Since reporting its third-quarter results on Tuesday, shares of cloud monitoring and analytics company Datadog (DDOG 4.95%) have surged about 25%. Investors clearly love what the company had to say in its quarterly update.
Investors cheered Datadog's strong revenue growth, improving profitability, and robust fourth-quarter outlook.
"Companies across all industries and sizes are building cloud applications and services to deliver positive business outcomes, including more users, higher revenue growth, improved productivity, and cost savings," said Datadog CEO Olivier Pomel in the company's third-quarter earnings release. "With our unified, cloud-native, end-to-end observability and security platform, Datadog is uniquely positioned to help our customers reach their goals."
While there's certainly plenty of reason to be upbeat about the company, there are also some reasons to be critical. Here are four key metrics from the quarter to better understand the company's recent success and one more pessimistic metric that could suggest the stock's recent hype is overdone.
Strong sales growth
Though Datadog's revenue growth was strong in Q2, coming in at a year-over-year growth rate of 25%, it was notably a deceleration from 33% revenue growth in Q1 and 63% for the full year of 2022. Some investors, therefore, may have been worried that Datadog's revenue growth would decelerate again in Q3. But it didn't happen. Instead, the growth rate stabilized, with third-quarter revenue rising 25% year over year again, coming in at $547.5 million.
Improving profitability
Strong revenue growth, combined with the company's increased efforts to improve efficiency and reduce costs, led to improving profitability in Q3. This is particularly evident in the company's non-GAAP (generally accepted accounting principles) operating income as a percentage of revenue. Datadog's operating margin for the quarter was 24%, up from 21% last quarter and 17% in the year-ago quarter.
Higher free cash flow
Another way to measure Datadog's improving profitability is its free cash flow, or the company's cash from operations, less capital expenditures. Free cash flow rose from about $67 million (15% of revenue) to approximately $138 million (25% of revenue).
Such robust cash flow, of course, is beefing up the company's already strong balance sheet. Datadog wrapped up the quarter with $2.3 billion in cash, cash equivalents, and marketable securities.
Better-than-expected guidance
Finally, investors were likely pleased with the company's revenue guidance. Datadog guided for fourth-quarter revenue to be between $564 million and $568 million. This is well ahead of analysts' average estimate for fourth-quarter revenue of about $543 million. This guidance range implies 20% to 21% year-over-year growth for the final quarter of the year.
Slowing momentum with large customers
Another area the company continues to do well in is its momentum with large customers (i.e., customers with annual recurring revenue of $100,000 or more). At the end of Datadog's third quarter, these customers totaled 3,130, up 20% or more. Datadog also said it closed deals with a record number of customers worth $100,000 or more in annual revenue.
However, Datadog's year-over-year growth rate in large customers may also be a reason to be concerned. Despite this metric's good performance in absolute terms, it's down meaningfully sequentially.
Its customers with more than $100,000 in annual recurring revenue grew 24% year over year in Q2 -- four percentage points higher than the company's 20% growth rate in Q3. If this deceleration persists in Q4 and into 2024, investors may have to revisit whether shares are worth their high valuation. The company's current market capitalization of more than $32 billion prices in rapid growth for years to come.
Overall, however, Datdog's third-quarter performance is good news for investors. Despite the company's strong growth, management emphasized that Datadog is still operating in a tough environment, rife with cloud optimizations (i.e., when organizations try to lower their cloud expenses or at least be more disciplined about spending) and macro uncertainty.
Despite its current challenges, Datadog remains confident in its long-term growth outlook.
"We continue to believe digital transformation and cloud migration are long-term secular growth drivers of our business and critical motions for every company to deliver value and competitive advantage," said Pomel.
