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Elastic (NYSE:ESTC) Q1: Beats On Revenue But Stock Drops


Full Report / August 25, 2022
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Search software company Elastic (NYSE:ESTC) announced better-than-expected results in the Q1 FY2023 quarter, with revenue up 29.5% year on year to $250 million. Guidance for the full year was in line with analyst expectations with revenues guided to $1.08 billion at the midpoint. Elastic made a GAAP loss of $69.5 million, down on its loss of $34.4 million, in the same quarter last year.

Elastic (ESTC) Q1 FY2023 Highlights:

  • Revenue: $250 million vs analyst estimates of $246.3 million (1.51% beat)
  • EPS (non-GAAP): -$0.15 vs analyst estimates of -$0.17
  • Revenue guidance for Q2 2023 is $261 million at the midpoint, roughly in line with what analysts were expecting
  • The company reconfirmed revenue guidance for the full year, at $1.08 billion at the midpoint
  • Free cash flow was negative $10.1 million, compared to negative free cash flow of $5.25 million in previous quarter
  • Net Revenue Retention Rate: 130%, in line with previous quarter
  • Customers: 19,300, up from 18,600 in previous quarter
  • Gross Margin (GAAP): 70.8%, down from 74.2% same quarter last year

Started by Shay Banon as a search engine for his wife's growing list of recipes at Le Cordon Bleu cooking school in Paris, Elastic (NYSE:ESTC) helps companies integrate search into their products and monitor their cloud infrastructure.

Building your own search engine is hard and even the biggest companies want to focus their energy elsewhere. Elastic offers a set of software products that ingest and store data from any source, in any format, and perform search, machine learning, and analysis.

For example Uber is using Elastic to power the systems that locate nearby riders and drivers, eBay is using it to help users find what they want to buy and Facebook is using it to power search in their help centre. Elastic is one of the companies that have been benefiting from the growth of the overall internet economy and has lately started expanding the use of their data processing technology from enterprise search into cloud-infrastructure monitoring and network security monitoring products.

Elastic’s business model is based on a combination of open source and proprietary software and the company uses the open-source part to power their distribution strategy. It is really easy to start using Elastic and developers can download limited versions of the software straight away for free, without speaking to any salespeople. Over time, if the software proves itself and the need for it expands inside an organization, it is easy to upgrade to a paid license.

Generating insights from system level data is an increasing priority for most businesses, but to do so requires connecting and analyzing piles of data stored and siloed in separate databases. This is the demand driver for cloud based data infrastructure software providers, who can more readily integrate, distribute and process information vs. legacy on-premise software providers.

Elastic competes in a segment that includes companies such as Yext (NYSE:YEXT), Lucidworks, and Splunk (NASDAQ:SPLK).

Sales Growth

As you can see below, Elastic's revenue growth has been very strong over the last year, growing from quarterly revenue of $193 million, to $250 million.

Elastic Total Revenue

This quarter, Elastic's quarterly revenue was once again up a very solid 29.5% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $10.7 million in Q1, compared to $15.4 million in Q4 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.

Guidance for the next quarter indicates Elastic is expecting revenue to grow 26.7% year on year to $261 million, slowing down from the 42.1% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 26.1% over the next twelve months.

Customer Growth

You can see below that Elastic reported 19,300 customers at the end of the quarter, an increase of 700 on last quarter. That's in line with the customer growth we have seen last quarter but a bit below what we have typically seen over the last year, suggesting that sales momentum may be slowing a little.

Elastic Customers

Product Success

One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.

Elastic Net Revenue Retention Rate

Elastic's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 130% in Q1. That means even if they didn't win any new customers, Elastic would have grown its revenue 30% year on year. That is a great retention rate and a clear proof of a great product. We can see that Elastic's customers are very satisfied with their software and are using it more and more over time.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Elastic's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 70.8% in Q1.

Elastic Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.70 left to spend on developing new products, marketing & sales and the general administrative overhead. Despite it going down over the last year, this is still around the lower average of what we typically see in SaaS businesses. Gross margin has a major impact on a company’s ability to invest in developing new products and sales & marketing, which may ultimately determine the winner in a competitive market so it is important to track.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Elastic burned through $10.1 million in Q1, with cash flow turning negative year on year.

Elastic Free Cash Flow

Elastic has burned through $24.3 million in cash over the last twelve months, resulting in a negative 2.64% free cash flow margin. This below average FCF margin is a result of Elastic's need to invest in the business to continue penetrating its market.

Key Takeaways from Elastic's Q1 Results

With a market capitalization of $7.88 billion Elastic is among smaller companies, but its more than $848.7 million in cash and the fact it is operating close to free cash flow break-even put it in a robust financial position to invest in growth.

It was good to see Elastic deliver strong revenue growth this quarter. And we were also happy to see it topped analysts’ revenue expectations, even if just narrowly. On the other hand, revenue guidance was quite conservative and gross margin deteriorated a little. Overall, this quarter's results were not the best we've seen from Elastic. The company is down 5.75% on the results and currently trades at $80.02 per share.

Is Now The Time?

When considering Elastic, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. Although we have other favorites, we understand the arguments that Elastic is not a bad business. Its revenue growth has been strong. And while its customer acquisition costs are higher than we like to see, the good news is its customers are increasing their spending quite quickly, suggesting that they love the product.

Elastic's price to sales ratio based on the next twelve months is 6.9x, suggesting that the market is expecting more moderate growth, relative to the hottest tech stocks. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Elastic doesn't trade at a completely unreasonable price point.

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