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

Really excited to have Datadog with us. David is the CFO. He's been with the company since 2018. And the company has been growing at an unbelievably incredible pace, growing over 80% the last couple of quarters. David, thanks for being here.

And maybe to kick off, what is giving you this ability to grow at such a great clip and produce profits? We see a lot of companies in our industry growing but not producing the bottom line. What is the secret sauce here?

First of all, thanks for having us, and great to be here live again with everybody. It's really a combination of a very large opportunity centered around cloud migration, migration of workloads and modern DevOps and then having the right product fit for that. And all credit to our product and R&D-led company in that we're continuing to innovate and add new products. So it's a great end market, having the right product. And then the way the product was designed, so it could be implemented without professional services can be used by everyone ubiquitously and is fully integrated in a tightly-knit platform has created the type of information that the DevOps world needs to manage the applications that they're deploying in the cloud and running in real-time. And so we have very strong gross and net retentions. The gross because of our client satisfaction and the stickiness, and the net because of that, plus the product innovation, all that's combined in producing this top line growth. And then in terms of our profitability, I think that's sort of within the scalability and efficiency in the business in that when you have a business that has frictionless selling and clients can be some of your best salespeople and can adopt the product any minute they want to. It creates very efficient sales and marketing costs that translate into a strong profitability and cash flow, which we've been able to deliver throughout the history of the company.

That's great. The elephant in the room right now is the economy. And everyone is asking, we heard from Workday, some pushouts; Snowflake, little capacity, capacity utilization was down. When you think about last night Salesforce said, we're not seeing it, which I don't think most people believe Benioff would show any weakness. But what's your sense of what's going on in the environment? And how -- assuming things got worse on the macro side, what is the insulation to your model that gives you a little more protection from the headwinds that are coming in?

Great question and something we think about a lot. We said on our earnings call that in our first quarter, we didn't see any impact from the economy or from Russia, Ukraine that we -- our first quarter was very similar to our previous first quarters in terms of net retention and adoption and the growth of the business. Of course, we're looking -- we're not naive. Back in the second quarter of -- at the beginning of 2020, at the beginning of COVID, we did see some flattening of the business. The business continued to grow very substantially, but clients began to look at their spend and do some rationalization. And that could happen again, that clients, in periods of time where there is some economic pushback, will look at their cost structure. We take some comfort in the fact that we are only low single digits cost of their cloud expense. And there are tremendous trends towards digital migration. In fact, there may be things in a tighter labor economy and with cost management where you want to go to more of a managed solution than do-it-yourself. So there are a number of things that we look at, but we haven't really seen any effect yet. In addition, we have a very long-term trend here in cloud migration and DevOps. In terms of what protections do we have in our model because I know that's top of mind, the whole world of consumption-based pricing, which was very appealing on the upside, but causes some concern is something on the mind of many investors. And I think I want to emphasize, we have a different model. 75% to 80% of our business is in take-or-pay subscriptions. And what that provides is a very strong underpinning, meaning most of our business is committed contractually. So we only have -- we have less than 10%, in fact, around 5%, of what you would call pure consumption month-to-month. The rest of it is on-demand pricing associated with the part that's not the 75% or 80% related to subscriptions. So whereas our organic growth can vary, there's a very strong underpinning in our business model in cases where there might be a little bit less consumption. In addition, we've seen such factors as our product growth, our expansion of SKUs and things like that be strong factors in clients continue to adopt more and more of the solution even if they're in a cost management mode.

When you think about the pandemic, you didn't take your foot off the gas. I think we kept asking you, are you changing, you're like we're heads down. We have a true North Star. We're spending. Do you -- are you still in that mentality of and philosophy of, hey, we're heads down. We don't really care about what's going on in the other picture. We care about we're such a small piece of the overall IT budget and such as the penetration so low. How do you think about this? Is it the same playbook?

It's the same playbook. I think it paid off very well for us. If you look at what we did during the pandemic, accelerating the top line, accelerating product introductions, it paid off very well. I'd also add the fact, emphasizing what you said that we think this is a very large market, and we're just scratching the surface. Secondly, we've always spent within our means. If you look at our margin expansion, we've always spent under the top line growth in terms of cost expansion, and we've been very good at efficiency in places like cost of sales. So we've not been the kind of company that spent beyond our means to grow. We've been able to invest very significantly in R&D and sales and marketing and support functions while growing within our means. Given our balance sheet, our cash flow generation and the opportunity, we plan to keep our foot down on the pedal, continue to invest. And in some ways, this could be a great opportunity in that potentially the end market for talent, et cetera, could become a little softer, and it could allow us to execute very well in this environment.

You mentioned the product organization. You're moving at an incredible speed. I think you have 14 products GA today versus 1, 4 years ago. Can you talk to how the conversations moving to kind of a platform versus a single adoption?

Yes, it's really at the core of the company. When you think of how we started out in infrastructure and now the strength of the platform, it's fantastic. And there always have been from the clients feedback that it makes sense to buy a platform, to see all the signals there deeply integrated. When you're trying to remediate in real-time, the benefit from having a distributed set of information organized with metrics and everybody is seeing it is fantastic. It allows you to operate more quickly, not have to run around and do things outside the system. So that buying impetus has always been there. And what we've been able to do, as you mentioned, is expand the number of SKUs, but also deep in the SKUs. So the investment in the products, whether it be infrastructure or APM, logs -- we didn't have that 4, 5 years ago -- continues. And each time we make investments, we make the product better and therefore, make the overall platform. So we designed the platform that way. We've developed the platform by getting feedback from our clients that, that's what they want. And the fact that we've been so effective in releasing the number of products, but also the feature set within the products has enhanced that trend over time.

I know you love all 14 modules equally, but is there a couple of areas that you see that you're really excited about that are resonating well with clients for uptake right now?

We get that question a lot. And of course, all 14 of our kids are lovely, and we really love them. But I think you got to go at the very start, you have to go back to the 3 pillars in observability, where, as I mentioned, the continuous investment in infrastructure, logs and APM is the core driver. There is tremendous opportunity both in terms of cloud workloads, in terms of market share and in terms of cross-selling. We are not penetrated in our infrastructure customers as it relates to APM and logs. Yes, we have a lot of customers taking 2 or 3 or more products but we still have a lot of customers that haven't taken most of the platforms. So that's a very, very strong growth driver, coupled with the trends in cloud migration, digitalization and DevOps. Secondly, we're very excited about the security product set. Again, we didn't have this a couple of years ago. And as we've told everybody, we're still in development. It's going to take a number of years. APM took a number of years to develop from scratch. But we have enough in the way of customers, thousands of customers on it, meaningful revenues that we think there's a big opportunity. And we think that we're early and have the right product for the evolution of DevSecOps. So that's the second area that we're excited about, that suite. And then there are some seeds that have been planted that are also very exciting, and I would cite our CI/CD, our shift left, in terms of real-time production environments, getting a view on the development of software and how that affects production earlier is an exciting expansion. And then I think we've mentioned a number of initiatives in data, including observability pipelines that we're still developing and putting out, which is all about how to manage data more efficiently for our clients and get more and more data into the platform. So I'd say those are growth shoots that we're excited about that we're in the beginnings of the product development.

I think you have a BFF named AWS.

They are. They are. Well, we like all our cloud. We all like all the hyperscalers as well. But they're a good friend. And I think when you say BFF, we don't talk like that. We're Switzerland. We like all of our cloud providers, but we have had a very, very long relationship with AWS. And it's a deep one that has to do with partnership and technology development, making sure that as you see in a number of our releases, that we're developing together. It has to do with marketing, going to market, it has to do with sales. And so I think they've been the model of how to partner, and they've been a very, very substantial partner of ours. And we've extended that model over the years into the other cloud vendors, into GCP and into Azure. So we want to be Switzerland. We want to be with everybody in facilitating cloud migration, both in terms of what we monitor and how we deliver the product through the public cloud.

There was a kind of a cryptic press release that came out earlier in the year saying you kind of renewed your vows to each other. Everyone was asking what was different in the Amazon relationship that you hadn't seen in the past? Or is this more just a, hey, we're still fully married.

Yes. I think it's -- I think that wasn't a renewal of vows in that there was a threat to our marriage before. That was a continuation of a lot of different initiatives that we've been working on together over a number of years. And I think the hyperscalers and AWS are in the business of selling more compute and storage. And I think they've realized and they are on board with our role in that. And we help clients to get visibility into their cloud environments, which is a very important piece of getting confidence in moving businesses to the cloud. So that was just another example of how we're partnering across the board technologically as well as go to market.

We get the question of who you're seeing the most in the field, and what the industry experts keep saying to us is the pool is so large and the swim lanes are so wide that the swimmers have plenty of room to operate, and you're not really running into each other as hard, but everyone asked about New Relic, Dynatrace. How do we differentiate? What are you seeing from that perspective?

The answer is yes and yes. It's a very large market, and the swim lanes are wide. So it's not a winner take all. I think if you look at the amount of new business that we're adding each quarter, you'll see that we're winning a lot of it. And the numbers are very striking if you line that up. And that has a lot to do with the fact that a lot of our business is greenfield. A lot of our business is -- the choice is in real-time production cloud environments. The true choice is do-it-yourself open source or the integrated platform of Datadog. That's at the core of the choice. And since that is such a large and growing market, we've been doing well. We have always said that we're looking where the puck is going, which we believe is in that direction. So we are not focusing our efforts on circling back and displacing on-premise type observability. That may happen over time. So I think you have our strength being in integrated, 3-pillar observability for complex cloud environments. A good clue would be is the client in the cloud and using containers, micro services, et cetera. And then you have some other companies that have come from a little bit of a different heritage, whether it be APM on-premise and expanding in the cloud or security, logging, on-premise expanding in the cloud. So we do see other competitors from time to time. But I think, broadly speaking, we stay where we're strong, and we've been very successful in that.

When you think about the perception of, okay, you're getting these young emerging cloud vendors, but the big enterprises are still with other vendors, what do you say to that? How do you -- I think your break -- you've mentioned a number of really good enterprise use cases. Is that just a perception? What would debunk that? What were the facts that you're seeing suggest that's not true?

Yes. The facts would be that, one, we've given countless examples of Fortune 100 and very large traditional companies. And then I think we've always said we have a very large enterprise business that is we split -- our business is split SMB, mid-market. A lot of those mid-market are enterprise-type clients and enterprise. And I would say that, that sort of characterization is too simple. Within a very large enterprise, there are activities, which are putting applications, that are client-facing, revenue-producing towards clients. And that's where we are. So in the enterprises that are -- and most are, are on their cloud journey and having -- using modern DevOps, we're there. So I think it's more use cases than it is whether it's a Fortune 100 or a venture-backed company. And in those places that are migrating to the cloud and have needs for observability in real-time DevOps, we're there, and we're there in many, many of the largest enterprises.

You touched on the pricing earlier. Is there a need for a change in pricing given you're getting more of a platform status? You're looking -- you're earning more kind of ELA, I want to go capacity versus -- has that changed for you or not? You just -- are you staying true to, hey, this is our model, and this is working and we don't need to change lanes.

Our model is working very well, and clients like it. We are very transparent. Our clients can buy capacity, as you're talking about, and then use it across the different products. And we tend to be very transparent on pricing. That gives us a lot of feedback on products, product use, and we try relentlessly to optimize our products so that clients are paying for what they use and maybe not what they store as much. In a lot of our pricing models, we already have, as I mentioned, this type of relationship where clients buy capacity and can use it as they are deploying applications. And it's worked pretty well. So we like where we are in terms of pricing right now and have no plans to change it, of course. We're always talking to our clients. We're always getting feedback. So we're going to do what's right for our clients and for the growth of our business.

The one thing that you see and we can't see that you're extremely proud or feel we're not truly understanding as a community about where you're at?

Yes, that's a good question. I think if you -- if a company is only as good as its employees, and if you looked at how we're viewed by our employees from engagement surveys to retention, to providing opportunities for growth of employees, to how they view how we've handled COVID and others, you would see we're top drawer. And that's a very important factor in a growth company. That enables us to recruit/retain. And I think because we've done such a good job, our position in the market and our ability to get the right people and to have them have fantastic careers at Datadog is only enhanced with our growth, and that's something that is not a metric that we put out, but is at the very core of growth of the company.

Any questions in the audience? Davidson, vote #1, aye, aye for Yuka in the front row.

Yes, #1 aye, aye for Yuka. I didn't even know there was an aye, aye for IR but we're campaigning.

Just following up on the employee question. Obviously, with stock prices where they are now relative to where they were 6, 12 months ago, certainly seeing some commentary of employees at other companies jumping ship because stock-based compensation is down so much. What's your view on that? And how you think those trends might play out over the next sort of 6 to 12 months and potential headwinds for your business or risks for your business if your employees can effectively earn a 20% or 30% pay bump by going to a competitor and by reselling their stock comp?

Yes. I think, first of all, we're in a pretty good position. We went public at $27 a share. We are trading at $100 a share. We have -- the vast majority of our employees are what you would say would be in the money. We have RSUs. We give RSUs to all our employees. We do refreshes. So I think we're in a pretty good position. We also think that there are a lot of companies that thought they were going to have their payday and have their IPO that might not right now an approximate term. But we are, of course, going to look at this, and we're committed to provide competitive comp and opportunities for our employees. And so we will -- we're going to look at whether there are employees that have been disadvantaged because they happened to get -- joined the company at the peak stock price. I don't think it's a very big dilution problem for our company given what I just said, but we're going to look at comp and do the right thing for our employees.

Got one more.

Can you actually talk for a little bit about what the priorities are of the employees that work for Datadog? In terms of like what ranks where in terms of the importance for them in terms of feedback from management team and engagement with other employees and events and just how you guys think about retention from that perspective?

Yes. Good question. So a lot of it is about having interesting work, interesting R&D projects and then having good management. One of the things you look at any engagement survey and the reason why employees might leave would be not the company, but their manager. So we've been investing substantially in developing a manager, second, third level of managers. So that's one area that we get a lot of feedback and think very -- we're very committed to diversity and trying to expand who comes into the company and stays at the company. So we have a lot of initiatives there. We also have become quite a bit bigger and more global. So we've gone from -- when I joined the company, there were 600 employees, and I think we reported over 3,000 and still growing. So we work a lot on communication. We are a hybrid company now. So we have part of the week in the office and part of the week out and we're trying, of course, to navigate through that like everybody is and do that the right way, understanding that everyone is not going to be in the same room at the same time, and that takes a lot of communication that we work on every day.

David, thanks so much for joining.

Thanks a lot. Thanks for having me. Thanks.