Datadog, Inc. (DDOG) Earnings Call Transcript & Summary

Thank you, everyone, for joining us here at the 2020 RBC virtual tech conference. My name is Matt Hedberg. We are thrilled to have David Obstler with us, Chief Financial Officer from Datadog. It seems like years ago when we were setting down -- I think you and I for the first time -- I think it was at AWS perhaps a number of years ago.

Two years ago.

Yes, 2 years ago. It seems like 5 years. In COVID year, I don't know, that's a lifetime. But you guys have obviously done some amazing things here. So thanks for your time, David, and we're...

Thank you for having us. We appreciate it.

Yes. We're going to work through some questions here. But I have to tell everybody, first of all, we could use an hour here. Half an hour is not going to do it justice. But if you do have questions in the audience, feel free to submit those through the portal. We'll try to weave those in where they make sense. But this is your meeting. We can sit here and talk for a number of hours. But ask questions, and we'll get to them.

So David, just to start out with -- you and I were talking a little bit ahead of time here. COVID is obviously, it's -- we're excited about news of a vaccine. But for what it is, I mean you guys have certainly, I think, benefited from what COVID will mean longer term in terms of increasing cloud adoption. But just to level set us, talk about what COVID has meant for you guys this year? There's obviously some -- probably some uncertainty. But on the other hand, talk about what -- how you guys see the profound change, the profound benefit to your market opportunity longer term.

Yes. Yes. Well, shorter term, as we said on our last 2 earning calls, what we saw was when COVID hit, there was a focus on some cloud optimization, especially in larger, faster-growing companies in the cloud. And I think you saw that in the reports from the cloud vendors itself. Generally, what happens over time is expansion first, et cetera, and then some optimization. And what we saw was more of that being done in a more concentrated period given the uncertainty of COVID. Well, since then, we said on our Q3 call that we saw a return to normal usage and growth trends. And that was very broad in terms of large customers down the SMB as well as COVID impact to customers and those not as COVID impact. So that pleases us and gives us some confidence that the long-term trends are in place, that it was transitory. And I think you're right, in longer term, we think this is -- imprinting this in the minds of CIOs and business leaders more the benefit of having digital operations in the cloud. And that we think, longer term, it's going to accelerate the growth and the movement that was already quite compelling to begin with.

So to double click on that a little bit. I mean we just fundamentally believe the whole monitoring observability space, throw in security monitoring as well, could be one of the biggest beneficiaries post-COVID. It's obviously not seeing maybe some of the short-term benefits that a Zoom is seeing. But longer term, we think it's -- there's a profound positive impact on your space. What are CIOs telling you guys right now about monitoring? Where does it sit in the priority level, both today but longer term? Has the priority level increased as a result of COVID?

Yes. I think at the beginning of COVID, you saw maybe a short-term focus on things like work from home, a lot of client -- of CIOs were focusing on getting their employees remote and the security. But longer term, and we're starting to see some of that in Q3, et cetera. We think it is creating, enhancing the priority for a lot of companies that are in digital e-commerce. They saw that not to have to go and mess with on-premise data centers to be able to burst their capacity during COVID with public clouds was very effective. And we think that a trend that was already in place is even more imprinted in the minds of CIOs. That will take some time. It's not -- they can't -- they're not switching and changing their priorities overnight. But in our conversations with customers, we think that a trend that was already pretty compelling is even more accelerated because of COVID.

And then just to ask the vaccine question because, obviously, that's relevant over the last 2 weeks here. How do you -- what is the -- how do you guys think about the benefit of -- obviously, there's a humanity side of it that we're all really excited about. But from a business or a demand perspective, what does the vaccine mean for you guys?

Of course, we want to see everybody safe. We want to see everybody back to normal, so on that societal, including in our company as well. But we really support the company's digital customer-facing operations. And it's not really focused necessarily on work-from-home. So essentially, the vaccine is -- will most likely cause some more back to normal in terms of pursuing digital projects. But just like we've seen in the last quarter, where we had record number of ARR adds, we think this is a powerful and long-term trend that has been continuing and will continue after we get back to more normal.

So yes, that brings me to my next question. And by the way, thank you, everybody, for submitting questions. We'll weave those into the conversation here. But you mentioned, I think, record new ARR adds in Q3, which I think it kind of got lost in the midst because I think everybody was focused on the revenue deceleration, which revenue in your model is -- tends to be a little bit more of a lagging indicator. Can you walk us through, first of all, the factors that have caused the deceleration here? But then conversely, why record new ARR is such an important comment in terms of what that could mean towards revenue growth in the future?

Yes. Good question. So as many of you have followed the stock know, we are a ratable model. Meaning, we're recognizing revenues over time, and revenues is indeed lagging. And the slowdown in Q2 of the growth of usage would have an effect on revenues in the subsequent 4 quarters. So essentially, we're seeing the effects of the slowdown or optimization that was in Q2 in Q3 and subsequently. And that will cause the compares or the growth to be affected in the subsequent 4 quarters. But when we gave comments like we're seeing more of a return to normal -- by the way, we see it, but we want to maintain -- we'd be cautious anyway because there's a lot of volatility in the market. But when you have return to more normal growth usage trends and overall ARR, what that indicates to us is that we're recovering from the initial impact and going back to more normal movement into the cloud and digital operations, which is a positive side for us. And we began to see that in Q3.

No. That's -- I think that's -- I thought that was such an important comment from your call, especially as the market's looking forward. And so obviously, there's some uncertainty here in the short term, but I thought that was a really, really bullish comment that you guys made.

We were very pleased with Q3, but we essentially built a return to normal usage trends. And the ARR performance is -- we were pleased with that and given the volatility of the environment.

So I guess -- and then I'm going to get to some of the questions here after this one. But when you think about -- if you're us and you think about the components of growth over the next several years, the kind of the building blocks, obviously, there's increased cloud usage. I think just the growth in applications, what are sort of the building blocks in your mind that we should think about when we think of not just growth in Q4, but longer term? What sort of the framework that you would help us out with?

Yes. I think you led off appropriately that we are very leveraged to migration to the cloud. As clients shift more of their workloads to the clouds and to hybrid environments, it benefits us. We are also very leveraged to modern DevOp practices, micro services, et cetera. The more complexity there is and the more we evolve not just to modern use of the cloud, but also modern development, DevOps, the better for us. As everybody knows, we're focused mainly on greenfield, which is the volume moving to the cloud. And then the last part, I think you're seeing this in some of the metrics reporting is we've gotten feedback from clients of the power of our uniform platform. The more data that goes in there, the more ability to analyze, the better for the clients in observability. And we're seeing, over the long term, our clients landing with more parts of the platform and growing as we evolve with our clients and land and expand to more parts of the platform, and that's a very important driver of growth as well.

That's super helpful. And so one of the questions -- I mean this would not be a conversation without a question about competition. I think you guys have been adamant, really, from day 1 that it's not -- you're not going at this market thinking, hey, I need to replace XYZ legacy vendor. But more so, I'm looking at net new. I'm looking at greenfield. And I think that's an important distinction here. Now that said, when you look at a lot of these greenfield net new wins, how do you see the competitors in some of these deals changing? Are they evolving as Splunk rolls out their observability suite or as Dynatrace starts to move out of APM and other categories? Are those greenfield wins? Are the players changing there? And maybe win rates that you guys have seen.

Yes. I think it's important to start with what you said, which is we're not rip and replace. We're not going back to on-premise. So we're really focused on cloud and hybrid workloads. In that, you have essentially the major competition is do-it-yourself open source. And we continue to see -- no, we continue to see no change in the competitive landscape. We're continuing to land with infrastructure, increasingly with both and see a tremendous buying movement towards the platform. I would say the only exception to that is because we are seeing our clients prefer the single platform, if we've landed with infrastructure or infrastructure and one other, when a client has an opportunity to buy again, they're tending to standardize on our platform. And therefore, you may see some of the other players, the New Relics or the Dynatraces be displaced. That would be a minority of what's happening. It's a longer-term trend. But that's when -- if you look at the net adds that we have every quarter, compare -- if you do the math, you'll see that the buying impetus tends to be either land with us or do open source and land with us and then expand, and over time, consolidate on a single platform, which has -- we feel we have a very strong product offering, a leader product offering. And we really haven't seen much change in that part of the market in the competitive landscape.

Your success in large deals, customers who spend over $100,000 has been impressive. But obviously, you guys have customers that are spending well over $1 million. Talk about when you're expanding outside of infrastructure and you're going up against more entrenched, sort of -- and I'm not talking about CA or IBM, but I'm talking about some of the more modern peers, why are they choosing your APM solution? When they may be using site, Dynatrace, they may have a large Dynatrace install already, why are these large customers, these G2K or Fortune 100 customers, they're choosing your APM solution as opposed to maybe what they standardized on maybe just a couple of years ago?

Yes, yes. And behind that, we have $1 million customers in each of APM and logs. It's grown to that type of size. And they're choosing us because of the single platform, the single data architecture, the ease of use and the relentless development and investment in product that we've been very successful at. If you look at our announcements over the many years, including recently at DASH, you'll see that we have extended -- we've invested in product substantially. So they're making that choice because of the preference for the things I said upfront and the product utility that comes from that. The land and expand, the ubiquity, the ability for all the parts of the DevOp in business to use it, to use it easily, produce custom metrics, dashboards and get many, many data ratings that can be correlated and actioned in a single platform are the reasons for the choice of Datadog.

That's helpful. This is a good question from an audience member, and we get this a lot of time. So I'm glad somebody asked this. But -- so the question is, could you expound upon the observation that customer spend is approaching a level where CFOs are paying more attention? And I'll add on to this. Obviously, as your spend goes up, you start to show up on the radar of CFOs. I'm sure like you look at your spending. So the question is, how do you think about scaling into enterprise-wide license? I think it's reasonably well understood that scaling your current license model does create some friction at higher price points.

Yes. I think in enterprises, we're very, very underpenetrated right now. We might be in part of the business or one digital operation. So there's a long way to go. We also are a very small fraction of the cloud spend. So we saw in Q2, a lot of the impetus there tends to be on the cloud spend. But yes, as we get to multimillion-dollar contracts, we do get more scrutiny for procurement or CFOs, people like myself. And what we try to do is give a very transparent pricing model that's based on usage. Everybody can see it. We try to make it so that everyone can use it. And we try to have flexible pricing that as usage is scaled, there is a discount on volume. So that correlates with a client's expansion. And essentially, when you get down to it, it gets down to the utility of the product and the desire to have our differentiated product, which has produced our gross retention rates that are in the low to mid-90s, and then enterprises are a lot higher than that. So that I think those numbers speak for themselves in terms of the choice and continued choice of Datadog even as spend increases.

So that's a great answer. And I guess the flip side to this is, when you look at some competitors -- and obviously, New Relic has been in the news recently about cutting price. Does price -- when you're talking to CIOs or customers, how do they think about price? And do they reference that? Or is there enough perceived value that a pricing debate really doesn't -- it's not really in customers' mind at this point?