First Look at Datadog’s Q1 2022 Earnings Report

Datadog (DDOG) announced Q1 FY2022 earnings on May 5th. Relative to earnings results from peers and consumer Internet offerings, Datadog’s report was stellar. Given the emerging headwinds to growth, Datadog’s durability is shining through. Of note is their sustained revenue growth coupled with strong improvement to the bottom line. While I was focused on y/y percentages of revenue increase, Datadog snuck in a quadrupling of operating income and nearly tripled free cash flow.

I will share a short summary of my reactions to the report, structured around positives, negatives and additional data points that are of interest. I won’t rehash all of the metrics, as those are readily available online in the earnings report and Investor Presentation.

The Good

• It’s rare that I don’t start an earnings review with revenue. As mentioned above, what stood out to me the most was the strong improvement in profitability measures. As market sentiment seems to be shifting to more consideration for multiples of profitability metrics for growth companies, Datadog provided investors with a strong foundation.

• For Q1, non-GAAP gross margin improved to 80%, reflecting improving efficiencies in underlying cloud hosting costs. As Datadog scales their operations on public cloud vendor infrastructure, they realize volume discounts. Additionally, they can continuously tune their applications to squeeze as much performance as possible out of the underlying compute and storage.
• Non-GAAP operating margin was 23%, which is up from 10% a year ago and 22% in Q4. Datadog even doubled the high end of their operating income estimate issued with Q4 results. Finally, free cash flow of nearly $130M generated a FCF margin of 35.8%, up from 22.4% a year ago and 32.7% from Q4. On a Rule of 40 basis, Datadog is now at 119. Further, if we annualize Q1’s FCF of $130M to about $500M, then the market cap / FCF multiple is about 60. Still relatively high, but the multiple is coming down quickly.
• Revenue growth didn’t disappoint either, particularly if we look at forward guidance. At a time when many other software companies barely beat or even missed estimates for the following quarter and full year, Datadog delivered plenty of headroom. Q1 revenue growth was 83%, up 11.3% sequentially from Q4. This beat the analyst estimate for 70% growth substantially.
• Looking forward, the Q2 revenue estimate would yield 62% of revenue growth, beating the analyst estimate for 55% growth. Datadog exceeded their Q1 estimate by about $26M. Applied to the high end of the Q2 range implies that annual growth will arrive at about 74% for Q2. So, we will likely see some deceleration off of the Q1 revenue growth rate.
• For the full year, Datadog raised their revenue target significantly. They are now expecting $1.61B in revenue, up 56.3% at the midpoint. This target was raised by $90M or 870 bps from the estimate given with Q4 results. They beat Q1 revenue by $26M, so the remaining $64M applies to subsequent quarters. In 2021, Datadog raised the annual revenue estimate by about the same amount in Q1 through Q3. I don’t expect that pace for this year, but could see Datadog reaching $1.8B in revenue on the high side at end of year. This would represent a 75% annual growth rate.
• Other revenue adjacent growth metrics were favorable. Billings were up 103% y/y, and Q1 represented Datadog’s second best quarter for new ARR added (behind the prior quarter Q4 2021). RPO growth was 85% y/y, versus 88% y/y in Q4. Current RPO grew in the mid-80% range as well.
• Datadog added 240 new large customers ($100k+ in ARR) in Q1, up sequentially from the 210 added in Q4 and representing an increase of 60% y/y.
• Customer spend expansion metrics continue to track well. DBNRR was again over 130%. In the 10-Q, Datadog reported that 80% of the new revenue in the quarter was attributable to existing customers, with the remaining 20% generated by new customers. This underscores the power of Datadog’s land and expand motion.
• To help investors appreciate their strategy of getting customers to continually increase their product subscriptions, Datadog reports on the percent of customers with 2 or more, 4 or more and recently 6 or more product subscriptions. These percentages have continually grown at a consistent rate. This motion drives their high DBNRR.
  • Customers using 2+ products were 81%, up from 75% a year ago.
  • Customers using 4+ products were 35%, up from 25% a year ago.
  • Customers using 6+ products were 12%, up from 4% a year ago.

• Security products continue to gain traction. Although leadership hasn’t reported exact figures for security product adoption, the CEO again referenced “thousands of customers” using Datadog security products as part of his opening remarks.
• During the quarter, they brought application security monitoring to GA. Datadog now has five security products with pricing, if we include Sensitive Data Monitor (which I think is reasonable). Datadog is rapidly growing into the category of products that keep cloud hosted applications secure. CSPM and Workload Security focus on the servers themselves. Application Security Monitoring and SIEM monitor and protect the application runtime. Sensitive Data Scanner ensures that application data exhaust isn’t a source of useful data for hackers. These application focused product offerings are distinct from endpoint security, which Datadog has made clear it will not enter.
• The scope of spend on Datadog is proving to be large and elastic. One of the customer highlights was for an “8 figure” upsell and the largest deal ever on an ARR basis. I interpret this to mean at least $10M in annual spend, which would represent a lot for an observability solution. In this case the customer is subscribing to 6 products, so the share of spend starts to make sense as Datadog addresses adjacent product categories, allowing customers to consolidate spend from other vendors onto Datadog’s platform.

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Areas for Concern

• While I highlighted strength in large customer additions, the total customer count growth rate did slow this quarter. Datadog added just 1,000 new customers in Q1, down from the record 1,300 added in Q4. The total was still up 30% year/year. There may be some seasonality here, but it will be worth watching. Another note is that 200 customers associated with Russia were shut off early in Q2, so this will be important for investors to keep in mind when evaluating next quarter’s customer results.
• While I like the revenue outperformance, Datadog’s annual revenue growth rate is slowing down. As noted above, Q1 delivered 83% and Q2’s estimate with a reasonable beat would land in the mid-70% range. As comparisons to 2021 get harder, Q3 and Q4 revenue growth might even drop into the low 70% or high 60% range. I think this is acceptable, particularly given that Datadog is growing profitability in parallel. If growth settles into the 50% range for 2023, that would still generate annual revenue approaching $3B. The concern arises with market expectations and the probable reaction to revenue growth deceleration. We might see an oversized re-rating until it’s clear where revenue growth stabilizes. Crowdstrike experienced a similar effect over the last year.

Other Data Points

There were other data points and comments made on the call that I found interesting. Some of these may benefit performance in the future, but the impact can’t be measured at this time.

• Hiring. Q1 was best quarter for hiring and leadership said that they plan to keep hiring aggressively. According to the 10-Q, they increased costs for R&D, S&M and G&A at different rates. This highlights Datadog’s product led growth and lower costs for cross-selling new products to existing customers.
  • R&D spending increased by 90% y/y.
  • S&M spending increased by 57% y/y.
  • G&A spending increased by 25% y/y.
• Acquisition of Hdiv Security. As part of Q1 earnings, Datadog announced an agreement to acquire Hdiv Security. Based in Spain, Hdiv Security further rounds out Datadog’s application security capabilities. They provide three solutions. The first two focus on identifying vulnerabilities surfaced by code within the application’s runtime. It doesn’t require access to the source code to do this. One solution focuses on the vulnerabilities in the organization’s own code. The other monitors the loading and execution of third party software libraries. The third solution focuses on RASP (Runtime Application Self Protection). These capabilities complement Datadog’s recently launched Application Security Monitoring product, adding protection of the application to the runtime. I am excited to see Datadog continue to deepen their coverage within application security.

Take-aways and Investment Plan

Overall, I thought Datadog’s Q1 results were strong. Coming into the earnings report, I was concerned that they might experience a spending reset by enterprise customers, similar to what occurred in Q2 2020. This didn’t appear to be the case, at least not at this point. While revenue growth should (expectedly) decelerate from the current extreme hypergrowth levels, I think their highly tuned land and expand motion will keep revenue growth elevated for quite some time. Further, the rapid improvement in profitability measures will provide support in this new market environment.

As we were approaching this past week of earnings, I decided to even up my allocations to DDOG, NET and SNOW. I like how all three are executing, for different reasons. I think these companies will be able to grow through the current volatility in the market and will eventually realize stock price appreciation, once the market considers their valuation multiples to be fair. I don’t know what level that will be, but will wait until they “bottom”. From there, stock price should scale with growth in revenue and cash flow.

For DDOG, it is now my largest position, as their relative outperformance in the last week has exceeded the others. I don’t plan to make any changes at this point.

NOTE: This article does not represent investment advice and is solely the author’s opinion for managing his own investment portfolio. Readers are expected to perform their own due diligence before making investment decisions. Please see the Disclaimer for more detail.