Datadog, Inc. Q1 FY2024 Earnings Call

Good day and thank you for standing by. Welcome to the First Quarter 2024 Datadog Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Yuka Broderick, Vice President of Investor Relations. Please go ahead.

Thank you, Marvin. Good morning and thank you for joining us to review Datadog's First Quarter 2024 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 second quarter and fiscal year 2024 and related notes and assumptions, our gross margins and operating margins, our product capabilities, our ability to capitalize on market opportunities and usage optimization trends. 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-K for the year ended December 31, 2023. Additional information will be made available in our upcoming Form 10-Q for the fiscal quarter ended March 31, 2024, 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 discuss non-GAAP financial measures, which are reconciled to their most directly comparable GAAP financial measures in the tables in our earnings release, which is available at investors.datadoghq.com. 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 with our execution at the start of 2024. First, we have continued to broaden our platform across observability, cloud security, software delivery as well as closing the loop with cloud service management. We also kept supporting our customers' adoption of new technologies including next-gen AI and large language models. And we have continued to add new customers and see existing customers increase their usage growth and product adoption. Let me start with a review of our Q1 financial performance. Revenue was $611 million, an increase of 27% year-over-year and above the high end of our guidance range. We ended the quarter with about 28,000 customers, up from about 25,500 last year. We had about 3,340 customers, with an ARR of $100,000 or more, up from about 2,910 last year. These customers generated about 87% of our ARR. And we generated free cash flow of $187 million, with a free cash flow margin of 31%. Turning to platform adoption, our platform strategy continues to resonate in the market. As of the end of Q1, 82% of customers were using 2 or more products, up from 81% a year ago. 47% of customers were using 4 or more products, up from 43% a year ago. 23% of our customers were using 6 or more products, up from 19% a year ago. And 10% of our customers were using 8 or more products, up from 7% last year. We continue to see robust growth in our 3 pillars of observability: Infrastructure monitoring, APM, and log management. But we also have many younger products that are becoming more meaningful contributors to our business over time. For example, our products outside of infrastructure monitoring, APM suite, and Log Management exceeded $200 million in ARR in Q1. And as a reminder, within the APM suite, we include core APM, Synthetics, RUM, and Continuous Profiler. And as we look at the 12 products that we launched between 2020 and 2022, those now contribute about 11% to our ARR. Of those 12 products, 8 are over $10 million in ARR, which is a nice milestone for these relatively new additions. And we are seeing some products grow faster than we initially expected. For example, Database Monitoring is already 1% of our revenue with strong and growing product penetration across our customer base. So we are very pleased with the progress of our newer products, even though we know we have much further to go with them. Now let's discuss this quarter's business drivers. In Q1, we saw usage growth from existing customers that was higher than in Q4. And this usage growth in Q1 was similar to what we experienced in Q2 and Q3 of 2022. As a reminder, that was a period when we started to see a normalization of usage following the accelerated growth we had experienced in 2021. Overall, we saw healthy growth across our product lines. And as usual, our newer products grew at a faster rate from a smaller base. While some of our customers are continuing to be cost-conscious, we are seeing optimization activity reduce in intensity. As an illustration, the optimizing cohort we identified several quarters ago did grow sequentially again this quarter. We also see that customers are adopting more products and increasing usage with us. We think this shows that they are moving forward with their cloud migration and digital transformation plans and that we are executing on opportunities to consolidate point solutions into our platform. And finally, churn continues to be low, with gross revenue retention stable in the mid- to high 90s, highlighting the mission-critical nature of our platform for our customers. Moving on to R&D, we had another very productive quarter. In the next-gen AI space, we announced general availability of Bits AI for incident management. By using Bits AI for incident management, incident responders get auto-generated incident summaries to quickly understand the context and scope of a complex incident. And users can also query Bits AI to ask about relative incidents and perform tasks on the fly from incident creation to resolution. We're also continuing to see more interest in AI from our customers. As a data point, ARR for our next-gen AI customers was about 3.5% of our total, a strong sign of the growing ecosystem of companies in this area. To help customers understand AI technologies and bring them into production applications, our AI integrations allow customers to put their AI data into the Datadog platform. And today, about 2,000 of our customers are using 1 or more of these AI integrations. And we've continued to keep up with the rapid innovation in this space, for example, adding a new integration in Q1 with the NVIDIA Triton Inference Server. In the cloud service management area, we released Event Management in general availability. Our customers face increasing complexity at scale, causing the volume of alerts and events to explode, which makes it difficult for teams to identify, prioritize, summarize, and route issues to the right responders. Event Management addresses this challenge by automatically reducing a massive volume of events and alerts into actionable insights. These are then used to generate tickets, call an incident, or trigger an automated remediation. And by combining Event Management with Watchdog, Bits AI, and Workflow Automations, Datadog now provides a full AIOps solution that helps teams automate remediation, proactively prevent outages, and reduce the impact of incidents. In the observability space, our Log Management product continues to expand in capability. In March, we made error tracking for logs generally available. Error tracking intelligently combines millions of errors from logs into a manageable number of issues for customers. And beyond error tracking, we are delivering new features to allow our customers to do more with their logs within the Datadog platform, starting with new core capabilities such as enhanced full-text search and support for advanced subqueries, both highly desired by our customers. We also continue to make progress with Flex Logs. As a reminder, Flex Logs allow customers to easily scale storage and compute separately, which in turn allows for new, very high-volume use cases in a cost-effective manner. While Flex Logs remains in limited availability, we are seeing a high level of interest from customers, many of whom want to retain logs for long-term purposes such as audit, security, and compliance. And we're pleased to see that with only a limited set of customers so far, Flex Logs already exceed $10 million in ARR today. In the digital experience area, we launched mobile app testing in general availability, giving access to fast, no code, reliable testing on real mobile devices, which was a big challenge for customers given the wide range of devices and operating systems in use by consumers. And in Cloud Cost Management, we've added full support for Google Cloud so FinOps and DevOps teams can optimize their cloud spend across their AWS, Azure, and GCP footprint. Cloud Cost Management is another of our newer products that exceeds the $10 million ARR milestone, and we believe there's significantly more opportunity for us to have our customers there. As usual, I'd like to thank our product and engineering teams for the quarter, and I'm looking forward to the many announcements we'll make at our DASH user conference in late June, here in New York. Now let's move on to sales and marketing. We've been pleased to once again add some exciting new customers and expand with many more. So let's go through a few examples. First, we signed a 3-year, 7-figure expansion with a leading online grocery business. This customer has used Datadog as their platform of choice for several years now. And as they migrate to Azure, they are looking to ensure reliability and security as they deploy at scale. With this renewal, they are adding Cloud Security Management, Application Security Management, and Cloud SIEM to enable a shift to a DevSecOps culture in the organization. And this customer expects to add 7 products for a total of 14 across the Datadog platform. Next, in 2 deals over the past 6 months, we had a 7-figure expansion with a medical device company. This customer was primarily using our infrastructure monitoring and APM suite, but its legacy logging solution was becoming cost prohibitive, while the lack of correlation across siloed teams was causing frustration and higher times to resolution. With this expansion, the customer plans to add up 9 products and consolidate its log management tool as well as 4 other commercial and cloud-native tools into Datadog. Next, we signed a high 6-figure expansion with an athletic apparel company. This company had a dozen disparate monitoring tools, which wasted time and was impacting operations, revenue, and customer experience. With this expansion, the company plans to consolidate out of 4 commercial and open-source point solutions. They also expect to save millions of dollars over the next several years while providing a great consumer experience. Next, we signed a high 6-figure expansion with a European division of one of the world's largest car makers. This customer has chosen Datadog as its observability vendor in many business units globally. And in Europe, they currently monitor about 1/4 of their applications with us and are migrating hundreds of applications to fully move to Datadog in the next 2 years. With this expansion, this customer is using Edge products in the Datadog platform. Next, we signed a 6-figure land with a division of a Fortune 500 industrial company. The company is moving its e-commerce application to Google Cloud. They felt that using on-prem monitoring tools would not transition well to the cloud and are starting with 3 of our products as they are confident in Datadog's ability to keep innovating in modern cloud and serverless environments. Finally, we signed a 6-figure land with one of the world's largest communication infrastructure companies. This company started cloud migration a couple of years ago and found itself limited by fragmented tooling and lack of data correlation. In contrast, the Datadog service catalog gives them a single view for performance, ownership, security, SLOs, and KPIs, which the customer believes is a unique capability among the vendors it considered, and which aligns with their goal of delivering centralized observability across the business. And that's it for another productive quarter for our mobile to market teams. Let me now say a few words on our longer-term outlook. Overall, we continue to see no change in the multiyear trend towards digital transformation and cloud migration. We are seeing improved usage growth with less impact from optimization than we had seen in the last few quarters. For those customers who are remaining cost-focused, we are very happy to help them get value from their observability solutions and consolidate into the Datadog platform to achieve time and cost savings. Meanwhile, we are seeing continued experimentation with new technologies, including a growing adoption of AI, which we believe will be an accelerator of technical innovation and cloud migration over time. And we're working every day to innovate and help our customers adopt new technologies with confidence and become better businesses in the process. With that, I will turn it over to our CFO. David?

Thanks, Olivier. In the first quarter, we generated $611 million in revenue, which is a 27% increase compared to the same period last year and a 4% increase from the previous quarter. Looking at some factors contributing to our Q1 performance, we saw stronger sequential usage growth from existing customers, surpassing the usage growth we recorded in the fourth quarter. This growth in Q1 was comparable to what we witnessed in the second and third quarters of 2022. As a result of this significant growth off a larger base, the additional annual recurring revenue we added sequentially was the highest since Q4 2021. Throughout Q1, we maintained a typical linearity pattern, with usage growth peaking in March, outperforming January and February. When examining usage growth by customer size, we noted an acceleration among larger clients, specifically those with an annual spend of $100,000 or more, with particularly robust growth from our largest customers who spend several millions annually. International markets outpaced North America in year-over-year revenue growth. As for our retention metrics, the net revenue retention over the last 12 months was in the mid-110s for Q1, consistent with last quarter, while our gross revenue retention remained stable in the mid- to high 90s. Moving on to our financial results, billings reached $618 million, marking a 21% year-over-year increase. Year-over-year, billing duration saw an uptick, though sequential growth was lower than in Q1 2023, consistent with seasonal trends. Our remaining performance obligations stood at $1.73 billion, up 52% year-over-year, with current RPO growth in the low 40% range. We noticed an increase in RPO duration year-over-year, although it declined quarter-over-quarter due to fewer multiyear deals compared to the last quarter. Overall, we are observing heightened interest from larger customers in committing to multiyear arrangements, which leads to longer RPO durations for both total and current RPO. It’s important to note that our RPO can be variable, a factor likely amplified as customers commit to multiyear deals. We believe that revenue is a more accurate reflection of our business trends compared to billings and RPO, which can vary relative to revenue depending on invoicing timing and customer contract durations. Now let’s take a glance at some key income statement results, using non-GAAP metrics unless stated otherwise. Gross profit this quarter was $509 million, yielding a gross margin of 83.3%, slightly down from 83.4% last quarter and up from 80.5% a year ago. We are continuing to enhance our efficiencies in cloud costs, thanks to our engineering teams focusing on cost-saving initiatives. Our operating expenses in Q1 rose by 14% compared to a year ago, up from the 10% growth we saw last quarter. As mentioned in the previous quarter, we plan to increase our headcount in 2024 and are accelerating hiring in sales, marketing, and R&D to support our growth strategies. Our operating income in Q1 was $164 million, reflecting a 27% operating margin, down from 28% last quarter and up from 18% year-over-year. Turning to our balance sheet and cash flow, we ended the quarter with $2.8 billion in cash, cash equivalents, and marketable securities. Our cash flow from operations amounted to $212 million for the quarter. After accounting for capital expenditures and capitalized software, our free cash flow was $187 million, translating to a free cash flow margin of 31%. Looking ahead to Q2 and the fiscal year 2024, our guidance philosophy remains unchanged. We base our projections on observed trends and apply conservatism to these growth estimates. For Q2, we anticipate revenue between $620 million and $624 million, equating to a 22% year-over-year growth. Non-GAAP operating income is projected to fall between $134 million and $138 million, corresponding to an operating margin of 22%. We will be hosting our DASH user conference in Q2, which we estimate will cost around $11 million, impacting our operating income outlook. We expect non-GAAP net income per share to be between $0.34 and $0.36 based on around 360 million diluted shares outstanding. For the fiscal year 2024, we are forecasting revenue between $2.59 billion and $2.61 billion, signaling a 22% to 23% year-over-year growth. Non-GAAP operating income is expected in the range of $585 million to $605 million, implying a 23% operating margin. Additionally, we foresee non-GAAP net income per share between $1.51 and $1.57 based on approximately 361 million diluted shares outstanding. Regarding our guidance, we estimate net interest income and other income to be about $110 million for fiscal 2024. We also anticipate cash taxes for 2024 to be in the $20 million to $25 million range, maintaining a non-GAAP tax rate of 21% for this year and beyond. Lastly, we expect our capital expenditures and capitalized software costs to comprise about 3% to 4% of revenues in fiscal 2024. To summarize, we are satisfied with our start to 2024, and I want to extend my thanks to Datadog's worldwide team for their hard work. Now, we will open the floor for questions. Operator, let's begin the Q&A.

Our first question comes from Sanjit Singh of Morgan Stanley.

It was encouraging to see that usage trends continue to improve, at least sequentially Q1 over Q4. I wanted to see if you could put like the usage trends you're seeing in your business in context of like the broader cloud landscape. And we're seeing some really nice results out of the hyperscalers. Obviously, those are much larger businesses and in different product areas. But when we think about the tailwinds of cloud migrations and also AI workloads starting to come on board, how does that play out in Datadog's business versus what we may be seeing from like the hyperscalers who seem to be accelerating to a higher degree?

Yes. Sanjit, this is Olivier. So I think, in general, it's hard to do a precise quarter-by-quarter one-to-one mapping between the revenue and the cloud providers and our revenue. I think you pointed out, there are things in their products that don't relate to us directly or things in their internal revenue that don't relate to us directly. We have products that don't tie one-to-one with the infrastructure on their end. But in general, over the longer term, we are very exposed to the growth trend you will see with the cloud providers, and the correlation you've seen in the past between our businesses, we expect will remain in some form in the future. We also are very exposed to the same tailwinds, obviously, cloud migration, but also AI adoption. I will say also on AI adoption that some of the revenue jumps you might see from the cloud providers might relate to supply of GPUs coming online and a lot of training clusters being provisioned. And those typically won't generate a lot of new usage for us. We tend to be more correlative with the live applications, production applications and inference workloads that tend to follow after that, and are more tied to all of these applications going into production. So these are the things to factor. But overall, same trends, just not a one-to-one timing.

That makes complete sense. And I was wondering if you had any comments on how usage trends coming out of March would seem to be stronger than in the beginning of Q1, how that sort of played out in April?

Sure. Sanjit, it's David here. As we always say, we try to look into the next month, but that’s a small-time set. In this case, the April trends continue to exhibit higher sequential growth rates than the year-ago quarter. But we caution everybody that 1 month does not a quarter make, and we'll continue to update that next quarter as we report.

And the seasonality in Q1 was very usual. Every year, there's a drop around the holidays in Q1 and January starts slowly, and then it accelerates into March. We’ve seen that pretty much every year so far and are seeing it this year as well.

Our next question comes from the line of Mark Murphy of JPMorgan.

Congratulations on the revenue acceleration during the quarter. Olivier, I'm wondering how commonly are customers in your gen AI cohort using Datadog to monitor for bias and hallucinations within their AI models as opposed to just keeping the systems running? And also, do you see more concentration of customers within that cohort? Or is there actually more diversity as more of the models move beyond the training stage and into the inferencing stage?

Yes. So we have products for monitoring not just the infrastructure, but what the LLMs are doing. Those products are still not in GA, so we're working with a smaller number of design partners for that. As I think not only these products are maturing, but also the industry around us is maturing and more of these applications are getting into production, you should expect to hear more from us on that topic in the near future. The customers we have that are the most scaled on AI workloads are the model providers themselves, and they tend to have their own infrastructure for monitoring the quality of the models. But we think there are good/bad weather in terms of what the adoption of AI is going to be from all the other companies, and we definitely see a trend where customers start with an API-driven or API-accessible model, build applications and then offload some of that application to other models that typically come from the open source and they might train, fine-tune themselves to get to a lower cost and lower time to respond.

I understand. Okay. David, you mentioned last quarter that cloud-native spending had rebounded and was outpacing the broader business. Can you clarify if you observed an increase in cloud migration activity within the traditional large enterprise sector during Q1, as suggested by the hyperscalers? I'm curious if you could elaborate on that comment and highlight any significant or noticeable trends among traditional large enterprises.

Yes, we observed growth accelerate among our larger customers, including major cloud-native companies and enterprises. We noted a return to more typical activity, featuring new workloads in both of these groups.

Our next question comes from the line of Kash Rangan of GS.

Congratulations to the team on achieving very good results. Olivier, could you discuss the consolidation trend you mentioned? The pace and intensity of consolidation and expenses seem particularly notable at this point. Additionally, David, our cRPO has been accelerating from the low 20s to the 30s and then to the 40s over the last few quarters. However, revenue expectations have not risen significantly. Could you explain the lead-lag effect? I understand you often emphasize that revenue is the best indicator, but it's difficult to overlook the cRPO acceleration we've observed in the past few quarters.

Yes. I'll let David discuss the cRPO dynamics, but we have observed a notable increase in consolidation over the last couple of years, especially in recent quarters. This is partly due to customers being cost-conscious and looking to save money, as well as them advancing further into their cloud migration and reassessing their usage. We continue to see this trend, and we've highlighted several examples in our previous discussions. This is a significant aspect of our enterprise business. There's been no substantial change in Q1 compared to Q4. Typically, we close more significant deals in Q4 than in Q1 during this season. As mentioned earlier, we usually experience a delay between large consolidation deals and when we recognize revenue from them. When we consolidate products, we tend to account for the time it takes to transition usage from other products to our platform, which can stretch over several quarters or even years. It may take time for these deals to translate into recognized revenue. On the other hand, we also have several deals where customers are rapidly increasing their usage, and we secure new commitments from them, which may lag behind their consumption and the revenue we recognize. So, we are seeing a mix of both scenarios.

Sure. As we mentioned previously, our larger customers are committing to us for longer terms. This includes multi-year deals and an increasing trend toward annual agreements rather than shorter contracts. This indicates that clients are more dedicated to Datadog as their primary platform, especially among larger accounts. However, it's important to note that our contracting and billing practices don't directly correlate with our revenues. Our revenues are linked to usage. While this trend is a positive sign, we want to emphasize that revenue remains our key metric, followed by our annual recurring revenue as an indicator of future growth.

Our next question comes from the line of Raimo Lenschow of Barclays.

Going back to the workload migration that seems to be kicking back in again from listening to the hyperscalers and you talked about the timing difference there. I wanted to kind of ask on a different aspect here and that's kind of your sales capacity and the ramp in sales capacity that we should think about it. Like can you speak about like where you are at the moment in terms of capacity? And then as the market reaccelerates, like what sort of investments should we think about there?

We are expanding our sales capacity, which has been a focus for the past few years. Last year, the growth was somewhat slow as we prioritized profitability and remained cautious given the challenging market conditions. However, we are indeed increasing our sales capacity, and there is a ramp-up model linked to this effort. Typically, capacity growth lags behind headcount growth, as it takes time for new hires to reach their full productivity. We are making investments and continuing to grow.

Long-term sales capacity is very much calibrated to revenue and ARR growth. As Oli mentioned, there are periods where it will move higher than that as we make investments, and there are periods where we might optimize. I think last year was a period where we digested previous investments and optimized a bit. And we said, this year, we're leaning into expansion of our sales capacity and investment. But long term, it correlates with revenue. And we look at that. We look at do we have enough sales capacity relative to what we see as the demand in the market, the territories, and the expected ARR growth.

To provide some additional insight, one of our main priorities is to accelerate our recruitment efforts. We are hiring much more quickly than we did last year and have restarted our recruiting initiatives. I want to commend our business recruiting team for their excellent work in getting things moving again.

Our next question comes from the line of Matt Hedberg of RBC.

Oli, you mentioned newer products continue to do really, really well. You gave some interesting data on Database Monitoring, for instance. I'm wondering, are these newer products resonating up and down your customer base? Or are these some of these cross-sell statistics stronger with some of your bigger customers?

Yes. So it really depends on the product. Some products are extremely broad-based in terms of their appeal. And some others are really more directed to certain types of customers. For example, all products that have to do with monitoring physical networks tend to be more appealing to larger, older enterprises because they are the ones with a large physical footprint, whereas products like Cloud Cost Management, for example, or even Database Monitoring have very, very broad appeal because every single customer cares about their cloud cost. And every single customer is using databases that are at the center of their applications, and that are absolutely critical to understand. And we mentioned those products because really like we see that as our efforts paying off in terms of broadening the offering and investing in R&D. And these are green shoots that we expect to grow into the future. Some of those products, we have extremely high expectations for because they correspond to very large categories, which we can think can be very meaningful to the business in the long run. Some others are surprising us a little bit. That's why we mentioned Database Monitoring. We were not sure if it was going to be a huge category in cloud environments, but it turns out, not only is there a very big problem our customers need us to solve there, but also this product hit that problem on the head from day one really, and now we expect a lot more from it.

Our next question comes from the line of Fatima Boolani of Citi.

David, you explicitly mentioned that the international book of business and activity was stronger than domestic. So I wanted to better understand some of the more intrinsic and maybe extrinsic dynamics that are driving that divergence in terms of your performance? And if you could sort of help us understand if it's an end market, a product-based or a budgetary-based set of distinctions that would be very helpful.

Yes. It's very similar to what we've been saying over time. The international markets have been more immature as to their cloud migrations and their deployment of digital applications than the North American markets, and we've been more immature in terms of our footprint. So we've talked about some examples in Investor Day and otherwise of places like Brazil and Korea to name just a couple, where we are seeing an increase of activity as well as an increase of our deployment of our capacity, which has resulted in an uptick of the international demand over time.

Yes. For us to be successful, there are two factors that are needed. The first one is cloud adoption needs to happen because we can't outrun it really. And the second one is we need to deploy sales capacity and grow sales capacity, and that's really combination of the two. In most markets today, cloud adoption is happening. There still may be a few holdouts that are a little bit slower. But we're not yet deploying enough sales capacity everywhere, and that's one of our big areas of focus, as I mentioned earlier.

Our next question comes from the line of Brent Thill of Jefferies.

David, good margins, 27%, but you're guiding full year to 23%. I know you mentioned you're stepping on the sales investments, but anything else that's coming into the investment mix this year that is different than we've seen in the past years to drive that margin lower throughout the year?

We have both the sales capacity and the entire ecosystem we've discussed. As Oli often mentions, we have more high-return product projects than we currently have capacity for, and we are working on making the necessary investments. We are layering in these investments. It's important to note that headcount cannot be adjusted as quickly as revenues fluctuate. Therefore, there are times when our investments exceed revenue growth and vice versa. This year, we are transitioning from a more conservative approach to increasing investments in both R&D and sales and marketing. There is nothing unusual about this; it pertains to both sales capacity and R&D projects. Oli, do you have anything to add?

Yes, bringing it back to what I was saying earlier, a major focus internally is recruiting and ensuring that we act quickly in this area. I would also like to mention that last year, when the market was slowing down, most of our competitors laid off their recruiting teams, but we chose not to do that because we realized our success would hinge on revving up the recruiting engine and expanding our engineering and sales teams rapidly to seize the generative AI market opportunity. We are pleased that we maintained our recruiting efforts, but there is still significant work to be done in hiring the right people swiftly.

Our next question comes from the line of Jake Roberge of William Blair.

Great to hear that AI-native customers represented 3.5% of ARR. I'm curious on what you're seeing on the demand front for your AI products like AIOps and cloud service management? And then you mentioned that the model providers have built their own tools to monitor the training of their models. As you start to roll out your own LLM observability solutions, do you see that trend changing? And is that something that customers have been asking you to build?

We are seeing significant interest in our new products, particularly the Event Management product, which fills a key gap in our AIOps platform, and the recently launched Bits for incident management. There is a strong demand for these offerings, and I personally find Bits for incident management to be very user-friendly. Expect more updates from us on this in the coming year, which is quite exciting. Regarding tooling, there are a few companies that have developed specialized tools tailored to their internal needs, which may not accurately represent the larger market. We are cautious about customizing products for groups that may not align with our target customer base, similar to how infrastructure monitoring designed for cloud providers might not suit wider industry requirements. However, we collaborate extensively with these companies, and while they meet many of their own needs, there are still gaps. For example, even hyperscalers use our services for applications, infrastructure, and logs despite having their own solutions. We believe there's potential for everything in the long run, but our main focus remains on serving the majority of our customers who will either utilize API-based products or adapt and operate their own models.

Our next question comes from the line of Karl Keirstead of UBS.

Great. Maybe to Olivier. Could you give a little context to the President stepping down into the Board, he's obviously been there a long time and has been a big part of the Datadog story. And then for David, you've done a great job over the years dissuading us from over-indexing on DR and billings. But as you actually pointed out, the sequential decline in DR and billings was quite a bit larger than normal. I'm just curious if there's a story there?

So I'll start with Amit, our President. So Amit wanted to stop working as a full-time operator but wants to stay close to the company, and we want to stay close to him, too. I mean, he's been, as you pointed out, a big part of the Datadog story, and we definitely want to keep him involved in the company and keep working with him. So the plan is for him to join the Board. You should expect him to maybe reappear at some point as a VC investor, something that's less operational than what he's doing today. And we expect him to be a part of the company for the future as well. I've always said, I will miss him every day in the office.

Yes. Now to the more mundane topic of billings. So yes, I think that we did see a deceleration. We had a very strong Q4 in terms of commitments to us, which manifests itself in billings. We talked about the larger customers committing to multiyear deals and committing to us. We do have a sequential factor, not in our revenues, which are based on usage as must, but basically in our billings and operations like that, usually in Q1 as clients sort of commit. So in some ways, we don't have the seasonality to speak of in the revenues, but like we talked about in billings and RPO, we do have variations in billings. We're not reading that much into it. Overall weighted, it's going to vary, and we point everyone back toward ARR and revenues, but acknowledge that, that seasonality may have been a little more pronounced in this cycle than in the previous one.

Our next question comes from the line of Brad Reback of Stifel.

Oli, one of the fastest ways to recruit quickly is via larger acquisitions. So maybe you can give us your thoughts on potentially going a little bigger here given that you're generating close to $1 billion of OCF a year right now?

Yes. So look, everything is on the table for us. Like we're very busy on the M&A side. We have a team that is, at any point in time, reviewing multiple deals. And everything is possible. I would say the larger the acquisition, the less likely it is to happen because we're extremely selective in terms of not only the economics of any deal but also the fit and whether we think it's truly going to accelerate us in the mid- to long term. But everything is possible. We are very fortunate to have a very efficient business. As we pointed, they're generating quite a bit of cash now, and that opens a number of doors for us, and we fully intend to use that if we have the right opportunity.

Our next question comes from the line of Koji Ikeda of Bank of America Securities.

I wanted to ask a question on AI. You mentioned in the prepared remarks about 3.5% of ARR, last quarter about 3%. So it looks like the trend is about plus 50 basis points a quarter right now. So really great to see the ongoing expansion there. So from a big-picture perspective, in your view, what needs to happen for this metric to start expanding, say, 1, 2, 3 points a quarter?

I'm not certain if this is a metric we will continue to emphasize. It was insightful for us to analyze this small group of early AI-native companies to gain perspective on future developments in AI. However, as time progresses and AI adoption increases, I believe this metric will become less significant. One point I want to make is that we compare our AI exposure to that of hyperscalers, as they are our upstream counterparts in this area. Among them, Microsoft is the most transparent about how much of their growth is driven by AI. When we compare our business to theirs, the Azure segment of our business is growing faster than Azure itself, and the AI-related part of our Azure business is also expanding quicker than the overall Azure figures. We believe our exposure is similar, and we are aligned with broader trends. Other cloud providers do not share metrics as openly, making direct comparisons more challenging. However, we expect these trends to continue in the long run.

Our next question comes from the line of Peter M. Weed of Bernstein.

One of the things that jumped out at me is you saw some improvement in net new customer adds quarter-over-quarter kind of for the first time maybe over the last year or so, which is pretty exciting. Obviously, I know there's a long tail effect with this. But as you look at that, do you see that as kind of a reflection of momentum in kind of the larger enterprise or a rebound in kind of the digital native venture-backed community, perhaps from that broadened AI? And if you think about pipeline going forward, should we anticipate kind of this bottoming and strength to continue and maybe accelerate?

Yes, the number of customers is increasing at a faster rate than in the past few quarters. However, it's important not to overanalyze this trend because we have a significant portion of smaller customers, which can lead to more variability in both acquiring and losing them without significantly impacting the business. Overall, I believe the trends in customer acquisition and retention are positive. Additionally, we've reported an increase in the number of customers exceeding $100,000 in revenue, a return to what we had previously experienced. Last quarter, that number was somewhat lower, indicating that customers are growing on the revenue curve. While there can be fluctuations in how customers are distributed across different revenue levels, the general trend is consistent: we are acquiring smaller customers who are expanding their business with us. This growth is resulting in an increasing number of customers above $100,000 and $1 million, which are contributing significantly to our revenue.

Our next question comes from the line of Eric Heath of KeyBanc.

Oli, in your prepared remarks, I don't think you talked too much on security and just given we're out here at RSA this week. I was curious if you could talk about traction you're seeing there. And then maybe any feedback on adoption trends following the new packaging you rolled out a couple of quarters ago?

Yes. So far, the news are pretty good on these new packages. Again, we want to wait to have seen them in the market for a few quarters before we comment too much on those, but the uptake is good. They seem to resonate well with customers, respond to the right need, and they're fairly easy to insert into the sales process. So all that are good news so far. I realize we didn't put too much in the script on security. We actually have a few things coming out. As there's RSA this week in San Francisco and our team is there to meet with customers. One of the new pieces of functionality we've announced last week was the agentless scanning for cloud security products, which we think is going to help a lot of customers deploy our product much more broadly, much more quickly. So we're very excited about that. It's in beta right now. And yes, overall, the same trends we commented on last quarter are still true, thousands of customers building on security, revenue growth, growth on a number of different pillars at the same time, which is very exciting and really speaks to our platform approach for security as well.

Our next question comes from the line of Andrew Nowinski of Wells Fargo.

I had a question on guidance for Q2. You had strong net new ARR in Q1. And you said you're seeing improved usage growth and less optimization. But based on your Q2 revenue guidance, it looks like you're assuming net new ARR in Q2 declines pretty significantly. I guess did you have some deals that pulled into Q1? And if not, why would net new ARR in Q2 be down year-over-year?

No. I mean, it's the same thing that we've said in every quarter that our guidance reflects the trends in usage growth and new business accumulation, and it factors in those trends. This has been our consistent approach since we became a public company. That's how we provide guidance, and we continue to do that in this quarter.

All right, and I'm wondering if you're seeing any sort of uptick in consolidation in the log management and SIEM markets given the M&A activity in that space?

Yes, there are definitely opportunities there. And so we spoke on the, I think, in the script on the advanced query functionalities, we're adding to logs. We spoke about Flex Logs. So those are all geared towards going after this opportunity. And we think also there's more specifically an opportunity around SIEM workloads, which is why we are investing heavily in our Cloud SIEM product. And so we think there's definitely a lot of opportunities there, and the teams are very focused on that. I don't expect these opportunities to make a big dent in our numbers in the next couple of quarters. But in the next year or so, definitely, we expect to see more.

Our next question comes from the line of Mike Cikos of Needham.

Just one topic, a bit of a 2-parter here, but I think in the prepared remarks, management incited improving trends for the number of or the cohort of customers who are moving past optimization sequentially. So I guess the question is really, can you help us think about the rate or pace of customers that are moving into this cohort, is the first piece of the question. And then the second piece, what kind of assumptions do you have for sustained improvement or additional customers entering that cohort as we think about the guidance that we have here today. I'm wondering how much needs to happen on that front for you guys to get more comfortable with the guidance? Or are you guys assuming steady state here and anything else is kind of really just upside?

Yes. No, we said that we don't provide guidance on the percentage of customers that are in this cohort. We just are commenting that the trends that we mentioned last quarter of the abatement of optimization in this cohort manifested itself again, and they continue to grow. Like always, our guidance takes conservative assumptions and looks across the trends in the business and assumes that there would be more conservative drivers of the business than we've had in the last quarters. So we continue with that methodology.

We mentioned that cohort because we believed it was a challenging time for them. We thought they were among the first to optimize and showed the strongest need for a quick improvement in their financial situation. However, there are other areas within the business that are also seeing optimization. Other customers are experiencing this process at a later stage, and it continues to be a trend. This has been a consistent aspect throughout the company's history. As we move further away from last year's macro situation, I anticipate that this cohort will become less significant in terms of what it indicates for the broader business.

This concludes the question-and-answer session. I would now like to turn it back to CEO, Olivier Pomel for closing remarks.

All right. Thank you. So again, I want to thank the whole team for what was a great quarter. And I know many of our customers and users are listening to the earnings call. So I want to make sure everybody knows we're having our DASH Conference in June in New York. You can go to dashcon.io, and we really look forward to seeing you there. So thank you all.

Thank you.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.