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Image source: The Motley Fool.

Elastic (NYSE: ESTC)
Q2 2025 Earnings Call
Nov 21, 2024, 5:00 p.m. ET

Highlights from Elastic’s Second Quarter Earnings Call

• Key Financial Results
• Strategic Developments
• Leadership Insights

Key Financial Results:

Operator

Good day, everyone. Welcome to Elastic’s second quarter fiscal 2025 earnings results conference call. All participants are in listen-only mode. [Operator instructions] This call is being recorded.

Now, I’ll pass the call to Anthony Luscri, vice president of investor relations. Anthony, please go ahead.

Anthony Luscri — Vice President, Investor Relations

Thank you for joining us today. We will discuss Elastic’s Q2 fiscal 2025 financial results. Joining me are Ash Kulkarni, our CEO; Janesh Moorjani, CFO; and Eric Prengel, our incoming interim CFO. Following our opening statements, we will open the floor for questions.

Our press release was released today after the market closed and is available on our website. Supplementary slides are also accessible on Elastic’s investor relations site at ir.elastic.co. Please keep in mind that our discussion may involve forward-looking statements, which are based on factors known as of today and carry risks that could affect actual results.

Positive Q2 Performance Points to Strategic Success

We disclaim any obligation to update these forward-looking statements unless required by law. For further details and reconciliations between non-GAAP and GAAP measures, please refer to today’s press release and accompanying slides.

The webcast replay will be available on our company website under Investor Relations. Our Q3 fiscal 2025 quiet period starts on Friday, January 17, 2025. We will present at Scotiabank’s Global Technology Conference on December 10, and the Needham Growth Conference on January 16. Now, I’ll hand over to Ash.

Ash Kulkarni — Chief Executive Officer

Thank you, Anthony. I appreciate everyone joining us today. Elastic has shown impressive performance this quarter with strong sales and customer engagement. In Q2, we surpassed our guidance across all metrics, achieving an 18% year-over-year revenue increase.

Cloud revenue increased by 25%, and our non-GAAP operating margin reached 18%. Additionally, we grew our number of $100K+ customers to 1,420. After some initial setbacks in Q1 due to changes in our sales segmentation aimed at targeting enterprise and mid-market customers, we’re now seeing the positive results of those adjustments.

This quarter’s success strengthens our confidence in our strategies, particularly in search technologies enhanced by generative AI. We’ve seen a surge in customer commitments, especially for our AI-driven search solutions. In Q2, new customer agreements for generative AI nearly doubled in terms of dollar value, with three contracts worth over $1 million annually.

Currently, over 1,550 customers utilize Elastic Cloud for generative AI applications, including 240 customers who spend $100,000 or more annually. A notable new agreement with a global automotive leader shows how our technology supports advanced chatbot applications and semantic search capabilities to enhance productivity.

Furthermore, we signed an expansion deal with a prominent North American sports retailer. They will leverage our platform to boost search relevance across their omnichannel operations through semantic search and advanced AI technologies.

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Elastic’s Strategic Moves: Enhancing Profitability and Driving Innovation

Improved Margins Through Technological Advancements

Elastic is focused on improving profitability both in-store and online. The company selected Elastic for its expertise in retail search transformation, integrating machine learning and AI search capabilities into a unified platform, T3. Alongside innovations in Generative AI (GenAI), Elastic has also capitalized on customer consolidation onto its platform, helping clients reduce complexity and cut costs as they consolidate multiple IT functions onto one solution.

Incentives Encourage Migration to Elastic’s Platform

To ease the transition for customers switching from existing solutions, significant investments have been made in migration incentives. Last quarter, commitments towards the Elastic Express Migration program and AI-powered automatic import functionality were discussed. These efforts yielded over 40 competitive wins in Q2 as customers opted for Elastic over legacy solutions or brought new workloads under the Elastic umbrella.

Major Deals in Cybersecurity and Security Operations

In a noteworthy strategic shift, an online marketplace for homestays has adopted Elastic Security to replace its outdated security incident and event management (SIEM) solution, reflecting a move towards a more scalable, AI-driven approach. This seven-figure deal is pivotal as it addresses the company’s growing threat landscape and data management challenges. Elastic’s offerings, such as the ESQL and AI Assistant, are set to enhance streamlined security operations and improve threat detection accuracy.

Another substantial seven-figure agreement was secured with an insurance provider, displacing two competitive solutions for their cybersecurity needs. The company currently leverages Elastic Security alongside the AI Assistant to bolster its threat detection, incident responses, and vulnerability management.

Continuous Innovation in Vector Database Performance

In terms of product development in Q2, Elastic has remained dedicated to enhancing its vector database capabilities. New features include support for bit vectors, SIMD acceleration, and INT4 quantization. Moreover, Elastic is now the first vector database to introduce advanced binary quantization, known as BBQ, which promises a 32x reduction in memory usage compared to traditional vector storage methods.

The initial benchmarks indicate a significant reduction in query times, with a up to 30x decrease in quantization time. These advancements aim to resolve the traditional trade-offs seen between cost and accuracy within vector searches, representing a significant development only available from Elastic. Additionally, the general availability of AutoOps simplifies the management of Elasticsearch clusters, providing real-time insights and performance recommendations.

AI Transformations in Security Analytics and Observability

AI continues to reshape the SIEM landscape, evolving it into a modern AI-driven security analytics solution. This new generation aims to merge traditional SIEM functionalities while consolidating protection tools across the IT infrastructure. Recently, Elastic included cloud detection and response (CDR) capabilities into its AI-driven security systems, enhancing threat detection and enabling contextual investigations through a unified workflow.

For observability, Elastic has become fully OpenTelemetry-native, allowing users to transition to an open data standard effortlessly. All OpenTelemetry-compliant data can now be processed without translation, simplifying operations for teams managing the system. Recent developments include new Kubernetes integrations and dashboards, allowing immediate visibility into performance metrics without manual input.

Expanding AI Ecosystem and Global Engagements

On the marketing front, the ElasticON events launched in Q2 have attracted thousands in cities like San Francisco and New York, fostering connections between customers, partners, and developers. These gatherings serve as a platform for showcasing Elastic innovations and expanding its reach.

The newly introduced Elastic AI ecosystem seeks to simplify and accelerate generative AI development through partnerships with major tech providers including Amazon Web Services and Google. Integrations with the Elasticsearch vector database aim to speed up the development of GenAI applications.

Leadership Changes: A Note on Janesh Moorjani

In organizational updates, Janesh Moorjani has announced his departure from Elastic to pursue new opportunities, with his last day set for December 13th. A significant figure in Elastic’s leadership, he has played a crucial role during his seven-year tenure, impacting major milestones like the company’s IPO in 2018 and guiding it past the $1 billion revenue threshold.

His contributions have been invaluable, both professionally and personally, as he has been a trusted colleague and friend to many in the organization.

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Elastic Appoints Eric Prengel as Interim CFO Amidst Strong Quarterly Performance

As Elastic undergoes significant leadership changes, the company continues to showcase its robust operational results. I am thrilled to announce that Eric Prengel, Elastic’s group vice president of finance, will step in as interim chief financial officer starting December 14. This transition comes as the company searches for a permanent replacement. Eric, who has been with Elastic for two years, has made noteworthy contributions, overseeing critical financial planning and analysis (FP&A) and business partnership functions.

Before his time with Elastic, Eric spent almost a decade at JPMorgan in various leadership roles within investment banking. He was also involved in Elastic’s initial public offering (IPO), strengthening his ties to the company. Having collaborated closely with Eric throughout his tenure here, I am confident in his leadership abilities and believe he is well-suited for this interim position. Notably, he will also be considered as a candidate for the permanent CFO role.

In conclusion, I am proud of our impressive performance this quarter. I want to extend my gratitude to our team for their hard work and to our customers, partners, and investors for their continued trust. As we see positive indicators, it appears we are on track to return to our historical execution levels, with our Q2 performance serving as a promising sign of this progress.

The innovations within our search AI platform, the growing momentum around generative AI, and the increasing consolidation of customers onto our platform fuel our confidence in developing a multibillion-dollar business over time. I will now hand it over to Janesh for a detailed overview of our financial results.

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

I appreciate your kind words, Ash. Being part of Elastic’s growth over the past seven years has been a rewarding privilege. Our successful history reflects well on our potential, and I believe Elastic’s future is very promising. The partnership we’ve built means a lot to me, and I’m grateful for both your trust and friendship.

While I am saddened to depart from such a talented team, many of whom have become good friends, I am excitement about my next opportunity. The business, I believe, will be in capable hands with Eric, who has been my right-hand support for nearly two years and has demonstrated himself to be a disciplined leader. Eric will now share a few words before we delve into our results.

Eric Prengel — Group Vice President, Finance

Thank you, Ash and Janesh. I am grateful for the support I’ve received over my near two years at Elastic. Working on the IPO was an eye-opener to the innovative technology and strong culture that Elastic offers.

Since joining, it has become increasingly evident that we have the potential to establish a generational company. Janesh, your impact on Elastic has been substantial, and I appreciate the opportunity to work closely with you. I wish you nothing but success in your new role, and I’m eager to take on this responsibility as we advance forward.

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Thanks, Eric. I am confident you will excel. Let’s review our Q2 results. After a challenging first quarter, we were pleased to see improved sales execution in Q2, with strong customer commitments as Ash noted. We outperformed the high end of our revenue and profitability forecasts.

In the second quarter, total revenue reached $365 million, an 18% increase year-over-year, both reported and in constant currency. Subscription revenue was $341 million, also reflecting an 18% year-over-year increase. Notably, revenue from Elastic Cloud amounted to $169 million, growing by 25% year-over-year. Elastic Cloud made up 46% of our total revenue for the quarter.

Consumption patterns in Q2 remained robust, with enterprise and commercial customers generally keeping pace with their commitments and several larger customers exceeding expectations. Revenue from our Elastic Cloud month-to-month services, primarily from self-service small-to-medium businesses (SMBs), aligned with our expectations at 13% of total revenue. Consumption revenue tends to vary from quarter to quarter, prompting us to monitor these trends closely. Professional services revenue grew to $25 million, reflecting a 7% increase year-over-year.

This quarter was marked by solid deal flow as we honed our sales execution, and we are optimistic about the progress made thus far. Growth was strong across our solutions, especially search, due to interest in generative AI. Geographically, the Americas displayed the most significant growth, followed by EMEA and APJ regions. Customers made considerable long-term commitments, indicating their preference for Elastic during their platform consolidation efforts.

As of the end of the second quarter, we had over 1,420 customers with annual contract values exceeding $100,000. This focus on higher-growth customers, particularly in enterprise and commercial segments, supports our strategy of “land and expand.” Our total customer base now consists of over 4,480 customers with contract values above $10,000, bringing our total subscription customers to about 21,300.

Our net expansion rate stood at approximately 112%, consistent with expectations, and we maintained strong customer retention throughout the quarter. Turning our attention to profitability and cash flow, non-GAAP measures indicate a gross margin of 76.9%, steady with previous quarters.

Operating margin was 17.6%, significantly surpassing expectations due to strong revenue performance and careful spending management. Diluted earnings per share for Q2 was $0.59, with adjusted free cash flow around $38 million, translating to a 10% adjusted free cash flow margin. As cash flow can fluctuate, we analyze this on a full-year scale rather than quarterly.

While we do not offer formal cash flow guidance, we anticipate the adjusted free cash flow margin for fiscal ’25 will exceed the non-GAAP operating margin for that same period. Looking ahead, our market potential is vast.

The Elasticsearch AI platform stands out in differentiation, and our progress with generative AI reaffirms the confidence we have in our growth trajectory.

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Elastic Reports Strong Q2 Results, Raises Full-Year Revenue Outlook

Elastic is consolidating workloads onto its platform, leading to impressive revenue growth in the second quarter. As a result, the company has increased its full-year revenue forecasts, asserting its confidence in future opportunities. Looking ahead to the second half of fiscal ’25, management anticipates that the business landscape will remain consistent with the first half. With a focus on execution, Elastic believes it is poised for long-term growth and profitability.

In the third quarter, Elastic expects both self-managed and annual cloud revenue to show slight increases in dollar terms compared to Q2. A few key factors influenced this guidance. Firstly, although recent performance has boosted confidence in sales execution, the shortfall on customer commitments experienced in Q1 will likely hinder year-over-year revenue growth for the latter half of the year. Additionally, revenue from both annual contracts and month-to-month agreements may experience fluctuations.

Prior experiences with these fluctuations have led to cautious assumptions about consumption rates for annual contracts moving forward. Furthermore, revenue from month-to-month transactions on Elastic Cloud is anticipated to remain relatively stable through the end of the year. Another factor considered was the revenue headwind presented by the recent strength of the U.S. dollar.

Seasonal effects also play a role, particularly in the third quarter, where professional services revenue tends to be negatively impacted due to the holiday season. Regarding Generative AI, interest from customers remains robust. As previously mentioned, the company views its technological strength and rapid innovation as key drivers in establishing itself as a market leader in this emerging area. Elastic is still in the early stages of capitalizing on a significant and rapidly expanding market opportunity, which the company expects will support long-term growth.

When it comes to business investments, Elastic aims to strike a balance between fostering revenue growth and maintaining profitability. The company is selectively increasing some investments in the second half of the year, particularly in areas aimed at driving growth in Generative AI. With the inherent operating leverage in its business model, Elastic is also raising its profitability outlook for the year.

Overall, the company believes it is well-positioned to achieve higher operating margins as it scales in the coming years. For Q3 of fiscal ’25, Elastic projects total revenue between $367 million and $369 million, reflecting an expected 12% growth year-over-year at the midpoint, and 13% growth when adjusted for constant currency. Additionally, non-GAAP operating margin for Q3 is estimated at approximately 15%, with non-GAAP diluted earnings per share expected between $0.46 and $0.48, based on 106 million to 107 million diluted weighted average ordinary shares outstanding.

For the entire fiscal ’25, total revenue is anticipated to fall between $1.451 billion and $1.457 billion. This represents 15% year-over-year growth at the midpoint for both as-reported and constant currency measures. The company expects a non-GAAP operating margin of about 13.5% and non-GAAP diluted earnings per share to range from $1.68 to $1.72 using between 106 million and 108 million diluted weighted average ordinary shares outstanding. In conclusion, Elastic is pleased with its Q2 performance and optimistic about sustaining profitable growth in the future. Now, let’s move to the questions.

Operator:

Questions & Answers:

Operator:

Thank you. We will now commence the question-and-answer session. [Operator instructions] The first question comes from Matt Hedberg with RBC Capital Markets.

Matthew Hedberg — Analyst

Thank you for taking my questions. Congratulations on a strong recovery this quarter. Several factors stood out to me.

Specifically, it appears cross-selling has gained traction, and Janesh, you mentioned an acceleration in consumption patterns among larger enterprise clients. Could you elaborate on that trend?

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Sure, Matt. Our overall consumption metrics for Q2 were quite encouraging, with strong engagement across both enterprise and commercial sectors, as well as across various geographic areas. Notably, several larger customers have increased their use of the Elasticsearch AI platform for both new and expanding workloads. While we have observed stronger consumption patterns historically, the specific clients can vary, so it’s not entirely consistent. We’re pleased with the uptick but will proceed cautiously to identify any emerging patterns.

Matthew Hedberg — Analyst

That makes sense. It’s interesting to see others report improved consumption trends this quarter. Ash, it’s encouraging to hear about the rebound in sales execution. What do you believe contributed to this positive change, especially in light of the adjustments made in Q1?

Ash Kulkarni — Chief Executive Officer

Thanks for your question, Matt. As noted in the last earnings call, we felt confident that the decisions made at the start of the year were correct. We have rigorously inspected our pipeline to ensure discipline in our operations, resulting in several promising developments. Firstly, the pace of pipeline creation and progression has returned to normal levels, which is reassuring. Secondly, changes aimed at emphasizing the enterprise segment and high-potential mid-market areas are beginning to yield benefits. As our team has had more time to engage with accounts, we are witnessing positive behaviors aligning with our expectations.

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Companies Report Strong Performance Amid Shifts in Generative AI Market

Matthew Hedberg — Analyst

Thanks, Janesh. Moving into Q2, what gives me a lot of confidence is witnessing how well the team rebounded after the near-term impacts we experienced in Q1. Their performance in Q2 shows that we are heading in the right direction.

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Thank you, Matt. It has been a pleasure working with you.

Operator

The next question comes from Pinjalim Bora with J.P. Morgan. Please go ahead.

Pinjalim Bora — Analyst

Congratulations on your strong quarter. Janesh, I wish you great success in the future. Eric, congratulations on your interim role. I want to ask about binary quantization. It seems to set Elastic apart in the vector database market. However, quantization often involves trade-offs between accuracy and cost. How pervasive will this be across various Generative AI (GenAI) use cases?

Ash Kulkarni — Chief Executive Officer

This is an area I’m incredibly enthusiastic about. Quantization does entail trade-offs between efficiency and accuracy, but our advanced binary quantization delivers exceptional efficiency. Not only does it require less memory, but it also improves query performance while maintaining a high level of accuracy. As I mentioned earlier, this technology could revolutionize the AI landscape. We’re still at the early stages of the AI revolution, and our innovations are designed to capture significant market share. The potential applications are extensive, and we’re committed to advancing this technology.

Pinjalim Bora — Analyst

I see. Janesh, I noticed a strong cloud consumption this quarter. However, RPO numbers appear subdued sequentially, even though several deals shifted from last quarter. How does your current bookings cadence compare to historical norms?

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Pinjalim, we were actually very pleased with our overall sales execution in Q2. The team has effectively bounced back due to the additional initiatives we implemented after Q1. Sales reps have had more engagement time with new accounts, contributing positively. While we closed many deals that were delayed from Q1, those were not the primary drivers of our success this quarter. Looking ahead, we have a solid outlook for the remainder of the year. The RPO timing and month-over-month changes are consistent with our historical performance and potentially slightly higher than last year’s figures, which is encouraging.

Pinjalim Bora — Analyst

Understood. Thank you.

Operator

The next question comes from Tyler Radke with Citi. Please proceed.

Tyler Radke — Citi — Analyst

Janesh, it has been a pleasure working with you. It’s great to see you end on a high note. Ash, returning to the GenAI use cases, it sounds like the quarter was strong, with commitments doubling. How do you see these use cases developing? You mentioned being the backbone for various applications including agents, chatbots, and semantic search. How is your sales team approaching the GenAI market?

Ash Kulkarni — Chief Executive Officer

Your question highlights a critical area, Tyler. Across industries, many business processes rely on manual handling of unstructured data. Generative AI significantly automates this workflow. Our strategy is to position ourselves as the essential platform for retrieval-augmented generation, which will support the development of diverse GenAI applications. Initially, this may involve improving search capabilities with techniques like hybrid search, which leads to building chatbots and generative applications. We emphasize a platform approach rather than targeting verticals. Our discussions center on semantic search and vector databases, which naturally guide the conversation toward potential sales opportunities. I am excited about the increasing integration of both internal and external applications as companies become more comfortable with this technology.

Tyler Radke — Citi — Analyst

That makes sense, Ash. Janesh, regarding the consumption patterns among larger customers this quarter, do you think these trends are one-off, or are they indicative of new use cases being adopted? Just to confirm, you noted that strong trends persist but won’t be included in your guidance. Could you clarify that?

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Tyler, what we observed was indeed encouraging. The strength was widespread, not merely one-time events. Larger accounts showing faster consumption rates reflect our ongoing efforts and improvements from previous quarters.

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Elastic’s Strong Q2 Results: A Positive Outlook Amid Sales Strategy Adjustments

Consolidation and Increased Consumption Propel Growth

Elastic has experienced a notable uptick in committed customer consumption, successfully translating team efforts into heightened consumption rates. Although these results exceeded expectations, leadership does not view this as a one-time occurrence, hinting at ongoing momentum.

In discussing future forecasts, Janesh Jamnadas Moorjani, the Chief Financial Officer, emphasized the importance of prudent planning. While the current business landscape remains stable, historical consumption rate fluctuations compel a cautious approach. “We want to ensure we’re not getting ahead of ourselves,” he noted.

Analyst Insights on Sales Strategy

Tyler Radke of Citi remarked on Elastic’s upcoming guidance before Thanksgiving, indicating an extended quarter. This raised questions about the company’s sales organization readiness and future performance.

Ash Kulkarni, the CEO, expressed satisfaction with their internal metrics, highlighting strong pipeline creation and progression. He emphasized that these fundamentals provide confidence in the company’s current sales strategy and results.

Future Growth and Customer Commitments

Eric Prengel, Vice President of Finance, noted that the company experienced significant revenue growth in Q2 due to both strong customer commitments and consumption. However, he cautioned that shortfalls in previous quarters would continue to affect year-over-year growth, particularly in cloud services, where ramp-up times are longer.

Koji Ikeda, an analyst from Bank of America, inquired about the generative AI deals, which are valued at over $1 million each. Kulkarni confirmed that while Elastic does not have a specific generative AI product, the area has become a fast-growing segment of their business, with more than 1,550 customers already onboard in the cloud. He described this growth as a robust indicator of future potential.

Questions on Performance Metrics

Brent Thill from Jefferies raised a critical point regarding Elastic’s relative performance, given their flat remaining performance obligation (RPO) compared to competitors’ growth rates. This prompted clarifications on the company’s sales pipeline and backlog conversion.

As discussions continue, the overall sentiment remains cautiously optimistic, with leaders focused on maintaining momentum in sales execution and fostering long-term growth in customer commitments.

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Elastic’s Growth in Search Highlights Shift Towards AI Solutions

The latest insights from Elastic’s leadership reveal an overall stable performance, with year-over-year metrics reflecting a flat RPO (Remaining Performance Obligation). This robust approach to business development illustrates how current trends are positioning the company for future success.

RPO and Quarterly Growth: A Closer Look

When examining the year-over-year RPO data, it’s important to understand that it serves as a cumulative snapshot of prior activities. The shortfall in Q1 does play a role in shaping the Q2 year-over-year growth rate for RPO. However, recent activity indicates a slight uptick in sequential growth for Q2, contrasting with typically observed decreases in the previous years. Last year, for instance, Q2 RPO was lower than Q1. This performance mini-rebound is encouraging, though the company leaders remind us that achieving sales execution perfection is still a work in progress.

Business Mix and Search’s Expanding Role

According to Ash Kulkarni, Chief Executive Officer, Elastic’s business mix is fluid from quarter to quarter. While broader observability remains crucial, search technologies are witnessing notable growth, particularly due to the rising interest in generative AI. In Q1 and Q2, every segment experienced growth.

Kulkarni expressed confidence in all three solution areas, highlighting that the search component is particularly benefiting from current market trends. Insights suggest that businesses are increasingly integrating AI capabilities into their existing search frameworks, which positions Elastic favorably in this evolving landscape.

Engaging Existing Customers in the Search Opportunity

Raimo Lenschow of Barclays delved into how Elastic plans to leverage its substantial search customer base. Kulkarni reinforced that the move toward hybrid search solutions will offer compelling enhancements for existing clients, showcasing the value of existing data stored in Elasticsearch. Many of these relationships already facilitate an effective sales communication path that boosts adoption rates of the new AI capabilities.

SIEM Market Potential amidst Disruption

On the subject of SIEM (Security Information and Event Management), Kulkarni noted the growing necessity of AI in this realm. As companies navigate market turmoil and consolidation, Elastic is capitalizing on opportunities to enhance security analytics with AI integration. The AI-centric approach is proving advantageous to customers seeking improved detection and remediation processes.

AI Adoption Among Elastic’s Customer Base

When questioned about customer penetration of AI-driven features, Kulkarni revealed that many of the 1,550 customers utilizing Elastic’s search capabilities are either long-time users or new clients benefiting from enhanced AI functionalities. The expansion of AI within the existing search framework provides substantial growth opportunities.

Competitive Landscape and Future Trajectory

Lastly, addressing competition, Kulkarni hinted at other market players with notable reputations in the GenAI and SIEM sectors. Identifying opportunities for customer displacement will be key in Elastic’s strategy moving forward, as the company continues to focus on integrating sophisticated AI solutions across its offerings.

In closing, Elastic’s leadership underscores a future rich with potential as they navigate current opportunities and challenges in the tech landscape.

Modern Strategies and Future Directions in Security Analytics: Insights from Top Executives

In the evolving landscape of cybersecurity, numerous established vendors dominate the space. Notably, companies like Splunk, QRadar, and ArcSight have paved the way. We consider ourselves a new generation of Security Information and Event Management (SIEM) solutions.

Unlike traditional providers, we focus on being a security analytics product. Our platform allows customers to conduct on-demand AI-based analyses, a feature that sets us apart. Thanks to the adaptability of our backend systems, we can seamlessly integrate data from various sources, which is a significant factor in our success.

Regarding Generative AI (GenAI), we do not produce our own large language models. Instead, we collaborate with several partners to access a wide array of these models. Our goal is to position ourselves as the preferred platform for retrieval augmented generation, serving as a crucial vector database while providing additional capabilities. Although we are not the only option available, all data platforms will likely incorporate their own vector functionality in the future.

Our primary advantage lies in handling unstructured and complex data, whether logs or product descriptions. Integrating this data into Elasticsearch is optimal for us, and we have developed a leading vector database to support these needs. This type of data is abundant in every organization, and by concentrating on our innovations in this area, we see vast market potential moving forward.

Ittai Kidron — Analyst

Thank you.

Operator

The next question comes from Howard Ma of Guggenheim Securities. Please proceed.

Howard Ma — Guggenheim Partners — Analyst

Thank you. Janesh and Eric, it seems that customer commitments did not rebound in Q2 despite improved performance. Considering the acceleration in consumption metrics, could it be that your revenue outlook is more conservative for the second half?

Eric Prengel — Group Vice President, Finance

Thanks, Howard. While Q2 demonstrated strong results, the challenges faced in Q1 will affect our overall guidance for the year. Although we were pleased with Q2’s performance, the issues that occurred earlier will persist.

Particularly, we anticipate cloud services to experience headwinds in the latter half, unlike the more favorable conditions seen in Q2. Even with the strong results from Q2, we would have made the same conservative adjustments to our forecasts.

Howard Ma — Guggenheim Partners — Analyst

I appreciate that clarification, Eric. A follow-up for Ash: Could you describe the current adoption pace of vector databases like ELSER in GenAI applications compared to your expectations for the next year? Additionally, do you plan to disclose AI’s contribution to total revenue when it reaches certain thresholds—say, 2%, 3%, or 5%?

Ash Kulkarni — Chief Executive Officer

On the adoption front, the current phases are similar to those seen with other emerging technologies, such as cloud computing. It often starts with prototyping and design work, with businesses still deciding how many solutions will go into full production.

About 18 months ago, we observed many companies beginning to apply these solutions. Initially, applications were mainly for internal use; however, they have progressed to external projects, reflecting anticipated trends. Importantly, this transition has occurred much faster than expected.

Customers are now concentrating on factors like efficiency and scalability, aiming not just for production implementation but also for usable solutions at large scales. Our innovations have continued to evolve to meet these growing demands.

Regarding the metrics, it’s worth noting that we do not have a separate SKU for AI-related revenue. However, we strive to provide indicators of our progress in this area. For instance, we currently have 1,550 cloud customers utilizing generative AI, including 240 that are significant contributors with over $100K in commitments. Our generative AI commitments in this past quarter have nearly doubled from Q1, suggesting promising growth ahead.

Howard Ma — Guggenheim Partners — Analyst

Thank you, great to see the positive turnaround.

Ash Kulkarni — Chief Executive Officer

Thank you.

Operator

Next, we will hear from Austin Dietz of UBS. Please go ahead.

Austin Dietz — UBS — Analyst

Thank you. Janesh, it sounds like you’re optimistic about the company’s trajectory in Q3 and Q4. Could you elaborate on your expectations for the second half of the year? Is it possible for Remaining Performance Obligations (RPO) to show a sequential dollar growth uptick, especially compared to last year?

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Austin, I’m pleased to discuss this. As we move into the latter part of the year, effective execution will be crucial in driving our performance.

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Positive Momentum Building: A Look into Generative AI and Market Strategies

Guidance and Metrics Reflecting a Bright Future

In our previous discussions, I outlined the specific assumptions behind our guidance. You correctly pointed out that if we execute our strategies effectively, it will show up not only in our Remaining Performance Obligations (RPO) but also across all our metrics, including revenue.

Expanding Greenfield Opportunities

Austin Dietz — UBS — Analyst

Thanks for the insights, Ash. It looks like your recent go-to-market changes have put a stronger emphasis on pursuing greenfield opportunities and new logos. Could you update us on the progress in these areas? Thank you.

Ash Kulkarni — Chief Executive Officer

Thank you for that question. We went through our accounts and identified those that were underutilized. We created distinct greenfield territories and assigned sellers to focus on them. Building a pipeline in these new areas usually takes time, and the conversion of these opportunities is also slower. However, I am optimistic about our pipeline creation and see it returning to historical levels. We will continue to monitor our greenfield territories closely to maintain our momentum.

Austin Dietz — UBS — Analyst

That sounds promising. Thank you.

Examining Generative AI Metrics

Operator

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

Kash Rangan — Analyst

Good luck in your next endeavor, Janesh. Ash, I have a couple of questions for you. First, regarding your progress with Generative AI, what metrics are you tracking? While you do not disclose revenue figures, you mention use cases. How can we measure GenAI success relative to companies like Microsoft or ServiceNow, which discuss their AI bookings? Secondly, in terms of your go-to-market strategy, you market a platform without knowing specific use cases. How does this impact your approach regarding the emerging GenAI use cases?

Ash Kulkarni — Chief Executive Officer

Great questions, Kash. Let’s break them down. Firstly, for Generative AI, we focus on how many customers are actively using our solutions within the cloud. This gives us clear data on their activities, particularly those creating indexes for dense vectors. Additionally, we track customer commitments linked to Generative AI use cases, which we obtain through our sales teams when deals close.

However, while we can clearly assess customer commitments, distinguishing revenue linked strictly to GenAI can be challenging. Once a customer implements a solution on a cluster, further uses, such as for observability, complicate our understanding of how much of that usage is related to Generative AI. Thus, we mainly rely on customer commitments for insights into our solutions mix.

This data guides our go-to-market strategy. We understand what works and where to focus our sales efforts based on successful customer use cases.

Kash Rangan — Analyst

I appreciate that clarification. I’m curious about how the long-term go-to-market strategy evolves, particularly in packaging products or use cases together. But more importantly, when do you see a need to accelerate growth in your sales capacity? Strong demand could necessitate further investment in sales, but I assume you’d balance this against maintaining current margins.

Ash Kulkarni — Chief Executive Officer

Absolutely. We envision continued growth opportunities. Even after our discussions at the end of Q1 about implementing cost-control measures, we made certain that our selling capacity would remain unaffected. We carefully evaluate our investments, and I will pass it over to Janesh for further insights.

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Kash, as Ash pointed out, we’re strategically investing. Due to our revenue success last quarter, we are increasing our investments slightly for the latter half of the year. Thanks to the model’s inherent strength in operating leverage, we can enhance both margins and investments. A portion of those investments will indeed aim to boost our selling capacity, keeping our future growth in view.

Kash Rangan — Analyst

That’s encouraging to hear. Thank you.

Operator

That concludes our question-and-answer segment. I’ll now turn the floor back to Ash Kulkarni for any closing remarks. Please continue.

Ash Kulkarni — Chief Executive Officer

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Excitement Surrounds Business Growth Fueled by Generative AI

Overview of the Conference Call

Thank you all for joining us today. Our company is witnessing significant progress, largely influenced by advancements in generative AI. We anticipate continuing our strong performance in this area. If you plan to attend AWS re:Invent, I look forward to reconnecting with you there. Have a great day.

Operator

[Operator signoff]

Duration: 0 minutes

Participants in the Call

Anthony Luscri — Vice President, Investor Relations

Ash Kulkarni — Chief Executive Officer

Janesh Jamnadas Moorjani — Chief Financial Officer and Chief Operating Officer

Eric Prengel — Group Vice President, Finance

Matthew Hedberg, Matt Hedberg — Analysts

Pinjalim Bora — Analyst

Tyler Radke — Citi — Analyst

Koji Ikeda, Brent Thill, Raimo Lenschow, Ittai Kidron, Howard Ma, Austin Dietz, Kash Rangan — Analysts

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