Datadog, Inc. Q2 FY2022 Earnings Call

Good morning, and welcome to the Q2 2022 Datadog Earnings Call. My name is Sheryl, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I will now turn the call over to Yuka Broderick. You may begin.

Thank you, Sheryl. Good morning, and thank you for joining us to review Datadog's second quarter 2020 financial results, which we announced in our press release issued this morning. Joining me on the call today are Olivier Pomel, Datadog's Co-Founder and CEO; and David Obstler, Datadog's CFO. During this call, we will make forward-looking statements, including statements related to our future financial performance, our outlook for the third quarter and fiscal year 2022, our gross margins and operating margins, our strategy, our product capability and our ability to capitalize on market opportunities. The words anticipate, believe, continue, estimate, expect, intend, will and similar expressions are intended to identify forward-looking statements or similar indications of future expectations. These statements reflect our views only as of today and are subject to a variety of risks and uncertainties that could cause actual results to differ materially. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our Form 10-Q for the quarter ended March 31, of 2022. Additional information will be made available in our upcoming Form 10-Q for the quarter ended June 30, 2022, and other filings with the SEC. This information is also available on the Investor Relations section of our website, along with a replay of this call. We will also discuss non-GAAP financial measures, which are reconciled to their most directly comparable GAAP financial measures in the tables in our earnings release. With that, I'd like to turn the call over to Olivier.

Thanks, Yuka. And thank you all for joining us this morning. We are pleased to report strong results in Q2 as we executed well, and we extended our category leadership. Let me start off with a review of our Q2 financial performance. In Q2, revenue was $406 million, an increase of 74% year-over-year and above the high end of our guidance range. We had about 21,200 customers, up from about 16,400 in the year ago quarter. We ended the quarter with about 2,420 customers with ARR of 100,000 or more, up from 1,570 in the year ago quarter. These customers generated about 85% of our ARR. We generated free cash flow of $60 million and a free cash flow margin of 15%. And our dollar-based net retention rate continues to be over 130%, as customers increased their usage and adopted more products. Now moving on to this quarter's business drivers. In Q2, while we overall saw strong customer growth dynamics, we have seen some variability in growth among our customers. We saw our larger spending customers continue to grow but at a rate that was lower than historical levels. This effect was more pronounced in certain industries, particularly in consumer discretionary, which includes e-commerce and food and delivery customers and affected more specifically our products with a strong volume-based component such as log management and APM suite. Note that we did not see this with our SMB and lower spending customers who continued growing with us as they have in the past. While these near growth data points and the current micro climate are leading us to be prudent with our short term outlook, we remain very bullish about our opportunities and confident in our execution as we continue to see positive trends underpinning our business. First, the number of hosts and containers being monitored by our customers is growing steadily, which points to continued momentum of cloud migration and digital transformation projects. Second, we had strong execution on the new logo side as new logo ARR was robust as we added a record 1,400 new customers in the quarter. We closed a number of sizable six to seven figure year-over-year deals during the quarter with diverse customers. Third, our pipeline of large new logos and new product cross-sells going into the second half of the year is strong. And fourth, churn remains low with gross revenue retention steady in the mid to high 90s. Moving on to our products, we are pleased with the continued adoption and expansion of our products for our customers. The three pillars of Observability, which are infrastructure, APM, and log management all grew strongly in Q2. Our APM suite and log management now exceeds $0.75 billion of ARR. As a reminder, we define APM suite as including core APM, Synthetics, RUM, and Continuous Profiler. In addition to that, infrastructure monitoring continued to grow strongly on par with recent quarters. We're also pleased with the adoption of our newer products, which continue to grow ARR more than 100% year-over-year. Our platform strategy also continues to resonate in the market. As of the end of Q2, 79% of customers were using two or more products, up from 75% a year ago. 37% of customers were using four or more products, up from 28% a year ago and 14% of our customers were using six or more products, up from 6% a year ago. Now let's move on to product and R&D, where our teams delivered another strong quarter of innovation. In June, Gartner published a 2022 Magic Quadrant for Application Performance Monitoring and Observability. Datadog has once again been the leader. We're very pleased that our APM product went from GA to best-of-breed in just five years, and I want again to congratulate our teams for this achievement. In June, we announced the general availability of Observability Pipelines, the 15th product in Datadog platform. By using Datadog Observability Pipelines, customers can control the cost and volume of data, decouple data sources from their destination, standardize and improve data quality and redact sensitive data to maintain compliance. Next, we announced the general availability of Audit Trail in June, and this week, we announced the general availability of Service Catalog. Finally, this morning, we announced that we acquired Seekret. This acquisition will accelerate our path to providing customers visibility into the APIs and unlock new exciting capabilities for our APM suite. That's it for our product update this quarter. And needless to say, we're all very grateful to our engineering and product teams for their continued hard work. Now moving on to sales and marketing, let's discuss some of our wins in Q2. First, we signed a seven-figure upsell with a global services and audit company. Next, we had a seven-figure upsell with a managed service provider in Asia. This customer transitioned from their legacy monitoring tool to Datadog and adopted the entire Datadog platform. Lastly, we had a six-figure land with a gaming division at a hyperscaler. In addition to these wins, we also had a number of sizable six and seven figure new logo and expansion wins with companies that have recently experienced business contraction. We believe that software is a deflationary force and we are confident in our ability to help our customers do more with less, should economic conditions worsen. Now let me speak to our longer-term outlook. We recognize the macro environment is uncertain as we look into the back half of 2022. But we also see no change to the long-term trends towards cloud-based services and modern DevOps environments, and Observability remains critical to that journey. We continue to drive market leadership and for our customer's value and efficiency to solve their complex monitoring problems. As a result, we continue to feel very confident in our opportunities. We believe cloud migration and digital transformation are drivers of our long-term growth and our multi-year trends that are still early in their life cycle. Before I hand it over to David, I wanted to make a couple of announcements. First, we are holding Dash 2022, our user conference on October 18 and 19 at the Javits Center in New York City. We also will organize an investor meeting at Dash. And last but not least, we are pleased to welcome Titi Cole to our Board of Directors. With that, I will turn the call over to our CFO for a review of our financial performance and guidance.

Thanks, Olivier. We delivered strong financial performance in Q2. Revenue was $406 million, up 74% year-over-year and up 12% quarter-over-quarter. As Olivier described, we executed strongly with robust new logo ARR growth, continued low churn and continued strong platform traction. But we did see some customers beginning to manage costs in response to macroeconomic concerns, which impacted our usage growth with some of our existing customers. Looking at our growth with existing customers, our dollar-based net retention was above 130% for the 20th consecutive quarter, remaining strong as we continue to see customers use more existing products and adopt new products on the Datadog platform. We saw usage growth with some existing customers decelerate in Q2 and that deceleration was concentrated in our larger spending customers as opposed to our lesser spending customers, where growth remained steady year-over-year. Amongst our industries, we saw relative deceleration in consumer discretionary customers. As a reminder, we are highly diversified in industries and segments. We believe that our gross retention has reached and is sustaining these levels because of the stickiness of our product and the criticality of our platform to our clients. We believe that our gross retention has reached and is sustaining these levels because of the stickiness of our product and the criticality of our platform to our clients. And as Oli mentioned, our new logos, we saw strong continued new logo acquisition and ARR growth, broadly by geography and across industries and company sizes. Finally, our platform strategy continues to resonate with customers with 79% of our customers now using two or more products, 37% using four or more products, and 14% using six or more products in the Datadog platform as of the end of Q2. Moving on to our financial results. Billings were $397 million, up 47% year-over-year. Remaining performance obligations, or RPO, was $881 million, up 51% year-over-year. Current RPO growth was in the mid-50s year-over-year, and contract duration was slightly lower than the year ago quarter. In addition, we observed that some customers aren't changing their level of usage growth but are being more conservative in their commitments, which impacts billings and RPO growth but not revenue growth. Gross profit in the quarter was $328 million, representing a gross margin of 81%. We continue to expect gross margins to be in the high 70s range. Our free cash flow margin in the first half of 2022 was 25%. Now for our outlook for the third quarter and the fiscal year 2022. For the third quarter, we expect revenues to be in the range of $410 million to $414 million, which represents 52% year-over-year growth at the midpoint. Non-GAAP operating income is expected to be in the range of $51 million to $55 million and non-GAAP net income per share is expected to be in the $0.15 to $0.17 per share range based on approximately 347 million weighted average diluted shares outstanding. For the full year fiscal year 2022, we expect revenue to be in the range of $1.61 billion to $1.63 billion, which represents 57% year-over-year growth at the midpoint. Non-GAAP operating income is expected to be in the range of $255 million to $275 million. Now as regards to our margin guidance, I wanted to point out that gross margins have recently been at the top of our historical range. We estimate that this was a 300 basis point sequential margin impact in Q2, and we expect an additional 100 basis point sequential margin impact in Q3. We will continue to closely monitor the demand environment and calibrate further, if necessary. In conclusion, while we recognize there is greater uncertainty in the macro environment right now, we see no change in the importance of cloud migration and digital transformation, which are critical to our customers' competitive advantage. We believe we are well positioned to help our customers embark on these journeys, and we are investing aggressively into our long-term opportunities while maintaining our financial strength. I want to thank Datadog's worldwide for their efforts. And with that, we will open the call for questions.

Thank you. Our first question comes from Sanjit Singh from Morgan Stanley. Your line is now open.

Yeah, thank you for taking the questions and really impressive Q2 results with 74% growth. I wanted to talk a little bit about some of the trends you're seeing in the business and particularly with respect to the guide. I guess the first question is, as the quarter progressed, when did you start to see some of these slower usage trends in some of these verticals? If you could give a comment on that? And then, David, in terms of the guidance in terms of how you were framing it, can you give us a sense of what you're sort of assuming in the back half with respect to Q3 and Q4? Is it some of the trends that you're seeing in July, did that improve or stabilize or worsen?

Okay. So I'll start maybe with the linearity. And we did see the variability in usage growth that we mentioned. We saw that start really in late April, May, and June. So as we got deeper into the quarter. I should say that this is not a sharp pullback as we have seen at that time. But we saw it's just for some customers still growth, but slower growth for certain types of customers and others than what we would have seen historically. I should say that while we did see that for some of our products, especially the ones that have more of a volume component, we did see continued healthy growth in host and cloud instances and containers, which we're really indicative of the fact that the cloud migration is proceeding as it was before. To fully answer the question also, I think you - maybe are getting ahead of what David is going to talk about a little bit. But in July, we did see an improvement on those trends, but we still remain conservative in our outlook for the short term because of the noisiness of the data we're seeing there. There's a few more valuations, a bit more noise. And all of that is underpinned by some macro uncertainty. So we want to derisk that a little bit and be a bit more careful. David, do you want to comment on that?

Yeah. On guidance, as you know, we have always been conservative in our guidance by using lower organic growth and other metrics than we've seen historically and continue to maintain that philosophy. I would note that if you look at the raise here and the percentage of the beat that was passed through into the raise from Q2, it is lower, more conservative than we have done in previous quarters. And the reason for that is the macro uncertainty where we can't be as confident about what happens given the macro uncertainty. So I would say there, if you want to take that, there were some incremental conservatism put into this. But I'd remind everybody that we've always been quite conservative in using assumptions that are lower than the past when we give guidance.

That's very helpful. Thank you for all the context. I have one more quick question. Olivier, regarding your comment about the products that may be experiencing slightly lower usage, I understand the volume-based products like logs, that makes complete sense. However, I'm a bit confused about the potential deceleration in APM, since I believe that is mainly based on host-based pricing. Can you share any insights about the differences in trends between APM and logs in terms of usage and cost across those two areas of the portfolio?

That's a great question. So for APM, there's actually part of APM that looks like logs, which is APM is - part of it is host-based and part of it is traffic-based. If you want to run analytics and have longer retention on certain parts of your APM data, it basically behaves like logs. And that's the part on which we've seen some slower growth. It's still growing, but both are actually still growing healthily, but I would say, slower than they were in recent quarters for these types of customers. And you can do the same thing - with this generative data you can show a little bit more, you can reduce retention, these other levers customers have to control the spend there.

Makes total sense. I got it. Thank you very much.

Thank you. Our next question comes from Raimo Lenschow from Barclays. Your line is now open.

Thank you. Can I ask about that topic, Olivier? Is there a different way that people engage with you regarding infrastructure compared to the log and APM parts? Are you more critical on the infrastructure side? Because when I consider monitoring my applications, it seems as essential as monitoring my infrastructure. Could you clarify some of the differences for us?

No, it's just that these are - you have more like short-term levers to actually optimize a little bit in logs and APM, anything that's volume-based. What we've seen customers do is - I mean, really, if we were to cater that customer then we would break them into three buckets. One bucket is the customers that spend a lot with us, have us word to word in their business, now seeing their business slow down. That's what we mentioned in consumer discretionary and for delivery, for example. In those cases, naturally, if customers are themselves are growing 10% to 50%, and they're using several already equivalent to us, they have always been, that's natural. But that's only a small part of our customers. The second bucket I would say is customers they have a series he can spend with us. And don't you see a little bit more uncertainty in the future. So their businesses might not be challenged today, but pretty much every CFO or whoever has a mandate to look more closely at their expenses. And what we see those do is they're looking for optimization. They're looking for maybe to find some leaky faucets they can close. And you can typically find some of those in logs, for example. And this is not something new. So we're seeing some of that there. And again, this is not comparable in breadth or in magnitude to what we've seen at the beginning of COVID. But still, we see that in the data, so we wanted to call it out on the call.

Just want to clarify, when - if you look after the call on our website, you'll see that in APM it's host-based pricing, but there's other parts that are like logs, as Oli mentioned. And so what we're saying is that the infrastructure part, both with the infrastructure and the APM didn't experience as much variability, but the ability to tweak the use of the data through both ingestion and indexing.

Okay, perfect. Thank you.

Thank you. Our next question comes from Kash Rangan from Goldman Sachs. Your line is now open.

Yeah. I can pronounce Raimo’s name perfectly well. So, thank you. Thanks for giving me chance to ask question here. So I'm curious when you look at AWS and Azure, I mean, much larger business. They had good bookings, I think backlog growth, whatever you want to call it. But if you can help us reconcile your CRPO growth. I'm sure there are company specific things that pertain to how you see of your growth on a year-over-year basis, sequential growth basis. How do we look at that in the context of what's happening with the hyperscalers?

Yes. So I'll start on the rapid trends with the hyperscalers and then maybe David can give you more color on the bookings part. So in Q2, we did a lot better than the hyperscalers. So we're growing a lot faster than all of them combined. And they've decelerated actually more than we've done in relative basis. So we actually feel good about the ratio there. In terms of the go forward, I don't think the hyperscalers have to guide specifically for that. But we - in terms of business trends, we see that all of the leading indicators of success are looking good for us. The pipeline's going into the second half of the year are very good. We've also done very well with the capacity we've added and the hiring.

Definitely. So remind everybody that with our land and expand where we start getting used by clients, they scale up the growth and when they get to a certain point through, this has been going on for the whole business model. They go to an increased commit. Because of that, there's variability in the billings and RPO that net-net, over time, on average, go towards the ARR growth. Again, remember, we mentioned that the ARR growth is the best metric. To illustrate this, we note that billings growth for the first half of the year of 2022 was 72% year-over-year. Now let's review some key income statement results. Unless otherwise noted, all metrics are non-GAAP, and we have provided a reconciliation of GAAP to non-GAAP financials in our earnings release. Our efficiency and financial strength affords us options in times of macro uncertainty that other market participants will not have.

Thank you, Oli and David. Appreciate it.

Thank you. Our next question comes from Fatima Boolani from Citi. Your line is now open.

Good morning. Thank you for taking my questions. Oli, one for you and one for David as well, please. Oli, you talked about some wins vis-à-vis, DIY and open source displacements in your prepared remarks. But I suppose in a more challenged or uncertain macroeconomic backdrop, the free or - if it isn’t broke, don't fix it type model is potentially more attractive. So I'm curious if you can give us some color commentary on how you expect to sort of effectively compete with 'free open source' alternatives, especially for some of your volume-based solutions?

Yes. So free is actually the most expensive typically because you have to build it yourself. And it turns out people tend to be the most expensive thing for our customers. We mentioned in the script earlier that we actually had a number of sizable wins with customers that had announced layoffs shortly before they actually bought from us for the first time. And that's because we have been more efficient. We have been concentrate their efforts where it actually adds to their business as opposed to reinventing - there were more expensive and efficient way themselves.

Yes, thanks for the question. We haven't seen any change in those numbers. We still have the land, commit, use, grow, we get into on-demand, recommit, but we did say that in the level of conservatism that was introduced to some clients that they may have stayed more into their previous commit plus on demand. This is really sort of in looking at financial management with level of uncertainty. This isn't going to have much effect on the drivers of our business.

Thank you. Our next question comes from Matt Hedberg from RBC Capital Markets. Your line is now open.

Hey, great. Thanks for taking my question, guys. Maybe David, a follow-up, I think really to Raimo's question earlier, in your guidance philosophy, did you assume other verticals beyond consumer discretionary slow their usage? And maybe what are the assumptions from smaller customers? It sounded like they actually were fairly strong this quarter.

Yes, to take the second part, I think we saw that in our smaller customers, we had very consistent net and gross retention. We always do that. So our guidance always takes the drivers, which would be the organic or usage growth and the new logos. So we do that in every quarter. In this quarter, I mentioned that by passing through less of the beat we inject an incremental level of conservatism.

Got it. Okay. And then was there a geographic element to any of the kind of the slowdown in consumption? Was there a European element? Or was it sort of just broad-based geographic?

There was not. We did not see that. It was not geographic. As we mentioned, it tended to be more either large spend or industry based, but we did not see that geographically.

Got it. Thanks a lot.

Thank you. Our next question comes from Kamil Mielczarek from William Blair. Your line is now open.

Good morning, everyone. Thanks for taking my question. One for Olivier, maybe. First of all, congrats on the acquisition of Seekret. Given the upward trend in cash generation and your cash and equivalents are now approaching $2 billion, have your thoughts changed around potentially making a more transformative acquisition, especially given the decline in market valuations today?

It's possible. Everything is open. We've looked at some of those in the past. We see the value is higher for larger businesses like that. But we're really looking at valuations coming down and some more opportunities presenting themselves to us there. So everything is possible.

Great. And just as a follow-up. Earlier this year, we saw Datadog building out its recruiting engine, and I see you accelerated investments into sales and marketing again this quarter. Can you update us on where these incremental investments are focused?

Currently, we are actively recruiting and expanding our capacity successfully, which I believe is a strong indicator of future success. Our company operates in an interesting position because we are very efficient and have maintained discipline in our funding approach. Historically, we spent less than $30 million leading up to our IPO, and since then, we've generated significantly more cash. This discipline has become ingrained in our company culture. Furthermore, we have structured our business model to be frictionless and highly efficient. Over the past two quarters, we have demonstrated this efficiency by achieving rapid growth while maintaining a good level of profitability. We are confident in the long-term profitability prospects of the company. This position allows us to seize investment opportunities during this time, which many others in the market may overlook.

Yes. I just want to add that what we said all along was, we try to maintain a steady investment profile, which is focused on R&D and sales and marketing investments. And it's banded by what we can execute, what we feel we can hire, integrate, et cetera. So we try to maintain a steady profile of investment and the variability is with this acceleration of the top line.

Thank you. Our next question comes from Brent Thill from Jefferies. Your line is now open.

Good morning. David, I think everyone is still a little confused. You're seeing an inversion with what's happening with SMB and large enterprise. Can you explain why you think you're seeing this inversion? And are you embedding a more conservative view in the back half?

Yes, we didn't observe the inversion you're referring to. Our smaller and medium-sized business customers behaved consistently with their past actions. In certain segments, such as consumer, we adopted a more cautious approach and focused on cost. We consistently project lower organic growth across all sectors compared to our historical performance.

We're critical to our customers. We're critically important, we deliver value. We have them to be more efficient. So in general, whatever the size of the customer is, we're not on the chopping block. But the more customers spend on us, they're going to look for savings where they're spending money, and they're going to see that at larger levels of spend with us.

And by the way, gross retention stayed the same at all the different levels, SMB, mid-market, and enterprise.

Thank you. Our next question comes from Gregg Moskowitz from Mizuho. Your line is now open.

Okay, thank you for taking the questions. Oli, you're frequently speaking to a lot of Datadog customers, are they raising more questions about your pricing levels in this environment?

We are very optimistic based on our conversations with customers because their numbers are increasing. They are looking to purchase more and utilize more of our products. While everyone is seeking better deals, this has always been the case and will continue to be true. It's especially relevant now as CFOs are compelled to adopt a more conservative approach. However, based on our observations with customers, we remain very positive. So we keep seeing more and more of it. It's still not the majority of what we do. But we think, again, if there is prolonged macro issues in the market, like we might see more consolidation and customers now want to really try to save on their legacy software by consolidating on us.

Hey, thanks for taking the questions here, guys. I would just want to come back for that other point previously, regarding the SMB versus enterprise. And really, is it fair to characterize some of the, I guess, movements you're seeing with these larger deals? Is it may be less of an impact to you at the SMB level, either because your license has been a wallet share when they're looking to pay out their vendors?

They have the same exposure but simply the difference is, what's your time to say, $5,000. Probably not. If you're a much larger customer, it's worth your time to sell $500,000. And that's what we see with those optimizations.

Understood. For my follow-up, I noticed that the trend in multi-product adoption among your customers appears to have declined sequentially from 81% to 79%. Does this suggest that your customers are starting with fewer products now or choosing to add another product from you at a later time?

It's just mechanicals because we - I think we said 75% of our new logos are landing with two or more products, and we have more new logos. And so this pushes the number down a little bit.

There's nothing, you know, 81%, 79% these are all just - there's nothing, no change in trend.

Thank you. Our next question comes from Peter Weed from Bernstein. Your line is now open.

Thank you for taking my question. I'm interested in the customers that are doing some cost rationalization. Help me unpack those two things, whether or not it's Datadog focused or more of a broader cloud focus.

It's focused on their cost structure. They organize their expenses in decreasing order and assess what they can do to optimize. Several customers have experienced layoffs, so they are addressing their cost structure, particularly their workforce, and we are involved in that process.

Now given the stickiness and our monitoring of real-time applications for clients, we believe, based on our experience, that the focus is less on other aspects than on Datadog.

Thank you. This has concluded the question-and-answer session. I will now turn the call back over to CEO, Olivier Pomel, for closing comments.

All right. Thank you. I want to thank everyone for spending time with us on the call. And again, I want to thank all of Datadog employees for a great quarter and for continuing build a fantastic company and so proud of our customers. So thank you all, and we'll see you next quarter.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation. You may now disconnect.