JFrog Ltd. (FROG) Earnings Call Transcript & Summary

Good afternoon, everyone. Thanks for joining us. I'm Alex Kurtz, senior software analyst here at KeyBanc Capital Markets covering infrastructure software. Thanks for joining us with this -- with our JFrog management team for our fireside chat. With us today is Shlomi Ben Haim, CEO and Co-Founder of the company. Good to see you. And then Jacob Shulman, CFO of the company. Jacob, good to see you, too. Welcome.

Thank you. Great to see you, Alex.

Good to see you guys. So Shlomi, let's start with you. Just talk about the growth in the cloud business. It's now 23% of revenue, up from 0% a couple of years ago. So what's been that progression? And where do you see the expansion opportunities there?

Yes. Alex, this is more than a 3-year journey for us when we identified the cloud as one of our differentiators and the hybrid solution that we provide in JFrog to the DevOps community. Our go-to-market philosophy, pre-, during and expected post-COVID-19 is a full multi-cloud hybrid environment. As such, we provide our customers not only with the end-to-end DevOps Platform-as-a-Service but also on the cloud of their choice. And this is not a fake hybrid. That's an actual identical solution that they get on-premise in the cloud. The cloud is also very efficient. So there are no frictions in setting up your environment, and JFrog will provide that as a service on all regions and Kubernetes and cloud-native ready. And the free tier that we introduced to the world in Q3 of last year also give you an easy access and an easy upgrade once you decide that you want to go all the way with JFrog. So we expect to see the cloud business and the cloud revenues climbing this year again, and we are fully focused on not just the hybrid solution, but also on the cloud expansion that goes beyond just the 3 providers that we are now working with.

And Jacob, what does it mean for the model as you move to the cloud as far as margins? Maybe LTV to CAC is slightly different. How do you view that journey?

Yes. As Shlomi noted, we continue to invest in the cloud, and we will continue to do that in this year and going forward. But a part of that investment is streamlining of our infrastructure. So in 2020, we significantly improved our efficiency of our infrastructure, which helped us to improve our cloud margins. And that's why we saw despite the fact that structurally, gross margins on cloud lower than for on-prem, but overall, we improved our gross margins in 2020. And that's primarily because of the improvement in the cloud gross margins that we saw. Obviously, going forward, we will see -- as cloud continues to become a bigger portion, we will start to see a slow convergence to our long-term gross margins of 80%. In terms of velocity in CAC, obviously, cloud represents much higher velocity. And therefore, it will be much favorable for the business if we continue to invest in the cloud and grow our cloud business as a majority of new customers come in on cloud.

So I want to go back to expansion with cloud in a second. But just for our audience, if you have any questions for Shlomi or Jacob, please go into the presentation portal that you're watching this. Please put the questions into the interface, and we'll get to those towards the end of the chat. Shlomi, just on the cloud offering relative to the on-premise offering. Does the adoption of your additional products happen at a different pace that they're in the cloud? Is it a different kind of expansion opportunity? Or is it tracked to what you see on-premise?

Yes. Well, obviously, Alex, when you download the trial free in the on-prem solution or what we call the self-hosted solution, you have to, number one, pick one product at a time or the full platform if you have the facilities to host it; and number two, to integrate it with your current environment. When it comes on the cloud, the free tier, just activate your platform. That seamlessly integrate with your current ecosystem, and it makes your life as a developer or a DevOps engineer much easier. Not only that, when you can also choose the cloud of your choice, whether you want to run it on AWS, GCP or Azure, it makes it easier in terms of the company policy of what cloud we are working with. And add to it the fact that you can run it on more than 25 different regions makes your life -- distributed life now under COVID even more simple. So obviously, the cloud user experience and ramping up is much faster. However, with that said, we were very pleased to see that our on-prem prospects are still by thousands a quarter using the on-prem trial. And I think it's demonstrated the need for real authentic hybrid solution.

Okay. Just to finish up on-prem because we got this question a lot during the IPO, Shlomi. And just why so many customers still want to run these binary managers on-prem? Can you just kind of -- just a couple of high-level points on that because that question does come up a lot.

It's a great question, by the way. And we are part of this transition, right? So I've heard all kinds of opinions from on-prem is dead to on-prem will live forever. So what we see now is that every company, every company, has some kind of legacy which we call on-prem. Even those that are moving to the cloud will argue that the self-hosted solution coming from a vendor like JFrog with an on-prem solution, they buy it from us and they host it on one of the clouds, what we wanted to provide is the freedom of choice. Remember, JFrog is working from the bottoms up. We are working with developers. We are working with the development management team. We are working with DevOps engineers, and we need to give them the freedom to choose their environment and their technology. So what we see a lot, especially in the Fortune 500 companies, is that the combination of having a self-hosted or on-prem with the cloud, not just allowing them to kick off fast, but also to expand the cloud easier because there is no learning curve. So in the next 10, 20 years, Alex, you would still see a lot of on-prem solutions. You will still see a lot of on-prem demand coming not just from the biggest banks of the world, but also tech companies and retail companies. And the progression of the cloud -- moving to the cloud will still happen. And what we will see there is a multi-cloud demand, not just only one cloud shop, but a multi-cloud solution that will also be aligned with regulation and other instructions.

That's helpful. So let's just move to the next key discussion point we get a lot is around your free tier offering. That was a big discussion over the last couple of quarters. So at a high level, what value does free tier bring to potential customers? And can you give us some color on how you've been able to convert those customers to paid offerings and kind of what that cycle looks like?

Yes. Well, look, every company now, especially the DevOps arena, would like to claim that they have a platform. Having a platform is not just having a few products that are bundled and integrated together. Having a platform means that you have a value by product that's well integrated under one UI and available on every deployment environment. And this is what we've released to the market earlier in 2020. And in February 2020, we released the full end-to-end DevOps platform solution under one UI with 6 products coming from JFrog. Part of it was Q2 acquisitions we did, and some of it was developed inside JFrog. It was all built on top of and around Artifactory, the primary repository solution. Part of this unified UI, unified solution, allowed us to introduce our customers with a one-click platform enablement, and what better than enable that in a frictionless environment in the cloud of your choice. Therefore, in Q3 of last year, we launched our free tier -- instead of a trial, a free tier, which is capped by data transfer and storage. But you can start your JFrog journey in the cloud, on every cloud and have a full end-to-end DevOps solution there. What we see there, we are happy to see that in such a short time, thousands of users already activated their platform on our cloud, and most of them are using more than just one product. We still have a lot to do in order to optimize that. That's an already cloud-native ready platform running on Kubernetes on all those regions. But we want to optimize it, not just from the user experience point of view but also from a margin point of view and expansion to other products. So we are very pleased with what we see so far. And the very nice thing that we were not completely ready to, but it was a great surprise, some of our on-prem customers are using the cloud platform as an easy way to start evaluating the platform and then land on a very high subscription level because they have the experience of all products together.

And if I may add to that, Shlomi, that this is the first time that we see -- we have visibility how prospects are using our products and how prospects engage with us. So that will help us to -- this data will help us to improve conversion and add more customers.

Absolutely. Absolutely. The optimization comes on both the user experience and our experience for the user journey is well said. Thank you, Jacob.

I mean, Shlomi, could you see free tier being your main customer acquisition channel over the next couple of years? Or do you think there's still more of a hybrid model about how you acquire customers?

Yes, Alex. The alignment is fully there. All the stars are aligned. We started to develop our strategic team to be focused on our top 100 customers. They are using the free tier because they can introduce the platform even to existing customers that are using 1 or 2 products coming to JFrog. We see it with a very small development team that for them, saving on cost of infrastructure is easier and they don't want to have any learning curve or DevOps engineers that will install the environment for them. We see it easier for us, as Jacob mentioned, to optimize and to be focused on the user happiness and to provide something that is answering the customer pain. So absolutely, we see the free tier as the main avenue. But still, as I told you, JFrog is an amphibian company. We see the land and we see the water, and we think that the cloud and the on-prem will live with one next to the other. Although this will be the primary avenue for our new business growth, the on-prem trial will still be available for our customers and community.

And just to clarify, Jacob, the landing ARPU around the customers that are coming through free, there's opportunity where it's a bigger land because they're using more of the products? Is that -- did I hear that right?

Yes. We started seeing our customers landing on higher-level subscriptions. Obviously, still majority land on entry level. But with -- these are the customers who experienced multiple products already landing on higher-level subscriptions.

Okay. And again, for the folks who are on the call, please, if you have any questions, go into the platform and the interface and punch the questions in, and we'll get to them at the end of the fireside chat. Shlomi, you've seen good momentum with Enterprise+ tier. It's obviously very important to the model, right, as far as what drives revenue and drives leverage. Can you help us understand and unpack what are the drivers around Enterprise+ kind of adoption over the last quarter?

Yes. Well, as we shared in the earnings last week -- 2 weeks ago, I -- we are not surprised. We are not surprised. JFrog is driven by a pain solver solution. We put the bricks one after the other in order to build the great wall of DevOps and help our customers. But when you own the repository, Alex, when you own the warehouse of all the software packages in the world and it's universal and it's hybrid, basically, you start to add value on top of it that completely makes sense to the users. I don't know any user that will say, "I don't want my repository to be secured." So here you go, Xray. And I don't know any of our enterprise customers that would tell us, "It starts with CI/CD, and this is where it's end." Never. You think about distribution and you think about how you get those binaries closer to the edge whatever the edge is. So yes, we still -- the majority, the vast majority of our customers, over 90% is using more than just Artifactory. That signals to us the growth in multiproduct and especially in the platform. We reported 26% of our revenue that comes from the platform. And the majority of the growth that we saw in Q4 came from customers that expanded the platform solution by more distribution and more security. And we were -- it was a great vote of confidence in our road map. Not just that. Also, we started to see some of the competition going forward this direction, meaning that we probably aim right to the North Star. However, this is very important, and Jacob mentioned it before, the majority of our installed base, the majority of our existing customers, paying customers, is still using a single product. For me, it signals a great opportunity to grow within my installed base. And when we double down on the differentiators and the values that they get on top of Artifactory, that even makes it more easier. And it comes back to your question about free tier and how they can explore the other products, not just as new business, but also as existing.