DDOG announces Q3 Results

Investment Analysis Clubs Saul’s Investing Discussions
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Q3 Results are out: https://investors.datadoghq.com/news-releases/news-release-details/datadog-announces-third-quarter-2022-financial-results

My very first take prior to the call:

  • Better than expected/feared with revenue coming in at $437M, which is 61% YoY, 7,6% QoQ and a 6,1% beat vs. midpoint guide.
  • Q4 guide stronger than Q3 guide (2,3% QoQ for Q4 vs. 1,4% QoQ for Q3) but still a lot lower than any previous guides (prior to Q3)
  • Raising Top and Bottomline for full FY by ~$50M

Conclusion:

  • Growth is coming down meaningfully (as expected), consumption-based model is showing its weakness
  • Still hard for any other company to compete with these stats
  • I remain fully invested and believe DDOG can accelerate growth again at some point in 2023 when macro improves
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I just don’t think you can look past the QOQ deterioration. At 8% QOQ, it annualizes to 38% but its going to be a tough ask to reaccelerate in 2023 with an impending severe recession.

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It’s been pointed out many times to be careful taking 7.6% QoQ growth, then annualizing it to get 38% and using that as your roadmap. Using sequential growth numbers is tricky and can massively amplify something that’s not there.

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Here are my notes from the analyst Q/A portion of the earnings call…

DDOG Q3 2022 Analyst Q/A
CEO Olivier Pomel
CFO David Obstler

Q Compare current situation/environment from pandemic, talk re: factors you’re seeing in Covid.
A Not seeing everyone trying to save money like they were during COVID. Looking at customers who are earlier in their cloud migration, they are not slowing down. Those companies who are later in their cloud migration are slowing down more than the companies who are earlier in their migration.

Q Have you seen any impact on billing terms or DSO’s.
A No material changes. When customers negotiate, they are more interested in optionality.

Q Many customers said cloud cost mgt solution is extremely well timed. Will this get off to a fast start?
A Any company who is fully scaled into the cloud is concerned with efficiency. Yes, it’s well-timed, and believe it will be used even more after we come out of this challenging macro environment.

Q Is 30% an appropriate glide path for the future?
A Part of this is driven by growth of new customers.

Q Competitive displacement and observability consolidation around DDOG.
A Consistent with what they’ve seen in the past. In the future, it’s going to become more compelling to consolidate around DDOG.

Q 1 customer is using 14 individual services. How does pricing work in this case?
A Red rate cards that can be negotiated and lower financing cost. This gives them more flexibility so they don’t have to decide what services they will use ahead of time.

Q How much of the FX vertical is international?
A We charge in US$ everywhere. Europe and Japan customers budgets are in Euro and Yen, so a stronger $ favors DDOG. The predominant effect is what’s happening in their sector rather than their geography.

Q Does Cloudcraft open the door for new opportunities?
A Works very well for cloud planning and it has a very broad reach, easy to embed 3rd party websites. It’s a small company, meaning it comes with several engineers, but a customer base and revenue that’s immaterial.

Q How did the linearity of this quarter trend and compare?
A Very similar, no difference from the past. Pleased with what they’ve seen so far, and October is usually strong for us in September/October. Q3 performance was very similar to Q3.

Q Investment philosophy, are you thinking planning to hire same number of reps?
A Always have lived withing our means. Use quota carrying reps. Investing behind this. Did not get out over our skis, so we can invest in a systematic say. Keep investing in R&D.

Q CRPO is continuing to decelerate. Why?
A Comps are very significant in this quarter. Had some large multi-year deals, and that’s why the current over time is somewhat correlated. Revenue is the best predictor of how they’re doing and where they’ll move next.

Q International demand is unchanged and what has made DDOG more resilient than your peers? Competitive displacement %’s?
A Small minority of their deals are competitive displacements. We don’t seek these.

Q Usage moderation, what are the signs/signals that would lead you to believe there’s more modulation? Is the worst of this behind us?
A We should expect their cloud spend to grow at the same rate as their top line. It all depends on how much of a down trend we see in macroeconomics.

Q How much osterity?
A Most of their customers are land and expand. Whay we said last time is that they’re not cutting their commitment, rather customer usage has been lower than historical trends, rather than the rates they experienced during COVID. We see Q3 as being worse than Q2 re: macroeconomics, and they see their performance as being better than Q2.

Q Net Dollar expansion rate, did it go down?
A If the organic rate of customers was lower than it was previously, but they don’t give more information than that. If the customers adopts this during their land, it shows up in revenue.

Q What is needed to keep driving progress?
A Specialized functions like VDA, today, due to database support it’s not as pronounced as it may be in the future.

Q Growth rates of hosts indicated that you weren’t sloweing.
A There’s some growth but it’s not extremely pronounced.

Q CAPX growth?
A Building and growing out offices and will report this in the future.

Remarks by CEO and CFO prior to analyst Q/A.

Outlook for 4th quarter: Basing guidance on current economic conditions. Expect gross margins to be in the upper 70% range.
Notes on guidance. Q4 includes Dash User Conference and their largest
Impact of 300 to 400 basis counts due to CAPX related to offices/facilities related to coming back to the office after COVID.

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Having worked my way through the earnings release and the transcript of the conference call, I have concluded that DataDog is going to be okay for the foreseeable future. It started with each of the analysts who asked a question starting with congratulations on the quarter, and went on to every question being answered with a positive response in terms of the business going well and continuing to go well. Management emphasized that Q4 estimates were very cautious because of seasonality and December holidays among their customers, meaning less usage, and less land and expand (especially compared to during Covid when people were taking fewer vacations), so they guided with a lot of caution. Fine with me.
Best,
Saul

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Definitely don’t use as your main roadmap in a vaccuum but also can not neglect it and its impact over the next 4 quarterly report YoY numbers. Gotta take the company, seasonality, trends and the other quarters around it into account.

For DDOG this quarter, the concern is around combination between the ONLY time aQoQ was under 50% was during the COVID quarter when aQoQ came in at 30%; this Q came in at 33% and signaling around 38% for next Q. If that comes to fruition, it’ll be very difficult for YoY rates to do anything but continue going DOWN until we lap this quarter. After Q4, can they re-accelerate above the aQoQ of 53% in seasonally weak Q1?

I think overall, this information is reinforcing what we learned during COVID about DDOG, that it is more susceptible to the macro environment then some of our other companies. What happens when we look further out to when the FED starts lowering rates again?? Well, I think its likely we’ll see DDOG have a nice re-acceleration like they did after COVID. Probably not back up to the 80s due to law of large numbers but enough to make us all very happy.

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I don’t disagree, but if this quarter is the low point with next quarter slightly up, projecting next quarter for 4 quarters could be a bit conservative. We have no idea on macro and I don’t really expect a quick re-acceleration in the next 2 quarters but i think 2H of 2023 could see that.
I’ve been more conservative than most and have had much more in cash this year than this board.

But this stock was $200 and it’s now $75. I suspect that DDOG is experiencing a short term period where customers are looking to optimize their spend and looking at things. I therefore suspect that the DIY folks out there will start to move out of that phase and adopt DDOG as we move into 2023.

Of course that assumes the macro doesn’t further decline worse than whatever the market is pricing in. If things proceed as expected, I think we see DDOG customers start to invest in the tools that achieve positive returns quickly.

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Very comforting

  • Operating cash flow was $83.6 million, with free cash flow of $67.1 million.
  • Cash, cash equivalents, restricted cash, and marketable securities were $1.8 billion as of September 30, 2022.

These are the times when good companies with good products and sound financials thrive and separate themselves.

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Customers Growth

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Screenshot above from Supplemental Doc

They have added 180 customers with 100K+ ARR to a total of 2600. And that customer segment contributes 85% of ARR as in previous Q. Similar add as last Q of 170.

They highlighted customer wins in the last Q in Prepared Remarks

  • 7-year land with a Fortune 100 grocery chain.
  • 7-figure land with a major multinational restaurant chain.
  • 7-figure land with a social networking app (previous customer who came back)
  • 7-figure upsell with a large Asia-based electronic conglomerate. (14 products) (NOTE: makker of IoT devices)
  • 8-figure multiyear upsell with a large e-commerce company

3 huge Lands and 2 huge upsells

Screenshot of my spreadsheet how I keep track of customers growth (time flows from right to left)

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Cheers ! Baconski

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Thank you all for sharing your thoughts on DDOG!

I don’t have much to add on the numbers, but would like to highlight some additional thoughts and takeaways from the CC.

#1 Strong R&D and Product Focus:

  • DDOG added an insane amount of 18 (!!) products to their portfolio. I can also see that their R&D spend remains at the same high level. And I like how they are adding new land & expand baits left and right of their core focus. This gives them a great chance to land new customers in adjacent areas and then funnel them trough to expand their usage of additional DDOG modules. Some highlights from Dash:
    • Cloud Cost Management : Cloud Cost Management allows stakeholders to analyze cost data alongside infrastructure and application telemetry, and it also shows them how each team, service, and application contributes to overall cloud spend. à I think this is a really nice add in times like these and also appeals to a new audience and presents a nice “land” opportunity
    • CoScreen : Datadog is launching CoScreen, a remote collaboration tool that enables users to seamlessly merge their work environments by creating virtual meetings that use voice and video chat and interactive screen sharing. à Reminds me a bit of Steam :smiley: I am pretty sure the dev community loves this, and it is a nice addition to the core products and helps companies break silos
    • Enhanced testing capabilities (e.g., Continuous Testing, Intelligent TestRunner) that help R&D teams move the testing “left”, which means it will be more deeply integrated into early development cycles and therefore, issues can be found and fixed earlier. Nice!
    • New Cloud & Application Security products (e.g., Cloud Security Management, Sensitive Data Scanner for APM and RUM). I think the latter can also nicely resonate in regions with strong data and compliance regulations, like Europe with GDPR.
    • Automation capabilities, e.g., Workflow Automation à What’s there to say, everyone loves automation!
    • Add ons in terms of Digital Experience Management. I’d specifically like to highlight Heatmaps, a tool that provides you with an aggregated view of how users interact with specific pages of your website or application by visually highlighting areas of that page at different levels of intensity based on user clicks. Let’s say you want to test whether any elements on a page are preventing users from discovering your main revenue-generating buttons and links by watching Session Replays. I find that particularly interesting, because it unlocks entirely new audiences and use cases ranging into Marketing and collaboration between Frontend Devs and Marketeers. Almost like Hotjar, it seems. Can be another nice vehicle to land new opportunities
  • I love that they added a dev certificate — this can be a nice community growth catalyst in an engaged dev advocate community
  • Acquired cloudcraft, a company to provide real-time cloud architecture visualization and design capabilities to help organizations with their cloud health, configuration and cost decisions. I think this is interesting, because it is a tool for cloud architects to map cloud infrastructure and migration, so I imagine this is a nice land & expand product for customers who are just getting started on the cloud (top of cloud funnel, if you want) and are very eager to ramp up: But when you look at the other customers, the ones that are earlier in their cloud migration, they are actually not slowing down, and we see the same urgency and eagerness for them to keep scaling and keep moving into the cloud. And that’s also where the bulk of our opportunities lies. Though, in full disclosure, DDOG expects It’s an immaterial amount of revenues relative to our total. Still, like it strategically

#2 Customers love their product

  • Strong trend and increase of customers adding 2+, 4+, and 6+ product modules
  • DBNRR remains unchanged at 130+ % which is great, especially considering the current environment
  • They see solid number of ARR and new logos added from large customers, and also claim to have a robust pipeline going forward. Since they are usage-based, and it takes customers some time to get ramped up, some of the revenue will only materialize a few months down the road, so I hope to see the effects of new logos and large customer add in the next quarters
  • They are still also seeing expansion into new products in existing customers and very low levels of churn, which indicates for me that their product is really core to their customers’ cloud transformation: Regardless of the macroeconomic environment, our customers still need to serve their clients, and moving to the cloud enables better service and cost savings against people intensive or on-premise technology based offerings

#3 Comments on Cloud migration & strategy

  • … all of our products meaningfully outperforming the growth of the large cloud providers. The weak reports from the hyperscalers did not materialize accordingly for DDOG. DDOG is also not at its top game but seems less negatively impacted due to their strong products and their focus on customers who are not fully scaled into the cloud yet and don’t want to slow down, see this comment:
    • But when you look at the other customers, the ones that are earlier in their cloud migration, they are actually not slowing down, and we see the same urgency and eagerness for them to keep scaling and keep moving into the cloud. And that’s also where the bulk of our opportunities.
  • Very interesting: Billing to customers who use a lot of different products: DDOG provides them with a kind of credit, so they can buy these credits and use them flexibly across the products. This makes it easier for customers to expand on new products and gives them flexibility to adapt usage as they need, without pre-committing to certain usage buckets by products, when they cannot really know yet. Very smart, as I think this can prevent committing to conservative usage to lack of flexibility on how that usage distributes across products
  • Nice add: Added Amazon Web Services (AWS) Security, Networking and Retail competencies, so they have in total 9 certificates and are the leading observability provider in that regard. This makes them very attractive for a wide range of industries

Bringing it all together

I think, despite slowed growth right now, DDOG is still a top investment and I feel comfortable holding it as one of my top positions. Their powerful product in conjunction with their land & expand model, high investments in R&D, solid cash and strong cloud migration tailwinds are compelling enough for me to sit through some tough-ish quarters.

They are acting really smart in continuously adding relevant (and adjacent) product modules that can be sold to existing customers, as well as unlock entirely new audiences to land new opportunities. Since they describe a lot of potential with customers earlier on in the cloud migration, they are adding a lot of relevant products and keep seeing momentum there, as well as existing customers still adding lot of new product modules. Plus: They make it easy for customers to add and pay for many modules, see billing comment.

Besides, growth is still high in terms of absolute YoY growth (and so is the absolute revenue, cash, and gross margin) and I hope that next year, easy comps and hopefully an improving macro environment will make our DDOG positions look happier again.

Overall, despite prudent guidance, they seem quite bullish, still invest aggressively in R&D and landing and expanding their rich product set to new large customers and logos (I am glad that large customer growth is still intact). I will, however, take a close look a large customer and revenue growth in the time to come to make sure they are not actually slowing down due to other reasons than macro.

Best & happy afternoon!
Lisa

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Lisa, Thank you again for an awesome, thorough, but easy to understand and very useful write-up. For a relatively new poster on the board you just blow me away.
Best
Saul

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