Datto Holding Corp. (MSP) CEO Tim Weller on Q4 2021 Results - Earnings Call Transcript

Feb. 24, 2022 1:14 AM ETDatto Holding Corp. (MSP)
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Datto Holding Corp. (NYSE:MSP) Q4 2021 Earnings Conference Call February 23, 2022 5:00 PM ET

Company Participants

Ryan Burkart - Director, Investor Relations

Tim Weller - Chief Executive Officer

John Abbot - Chief Financial Officer

Conference Call Participants

Sanjit Singh - Morgan Stanley

Saket Kalia - Barclays

Kirk Materne - Evercore

Sebastien Naji - William Blair

Fred Havemeyer - Macquarie

Dan Bergstrom - RBC Capital Markets

Edward Magi - Berenberg Capital Markets

Nehal Chokshi - Northland Capital Markets

Mike Cikos - Needham & Company

Operator

Good afternoon. My name is Emma and I will be your conference operator today. At this time, I would like to welcome everyone to the Datto Fourth Quarter 2021 Earnings Results Conference Call. [Operator Instructions] Thank you. Ryan Burkart, Director of Investor Relations, you may begin your conference.

Ryan Burkart

Thank you, operator. Good afternoon, everyone and thank you for joining us today to review Datto’s fourth quarter and full year 2021 financial results. With me on the call today are Tim Weller, Chief Executive Officer and John Abbot, Chief Financial Officer.

During this call, we may make statements related to our business that would be considered forward-looking statements under federal securities laws, including projections of future operating results for our first quarter ending March 31, 2022 and full year ending December 31, 2022. As a result of a number of factors, actual results may differ materially from those projected in such statements. These factors are set forth in the earnings release that we issued today under the section captioned forward-looking statements, and these and other important risk factors are described more fully in our reports filed with the Securities and Exchange Commission. We encourage all investors to read our SEC filings. The following statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. In addition, Datto undertakes no obligation to publicly update or revise any forward-looking statements made here.

Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation of these non-GAAP financial measures to our most directly comparable GAAP financial measures is available on our fourth quarter 2021 earnings press release, which can be found on our Investor Relations website. Financial supplement and webcast of today’s call are also available on our Investor Relations website.

With that, I’d like to turn the call over to our Chief Executive Officer, Tim Weller. Tim?

Tim Weller

Thank you, Ryan and many thanks to everyone for joining us on the call this afternoon. We are excited to report strong Q4 results, capping off an exceptional 2021. I will begin with a few highlights from the quarter and the full year, followed by an update on our security journey, including our recent Infocyte acquisition. And then I will give you some insight into the key growth areas we are focused on for 2022. Finally, I will turn the call over to John to discuss our financial results and guidance in more detail.

The fourth quarter was another record quarter for Datto. Subscription revenue and ARR growth continued to accelerate, a pattern we saw throughout 2021. ARR growth was above 20% and net new ARR in the quarter was a record $31.7 million. We continue to add new MSP partners and deepened our relationships with existing partners. The total number of MSPs we serve grew nearly 9% year-over-year to 18,500 and ARR per MSP grew over 11%. Our top MSP relationships also expanded as we ended the quarter with more than 1,400 MSPs with over $100,000 in ARR, which is up 27% year-over-year. Demand was strong across our product suite, underpinned by the increasing need for security among SMBs and our MSP partners who serve them. Datto solutions help our MSP partners secure their clients’ digital assets, both applications and data. In sum, it was an excellent quarter overall and punctuated a great year for Datto.

2021 was a year of reacceleration following the headwinds of the pandemic in 2020. Subscription revenue growth, in constant currency terms, bottomed out a year ago in Q1 2021 at 14%, then accelerated to 17% in Q2, 18% in Q3 and 19% in Q4. I am pleased that we exceeded our targets in 2021, our first full year as a public company. And our sights remain on building to 20% sustainable growth. In 2021, MSPs found themselves thrust into the security business seemingly overnight with high-profile breaches in the news throughout the year and SMB clients becoming vulnerable targets. Security has always been at the core of everything we do at Datto, and we made significant progress in 2021, broadening our security capabilities to help MSPs and Datto address the large security opportunity.

In October, we launched Datto SaaS Defense, an application and e-mail security add-on to our SaaS protection product, and we have seen strong early adoption with revenue per seat roughly doubling for those who adopt SaaS Defense. We also saw rapid growth in our Ransomware Detection for RMM product, which is now active on nearly 1.7 million endpoints, just over a year from launch. These two products, SaaS Defense and Ransomware Detection on endpoints, are frontline defense products that give MSPs coverage across the vast majority of clients’ attack surfaces.

We also built on our industry-leading position in the last line of security defense, our Continuity offerings. In addition to our best-in-class business continuity and disaster recovery solution for virtual machines across client locations and data centers, we launched Datto Continuity for Microsoft Azure, an equivalent and highly performant solution that protects MSP client Azure public cloud workloads, providing protection against malicious ransomware attacks, security breaches, software service problems and cloud outages. Lastly, our SaaS Protection offering for Microsoft 365 and Google Workspaces continues to grow rapidly. So, we now protect data and applications wherever they live whether in private clouds or the top public clouds for MSPs.

Let me now turn my attention forward to 2022 and talk about the themes of overall growth, security products and the global opportunity. First, growth, we are in the golden age of the MSP and we see a large opportunity to help MSPs capture the generational shift that’s happening now in SMB IT management. The secular trends of digital transformation shift to cloud, remote work, tech labor shortage and especially cybersecurity attacks are driving strong demand for MSPs, creating an amazing growth opportunity for both our MSP partners and for Datto.

At our recent Investor Day, we laid out the case in 4 pieces for our path the 20% sustainable growth. First, the massive and expanding global MSP industry and our leading position within it. Second, our product portfolio to address the security needs of MSPs and their clients. Third, the many levers of growth in our unique sell-through business model. And fourth, the major international opportunity. In 2022, we see opportunities to drive growth across our entire product suite. We are the MSP channel leader in continuity, and we expect to build on this leadership position with sustained growth in our flagship BCDR product and through introducing MSPs to Datto Continuity for Microsoft Azure, or DCMA for short. We continue to view DCMA as a net new opportunity to build business with all of those MSPs globally who use Azure today and are not yet Datto partners.

In the PSA market, we have a strong presence with our Autotask product, which continues to grow nicely. And we’ve recently introduced add-ons such as documentation and Datto Commerce for quoting and procurement to extend our MSP business management category. As we highlighted at our Investor Day, leading our overall acceleration in revenue growth are the Datto end user and endpoint security platforms, SaaS Protection and RMM. This is a large and fast-growing market with tens of millions of users and often multiple endpoints per user. Our addressable market continues to grow as we add MSPs, those MSPs add clients, those clients add employees and endpoints and we launch new products. These are the multiple levers of growth in our business model. So that’s the growth theme.

Next, let’s talk a bit more about security. I’ll remind you of our 3 concentric rings approach. First, we have invested for years and continue to invest in Datto’s own security, protecting our systems, employees and assets. Second, we invest in protecting our partners, helping MSPs secure themselves with our thought leadership, resources and embedding security into the Datto products they rely on daily. Both rings 1 and 2 produce only indirect revenue through high trust in our brand and solutions. In ring 3 are the new Datto products, which provide MSPs a direct revenue and margin opportunity to sell through to their clients. In 2021, that meant SaaS Defense and Ransomware Detection for RMM. We got off to a fast start in 2022, further bolstering our cybersecurity leadership with the acquisition of cybersecurity company, Infocyte, an innovator in endpoint detection and response, or EDR technologies, and in Managed Detection and Response, or MDR services.

Last year, we acquired BitDam and integrated it into our SaaS Protection platform before launching it as SaaS Defense. In analogous fashion, Infocyte’s technologies will now be integrated with other new security technologies that our internal teams have been developing, and everything will be neatly packaged for launch later this year, well integrated within Datto RMM, with an eye towards further securing endpoints and increasing the dollars per endpoint we are able to command, the Infocyte team and technology augment Datto’s capabilities within the critical protect, detect and respond phases of the NIST security framework, particularly in endpoint security, all this in addition to core RMM in the identified stage and Continuity in the recovery stage.

Looking at the big picture, Datto has product offerings in every phase of the NIST framework, and 2022 will see us deepen and broaden our portfolio of security products, all integrated, built for ease of use by MSPs in their multi-tenant environments and targeting the highest efficacy in stopping cyber attacks. We sell our own technology solutions and are not a security reseller like many competitors. We’ve been patient over a multiyear period in building and acquiring our proprietary security components. This also means higher long-term margin potential for Datto and our MSPs. We have high standards and are thrilled with the field data on what our SaaS Defense and Ransomware Detection solutions are catching and isolating, live real-world attacks that other vendor products have often missed. It’s this combination of high effectiveness and ease of management for MSPs that will continue to define our security product strategy going forward.

Our third theme this year is global expansion. We already have a strong global business with over 30% of our revenue coming from outside of the U.S. But we see an opportunity to grow our global presence even further. Our first wave of international growth came largely from English-speaking countries, and we still see great potential in these regions. The next evolution is more broadly localizing our solutions for non-English speaking countries. And we are investing in global technology platforms, new people and processes and some key partnerships. This will be a pivotal year in opening up this next frontier of global opportunities for Datto.

Finally, let me comment on investment as we continue to see acceleration in the top line ahead of us and we continue to affect a broader pivot to security products, investment will remain strong. Our solid unit economics, attractive gross margins and positive free cash flow give us confidence that our timing is right to pursue the larger opportunities in front of us. John will talk about our specific growth and profitability outlook for 2022. But rest assured that the incremental investment is going towards product and technology development in the highest areas of growth potential, partner-facing platforms to extend our leadership position with MSPs and globalization to capture the massive white space we see there.

On the journey to achieving our goal of surpassing $1 billion in revenue in 2024 and driving strong returns on capital in the process, we will also scale our back office to support this growth and beyond. As we outlined in our recent Investor Day in December, balancing our investments in growth, we intend to be a solid Rule of 40 company in the near term. The underlying profitability of our business model is strong. And as we grow in the long-term, we expect to be a Rule of 50 company.

In summary, we are pleased to have delivered a strong year of revenue growth acceleration and key security and cloud product launches in 2021. We see great momentum across our business today, and we’re excited about the outlook for 2022 and beyond. We remain well positioned to capitalize on the large and growing opportunity with our current product portfolio and road map and the deep trusted MSP relationships we have built over many years. I want to welcome our new Infocyte teammates. We have big dreams to build together. Finally, I want to thank everyone on the Datto team for all of their hard work and all of our MSP partners for their continued support.

With that, I will turn the call over to John.

John Abbot

Thank you, Tim and good afternoon everyone. We are pleased to report terrific fourth quarter and full year results today. As I review our numbers, please note that I’ll be referring to non-GAAP metrics, unless otherwise specified. You can find a reconciliation of non-GAAP measures to GAAP measures in the press release that we issued this afternoon and in the supplemental financials posted on our website.

Our fourth quarter results reflect strength across all geographies and across our full suite of products and another quarter of accelerating revenue growth. Fourth quarter recurring subscription revenue of $153.2 million grew 19% over Q4 last year, both as reported and on a constant currency basis. Subscription revenue comprised 93% of our total revenue, which came in at $164.3 million in the quarter, representing 18% year-over-year growth, again, as reported and on a constant currency basis. Strong operating results drove the outperformance relative to our guidance, with currency providing around 25 basis points of benefit, which was less of a tailwind than in prior quarters and less than we had forecasted. ARR at December 31 was $658.4 million, up 21% from a year ago and nearly a $32 million increase sequentially. In a quarter with strong results across the board, this stands out as the most exceptional accomplishment by the team. It’s the largest sequential quarterly increase ever for Datto, surpassing pre-pandemic levels.

We ended the quarter with more than 18,500 MSP partners, a net increase of 300 in the quarter and 1,500 or 9% for the year. We also grew the number of MSPs contributing over $100,000 in ARR to more than 1,400, a 27% increase from a year ago. Our sell-through model continues to drive strong growth within our installed base of partners as they roll out Datto solutions to more SMBs, those SMBs consume more data or add more seats and endpoints and they both adopt more Datto products.

Our fourth quarter gross margin remained strong at 72.5%. We saw some higher costs associated with new product launches and shipping expenses in the quarter, but for the full year, gross margins increased to 74% from 73% in 2020. Fourth quarter operating expenses were $88 million a 29% increase from Q4 2020 when expenses were still artificially depressed because of the pandemic. We continue to invest to drive revenue growth with a focus on security and cloud. The majority of the increase in operating expenses in the quarter was driven by strong hiring in the back half of the year and some inflationary pressures on personnel costs.

Within OpEx, sales and marketing expenses were $37 million, an increase of $9.9 million from Q4 2020 as a result of higher advertising and marketing expenses, including increased spending on events, conferences and trade shows and higher personnel expenses, including increased sales commissions. R&D expenses were $25 million, an increase of $6.6 million from Q4 2020, which underscores our continued investment in technology development and security.

G&A expenses were $23.4 million, an increase of $2.9 million from Q4 2020, primarily driven by increased expenses associated with being a public company and recruiting costs to support increased hiring levels in the back part of the year, which were partially offset by favorable bad debt expense as the company significantly improved its accounts receivable aging profile.

And finally, depreciation expense within operating expenses was $2.5 million compared to $2.2 million in Q4 2020. Operating income for the fourth quarter was $31.1 million compared to $34 million in Q4 2020. Adjusted EBITDA for the quarter, which excludes stock-based compensation, restructuring costs and transaction-related and other expenses, was $39.8 million compared to $40.8 million in Q4 2020. Our adjusted EBITDA margins were 24%, reflecting continued hiring in the areas of security and cloud, some normalization of travel and return to office expense and higher costs associated with being a public company. CapEx in the quarter was $15.1 million, and free cash flow was $11.2 million. Our balance sheet remains very strong with no debt and approximately $220 million in cash at the end of the quarter.

Moving to our full year 2021 results, total revenue grew 19% year-over-year to $618.7 million and subscription revenue also grew 19% year-over-year to $577.3 million. Our full year 2021 revenue results reflect the benefit from foreign exchange rates of approximately 200 basis points. We delivered full year adjusted EBITDA of $175.4 million, an increase of 17% year-over-year.

Before we turn to guidance, I wanted to highlight some changes to our guidance process and some reminders to think about as you’re adjusting your models. First, we’ve decided to add guidance for subscription revenue and we will be providing that going forward. Subscription revenue is already the vast majority of our total revenue, and we manage the business to drive subscription revenue growth, so we believe it’s appropriate to provide this level of transparency. Second, as you know, over 30% of our revenues are international, and these revenues are subject to currency fluctuations. To help you understand and adjust for the currency assumptions in our guidance, we will be providing constant currency growth rates as part of our revenue guidance. Finally, as a reminder, we typically see a sawtooth pattern in ARR growth where increases in ARR tend to build across each quarter in the year and then move lower in the first quarter, before building up again. The impact of the pandemic masked this seasonality in 2020 and 2021, but we expect a more normal seasonal pattern in 2022 and beyond.

Now, turning to guidance for the first quarter and full year 2022, for the first quarter, total revenue is expected to be in the range of $168 million to $169 million, subscription revenue is expected to be in the range of $158 million to $159 million and adjusted EBITDA is expected to be in the range of $37 million to $38 million. Our first quarter subscription revenue guidance represents year-over-year growth of 18% to 19% on a constant currency basis and we are assuming about 150 basis points of currency headwinds in the quarter.

For the full year 2022, revenue is expected to be in the range of $720 million to $726 million, subscription revenue is expected to be in the range of $676 million to $682 million and adjusted EBITDA is expected to be in the range of $163 million to $168 million. Our full year subscription revenue guidance represents year-over-year growth of 18% to 19% on a constant currency basis, adjusted for approximately 130 basis points of currency headwind. This strong revenue guidance represents continued acceleration in our top line and is consistent with the themes many of you heard at our Investor Day. We’re on a path to 20% sustainable revenue growth and surpassing $1 billion of revenue in 2024.

Our EBITDA guidance is consistent with the message you’ve heard over the last several quarters and that we reiterated at our Investor Day. In Q4, margins reached the low to mid-20% levels we’ve pointed to in prior calls and is reflected in our guidance. We expect margins will stay around this level before beginning to move up later in the year. Some of you may be wondering about the impact of Infocyte on our financials and guidance. First, the total consideration paid for Infocyte was approximately $44 million in cash. The revenue impact embedded in our guidance is very small, and the margin impact is just under 1 percentage point of dilution. Of course, as that business ramps in the coming years, we expect it will provide a nice lift to the revenue line and help drive operating leverage for us.

Moving on to cash flows and the balance sheet, once again for 2022, capital expenditures for the year are expected to be in the high single-digit percentage range of revenue. As a reminder, for non-GAAP income taxes, we use an effective tax rate of 25%. For calculating EPS, we estimate approximately 169 million fully diluted shares for Q1 and 171 million fully diluted shares for the full year.

In closing, we believe our exceptional 2021 results and 2022 guidance reflects ongoing strength of the business and we are very excited about our momentum going into the year. With that, we will open up the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Thank you. Your first question today comes from the line of Sanjit Singh with Morgan Stanley. Your line is now open.

Sanjit Singh

Hi, thank you for taking the questions and congrats on the strong end to the year with the 21% ARR growth. Really nice to see. I had a sort of a macro level question just in terms of the spending environment and how you sort of – in terms of putting together the 2022 guidance, what are some of the underlying assumptions that factor into your revenue guidance for the year in terms of both the spending environment? Any sort of assumptions around the macro impact from potentially inflation or higher interest rates, how that might impact or not impact the business from a high level perspective?

Tim Weller

Yes. Hey, Sanjit, this is Tim. And I will ask John to make a couple of comments too. He is a little closer obviously to the numbers. But we haven’t seen a lot of impact certainly on the revenue side. We haven’t been the company that’s always quick to raise prices, for example, but we haven’t seen much price competition either in a couple of years. So, I think that’s probably positive macro trend. The demand side has been very good. You can’t think of anything in this environment that has sort of slowed that down. John, you mentioned a couple of little challenges last year in the supply chain. You might pay extra for express shipping things like that here and there. And then we all know what the war for talent looks like and that continues. Although you probably know better than me, but it feels like maybe some people that felt like they had unlimited capital last year might be slowing down a bit. They might start to think about long-term business plans. So we are hopeful that maybe that’s something that slows down. So, we factored in what we know and certainly nothing is happening right now that we haven’t been dealing with for 6 to 12 months last year.

John Abbot

Yes. Tim, the only thing I would add is because I think you are asking a little bit about what we factored into our guidance. Price has not historically been a lever for us to address rising costs and we have not assumed any price increases to address any inflationary pressures. As Tim said, we certainly have seen some pressure on personnel costs and the war for talent is real, but – and so we factored some higher increases for that into our models for this year and therefore into our guidance. On the supply chain side, maybe the short answer there is that we have built up some good levels of inventory. And we feel like we are moving to the other side of some of the pressures we felt there that led to some higher spending on shipping. And so we think that some of that should abate in the year. That’s not a huge number, but that’s another sort of macro trend that we are seeing.

Sanjit Singh

Super helpful. And then on the product side, I just wanted to get a sense of what some of the early uptake is on Datto Continuity for Microsoft Azure in terms of when do we expect that to start to become a potential driver for revenue and revenue contribution going into next year?

Tim Weller

Yes, it’s a good question. Overall, we are pleased obviously sort of 90 days in here or so. I’m pleased with the launch so far. I think we’ve become convinced now with so many commercial MSPs and workloads in the cloud that the team did their job getting the product right. It’s the right product for the market. It was delivered on schedule. We have a very strong pipeline. It’s building. Early adopters have given us a fair amount of feedback. It’s not something you can use for a day and tell us, you got to use it for a few months, and we’re gathering that. And I think our overall product strategy, which has always been high efficacy meets maximum ease of use for MSPs, I think the teams have nailed it on that front. So now it’s just laps on the track this year. And remember, it’s a largely net new opportunity for us, certainly in the early days where we’re sort of focused on finding MSPs that may already be in Azure and don’t know Datto so well, so less kind of migration going on than net new. And so excitement remains high. Give us a little time before we sort of have enough stability and metrics and conversions and attaches and things like that, but it’s something we will keep you posted on throughout the year, Sanjit.

Sanjit Singh

I appreciate the thoughts, Tim. Thank you.

Tim Weller

You are welcome.

Operator

Your next question comes from the line of Saket Kalia with Barclays. Your line is now open.

Saket Kalia

Okay, great. Hey, Tim. Hey, John. How are you guys doing? Thanks for taking my questions here.

Tim Weller

Hi, Saket.

Saket Kalia

Tim, maybe just to start with you, zooming out a little bit, right, like you talked a lot about security in the call and going back to Analyst Day. You sort of talked about the business in terms of sort of a mix from newer products versus a mix for maybe some more mature products, let’s say. I guess the question is, how do you sort of envision that mix in 2022? And maybe we just touched on one of them, but like what products do you think are going to be particularly impactful in that sort of newer product bucket, if you will? Does that make sense?

Tim Weller

Yes, it does. I would tell you, it’s only been 2 months. I would stick with that Investor Day slide. I know the one you’re thinking of, where we broke down not only the product line sizes, but also growth. I think we’re pretty transparent there. Those are LTM numbers, but they sort of reflect the run rates to a degree, I think. And that’s probably your best indicators of how the mix might shift. Of course, faster growing lines become a bigger part of the mix. That’s sort of business 101, I guess, for anybody. Our flagship BCDR product is our largest and has been a mid-teens grower. I think one key message of that day from us was that we believe BCDR still has plenty of growth in its future. And our Datto Continuity for Microsoft Azure product should be an accelerant as it scales up. It’s just going to take a little while before it can move the needle relative to the larger BCDR core. I think cyber-attacks also fuel BCDR. And there is nothing that makes me believe your first dollar security shouldn’t be on a strong recovery solution.

Then you look at a more mature product might be PSA, still a steady grower, and we continue to see good potential there, and we gave a little peek at that. And then what you’re referring to, in particular, SaaS and RMM, and the sort of security attachments that are now being rapidly introduced with them, surely, are going to remain the fastest growth engines over the next couple of years, both because we’re winning in the market on the cores there with a strong unit growth in the base products, but also because of those security attachments, we started with Ransomware Detection, we’ve got SaaS Defense now, a number of new things coming this year. That drives the dollars per end user, dollars per endpoint. So it would be hard to bet against those two as the fastest growing, I think, percentage-wise and over a couple of years, even dollar-wise. And then long-term, you know the trends as well as anybody. Security is a strong trend. Cloud is a strong trend. Those two overlap, which I think is going to get interesting, and maybe you throw in new ventures like commerce and networking, and I think we’ve got a nice multi-cylinder growth engine.

Saket Kalia

Got it. That makes sense. John, maybe for you, as you kind of look at 2022 and I realize we’re not guiding to ARR, but how do you sort of think about, even just high level, the balance of growth between sort of the number of ASPs and that ARR per MSP? Could that sort of mix to the ARR equation be different than what we’ve historically seen? Or look similar as we sort of put the pandemic kind of further and further in the rearview mirror?

John Abbot

Yes. Thanks, Saket. I think that picture is going to be fairly similar to what we’ve seen. And the model and construct we laid out at Investor Day, we talked about achieving our growth rate targets by a combination of growth in MSP counts and growth in ARR per MSP. And we talked about a range of 5% to 10% growth in MSPs – net new MSPs, and 10% to 15% growth in ARR per MSP. And we still think that’s really the model for the next couple of years and those ranges are likely to hold. And as you know, in any given period, the vast majority of the growth comes from the existing MSPs. But adding those new MSPs does add to the cohorts and provide growth longer term. And we feel very good about – continue to feel very good about the gross additions and the new cohorts of MSPs we’re bringing in.

Saket Kalia

Very helpful. Thanks, guys.

Tim Weller

Thank you.

Operator

Your next question comes from the line of Kirk Materne with Evercore. Your line is now open.

Kirk Materne

Hi, thanks very much and congrats guys on a good quarter. Tim, I was wondering if you could just follow-up a little bit more on the earlier question just around inflation. I was just kind of curious with MSPs, how they sort of think about pricing increases, given that they do have services and people costs that are probably going up. And how do you think about sort of your pricing along those lines as well, obviously, being an important part of their COGS. I was just kind of curious if you could maybe dive into that a little bit more. Maybe you’re not seeing it yet, but I imagine it’s something you guys are at least contemplating as we go into this year?

Tim Weller

Yes. We have talked about tech labor shortage as being a driver for MSPs and for businesses. So you start with SMB, they can’t find the tech talent they need, they hire an MSP. Then you look at MSPs having tech labor shortage, they look to large-scale vendors like Datto. It would seem to me that the inflationary trend also gets them. So not only is it harder to hire techs, it’s more expensive to hire techs. And so you think about something like Continuity. We have a turnkey solution that is 100% focused on minimizing the MSP’s time. And if you’re a small shop and you start off spending every weekend, restoring backup images and monitoring them and writing alerts, if you like, writing code and babysitting servers, maybe that was fun. It becomes a lot less fun if you’re paying people and they are looking for 20% pay raise this year, and they are hard to find in the first place. So I think the kind of turnkey solutions that we offer should play well into that. And I think that will be no more – nowhere more apparent than in security, where you can buy lots of security tools, as you well know, and you can stare at a lot of blinking red lights in your operations center. But what are you going to do with all of that data? And where are you going to find those people? So I think it kind of cuts both ways. And I think in general, it helps us – I was thinking about Sanjit’s question on inflation, it helps us – we can spread one person over a lot bigger revenue load, we can spread one server over a lot bigger revenue load. And so I think, in the same way that some of the hyperscalers might benefit in other service lines, I think we’re going to benefit from this.

Kirk Materne

That’s helpful. And then, John, one quick one for you, anything we should consider from a seasonality perspective on cost this year, just in terms of things that maybe one-time in nature, we should at least think about whether it’s first half versus second half or how fast maybe cost from a travel perspective are coming backup? Any color or additional color on that would be appreciated? Thanks.

John Abbot

Yes, Kirk, that’s a good question. I think a couple of thoughts, and these are a little bit on the margin, but they have an impact. Second quarter is typically when we’re doing pay adjustments for folks. And so, we will often see that as a quarter where expenses will be going up more than most quarters. That’s our biggest cost, by far, obviously, our people cost. And then DattoCon, we’re assuming we’re going to be back in person, and we’re going to be hosting a DattoCon, and right now, we’re assuming that’s going to be in Q3. So I’d say Q2 and Q3, we will feel a little bit of maybe extra pressure on costs. And then the other point about sort of return to normalcy, return to travel, return to office is a tough one. And we certainly – we played that very conservatively last year in our guidance. But we’re assuming that, that’s really started picking up even in Q4, and you can see that in the margins. And so we’re assuming we’re at a little bit higher and steady pace on that front throughout the year.

Kirk Materne

That’s helpful. Thanks, John.

Tim Weller

Yes. And Kirk, I realized I didn’t – I may not have completely answered your question. You talked about how we think about price increase and what have you. You think about Microsoft which has put through, as you would well know, a very large M365 price increase, and that’s tough for an MSP in real time, if Microsoft is jamming you up in a particular month, and you’ve got 6, 12, 18 months left on your contracts with your end user. We tend – among our many things we think we do well relationship-wise is we don’t surprise MSPs. Price increases, to the degree we do them, come through in new SKUs, they come through in upsold attachments and what have you. I mean they kind of know that our costs from a COGS perspective are probably not really going up right at that scale. So it’s something we do, but we spend all day thinking about what’s the impact on our partners.

Kirk Materne

Thanks, Tim. That’s helpful.

Operator

Your next question comes from the line of Jason Ader with William Blair. Your line is now open.

Sebastien Naji

This is Sebastien on for Jason. Thanks for taking the question. I think you’ve answered a lot of the questions I had. So maybe if I could just get a little bit more color around the Infocyte acquisition, when you expect that product to be integrated into the Datto platform and sold as such. And then maybe what are the advantages of bringing that kind of EDR technology in-house versus competitors that might be leveraging a third-party solution like SentinelOne to fill that gap in their portfolio?

Tim Weller

No, it’s a great question. Well, you won’t be surprised to – so remember, we talked about SaaS Protection and RMM as our kind of two key security platforms, end user and endpoint. So I think back a year ago, Sebastien, we bought BitDam as a security extension to SaaS Protection, and we introduced that technology a little later in the year as SaaS Defense, and we have some terrific bundling going on there. That team stays active today in SaaS Defense development, but they have also had impact on other security products and we’ve got a number of teams developing security technologies. Now along comes Infocyte, and you’re going to see that included in a set of security extensions to RMM in the endpoint security arena. Infocyte actually brings us several relevant technologies and offerings including an operational security team, they are live in market with partners of their own. And all of that’s going to be incorporated into some new Datto Security offerings in ‘22. I probably won’t preannounce anything, but I don’t think you’ll have to wait that long either. So stay tuned, and we will keep you very updated. But you should think about it as sort of very analogous in shape and timing to what we did with BitDam becoming SaaS Defense. It’s something we’ve been studying now for well over a year.

And I guess you asked one last question just about in-house. It’s always been in Datto’s DNA, in general, to either build or buy small technology companies or build our own tech. But to own and control our proprietary tech, we get to customize and tailor it for MSPs. We get to really focus on efficacy, as I described. And it won’t be a surprise that the long-term target margin potential is meaningfully higher. It’s harder to differentiate and get margin and deepen the relationships if you’re primarily reselling. So we’re completing a very strong pivot to a full security company, and this is a key point for us on that line.

Sebastien Naji

Great. Thank you.

Operator

Your next question comes from the line of Fred Havemeyer with Macquarie. Your line is now open.

Fred Havemeyer

Hi, thank you. First, I wanted to hit, I think, on the cybersecurity side of things here. Specifically, I saw that you rolled out quite quickly an RMM-based solution for the Log4j exploit that was out there. So I just wanted to ask, generally, how have your MSP partners been approaching their entire ecosystem and their approach to cybersecurity in the wake of that Log4j attack? And what did Datto’s quick rollout of the mitigation for such like a critical cybersecurity incident do for your awareness in the cybersecurity marketplace among your partners?

Tim Weller

Fred, I think I caught all that. You’re a little quiet at the beginning. But that’s not the first one, right? You’re well aware of the kinds of breaches, threats etcetera. So Log4j was definitely a biggie. First, you run around and take care of your own house, which we did quickly. We’ve got a terrific team. Secondly, we immediately go to that second ring that I talk about, which is get to MSPs, thought leadership. It is accruing to our brand. We’ve – I think I have permission after a couple of years of doing this, we immediately think about what content do we need to get out there proactively. What, do we need webinars in addition to that? What can we do scripting-wise within Datto RMM to help people? If not within Datto RMM, broader world, we’ve had a few of these. I seem to recall Silver Sparrow. We put out just public domain tools. We’re never in that context trying to create direct revenue opportunities. We’re building our brand, thought leadership, help MSPs. As time goes on though, again, it goes back to that inflation question and shortage of talent question. It’s hard for them. That was a multi-week effort for most MSPs, maybe still ongoing, versus large enterprise like ourselves within a week or so, you sort of know your exposure, you plug the holes. And I think they are going to look to consolidate vendors over time and find more of that help. I can tell you from just the social media threads, lots of MSPs who are otherwise pretty sophisticated take a few days just to process the question. Where do I have to go look? What am I doing? Where are the scripts, etcetera? So, we love – we don’t love those events with our citizen hat on, but we love those events in terms of our ability to help. And then I think, as you noted, continue to connect to our brand. I think we’ve had over 3,500 downloads of just that script alone. And that’s 3,500 people that are touching that tool very directly and really, you don’t have to actually sell with a sales rep at that point, your product is selling itself.

Fred Havemeyer

Thank you for that context. And then touching on or rather hitting on social media here, it is interesting to see though the – so as the pain that was expressed by MSPs as they are talking with each other regarding the changes to Microsoft’s pricing, I mean there is a change.org petition that was trying to push back on it. To what effect, I don’t know. That said, it’s clear that it’s putting the pressure on MSPs. So I would just like to ask, from your perspective and Datto’s perspective, have any of the conversations changed with how MSPs are thinking about budgeting in the future or how they are approaching just working with their own end clients? And does any of that flow through into demand for Datto or any sort of demand conversations that you’re having now that these price changes are going into effect?

Tim Weller

Yes, it’s a great question. It is an active conversation, again, because MSPs have to either pass that through or eat a piece of that, and they not only changed price, they changed some Ts and Cs and how you contract. So big shuffle, Microsoft has their strategic reasons. I’m old enough to know that they are very capable of viewing a strong strategic position in a particular product line and taking price wherever they need to, so not completely surprising. I think it’s interesting for us in a couple of dimensions. One, we’re very much in their ecosystem. They are partners of ours. And an MSP can now look at some of our solutions as cheaper on a percentage basis. They can look at our Ts and Cs and find that – reminded again that we’re very partner-friendly in that context. But I don’t think it changes their need for protection, defense, all the different kinds of things that live as adjacencies in a Microsoft ecosystem that we sell. So unless you’re ready to call a broad move away from Microsoft 365, which is overwhelmingly the largest within MSP ecosystems, and – but at the same time, our protection sits in Google Workspaces today, our SaaS Defense, we know how to do that for Google Workspace. In fact, BitDam was working pretty close to launch on that before we acquired them. But Microsoft is really the lion’s share of what MSPs do. So it’s something we watch carefully because of our close connection to Microsoft, but it’s – you mentioned all the different kinds of things. That wasn’t their finest day with MSPs from a brand perspective. And those are the kinds of things we think about very carefully.

Fred Havemeyer

Yes, certainly not based on all the angry posts in social media about Microsoft. So, thank you for the clarification.

Tim Weller

You are welcome.

Operator

Your next question comes from the line of Matt Hedberg with RBC Capital Markets. Your line is now open.

Dan Bergstrom

It’s Dan Bergstrom for Matt Hedberg. Thanks for taking our questions. So it’s really nice to see the ARR accelerate in the quarter here and the year-over-year growth rate. And with net new ARR really accelerating through the year, I guess, could you expand on the sawtooth pattern to ARR growth that you highlighted in the prepared remarks. As you mentioned, we haven’t really had a non-COVID quarter, any better way to think of the cadence of that sawtooth through the year?

John Abbot

Yes. The sawtooth pattern really is, you think about the change in ARR in each quarter builds over the course of the year so that Q4 is typically our strongest quarter. And then when you flip over the year-end Q1, there is historically been seasonality and a dip in that change in ARR. And then you start building back up again. And in overall growth trend, obviously, to higher levels, ultimately, but there is that bit of seasonality.

Dan Bergstrom

Great. Thanks. And then just thinking about guidance for the first quarter and full year that you provided, and thanks for the additional disclosures, I guess it looks like growth as reported is expected to be kind of consistent year – through the year, but there is more FX headwind to the full year than the first quarter. Maybe what are some of the expected growth drivers coming online through the year? What enables that consistent kind of as-reported growth despite incremental FX headwinds?

John Abbot

Sure. I mean it’s – I would point to a couple of things. One, the product mix that Tim talked about earlier, right, those key drivers of our growth will continue to be the core engines of the growth, RMM and SaaS. And the attaches to those, over time, will add more and more to the growth. And as we have discussed it’s, of course, the existing MSPs that are going to drive growth more in the near-term than adding new MSPs, but those components will play a part across the year. And we have added very healthy gross cohort of MSPs. I think we talked about last year, very strong recovery and actually consistent addition of cohorts of new MSPs even during the pandemic. So, we feel like we have a lot of room to run with those – growing the ARR per MSP with those existing MSPs.

Dan Bergstrom

Thank you.

Operator

Your next question comes from the line of Edward Magi with Berenberg Capital Markets. Your line is now open.

Edward Magi

Thanks for taking my question and congrats on the strong finish to 2021. Previous questions have asked about the ranges for ARR per MSP and net new MSP growth. Our checks keep pointing to further consolidation at the MSP level. Would you say this was a key factor in selecting these ranges from the Analyst Day, even though they have been fairly consistent with recent term? And is there anything further you would like to share regarding MSP consolidation in the future?

Tim Weller

Yes. This is Tim, Ed. I will take a shot at it because I think it’s probably more qualitative than quantitative. We do see MSP consolidation. We tend to be beneficiaries of that. We are a little larger, more premium provider. We tend to serve larger MSPs. So, they are the net buyers in that. I think you do see occasionally two Datto MSPs merge. And I think you are on the right point there. That would give you a higher average per MSP given that you double the MSP and a lower MSP count, but that’s still probably not a big enough material effect to just sort of really label at this point nor something that we forecast. So, I think John gave you those ranges previously, the 5% to 10% and 10% to 15%. And we certainly factor in what we see of consolidation at this point. We would like to think that if we are net beneficiaries of that, the 18,000-plus MSPs, you might get another 100 of them just from acquisition, and we don’t get to count them, but we get all their clients.

Edward Magi

Absolutely. Great to hear. That’s helpful. And then another question here, globalization was a theme that stuck out a little more in this quarter than in previous. Curious if you see M&A as a vector to drive international expansion? And in general, I think it should be helpful to double-click on the strategy for international expansion and how that may have changed from previous years? Thanks.

Tim Weller

So, I would say no to consolidation. I don’t see the Datto fill in country or fill in a region, right. That looks so easy. We are in enough places. We think we know what we are doing. We tend to be targeted. We will pick a country, try to go in. I think in some countries, you may see different structures, so you may have a two tier distribution where we are working through a distributor who has been working with the MSP. In some countries, you might see fewer MSPs that are larger and others you might see more MSPs that are smaller. We talked a little bit about that. But we are certainly aware of those dynamics. We are in enough countries now in every major theater. And then of course, some MSPs will sort of go across country lines. That tends to be more rare, but – certainly in Europe and a couple of places like that, I think you’ll start to see maybe some MSPs themselves merging into more multiregional kinds of players, and we would be focused on getting them. So, I don’t have a one-size-fits all there. Our scale helps because we have seen a little bit of everything.

Edward Magi

Great. Excited to see how it plays out over the next few years. That’s it for me. Thanks.

Tim Weller

Thank you.

Operator

Your next question comes from the line of Nehal Chokshi with Northland Capital Markets. Your line is now open.

Nehal Chokshi

Yes. Thank you. And my congrats as well on delivering an ARR above the high end of my previous expectations, and further accelerating to 21% year-over-year growth, that was great. So, as you are going to be coming up against a much tougher incremental ARR comps starting this March quarter, what needs to happen to get to basically an incremental ARR $36 million per quarter to support a 20%-plus ARR growth in the back half of calendar ‘22?

John Abbot

Nehal, it’s John…

Tim Weller

Yes – go ahead. Go ahead, John.

John Abbot

Yes. And I will take a shot, Tim, and then certainly jump in, but it takes a few things. One, I would point to the growth engines we have highlighted, and we have had – you have seen acceleration in the growth of I would call the products we have on the truck. We have just launched a couple of new products, obviously, in DCMA and SaaS Defense. As those start to build some momentum over the course of the year, they will ultimately be adding to growth. Obviously, the Infocyte acquisition, we are looking ahead to that for that to start layering in future quarters, more like BitDam might help later this year, that could help in future years. And then obviously, we remain very focused on keeping churn under control. So, we spend as much effort and energy thinking about how to maintain our MSP customer base, how to keep them happy, how to keep them in the ecosystem. And a lot of focus on the reliability and security of the product set so that we keep churn down. And I guess the last thing I would add is we just – we are talking about international and international expansion, and that’s absolutely part of the equation as well. I think this year, we are laying a little bit more of the groundwork for that. But certainly, as we get near the end of the year and into next year, there is a component there.

Nehal Chokshi

Tim, did you have anything to add before I go into my follow-up question.

Tim Weller

No.

Nehal Chokshi

And then can you give us some sense as far as how did BCDR contribute to the ARR growth relative to the PSA RMM piece and then the security piece as well?

Tim Weller

Yes. I don’t think we are going to go into product mix more than we did at Investor Day or what we have given on the call. So, we know you are anxious for it, and we will give some check-in color from time to time on it.

John Abbot

I mean the only thing I would highlight, Nehal, what we have said is that we did see nice recovery in core continuity in the year last year and that was definitely a big part of the mix all year long, so.

Nehal Chokshi

Okay. Thank you very much.

Operator

Your next question comes from the line of Mike Cikos with Needham & Company. Your line is now open.

Mike Cikos

Hey guys. Thanks for getting me on for the Q&A here. Maybe first question going to John, but if I am looking at the gross margins, I know that this quarter, you had called out maybe some higher costs from these newer product launches and shipping expenses. But as we are looking forward from here, is it fair to assume that we have kind of bottomed here, or should we expect, I guess additional pressures as those newer product launches continue to build scale? And then any comments on the shipping expenses would be helpful. The second part of that question then would also look at the OpEx. I know that you guys have spoken to the additional investments you are making in product and tech and laying the groundwork for international. But just wanted to help – I guess with broad strokes here, we have heard from other companies that with the return to work post-COVID, they are experiencing anywhere from like a 2% to 3% cost headwind when it turns to operating margins, just on this return to normal and potentially another point of headwinds coming from wage inflation. Is that a fair way to think about how you guys are going through this year, or is it either heavier or lighter than what you guys are thinking, anything that would be beneficial?

John Abbot

Sure. A lot in there I will try to address. First, on the gross margins, we have – I think we are in a range right now that’s probably a reasonable range going forward to your point about new product launches and the cost ramping there. And so I think we feel good about that. On the shipping cost, I feel like we are getting to the back end of that. I will highlight a couple of things. One, we have built up, as you can see, nice inventory. We have gone from probably two months of inventory to six months. We feel less of a need to expedite shipping to make sure that we always have goods on hand. And so we feel like we are probably moving to the backside of some of the excessive shipping costs. So, I guess that’s really what I would say on gross margin. On OpEx, I think the best way to guide you there is to think about the overall EBITDA margins that are expressed in our guidance, combined with some of the other comments we have made. Without a doubt, we feel and see the war on talent. We are feeling some inflationary pressures on personnel costs and factoring in a little bit higher increases in our personnel costs year-over-year, in addition to continued robust hiring and investment in the business. But all that’s reflected in the EBITDA margins that we are showing, which you sort of look at Q4 and the guidance we have for Q1 and the rest of the year, you can see that we are essentially holding at these levels on margins and that over the course of the year, we would expect those margins to start moving up. The last thing I would add is that – and you may have caught this already, but the Infocyte acquisition is impacting margins by nearly a percentage point of dilution over the course of the year. And that acquisition closed in January. So, it’s really a full year impact.

Mike Cikos

That’s very helpful. Thank you for that. And then just one quick follow-up for Tim, I know we have spoken about Infocyte a lot on this call and I really appreciate the color. Just as we are thinking about the acquisition strategy, and I appreciate the commentary on owning the IT and taking ownership for the richer margins in hand, but at the same time, understand that there is a balancing when I think about some of the different moving parts for – from an investment profile perspective, for maintaining a very robust EDR solution. Can you kind of help us think through your M&A strategy on that front, especially as I am sure that you guys are continuing to look at other candidates out there in the market? That would be helpful.

Tim Weller

Yes. I mean I think as I referred to in my prepared remarks, we have got a good play now in every stage of the NIST framework. And it’s a question of integrating them, making sure they are easy to use, and we test our solutions quite a bit. So, I think we have always sort of found our spot. I won’t call it mid-market, but with MSPs, well above cheaper solutions, we are never the price leader, but stopping well short of all the complexity that enterprise players get pulled into. So, I don’t know if that’s a – called a saddle point in mathematics or there is some kind of optimization going on. And we just have an instinct for where to be there in terms of high performance but easy to use. It’s really the founding principle of the company, if I go back 5 years ago and listen to the founder’s pitch to me. And so I think we feel like we are on a good road to doing that in security overall. And I don’t think endpoint security is going to be any different there. So, we don’t feel a strong need to have to buy five more things to do something that will be very, very effective. Even our Ransomware Detection, which was built in-house in a fairly short order before launch, we have now extended it quite a bit. It’s – what it catches is pretty amazing, and it’s catching that sitting behind other AV and some EDR solutions that are household brands, and that’s really exhilarating and MSPs see that. So, I understand the nature of the question, but I think this is always how we have rolled. So, we are not opposed to any kind of resale. We just tend not to do it. We are certainly not opposed to licensing components if they are interesting. It’s not a not made here mentality kind of thing. But I do think the proprietary technology to control the environment, control the solution, the experience for the partner and, of course, get better margin at the end of the day.

Mike Cikos

Understood. Thank you very much for the color guys. Appreciate it.

Tim Weller

Alright. I think we might have one or two more in the queue. I didn’t realize we are past the top of the hour, but let’s try to get a couple in real quick, if there is one or two more, operator.

Operator

Definitely. Your next question comes from the line of Koji Ikeda with Bank of America. Your line is now open.

Unidentified Analyst

This is Laurie on for Koji. Thanks for squeezing me in. So, I just want to follow-up on the margin question. One is that, how is that, the international expansion, having an impact on margins? And then just like you pointed out a couple of positive things for margin expansion, the new products, the Infocyte and the ARR, what are some – what is the major driver that you see?

Tim Weller

John, do you want to take first part about internationalization. What – and the second – I missed the second part, I am sorry.

Unidentified Analyst

Yes. Just the major drivers for the margin expansion, there are a couple of positive comments on that. Just wondering what are the biggest ones?

John Abbot

Of margin expansion?

Unidentified Analyst

Yes.

John Abbot

Is that the question? Okay. Sure. Internationalization, I think and sort of the global expansion, absolutely in the short-term will depress margins, right. And so that’s an investment. When we talk about investing in growth, that’s an area where we definitely are investing, just like a new product launch in a lot of ways, right, moving into a new country, the expenses are going to precede the revenue typically. So, that is all factored into the guidance that we provided. And so that’s part of the program that we have planned for the year. And again, we are laying a lot of the groundwork this year. And so then when you think about what are the drivers ultimately of expanding margins over time, it’s really the back end of those J-curves, right. So, you start – you have a lot of expense upfront that ramps both for the revenue that is the revenue starts ramping. And if you have the right unit economics and the right model, which we feel like we do, then those revenues are going to grow much faster than the expenses, and we are going to benefit from that over time. It’s about the position we are in, the model we have. And you think about the number of products we have sort of at still a fairly early stage in that J-curve. It’s exciting to think about the ramp that we will benefit from there.

Unidentified Analyst

Yes, great. Thank you, guys.

Tim Weller

Thank you, Laurie.

Operator

Your last question today comes from the line of Brent Thill with Jefferies. Your line is now open.

Unidentified Analyst

Hey guys. You have John on for Brent. I appreciate the question. It was a really good quarter for large customers. I think you added 100,000 customers versus 50,000 the past few. Was there any commonalities with those larger expansions and did that drive the gross renewal rate higher?

Tim Weller

John?

John Abbot

Yes, that’s a good question. I don’t know that there is any commonality. Obviously, those large customers are typically customers who have been with Datto for quite some time. I mean the profiles generally are pretty consistent that MSPs start small with us and grow over time and so very unlikely to churn. Typically have standardized on one or more, maybe even three or four Datto products, but – and extending that across their base. I think we are doing a better job of qualifying and prioritizing our focus on MSPs that have a propensity to grow. And maybe we are starting to see the fruits of some of that effort flowing through. And yes, without a doubt, I mean it’s all part of the mix, right. The improvement in net MRR certainly is helped by those large and growing MSP partners that we have.

Unidentified Analyst

Okay. And then any sense of how security did relative to that 40% growth number you gave at the Analyst Day? And if I can sneak in one quick one, is the constant currency impact on EBITDA the same as revenue?

John Abbot

I think the first one, if you are talking about sort of the mix of the growth mix, we are not really going to break that out. I think the way we have characterized it is that the sort of the proportionate mix of drivers of growth that we shared in December, as we sit here in February, are really not very different. It takes time, a year or more, before that mix starts moving meaningfully. On – and then the other question was constant currency or – yes, much less impact on EBITDA than on revenue. So, there is a natural bumper on the expense side. So, the EBITDA is impacted much less than revenue.

Unidentified Analyst

Thanks.

Tim Weller

Okay. Thank you.

Operator

That concludes your Q&A today. Tim Weller, I will turn the call back over to you.

Tim Weller

Okay. Well, thanks everybody for joining us. We decided to go a little past the top of the hour, given that it was year end and so much happened and we appreciate your continued interest in Datto. And again, thanks for joining. We are going to go back to work.

Operator

This concludes today’s conference call. Thank you for attending. You may now disconnect.

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