JFrog Ltd. (FROG) Earnings Call Transcript

All right. Thank you very much. I am Sanjit Singh, infrastructure software analyst at Morgan Stanley. Welcome to the afternoon session of the Morgan Stanley TMT Conference. It's great to see everyone live for the first time in almost 2 years. We're really happy to have Jacob Shulman, Chief Financial Officer of JFrog, and we want to dive into that story. Before we start, let me just quickly get through to some disclosures. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. So thank you, Jacob, for joining us at the conference once again this year. I think in my space, understanding what companies do is sort of part 1 of the story, right? And so maybe just for those who are unfamiliar with the JFrog story, can you describe the problem that you are solving for your customers and how you're helping them innovate for their own end customers.

Yes. First of all, thank you for having me at the conference. It's great to be back to in-person relationships. It's much better than Zoom, right? The Zoom fatigue is skilling everyone. So everyone knows that software is eating the world, actually software ate the world. And how fast you release your software, how secure you release the software is what defines our competitive advantage. And I know that many people here know that software engineers writing the code and software running on machines, but one in between is a huge industry, full of manual siloed processes, full of vulnerabilities and JFrog came to this world to build a platform that streamlines software release process, all the way from developer keystrokes to the machine. Basically, our product -- suite of products that we have provides the -- provide our customers ability to automate this entire process, make it very fast and secure.

Makes total sense. So now we're going to pretend we're all software engineers for 30 seconds. Can you describe where you sort of started sort of managing binaries in Artifactory? Why starting from that part of the software release cycle? Why does that give you the strategic high ground? And why does doing that really, really well, managing binary, software binaries, why does that give you what you think will help you give you more license to do more with customers over time in terms of managing the software release cycle? We're going to talk about security after that. But why starting from there gives you guys a competitive advantage?

Yes. So when the company was founded, there -- a few fundamental shifts in the industry happened. There's nothing new about managing source code. Source Code has been around for 40-plus years, and there were different tools that helped our customers to manage source code. Git is the new technology, very, very efficient technology. And there are several Git players that today -- or 3 of them basically control that space. It's GitHub, GitLab and Atlassian Git market. But the shift that happened were around how people create software. The rate of open source. And today, about 80% to 90% of application is written by someone else. And the way that open source comes into your company is by way of binaries. The rest are containers. Container is also binary. The automation around CI/CD plays where binary is created by tens of thousands a day. So the number of sources for the software, the number of deployment environments that happens, the number of engineers involved not just developers, it's also security engineers, also product managers that are involved in that. So this kind of created this very complex picture how to manage your software supply chain. And this is something that's becoming on top of mind, and even kind of overarching theme recently is that every company in the software business, and pretty much any company is in software business today, needs to know their software supply chain, where this software bill of material coming from. And if you think about it from the moment binary is created all the way to deployment, there is only one asset that matters, and this is binary. Prior to JFrog, no one managed binaries, but JFrog was the first one to identify this pain. And we started with a simple solution for developers to automate certain tasks around binary management. And then the next initial step for that was to add security because if you have your database of all the software that's being created by organization inside, but also what is brought outside. So you have full picture of the applications that you developed. The next natural step for you is to secure that database. And then once if we are able to become standardized in the organization, the next natural sale for you is to enable organizations to deliver that into different environments or devices. So that's how JFrog's platform has started with our flagship product Artifactory, which basically became your database of DevOps. And then on top of that, a few years later, we added security tool called Xray, then added distribution capabilities and along with pipeline product, which is our CI/CD for automation of all of the steps within the platform and few administrative products such as Insight and dashboard that shows you how fast you release. This is what comprises our platform and this is how it developed.

So essentially, what we're saying here is that software development has gotten much more complex. It's not built in a silo, you're integrating different software components to actually build an application. You guys are essentially like the repository, the database that secures all of that, which makes total sense. And so when we think about talking about the opportunity, what you guys do, at your Investor Day, you sort of laid out a framework where you targeted sort of 30% growth of the medium term. Jacob, could you give us the framework on how you sort of get there, that sort of underpins your confidence in sustaining that 30% growth profile? What's sort of the Ps and Qs, if you will, to get to that 30% growth?

Yes, absolutely. So first of all, we play in a very large market. At our Analyst Day, we estimated our market just on DevOps side to be about $40 billion, on DevSecOps side to be about $17 million. And with the recent acquisition of Upswift, where we extend our distribution capabilities all the way to IoT that's even opened us to a much larger market. So we adjusted very first innings of this transition and the concept of binary management. We have around 6,600 customers today and penetrated into 85% of Fortune 100, 45% of Fortune 500, above 30% of Global 2000. So there is still a lot of room for us to grow in the market. Second, we see a lot of penetration in our existing customer base, a lot of opportunities for growth. Pretty much any customer of a Fortune 500 company or Fortune 100 could be multimillion dollar accounts. During our Analyst Day, we provided a metric that our ASP for Fortune 100 company is about $400,000. Our ASP for Fortune 500 company is about $200,000. So pretty much we see a lot of opportunity even grow within our existing customer base. Next is that our platform adoption is just starting. Out of 6,600 customers, only about 5% of our customers transition to the platform. To remind you that the entry level into the platform is $115,000. And already 35% of our revenue coming from the platform, about 35% of our customers on enterprise package and vast majority about 60% of our customers at entry-level subscription. So really just expanding that customer base creates significant opportunity for us. And this is what we see in that our expansion rates stabilize around 130%. We reported in Q4 our net dollar retention rate of 130%, which improved actually from 129% previously. And this is what gives us confidence that we'll continue to expand these customers. On top of that, we also accelerated growth in new customer addition. So definitely, that's why we felt confident saying that we will continue to grow at 30-plus percent.

Great. I want to unpack some of the drivers there, starting with the dollar-based net expansion. That sustained very well in 2021 coming in at 130%. How -- if you're just sort of break down the primary factors between pricing, usage and multiproduct adoption, how does that shake out in terms of the factors driving that 130% that you saw in 2021?

Yes. So just to remind everyone, in -- effective April 1, we changed some of the prices of some of the subscription. And actually, streamlined our enterprise subscription as well. So pricing, as estimated, was very small contributor to revenue growth this year. Initially, for the entire customer base, we estimated that pricing will contribute up to 10% growth. And for 2021, we estimated to be low to mid-single digits. And this is what happened. Obviously, we continue to go through this price update with customers because the price that became effective April 1 for those who renewed after April 1. So we still have a group of customers who are subject for renewals in Q1 of this year, but also multiyear customers who -- about 20% of our business comes from multiyear product arrangement. Typically, what we see is a typical customer journey is that when a customer -- when new customer becomes -- joins JFrog, they typically more than double in the first 3 years. And that typically comes as a result of upgrades to high-level subscription, basically, meaning adopting more capabilities, security capabilities and sometimes when upgrading to the platform. Once you have the platform, which is enterprise subscription -- Enterprise Plus subscription, then growth opportunities for you by helping organizations to standardize on the platform and growing through server for self-managed deployments and through data transfer on the cloud. So that plays a significant control expanding our customers for transition to the platform that's basically vital for us to continue to expand them at over 130% because more and more customers become a bigger portion of our business at these sizes. And that's why we established our strategic team back in 2021, and we'll provide these stats that in 2020, our Fortune 500 customers grew about 26% year-over-year. While in 2021, this growth accelerated to 38% as a result of this strategic team. So our investments are bearing fruit, and we'll continue to see expansion with these customers. Cloud typically allows lower land, but much faster expansion. And cloud is more directly correlated with the usage. And that's why we see that cloud is growing faster and also a big contributor to our net dollar retention rates.

I wanted to hit on another point on the platform subscription, Enterprise Plus. 5% of customers using it accounts for 35% of revenue. What are the sort of triggers of the triggers for customers to upgrade to Enterprise Plus? And when you think about that 35% longer term, what do you think that 35% can go?

So primary trigger for customers to upgrade to the full platform is distribution today. So there are some prerequisites to be able to enjoy the value that the platform provides. First of all, you need to have your standard dives on Artifactory, which is basically a database of all of your software, and it needs to be secure. Only then customers have peace of mind to be able to distribute that software either to different locations within the organizations or within the organization or to its customers. So we don't -- we very rarely see that customers land on the platform. That would typically happen when they transition from competition. So it's a typical journey that customer would grow into the platform over time. And distribution becoming a bigger portion of our revenue as well. In terms of going forward, does everyone in our customer base need the platform, so if you're a small startup with one customer in one region in cloud, probably not. But if you look at our customer base with these marquee customers, top 10 pretty much in every industry, we definitely believe that majority of our customers would eventually transition to the platform and therefore, we believe that platform will present well over 50% of our business over time.

Yes. It's such a huge uplift in terms of revenue when you get to look at Enterprise Plus. Very interesting. We've been talking about this equation for 30% growth. And one of the things that improved last year was the customer base growth. So I think the customer base grew 20% in 2019. It slowed down to 7% in 2020, which I assume is the impact of the pandemic and the customer base reaccelerated the 10% growth in 2021. Can you talk about what drove the acceleration in 2021 and what initiatives you have in place to keep that going next year?

Yes. So you're absolutely right that when COVID hit, we infrastructure play, and we see our expansion, by the way, declining of existing customers and also adoption of our products by new customers decline because the world faced unknown. And no one replaces infrastructure when they face unknown. And since then, people kind of know how to assess the COVID risk, and that's why we started seeing the improving business environment and our customer growth resumed. So there are also a few things that we did in order to accelerate this growth. First of all, we transitioned our funnel into cloud. So now when you go to jfrog.com, and as you know, we grow bottom up primarily, you will be, as a developer, led to the cloud adoption rather than on-prem adoption. That allows you a smaller land and that's why we see many smaller companies also can afford and join JFrog products. Second, we launched free tier. So COVID -- while COVID negatively impacted the adoption by new customers, but it crystallized the need for our products. And that's why we launched the free tier in September of 2020, and we see thousands of users joining our free tier and thousands of active users enjoying that on a daily basis. So free tier has a usage cap. And once the user hit this usage cap, they actually convert to the paid customer. And we've seen growing conversion of our free tier users into paid customers. Every quarter, we actually see more and more customers joining us. And that's what also helped us in terms of -- in 2021, majority of new customers who joined JFrog were cloud customers versus on-prem customers previously. So those are dynamics that we currently see in this new customer growth.

Yes. If I could segue into the broader topic on SaaS and cloud, which I've sort of noticed a tone shift in terms of how you guys talk about the balance between self-hosted and SaaS, that seems like you guys are definitely leaning more into SaaS going into next year. Two questions I had. One, why did the SaaS growth slow in 2021? And what's changed in the market or customer buying criteria that makes the team more optimistic that SaaS adoption will improve in 2022 and beyond?

Yes. So just to clarify, when we're talking about on-prem, doesn't necessarily mean that customers running the software on the servers. Majority of it is running in public clouds in a dedicated environment and managed by customers. So a lot of that is still in the cloud. But for us, it's kind of on-prem revenue. So first of all, we see the shift of our customer base or cloud. Everyone understands that cloud is the future. But everyone understands that it's not going to be 100% cloud. It's going to be some sort of hybrid. And this is our philosophy from get-go was to offer freedom of choice to our customers, whether to use on-prem or cloud or a hybrid. And by the way, it's also a big competitive advantage for us. And we've seen that none of our large enterprise customers want to be just AWS shop or Azure shop. They actually want to be hybrid and multi-cloud shops. And these capabilities only JFrog can offer. Specifically to your question on deceleration in 2021. So first of all, when COVID hit, many of our customers transitioned to the cloud, but they did not do that in very methodical and strategic way. We have 2 types of arrangements in the cloud, pay-as-you-go and annual minimum commitment. So we saw many customers just adopting our pay-as-you-go solutions. And there's typically no commitment and much higher prices than if you committed to certain minimum usage. So in Q2, upon the first anniversary of the pandemic, they -- the purchasing department came in and start to kind of rush analyzing this consumption consolidating the accounts and moving them to our kind of minimum commitment solution. So this is why we saw kind of deceleration in the cloud revenue in Q2 due to this customer dynamics. And from those levels, we kind of saw the reacceleration of the cloud growth. There are several reasons why customers want to transition to cloud. A, that don't have same capabilities in different regions they operate. And many times, they want to augment these capabilities in those regions with our soft solutions. B, is just company policy, companies just decide, oh, we're going to move everything to the cloud, and this is yet another reason. C, they just -- in terms of resiliency of employee market and turnover is high in some companies. So they want to -- don't want to be dependent on certain employees in these critical areas, and that's why they prefer JFrog to manage this solution for them. So typically, we see uplift in ARR between 20% to 80% when customer transitions from on-prem to cloud. Having said that, it's not always apples-to-apples comparison because many times, customers use this transition has opportunity to add more capabilities. And that's why they sometimes upsell to higher subscriptions, et cetera.