Cloud monitoring software company Datadog (NASDAQ:DDOG) beat analysts' expectations in Q3 FY2023, with revenue up 25.4% year on year to $547.5 million. On top of that, next quarter's revenue guidance ($566 million at the midpoint) was surprisingly good and 4.1% above what analysts were expecting. Turning to EPS, Datadog made a non-GAAP profit of $0.45 per share, improving from its profit of $0.23 per share in the same quarter last year.
Datadog (DDOG) Q3 FY2023 Highlights:
- Revenue: $547.5 million vs analyst estimates of $524.2 million (4.5% beat)
- EPS (non-GAAP): $0.45 vs analyst estimates of $0.34 (33.5% beat)
- Revenue Guidance for Q4 2023 is $566 million at the midpoint, above analyst estimates of $543.9 million
- Free Cash Flow of $138.2 million, similar to the previous quarter (big beat vs. expectations of $83 million)
- Customers: 3,130 customers paying more than $100,000 annually
- Gross Margin (GAAP): 81.1%, up from 78.6% in the same quarter last year
Named after a database the founders had to painstakingly look after at their previous company, Datadog (NASDAQ:DDOG) is a software-as-a-service platform that makes it easier to monitor cloud infrastructure and applications.
Founded in 2010, Datadog was designed to help companies that were then just starting to move from legacy on-premise servers to hosting their systems in the cloud. Because the rate of deployment of software increased from weeks to days and hours, the engineering teams needed a way to observe their cloud infrastructure in real-time.
Datadog seamlessly integrates into a company’s tech stack and pulls all the metrics that matter for different cloud services and databases and makes them available in a single real-time dashboard. The shared dashboard then makes it easy for different teams in the company to collaborate when investigating why a service broke down or became really slow.
Software is eating the world, increasing organizations’ reliance on digital-only solutions. As more workloads and applications move to the cloud, the reliability of the underlying cloud infrastructure becomes ever more critical and ever more complex. To solve this challenge, companies and their engineering teams have turned to a range of cloud monitoring tools that provide them with the visibility to troubleshoot issues in real-time.
Cloud infrastructure monitoring is becoming a competitive space and Datadog is competing with offerings from New Relic (NYSE:NEWR), Elastic (NYSE:ESTC), Splunk (NASDAQ:SPLK), monitoring tools made by the cloud providers themselves and up and coming startups.
As you can see below, Datadog's revenue growth has been exceptional over the last two years, growing from $270.5 million in Q3 FY2021 to $547.5 million this quarter.
This quarter, Datadog's quarterly revenue was once again up a very solid 25.4% year on year. On top of that, its revenue increased $38.1 million quarter on quarter, a very strong improvement from the $27.7 million increase in Q2 2023. This is a sign of re-acceleration of growth and great to see.
Next quarter's guidance suggests that Datadog is expecting revenue to grow 20.6% year on year to $566 million, slowing down from the 43.9% year-on-year increase it recorded in the same quarter last year. Looking ahead, analysts covering the company were expecting sales to grow 17.9% over the next 12 months before the earnings results announcement.
Large Customers Growth
This quarter, Datadog reported 3,130 enterprise customers paying more than $100,000 annually, an increase of 140 from the previous quarter. That's quite a bit more contract wins than last quarter and about the same as what we've seen in past quarters, demonstrating that the business has the sales momentum required to drive continued growth. We've no doubt shareholders will take this as an indication that the company's go-to-market strategy is running smoothly.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Datadog's gross profit margin, an important metric measuring how much money there's left after paying for servers, licenses, technical support, and other necessary running expenses, was 81.1% in Q3.
That means that for every $1 in revenue the company had $0.81 left to spend on developing new products, sales and marketing, and general administrative overhead. Significantly up from the last quarter, Datadog's excellent gross margin allows it to fund large investments in product and sales during periods of rapid growth and achieve profitability when reaching maturity.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Datadog's free cash flow came in at $138.2 million in Q3, up 106% year on year.
Datadog has generated $492.6 million in free cash flow over the last 12 months, an impressive 24.4% of revenue. This high FCF margin stems from its asset-lite business model and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a cash cushion.
Key Takeaways from Datadog's Q3 Results
With a market capitalization of $25.9 billion, a $2.3 billion cash balance, and positive free cash flow over the last 12 months, we're confident that Datadog has the resources needed to pursue a high-growth business strategy.
This was a classic "beat and raise quarter". We were impressed by Datadog's significant improvement in new large contract wins this quarter. This helped contribute to the revenue beat. Additionally, non-GAAP operating profit and adjusted EPS both beat handily. We were also glad next quarter's revenue guidance came in higher than Wall Street's estimates. Full year guidance was raised across the board. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The stock is up 18.7% after reporting and currently trades at $94.49 per share.
Is Now The Time?
Datadog may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
We think Datadog is a good business. We'd expect growth rates to moderate from here, but its revenue growth has been exceptional over the last two years. On top of that, its impressive gross margins indicate excellent business economics and its bountiful generation of free cash flow empowers it to invest in growth initiatives.
Datadog's price to sales ratio based on the next 12 months of 11.8x indicates that the market is certainly optimistic about its growth prospects. There's definitely a lot of things to like about Datadog and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.Wall Street analysts covering the company had a one-year price target of $104.2 per share right before these results, implying that they saw upside in buying Datadog even in the short term.
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