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

All right. Welcome to Credit Suisse's 26th technology conference. My name is Fred Lee. I'm the small and mid-cap software analyst for the firm. And with me today is David Obstler from Datadog, Chief Financial Officer. Thank you for joining us today.

Thank you for having us.

I think everyone is familiar with Datadog, but I did want to start with a higher level. Start and talk about -- if you could talk about the company's overall vision and what problems Datadog solves.

Okay. I want to say upfront because it will be related to some of the questions that we are not giving intra-quarter commentary. So much of what -- or all of what we're saying will be what we spoke about on our earnings call. As far as Datadog, so we are a multiproduct monitoring platform that services DevOps in real-time client facing application. So our clients are essentially deploying applications using modern development techniques, containers, micro services that are delivering their product to their client, and we provide a platform for them to monitor the uptime effectiveness of that platform. Some of the advantages of Datadog have been the single pane, everything in one platform. The fact that it is easy to use. We call it simple but not simplistic, fully function, but easy to use and it's ubiquitous, meaning it's not on the seat model. It's either on a host model, a data or test model, meaning that the whole DevOps department can use it in order to put applications into production and monitor them.

And so what do you think is the long-term structural growth rate for the company? What are the key drivers to the unlocking the industry and some of the value there? And a second part to that question is, how closely tied is your business to hyperscaler unit growth?

Yes. So essentially, the -- first of all, I think I won't repeat all the numbers, but we have a very large TAM. It is driven by workloads being put into the cloud. We think there's a very, very long-term high growth rate. We won't give a number specifically in this activity that we're early stages in it and then applications, a significant minority of applications are being monitored in the cloud today. So that is sort of the underpinnings of the company's growth. As you know, as a public company, we've been growing so far in the range of the low is 50%, the high is around 80%. We've always been growing at a higher rate than the hyperscalers. The hyperscalers have a broader business which is delivering applications that are more diversified. For instance, a number of the hyperscalers are delivering office products or types of things. And when we think about our growth rate relative to the hyperscalers, some of the reasons that we've been in excess of it are, one, we tend to focus on high-priority workloads, client facing, modern dev and complicated applications. And we believe the growth rate of that cloud workload has been higher than the weighted average of the cloud providers. We also have been -- we also have been expanding our product suite. So when you look at just the infrastructure portion of it, we've also added on a lot of elements to the platform. 5, 6 years ago, we didn't have the logs and APM much less some of the other products. So that's created a higher growth rate as clients have adopted more of the platform. And we've also been winning market share in the market from both other companies and most likely open source, although most of our business is greenfield workloads.

I'd like to touch a little bit on your product portfolio today. And where -- how you would evaluate the overall portfolio, where you think you are missing some features and the products that have the greatest customer pull?

So the greatest customer pull has been landing and infrastructure, which is generally right after you move workloads to the cloud as a client, you need to monitor the infrastructure. But then extending that parts of the platform that clients are buying into the other main pieces, which are APM and logs and then on to digital experience, which monitors how clients are interfacing -- of their clients interfacing with their websites and using the applications. And so the biggest opportunity is that we have relatively few customers. We have 20-some thousand, but that's a fraction of the available universe. And most of our customers don't have a full bore, who are infrastructure customers, logs in APM. So there is a huge opportunity for us in having our clients adopt more of the platform. If you look at the metrics we've produced in 2 products over 80%. But then when you go out to the metrics in 6 products or 4 products, you see a very rapid increase on that. In fact, we said, I think, a couple of quarters ago that our APM and logs, which we didn't even have 5 years ago were over $750 million. So that's a huge opportunity in selling more of the platform to our clients. The next opportunity would be more clients. Again, we've had very good success in new logos, but there are many, many customers who are not buying Datadog, who are very early in their cloud journey. A lot of traditional enterprises are just scratching the surface. So we think there's lots of opportunity to acquire additional clients. And then when you look at the DevOps client base, how they're expanding their use cases and DevSecOps would be a good example of that, where this is very, very new, but using security data and designing security into applications as they're launched into production rather than monitoring it after them, we think is a very large long-term opportunity. Last one, I would say would be shift-left and getting earlier in the process of developing software and deploying and looking at the functionality of the software, which is a nice opportunity. In addition to that, we're investing substantially in the platform itself. At Dash, those of you that listened or paid attention, saw that we're in workflow, in automation, in collaboration, in many things around the platform to create better use cases for our clients. And we think that will long term be an opportunity in anything that makes our DevOps customers have a more effective work experience, that means they'll use more of the platform.

Now you touched a little bit on this just a moment ago, but I would love to learn more about, well, as DevOps vendors tend to be more towards product-led growth models, what the benefits are as you land as closer to [ $25,000 ] versus some of your peers in north of [ $100,000 ], what are the benefits of a product-led model? And how do you see that evolving over the next few years as your customer base is -- or further penetrated in your larger customers?

One thing in looking at those numbers is we have a broader customer base from SMB to enterprise. So I think in looking at those numbers, that's a weighted average. If you look at the enterprise side of things, it's more like others. And if you look at our customers over $100,000, you'll see that the average of those customers is around $600,000. So we've had tremendous success in getting to numbers that are higher than the numbers that you cited in customers. Product-led growth and clients adopting. Why is that so good? One, clients said simple but not simplistic, meaning the platform is very easy to use. Clients can put their data in it and begin using it right away. That has -- looking at our cohorts over many years, proven to create a lot of expansion. And so our whole structure and strategy of ground has been getting clients going, that's possible because it's so easy to implement. And then as clients start using it, we've seen very rapid growth of their usage and their demand for the product. So we think we've proven out that not only is it quite efficient, it's quite client pleasing and it leads to the behavior of clients spreading out and growing it in a lot of places and not having it decentralize use but democratize use, which creates a larger average purchase over the long term with us.

And so this leads me a little bit into your new security offering. And you recently repackaged it into a bit of a CNAPP portfolio -- CNAPP offering. There's a private company called VIZIO that we've been doing a little bit of work on, and we've rapidly grown to $100 million in ARR. It's been largely from scratch. You have a large existing installed base. And considering the frictionless shift over in terms of selling into that installed base, why can't security grow as quickly as with VIZIO security offering?

We think it can, and we haven't released the numbers, but that we have been experiencing that very rapid growth. I would say on the one hand, we're still building a product. Same thing for APM. We grew very rapidly in APM. It took us a number of years to build it and be fully function. So we're still in the process of building that functionality and -- but for the amount of functionality that we do have, we're seeing tremendous traction. And we agree with you. We do believe that the fact that we have the real estate, the DevOps customer base using it, and we have the data means that we have a tremendous competitive advantage that we think will play out over time and result in very rapid growth. It's just early in our evolution as we continue to construct the product. Our announcements at Dash where steps along the way. And we're a lot closer to having a fully functioned product, but we're still building that out. And so I think it will be the building out of the product fully and the unleashing that into our customer base that will show in the end what the possibility of that for Datadog will be.

And how should we think about the pricing strategy of the security operation? Will it be similar to APM and infrastructure or there will be differences?

Yes, it's going to be based on the same types of things, whether it be hosts or whether it be data or tests. That pricing strategy of making it very transparent and having clients able to tweak and use what they want. Generally within the platform, they can now use any of the products and pull them through, has proven very effective. It's been very flexible for clients and it's also helped the adoption of security and that clients have been able to use it, experiment with it, see what happens is similar to what's happened to some of our other product. So at the present, we intend to price in similar ways. But of course, we're always open to feedback. We're always experimenting and looking at price and are open if that's not the right way to go to learning and to evolving.

And are there any structural reasons why the selling motion will be any different as we think about the penetration of your security product?

It depends, a, who the users are and who's budget and decision maker. So if we are targeting a DevOps and it's going to be used by that cohort of clients, it should be able to be adopted the same way. But security tends to be a more centralized spend, having an influencer of the security department in CISO and it's the ying and yang of that will determine whether it can flow through in a very similar motion to fully similar motion to observability or whether there'll have to be some other influencers. We don't really know the answer. It could be that like DevOps, it's used, ground up organically. The CISO sees it. I say "What's this?" and I say, "Well, this is integral to all of our operations and it continues on or it could be their -- the gatekeepers. And what we've always said is we're going to learn about that as we build out the product suite and are willing to invest in specialist overlays, those types of things if we need to break through another buying group. So it's really the cross-section between the user persona and the buyer persona that determines the behavior that we have to evidence in go-to-market.

Right. And so I know most of the competitive landscape is really security, it's greenfield today. So -- but as it relates to your other offerings, can you talk a little bit about how the landscape has shifted, how it's evolved over the past 5 years, who's getting more aggressive, who is becoming more competitive, who's becoming less competitive?

It really hasn't changed that much for our use case, which is distributed real-time client-facing monitoring of applications and infrastructure. It's really been since we went public, greenfield -- as greenfield mainly, and it's been open source, clients put it together themselves or use point solutions or use the cloud solutions or Datadog. And that really hasn't changed. If you're going to different use cases on premise, customized, then you have a number of the other competitors having positions. We don't really compete very much with them and they don't compete very much with us around the edges. But it's always been that the largest competitor to us has been do-it-yourself and put together the components. And still that's the case. I think if essentially, we've been able to, I think, begin to consolidate some of the other point solutions into our platform, in our deals, landing first with infrastructure. And -- but that's been going on for 3 or 4 years, and we'll continue, we believe. And so the competitive landscape really hasn't changed. Some of the smaller companies that have come up and been bought haven't really increased the competitive intensity in the market in a material way, which is part of what I mentioned when I say the competition really hasn't changed very much. I think it has to do with -- at the very center of Datadog. Datadog is relentlessly innovating and in product-led growth. And if we continue to do that and satisfy the client needs, it closes it say, so it deepens the moat or closes the opportunities in some ways.

And so a number of the questions -- we get a lot of questions from investors about open source and the potential threats there. Can you talk about the advantages of Datadog versus open source specifically?

Yes. And open source, this choice has always been there and there are clients that use Datadog, there are clients that use open source, and they're ones that use different components. So for the advantages of Datadog are that you get the best of breed. So if you're a manufacturing company to create this yourself, you're generally not going to have the best-of-breed monitoring platform. Your job is manufacturing with widgets. And so you generally get the best of breed. You generally -- it's cheaper, meaning that the cost of creating the platform, maintaining the platform and having the IT staff to do it, is higher than subscribing to Datadog, and that's one of the ways we sell. And you get all the continual functionality, which we've been very rapid in doing from Datadog. The reasons why you might want to go open source would be that you want -- we don't offer an on-premise solution, meaning we monitor on-premise workloads, but we don't offer a solution that is your own instance. So if you want something that's your own, particularly if it has to be highly customized, so maybe only you want it or you might have regulatory requirements that, in your mind, think that you can't use the cloud, then that type of client might want to do -- put open-source components together. We don't really compete for that like it's horses for courses. Another reason could be that you have a large IT staff that you want to retain and you want them to have something to do. It's not economic, but there are a lot of IT staffs out there that are very large. So it's those types of things. But I would say for the most part, it's that you want something that is an on-premise that you create yourself that specialized for you. And therefore, a managed service like Datadog might not work for you.

Okay. Shifting gears a little bit. I just want to talk about the dinner last night. And I think one of the key questions where there was a lot of conversation around was how you drive your guidance, how you drive your process that you go through. And so if you walk a little bit through your process, how you come to your guidance and share with the...

I mean in the shorter term, we generally have guided and it can be using conservative assumptions relative to what we had. So one of the most important near-term assumptions would be the organic rate of growth. And so we've tended to discount that. I think it was said last night that for the most part, we're taking the run rate of revenues at the end of the quarter, which is the ARR. Remember doing a quarter, you generally are ramping up your ARR and carry that forward. And that's the way we've always guided. I think that you've seen in different periods where the organic growth is at different ranges in the next quarter or 2 that the beat goes up or down because of that. And so we've always taken that conservative tact in guiding, assuming not much more business comes in, in the near term. And so that's been our approach. We've also been conservative in our EBIT guidance. You can see you can just plot out how we've done versus how we've guided. So that means we are forecasting light on revenues relative to the trends we've seen and heavier on expenses relative to the trends we've seen. And that's been our philosophy since we went public.

I'll ask one more question, and then we'll open it up for questions if you have any. Another inbound that we get regularly is around macroeconomic pressures and should they persist if topline were to decelerate, how confident you are in protecting your margins?

Yes. Good question. So I think if you step back, we've had revenues accelerate and decelerate. We've seen this in COVID. We've always said that really our -- sort of our way of getting resources is really more limited by what we can do. And so therefore, when revenue spikes up, we're not able to plan and get our resources to grow with revenues. And when they go down a little bit more, we're closer. And we've always been a company that's lived within our means, meaning we've never invested beyond what we can afford. I think Oli cites that in the whole history of the company and before we went cash flow positive, we burned $28 million of cash, and we're a pretty big company for that right now. So it's always been the way we've been doing. And weighted average long term will continue that. There will be periods we said where revenues might spike up and we're not able to invest and there'll be periods where revenues might decel like they might be doing now given what's going on in the world. And in that case, we're in a good position that we can continue to invest, but we've always calibrated, and we think there's a large long-term opportunity, so we want to continue to compound and do that. But we're also cognizant that it's a balance. We've always operated in the balance, and we'll continue to watch that. So I think that we're going to try to continue to invest but continue to be profitable like we've always been. And we can't, with a straight face guarantee that is always going to be the exact same margin because we don't know what the world is going to bring, and we don't want to shortchange the company. So there'll be certain types of investments that we're going to want to do in most environments. But we're going to calibrate that. The fact that we have grown so much and made the investment means that we're in a really good position and that we can continue to invest yet still be profitable and very cash flow generative and are going to continue to plot out the company in that way.

Great. We have a lot of people in the room. Let's open it up for some questions.

I was hoping you could talk a bit about your end markets and maybe how your end markets might be evolving in terms of their consumption. I also cover kind of the financial services space and then I've looked at your client base. And I can see what's going on with the crypto side of the world. But just trying to understand what's going on maybe in your end-client base.

So one thing is that we are very diversified by end market or industry because we are a reflection of the digital economy. And when you think about it, they're manufacturing companies that are delivering product digitally. You're talking about big money center banks, investment management companies, travel, airline, et cetera. So we're not that concentrated. I think at the time of COVID, we said one of the more impacted sectors was travel, which was I think we said around 10%. So what we said was that we're not immune from what's going on. So in the parts of the end markets that are more cloud native and have expanded very rapidly but are being affected and you could put consumer discretionary in that, food delivery. We don't have a very large crypto business, but of course, they be affected. Those companies, the combination of them being affected and expanding too rapidly or, let's say, too full in a number of different ways as a result in that being the place where we've seen the most intense optimization. Now we said that the sector of consumer discretionary is low double digits. And we have a number of sectors that are low double digits. We have some sectors that might be a little bigger like enterprise software, which is more stable or financial services like banks and insurance companies. So it's the weighted average of that. All sectors optimize over time. We've always said that, but it's the relative intensity and we're finding that in the places where there's been the most effect given what's happened in the environment are the places where it's been most intense and we report it that way.

I was wondering if you could just talk about. So if you win a customer and you start off on the infrastructure side, and then you develop additional touch points on the APM log side, it didn't become pretty entrenched with the customer, just what it's like from a rip and replace standpoint as a means to kind of assess your pricing power?

Yes. So we're not a rip and replace company. It's mainly greenfield, and we land with infrastructure, we're generally the infrastructure provider. And what tends to happen is you just look at the metrics of adoption of the different parts of the platform. They tend to grow into the other parts of the platform over time. There are various things that get replaced from open source to cloud native to some of the public companies. And it's for this use case of real time. They tend to consolidate on this platform over time. So it happens gradually and it's been part of our expansion given what the clients really are trying to do is they really view this as -- and if you saw a demo, you'd say, we only have one product, the platform, and they want to use different parts of it. So that's the motion that we generally have. I think you know from some of the things we said that the businesses of APM and logs are roughly the same as the business of infrastructure, and that indicates that essentially having those part of it roughly results in double your spend with Datadog and then if you have infrastructure only.

Got it. Yes. And just to clarify, I guess, less you rip and replacing works how difficult would it be to kind of replace Datadog once it is -- once you guys have established that platform?

Our gross retentions are in the mid-90s, including SMB. We said that in the enterprise, it's in the very high 90s. Most of our customers are essentially standardizing their processes on our platform and are using us as one of the main ways they do their business every day. They're building on metrics, dashboards and connections. So we've seen huge stickiness, generally, the industry is pretty sticky. It's been that way for a long time. And the evidence we have so far is that once Datadog is entrenched and the way it spreads out ubiquitously, it's very hard to get rid of a Datadog. And one of the major reasons is that the users essentially tell anyone who tries to mess with that. I'm not going to give up my Datadog.

Any other questions? So last year at the conference, we asked you to make a technology prediction. And one of the things you said was that you expected the collapse of the silos between DevOps and Security. Wondering how that's progressed relative to your expectations and your prediction. And I guess another prediction to it.

So I think that on that one, it's happening. We have very meaningful revenues and the companies you're stating have had very meaningful revenues. So we believe that this collapse of both security and even sort of the shift left side is happening. We're really pleased with both our investments we've made, our acquisitions we've made. I mean we made a very small shift left CI/CD and it's done really well. So I think it's proving out that the collapse of silos is inexorable and is continuing. And we think it's very early in that and it will continue. As far as predictions, one thing that's really struck me is that the types of customers and the end markets and industries that are adopting Datadog are some of the most stodgy industries. And like it surprised me when you see farm machine equipment and plumbing manufacturers and traditional grocery stores. And so my prediction here is that we're really early stages and that there's going to be tremendous sustainability of this trend of traditional industries marching and that, that will be less affected by economic concerns than we might have thought.

Great. Thank you for your time today.

Thanks.

Everyone, enjoyed your conference.

Thank you. Yes.