Strictly Business: Datadog and Cloudflare Earnings Recaps

Thoughts on recent reports from DDOG and NET.

Aug 05, 2022

DDOG 0.00%↑ – Shoot. I’d label this as Datadog’s first mixed result since Q2 of 2020. I was looking for $405M in revenue with a Q3 guide around $422M. I wrote “a significant Q2 miss would be surprising. The wild card is whether management sees enough hints of tightening usage to negatively affect the Q3 guide.” We got $406M and $414M with unfortunate hints that wild card is coming into play.

Other expectations:

A 20th consecutive quarter of 130%+ NRR. Check.
The usual steady increase in customers using 2+, 4+, and 6+ modules. A partial check. 2+ customers dropped from 81% to 79% while 4+ rose from 35% to 37% and 6+ rose from 12% to 14%. Close enough.
For customers, net new adds will be more important than total customer growth. We need to remember DDOG canceled ~200 Russian and Belarusian customers at the start of Q2 and adjust accordingly. Management touched on it only briefly, but DDOG added a record 1,400 customers this quarter which means closer to 1,600 accounting for the dropped accounts. A pleasant surprise.
I’d expect some sequential dip from last quarter’s record 240 new $100K customers but still hope to see solid growth in that cohort. It added 170, just above last year’s 164. I’m lukewarm on that figure and will at least be keeping an eye on it going forward.
Another quarter of double-digit profit and cash flow margins. No problems here.
Continued management confirmation its committed and recurring business is holding up well enough to alleviate any major short-term concerns about usage contraction. And there’s the rub. On the call management referenced macro and usage with much more caution than previous comments. Despite “no change to the long-term trends,” management noted “larger spending customers continue to grow but at a rate that was lower than historical levels” and “some customers beginning to manage costs in response to macroeconomic concerns.” While that’s totally understandable, it certainly complicates things and is likely to be a continued drag until the economy clears.

In total this looks like a solid quarter with a macro hiccup looming. The question becomes how long that hiccup will last. Management has enough short-term concern it barely touched the full year guide only raising it $10M. That unfortunately creates difficult comps in the second half. During the COVID pullback, DDOG’s stock drifted until the business reproved itself. Will we see the same here? Though management says this downturn is “not as sharp”, it’s still too early to tell. That’s a wrinkle we didn’t have before. So, while Datadog remains a top conviction holding, the new headwinds drop it slightly from clear portfolio leader back toward the rest of the pack.

NET 0.00%↑ – Good on you, Cloudflare! NET posted a strong quarter while answering many of the questions raised after Q1. I estimated $235M in revenue with a Q3 guide around $253. We got $234.5M and $251M. I’m good with these numbers, especially considering NET’s 47% international revenue was pressured by recent strength in the US dollar.

As for other expectations:

A big enough raise to FY22’s current 46% growth guide to think 50%+ is attainable. The bump to 48% with two quarters to go keeps it right on track.
A repeat or better of last quarter’s 127% NRR. Close but no cigar at 126%. An acceptable number though.
An increase from last Q’s 121 net new $100K customers added. Cloudflare crushed this expectation with a record 212 new $100K customers for 1,749 total. These large customers now account for a record 60% of total business. NET has made excellent progress with these more established clients in recent quarters. This bodes well.
A small operating profit as opposed to management’s guided $1M loss. Not quite with a $900K loss. Management did, however, guide for a $1M profit in Q3.
Confirmation that FedRAMP government approvals remain on track. CEO Matthew Prince reiterated the status quo and likened it to waiting in line at the DMV. The paperwork is submitted. NET just needs its number to be called.
Confirmation of a return to positive cash flow in the second half. Management has targeted this timeline each of the last two quarters, so I’ll be wary of any hedging especially given the current environment. I consider cash flow a main reason - if not THE main reason - the market hated last quarter and loved this one. Cloudflare churned out $38M in Q2 operating cash flow to get back to positive on the year. Free cash flow came in at -$4M with management emphatic on both the call and slide presentation it will be positive the rest of year. Management clearly got the market’s message after Q1.

In many ways this was a typical Cloudflare quarter. Continued innovation, 50%+ growth, breakeven profits, and a strong enough guide for a chance to do it all again next time around. Even so, the market had its doubts coming in. Kudos to NET for putting those to rest. I wrote last month I hoped this quarter’s numbers would be strong enough to let management focus on the future. Mission accomplished (as evidenced by the after hours jump).

As usual, thanks for reading and feel free to reach out with any comments or questions.