done in Endpoint. And they can't wait to have Endpoint protection. That just like -- I feel like it's similar to what we had about six or seven years ago when it comes to the logging space. At the same time though, I had meetings all day in RSA and I was meeting with CSOs and CIOs that are up there in the ranks, making buying decisions and making decisions around, which technologies, and which vendors they're going to bet on towards the future and that can satisfy their needs when it comes to the security space. And our story really resonates with them. Our story around the convergence of SIEM and Endpoint, our resource-based pricing and packaging, the fact that everything is built on top of a single stack, the observability and security use cases, all of that really resonates with our customer base and our user base and everybody that I'm talking to and I'm encouraged by it.

That's super helpful Shay. Thanks. And then maybe another product question. The beta version of Kibana Lens was launched this quarter. It feels like really a big step forward on the BI side, which just really is making business data more consumable for nontechnical users. Could you talk a little bit more about that product, how it might help sort of broader enterprise adoption and consumption of Elastic?

Yeah, of course. So I'll start with saying that one of the things that I really like about what we do is we're really trying to think about -- I mentioned first principles. And if you think about the technology stack as being layered it's like how low can we implement it in a way that ends up manifesting itself across all of our solutions. And I think Kibana Lens is a great example of that. And I'll start with just saying like even developers, practitioners or users on the ground, they love simple tools. Our developers become consumers. They want to be able to have simple and easy to use tools and they love the fact -- and the reaction that we got to Lens, was amazing. And they love the fact that they can take and apply Lens on top of their observability data, on top of their security data, or even enterprise search data. As we make inroads into this space, we have, what we call, the other use cases, the fraud detection that Elastic Search is being used for and matching rides on Uber and tons of use cases that Elastic is being used to that's somewhat hard to bucket, into these three major solutions that we have, enterprise search, observability and security. And definitely business analytics falls into them. We're making, tactical investments that helps us go. And slowly mature also in this space. But for now, we're spending all of our time being, highly focused on these three solutions that I mentioned.

Thanks, well-done guys.

Thank you.

Our next question comes from Brent Bracelin with Piper Sandler.

Thank you. And good afternoon, I guess, I had one for Shay and one for Janesh. Shay, as we approach the 1-year anniversary of Amazon Open Distro, I was wondering if you could just share with us what have you learned about that competitor in the last year. And if you could just kind of maybe explain despite increased competitive overlap why that cloud SaaS business is actually accelerating here in the short-run? And intuitively I would think, with more competition, you wouldn't see acceleration. So, what have you learned about Open Distro in the last year? And why is that SaaS business accelerating and then, a quick one for Janesh.

Yeah. So maybe, I can take that. So, first of all, the situation at least from our perspective, when it comes to Open Distro, hasn't changed. We see very little adoption of it. Our users come and still download. And deploy our software and the capabilities that we deliver to them, really resonates. We set on a path to start to create differentiation on the product level, through our free yet proprietary features. SIEM is one of them, the Elastic Security SIEM product. Kibana Lens is another. And the amount of differentiated features is just increasing exponentially, every single release. So I'm really encouraged by that. That also has resonated with our user base. They want to get a product that actually delivers their outcomes that they look for. They'll happily engage with us on a community level, when it comes to the fact that part of it is free at proprietary and open. And I think that that helps just drive, the large adoption that we have. And the vast majority of our, downloads and obviously our developments. Because we're the only one that can provide it, includes our default distribution, which is basically our -- includes both open source and our proprietary features. I think for all of these reasons, we haven't seen Open Distro really make any change or difference for us. When it comes to Saas, the answer is the same. We're driving for product differentiation. And only way, that you can get Elastic SIEM or Elastic Lens, Kibana Lens or other major substantial solution-oriented features as well as low-level optimization ones is our cloud service. And our users are seeing that and they're using our SaaS service to be able to get the best product possible.

Helpful color there, and then, just Janesh, here as we think about 2020 here, I know Endgame's contributing. But operating expense growth will actually be faster than revenue for the first time that we've seen. Your operating expenses now are going to be north of $400 million. I guess my question really is from a philosophy standpoint, given the accelerated investments that you made -- I get this year. But what is your general philosophy around kind of showing -- now that you're going to be above $400 million OpEx spend going into next year what's your philosophy around trying to show some leverage on that investment that -- aggressive investments that you've made this year?

Yeah. Thanks, Brent. So broadly I'll say, we continue to see a pretty rich market opportunity ahead of us, in enterprise search and observability as well as security. In the near-term we are focused on continuing to grow and scale the business, as we capture that opportunity. And we've been investing against that market opportunity. At the start of this fiscal year we laid out our plan to accelerate organic hiring into the first half and then we actually doubled down with Endgame with closing that transaction in Q2. So as you point out there was a significant investment there. And we've executed well according to the plan that we laid out. So we've had pretty strong results every quarter. We've raised our outlook every quarter and managed the dilution from Endgame quite nicely and you'll see have raised the OP margin outlook for fiscal 2020 again. And as I think, about the future longer term we continue that -- we continue to believe that we'll invest in a disciplined way commensurate with the growth opportunity that we see and importantly against -- we'll invest against, our execution against that opportunity as well. So it's important for us to be good stewards of capital. If we see the opportunity to invest and grow we will. If not then we'll adjust accordingly. And there is leverage inherent in the model which we've demonstrated this year and then we will take that course. So I'll give you a view on how we see fiscal 2021 unfolding in about 90 days' time. But conceptually we are aligned with the thought that we need to continue to grow the business and invest against that growth. And that gives us the ability to drive business forward in fiscal 2021.

Helpful color, thank you.

Our next question comes from Tyler Radke with Citi.

Hey! Thanks good afternoon. Shay, in your prepared remarks you talked about enterprise search, I felt like more than you normally have and I think mentioned some competitive displacements. Maybe just talk about that market opportunity was it a higher mix of use cases than typical this quarter? And maybe just give us a sense on how that competitive environment is evolving. Thank you.

Yeah, of course happy to. So first of all, I'll start with saying that observability still represents the biggest out of the three solutions that we have as – when it comes to landing customers or the mix that we have. I am excited about the enterprise search opportunity for multiple reasons. The first one is, we've established ourselves as a leader in the enterprise search space for many years now. We have one of the most popular search engines out there and we've been implementing enterprise search use cases for many years. And within the enterprise search solution though, we have a whole team that continues to not only think about the present, but also about the future and where we can we take it forward. And what we chatted about creating products that are more consumer oriented we believe that there is an opportunity to take these products to the workplace and being able to with one-click deployment connect to all of your SaaS services and being able to go and search easily and within seconds your Zoom chats, your Slack messages, your Salesforce data, Workday, ServiceNow and other tools. We're working on this product. It's in beta version now. And we think that that's another opportunity for us within the enterprise search space to really revisit some core assumptions that has been done over the last few years.

Thanks. And maybe I could ask a follow-up just on – Janesh for the – as I think about the cloud business the SaaS business, I think historically you kind of cautioned us on modeling that continuing kind of going up to the right as a percentage of overall revenue and I know in the last couple of quarters you've kind of seen the tailwind of lapping the SaaS pricing headwinds. How should we just think about the sustainability of kind of the growth rate of that business? I mean, it's kind of growing at almost double the rate of overall. Is that more of an optical kind of phenomenon just from the lapping of the tailwinds or is there kind of a fundamental reason that maybe that should continue? Thanks.

Yeah. Tyler a couple of different dimensions to that answer. So one is in terms of the growth rates that we've seen as I mentioned earlier a significant part of that is because of the investments that we've made in the business and in the reach as well as the customer acquisition efforts that we've got over there. So we've been quite pleased overall with the growth rate of the SaaS business as a whole. And we continue to be excited about the possibilities on that front as well. The team has executed really well over the course of Q3 as well as the prior quarter on the SaaS side. So we've seen this broad-based strength in Saas, but as we've said longer term the growth in SaaS will generally mirror customer preferences and where their workloads reside. And so as the business grows I think it will be hard to sustain triple-digit growth, but we do expect SaaS to continue to grow faster than the rate of the growth in the overall business. So we continue to be really excited about the possibilities on the SaaS business.

Thanks.

And our last question will come from Ittai Kidron with Oppenheimer.

Hi. This is George Iwanyc for Ittai. Janesh, maybe can you give us a sense of your assumptions for the coronavirus? Are you building in any conservatism into the guidance for that?

Not particularly right. As Shay mentioned, we are watching the situation quite carefully and it seems to be evolving in near real time. So it's a little bit hard for us to think about that and the potential impact it might have. But broadly, I can tell you that, the way we've constructed guidance is to reflect all of the things that we know about the business at this point in time. We are quite pleased with the track record that we've had so far in terms of delivering expectations that we've set forth. But Q4 is a pretty large quarter for us and there's a lot that we need to get done over the next 60 days. So we haven't discretely factored in any particular disruptions into the business. We will keep an eye on that. One of the advantages of us being a distributed company is that we can – we're a little bit more resilient, if you will from that standpoint. But obviously to the extent that, we start to see things happening more broadly in the marketplace with our customers and partners in our community and if there are travel restrictions and so forth that can clearly have an impact and have not discretely thought out any of that. But broadly speaking, I can tell you that at this point, the guide reflects my best view of the business based on everything we know here and now.

All right. And you mentioned that you closed some of the Fed deals. Have you lost any of those? And with the ones that are remaining what kind of time frame do you think to close the rest?

Yeah. Broadly – so the short answer is no, we didn't lose any of those competitively. But I'll tell you looking back we are quite pleased with our performance overall in the Fed space and also in public sector worldwide. We did close some of the deals. We had several strong security wins as well in the public sector space overall. So we continue to work very closely with our customers both in Fed as well as more broadly in public sector. The remaining deals that are in the pipeline the timing continues to be unpredictable. But as I said it's not going to have a meaningful impact one way or another here in Q4. And at this point, I just look at them like I do any other deals that are in the pipeline.

All right. Thank you and congrats on the solid quarter.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Shay Banon for any closing remarks.

Thank you all for joining the call. Q3 was a strong quarter for us. We remain focused on addressing the large and exciting market opportunity ahead of us and look forward to sharing our progress with you again next quarter. Bye.

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