Datadog Inc

NASDAQ:DDOG

Earnings Call Analysis

Datadog Announces Strong Q2 2024 Performance and New Product Launches

Datadog reported a robust second quarter for 2024, with revenue reaching $645 million, marking a 27% year-over-year increase. The company saw growth in its customer base to 28,700, alongside impressive adoption rates, with 83% of customers using multiple products. Free cash flow was strong at $144 million, representing a 22% margin. Looking ahead, Datadog expects third-quarter revenue between $660 million and $664 million, and fiscal year 2024 revenue between $2.62 billion and $2.63 billion, reflecting a 23-24% year-over-year growth. The company’s ongoing innovations, particularly in AI and cloud security, continue to fuel its optimistic outlook.

Introduction and Overview

Datadog had a highly productive second quarter, marked by the successful DASH conference and the introduction of new products and features. The company continued to add new customers and support existing ones in navigating their cloud environments.

Financial Performance

Datadog reported Q2 revenue of $645 million, representing a 27% year-over-year increase, surpassing their guidance range. The quarter ended with approximately 28,700 customers, up from around 26,100 in the same period last year. Furthermore, the company achieved a free cash flow of $144 million, with a cash flow margin of 22%.

Platform Adoption

Datadog's platform strategy continues to resonate strongly in the market. By the end of Q2, 83% of customers were using two or more products, 49% were using four or more products, and 25% were employing six or more products. Penetration of observability products like synthetics and real user monitoring, both of which achieved $100 million in ARR, highlighted the growing adoption and expansion of their platform capabilities.

Business Environment

The overall business environment remained stable from the previous quarter, with customer cloud usage growing despite some ongoing cost-conscious behaviors. Datadog observed usage growth with existing customers aligning with their expectations and saw an improved trend over recent quarters. Gross revenue retention remained stable in the mid- to high 90s.

Operational Developments

Datadog continued significant investment in R&D, adding multiple exciting new products like LLM Observability and enhancements to Bits AI, their AI copilot. They maintained strong execution with go-to-market strategies, landing substantial new deals with large institutions and expanding their footprint with existing clients. For example, they secured a multiyear deal worth tens of millions with one of South America's largest banks and a seven-figure deal with a major travel management company.

Guidance for Future Growth

For Q3, Datadog anticipates revenues between $660 million and $664 million (a 21% year-over-year growth) and non-GAAP operating income between $146 million and $150 million, translating to an operating margin of 22% to 23%. For the full fiscal year 2024, revenue is projected to be between $2.62 billion and $2.63 billion (23% to 24% year-over-year growth), with non-GAAP operating income expected to be between $620 million and $630 million, implying a 24% operating margin.

Closing Remarks

Datadog's outlook remains positive with a focus on helping customers observe, secure, and act within their cloud environments. The company is well-positioned for continued growth with its diversified product offerings and solid customer base, aiming to drive further innovation and customer satisfaction.

Earnings Call Transcript 2024-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Second Quarter 2024 Datadog Earnings Conference Call. [Operator Instructions] Please be advise that today's conference is being recorded. I would now like to hand the conference over to your spear today, Yuka Broderick, Vice President of Investor Relations. Please go ahead.

[Yuka Broderick, executive]

Thank you, Michelle. Good morning, and thank you for joining us to review Datadog's second quarter 2024 financial results, which we announced in our press release issued this morning. Joining me on the call today are Olivier Pomel, Datadog's Co-Founder and CEO; and David Obstler, Datadog's CFO.

During this call, we will make forward-looking statements, including statements related to our future financial performance, our outlook for the third quarter and fiscal year 2024 and related notes, our gross margins and operating margins, our product capabilities, our ability to capitalize on market opportunities and usage optimization trends. The words anticipate, believe, continue, estimate, expect, intend, will and similar expressions are intended to identify forward-looking statements or similar indications of future expectations.

These statements reflect our views only as of today and are subject to a variety of risks and uncertainties that could cause actual results to differ materially. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our Form 10-Q for the quarter ended March 31, 2024. Additional information will be made available in our upcoming Form 10-Q for the fiscal quarter ended June 30, 2024, and other filings with the SEC. This information is also available on the Investor Relations section of our website, along with a replay of this call.

We will also discuss non-GAAP financial measures, which are reconciled to their most directly comparable GAAP financial measures in the tables in our earnings release, which is available at investors.datadoghq.com.

With that, I'd like to turn the call over to Olivier.

[Olivier Pomel, executive]

Thanks, Yuka, and thank you all for joining us this morning. We had a very productive second quarter. First, we welcomed thousands of Datadog users to our DASH conference in June where we announced a broad range of exciting new products and new features for customers to observe, secure and act in their cloud environment. And we continue to add new customers and help existing ones as they grow in the cloud.

Let me start with a review of our Q2 financial performance. Revenue was $645 million, an increase of 27% year-over-year and above the high end of our guidance range. We ended the quarter with about 28,700 customers, up from about 26,100 a year ago. We had about 3,390 customers with an ARR of $100,000 or more, up from about 2,990 last year, and these customers generated about 87% of our ARR. And we generated free cash flow of $144 million with a cash flow margin of 22%.

Turning to platform adoption. Our platform strategy continues to resonate in the market. As of the end of Q2, 83% of customers were using two or more products, up from 82% a year ago. 49% of customers were using four or more products, up from 45% a year ago. 25% of our customers were using six or more products, up from 21% a year ago. And 11% of our customers were using eight or more products, up from 7% a year ago.

We continue to expand the capabilities of all of our products over time, enabling our customers to solve more of their critical challenges. This includes our efforts in digital experience monitoring, an area of observability, which includes synthetics and real user monitoring or RUM. And both synthetics and RUM are seeing growing adoption and each product today represents more than $100 million in ARR, becoming our fourth and fifth products to achieve that milestone.

We have also been innovating rapidly in this area with recent capabilities, including mobile app testing, future flag testing, user journey visualization and retention analysis. And with our recent announcement of product analytics at DASH, we are excited to go further and allow our customers to consolidate more of their usage and business insights into Datadog.

Now let's discuss this quarter's business drivers. Overall, the business environment for Datadog was roughly unchanged from last quarter. Our customers overall are growing their cloud usage, while some are continuing to be cost conscious. In Q2, we saw existing customer usage growth that was broadly in line with our expectation and consistent with the overall improved trend that we have experienced over the past several quarters. Our usage growth with existing customers was higher than in the year-ago quarter. And we saw continued healthy growth across our product lines with newer products growing faster from a smaller base. Finally, churn continues to be low and gross revenue retention was stable in the mid- to high 90s, highlighting the mission-critical nature of our platform for our customers.

Moving on to R&D. We had our DASHes of conference in late June, and we are excited to announce many new products and features for our users. We have too much for us to cover in detail, but let me review just some of the announcements we made in the past 3 months.

In the next-gen AI space, we announced the general availability of LLM Observability, which application developers and machine learning engineers to efficiently monitor, troubleshoot and secure LLM applications. With LLM Observability, companies can accelerate the deployment of AI applications into production environments and reliably operate and scale them.

We also expanded Bits AI with new capabilities. As a reminder, Bits AI is a Datadog built-in AI copilot. In addition to being able to summarize incidents and answer questions, we previewed at DASH, the ability for Bits AI to operate as an agent and perform autonomous investigations. With this capability, this AI proactively surfaces key information and performs complex tasks such as investigating alerts and coordinating -- response.

Taking a step back and looking at our customer base, we continue to see a lot of excitement around AI technologies. All customers are telling us that they are leveling up on AI and ramping experimentations with the goal of delivering additional business value with AI. And we can see them doing this. Today, about 2,500 customers use one or more of our AI integrations to get visibility into their increasing use of AI. We also continue to grow our business with -- customers. which increased to over 4% of our ARR in June. We see this as a sign of the continued expansion of this ecosystem and of the value of using Datadog to monitor the product environment. I will note that over time, we think this metric will become less relevant as AI usage and production broadens beyond this group of customers.

Last, but not least, we announced [ TOTO ], our first foundational model for time -- forecasting, which delivered state-of-the-art performance on all 11 benchmarks. In addition to the technical innovations devised by our research team, TOTO derives its record performance from the quality of our training dataset and points to our unique ability to train, build and incorporate AI models into a platform that will meaningfully improve operations for our customers.

Moving on from AI. We have a lot more to show in observability. We announced the general availability of Flex Logs, which extends our logging with limited approach and allows our customers to scale storage and compute separately for cost efficiency. And our customers can today use our new Log Workspaces for log analysis. Log Workspaces is an advanced analytics feature that allows users to connect datasets, build and realize complex queries and create usable composable views and reports. It is particularly relevant to customers who previously built sophisticated analysis and workflows in legacy log management tools.

We announced the general availability of Data Jobs Monitoring, which allows data engineers to detect and fix issues with our Spark and Databricks workloads and to optimize the cost and performance of their data jobs.

Moving and transforming large amounts of data has grown in importance and become a mission-critical capability for many businesses, a trend that we believe will continue with the adoption of AI. With this, our data observability set of products is expanding. Data Jobs Monitoring works alongside our Data Streams Monitoring product, which helps customers understand the -- pipelines involving components such as [indiscernible]. And we're increasingly providing visibility for data lakes and data warehouses, such as Snowflake, to deliver end-to-end data observability across customers better resources.

Moving on from data observability. We introduced capability [ photo scaling ] to allow customers to optimize for cost and performance by automatically rightsizing company resources.

For our customers using OpenTelemetry, the Datadog Agent will embed a fully configurable OpenTelemetry Collector, giving hotel customers access to Datadog products such as container network and universal service monitoring and offering our customers what we believe will be the best fully managed OpenTelemetry experience in the market.

In shifting left, our new Live Debugger, enables developers to step through code directly in production environments and find the exact root code of production errors.

As I mentioned earlier, we are building up on our success in digital experience monitoring, and we announced Product Analytics, providing in-depth product and user insights for product managers and business owners.

In the cloud security space, we launched a new application security capability called Code Security, which allows our customers to detect and prioritize code-level vulnerability in their products and applications. We also announced Data Security, which allows our customers to automatically pinpoint sensitive data, starting in AWS today and expanding to other environments in the future. And for instances where customers can't or don't want to deploy agents, our new agentless scanning capability provides visibility into risks and vulnerabilities within host, containers and several functions without requiring agents to be installed.

Finally, in the cloud service management space, we're going further to allow our customers to take action directly within Datadog platform. We announced the general availability of App Builder, which lets teams rapidly create self-service local applications and integrate them securely into their monitoring staff. And we introduced Datadog On-Call, a modern on-call experience with paging and incident management workflows pre-integrated with observability.

So let's move on now to sales and marketing. We again saw strong execution from our go-to-market teams this quarter, and we added some exciting new customers while expanding with many more. So I'll go through a few examples.

First, we landed our largest ever new logo win, a multiyear deal with total contract value in the tens of millions of dollars with one of the largest banks in South America. This customer was using a commercial observability product as well as open source tools, but didn't have full stack visibility. With Datadog, they will enable end-to-end observability. And they expect to transition to modern infrastructure, sorry, with confidence. They also anticipate better management and predictability of their observability costs, thanks to products such as Flex Logs.

Next, we signed a seven-figure annualized land deal with one of the world's largest travel management companies. This company was using a commercial lot management tool, but find it expensive and complex to support. They're also worried about stability as the tool with crash and [ cause fires ] across the organization. By moving to Datadog and replacing this tool, they expect to drive significant savings with log management and will benefit from our unified platform across infrastructure monitoring and APM.

Next, we landed a seven-figure annualized land with a security software company. This customer felt their overspending on their commercial volume tool and lack of visibility led to issues catching incidents with users notifying them first about this. This customer has now obtained the Datadog unified platform across all three dealers and displacing one commercial and two open source -- in the process. This customer also expects net savings of $0.5 million every year by switching to Datadog.

Next, we signed a seven-figure annual extension with the leading central bank in Europe. This institution became a Datadog customer 3 years ago, to enable its ambitious plan to move half of its applications to the cloud over a couple of years. And they have been increasing the usage of Datadog as they move into the cloud, displacing two commercial observability tools, which they use in their on-premise environment. They have now added a total of 17 Datadog products.

Next, we signed a seven-figure annualized expansion with a large American insurance company. The customer had been using Datadog for full stack of observability at one business unit. With this [ intention ], they have chosen Datadog as enterprise-wide observability provider. In comparing us to the performance of other tools, this customer measured stronger developer adoption and fewer incidents with Datadog. And in displacing its legacy APM and log management, they expect to save over $1 million annually on tool costs alone.

Finally, we signed a high seven-figure annualized expansion with a leading online gambling and entertainment platform. This long-time customer uses Datadog as its strategic observability partner, enabling full visibility across infrastructure, applications, logs, network and their public -- them with users spanning from hands-on keyboard engineers all the way to their sea level -- This renewal support its customers' expansion into new use cases to have security embedded into the operations by using all of our cloud security products, to build a culture of cost accountability with cloud management, and to take action -- management and workflow automation. And this customer to date has adopted 19 products in the Datadog platform. And that's it for another productive quarter from our go-to-market teams.

Now let me say a few words on our longer-term outlook. Overall, we continue to see no change to the multiyear trend towards digital transformation and cloud migration. We are seeing continued experimentation with new technologies, including next-gen AI, and we believe this is just one of the many factors that will drive greater use of the cloud and next-gen infrastructure.

As indicated by our many announcements at our [ DASH conference ], we are delivering rapid innovation at scale. And we are helping our customers every day to deploy and scale the model environment with confidence across observability, digital experience, cloud security, cloud service management, software delivery and product analytics.

Finally, I'd like to welcome two new leaders to our team Yanbing Li is joining us as our Chief Product Officer. Yanbing has more than 25 years of product, technology and engineering experience, spanning enterprise software, -- structure and AI at companies such as VMware, Google and Aurora. She will lead our product team's efforts to expand and adopt platform.

And David Galloreese is joining us as our Chief People Officer. David has more than 20 years of HR experience at tech companies and large-scale high-visibility enterprises, such as Sigma, Wells Fargo or Walmart. He will help us drive the next sector of growth and scale at Datadog.

With that, I will turn it over to our CFO. David?

[David Obstler, executive]

Thanks, Olivier, and good morning to all. Q2 revenues was -- were $645 million, up 25% year-over-year and up 6% quarter-over-quarter. To dive into some of the drivers of the Q2 revenue growth, first, regarding usage growth from existing customers. The overall trend we saw was consistent with our expectations.

In Q2, we saw usage growth from existing customers that was higher than usage growth in the year-ago quarter. And as we look across the first half of 2024, our usage growth was higher than the first half of 2023. And we are seeing solid growth across our products. Our three pillar products continue to increase in customer penetration and usage and our newer products across observability, cloud security and cloud service management are ramping.

Regarding usage growth by customer size in Q2, we saw strong performance amongst our largest customers who spend multiple millions of dollars with us annually, as they continue to return to growth and strike a balance between new deployment and focus on optimization. As we look at usage growth by segment, we saw the strongest growth with our enterprise customers, where year-over-year growth in usage has accelerated over the past several quarters. Over the same period, we have seen more steady year-over-year growth trends amongst our SMB and mid-market customers. As a reminder, we define enterprise as customers with 5,000 employees or more, mid-market as customers with 1,000 to 5,000 employees and SMB as customers with less than 1,000 employees.

Regarding our retention metrics, our net revenue retention percentage was in the mid-110s in Q2, similar to the past couple of quarters. But remember, this is a trailing 12-month measure, and we've seen an increase in recent quarters as we look at the NRR quarterly trend. And finally, our trailing 12-month gross revenue retention percentage remained stable in the mid- to high 90s.

Now moving on to our financial results. Billings were $667 million, up 28% year-over-year and similar to the trailing 12 months [indiscernible] year-over-year growth. Billings duration was roughly flat versus a year ago. Remaining performance obligations or RPO, was $1.79 billion, up 43% year-over-year. As we said before, contract duration has generally been increasing as customers choose more multiyear deals and contract duration increased modestly in the year-over-year period relative to a year ago.

Current RPO growth was in the [ mid-30s ] percent year-over-year. We continue to believe revenue is a better indicator of our business trends than billings and RPO as those can fluctuate on a quarterly basis relative to revenue based on the timing of invoicing and the duration of customer contracts.

Now let's review some of the key income statement results. Unless otherwise noted, all metrics are non-GAAP. We have provided a reconciliation of GAAP to non-GAAP financials in our earnings release.

Gross profit in the quarter was $530 million, representing a gross margin of 82.1%. This compares to a gross margin of 83.3% in the last quarter and 81.3% in the year-ago quarter. Our Q2 OpEx grew 21% year-over-year and increased from 14% year-over-year growth last quarter. Oli mentioned last quarter, Q2 OpEx included $11 million in expenses related to our DASH user conference. And as we've discussed, we are investing in headcount in 2024 and the growth in OpEx reflects our execution on hiring in sales and marketing and R&D so far this year. Q2 operating income was $158 million, or a 24% operating margin compared to 27% last quarter and 21% in the year-ago quarter.

Now turning to the balance sheet and cash flow statements. We ended the quarter with $3 billion in cash, cash equivalents and marketable securities. Cash flow from operations was $164 million in the quarter. And after taking into consideration capital expenditures and capitalized software, free cash flow was $144 million for a free cash flow margin of 22%.

Now for our outlook for the third quarter and the fiscal year 2024. First, our guidance philosophy remains unchanged. As a reminder, we base our guidance on trends observed in recent months and apply conservatism on these growth trends.

For the third quarter, we expect revenues to be in the range of $660 million to $664 million, which represents 21% year-over-year growth. Non-GAAP operating income is expected to be in the range of $146 million to $150 million, which implies an operating margin of 22% to 23%. And non-GAAP net income per share is expected to be $0.38 to $0.40 per share based on approximately 360 million weighted average diluted shares outstanding.

For the fiscal year 2024, we expect revenue to be in the range of $2.62 billion to $2.63 billion, which represents 23% to 24% year-over growth. Non-GAAP operating income is expected to be in the range of $620 million to $630 million, which implies an operating margin of 24%. And non-GAAP net income per share is expected to be in the range of $1.62 to $1.66 per share based on approximately 360 million weighted average diluted shares outstanding.

Some additional notes to our guidance. We expect net interest and other income for the fiscal year 2024 to be approximately $125 million. Next, we expect to pay cash taxes in the range of $20 million to $25 million and we continue to apply a 21% non-GAAP tax rate for 2024 and going forward. Finally, we continue to expect capital expenditures and capitalized software together to be in the 3% to 4% of revenues range in fiscal 2024.

And now to conclude. As Oli mentioned, we are pleased with our execution in the first half of 2024, and plan to continue to help our customers observe, secure and act in their modern cloud environments.

I want to thank Datadog's worldwide for their efforts in this. And with that, we will open up the call for questions. Operator, let's begin the Q&A.

[Operator]

[Operator Instructions] And our first question is going to come from the line of Sanjit Singh with Morgan Stanley.

[Sanjit Singh, analyst]

And congrats on Q2. I wanted to get your assessment of the sort of demand environment, spend environment and your description of like how the usage trends played out by end market, mid-market versus enterprise was super helpful. Microsoft had noted that they saw some weaker usage trends in June. I just want to get a sense of if you look across your geographies or even across some of your key verticals, anything that stood out sort of positive or negative in June going into July in terms of the usage trends?

[David Obstler, executive]

Yes. Thanks, Sanjit and hello. Again, I think you've noted, we said that we experienced strength in our enterprise segment and stability in our SMB segment. And that continued throughout the quarter.

As far as the more recent trends for what we're seeing towards the end of the quarter and also in July, very similar trends to what we saw in Q2 and for the first half of the year. So a continuation of higher usage growth than we saw in the comparable period in the previous year.

[Sanjit Singh, analyst]

Understood. And Oli, maybe for you. I know at the Investor Day, you sort of outlined the sort of thoughts and strategy on M&A and sort of identify the criteria. It sounds like your [ corp desk ] team sees a lot of opportunities, but the bar was pretty high was the message from the investor a couple of months ago. I wanted just to sort of double check your latest thinking on the M&A strategy with respect to potentially being looking at more strategic or transformational larger sized deal. Has anything sort of changed in the way you view M&A as part of the Datadog growth strategy?

[Olivier Pomel, executive]

So no, there's no change to the way we see things. Because we have this platform strategy where we're building a consolidator, and we're bringing together many different use cases into one shared platform, we had very broad interest and a very ambitious road map in many different directions. So as a result, we cast a very wide net when it comes to M&A. There's many possible potential fit for us.

So historically, we've been very successful with doing a lot of small and medium-sized deals. At any point in time, we're going to look at a lot of deals that might be small or big. We expect the bigger deal to be fewer and far between and the bar is very high for those. And today, we're also not looking into anything that would be very material to the business.

[Operator]

[Operator Instructions] And our next question comes from the line of Raimo Lenschow with Barclays.

[Raimo Lenschow, analyst]

Has there been any impact or what are you seeing in terms of as a reaction from customers around the Crowdstrike outage because that's obviously an event that impacted the whole industry? You guys, I'm sure, kind of saw some of the -- mitigations there. Just talk a little bit about how that impacted you in the quarter, but also what it means to customer conversations?

[Olivier Pomel, executive]

Yes. So I mean, obviously, this is something that was very much in the news, was very visible. It was particularly visible because it affected devices that airport kiosks, basically and point of sale, that are industrial in front of consumers and it was pretty much everyone. So very visible incident.

That being said, in the great scheme of observability, like it's very unremarkable. So the Crowdstrike event is very visible to everyone everywhere. But every single day, there's 100 or 1,000 companies that are having their Crowdstrike moment because they've updated software, either third-party software offers to soft that they've built, and they cause large business disruptions like -- issues. And that's what we deal with pretty much all the time.

So what you see in public eye is really a reflection of the value we provide every single day to our customers when it comes to preventive and whenever this should happen to remediate them extremely quickly.

So of course, we had all of the interactions you can imagine with the customers around it in terms of how they use our product to come back online, debug and everything. Even though the fix in that case was very, very manual. There was really no good way to automate it. But again, we see that every single day. That's what we do.

[Raimo Lenschow, analyst]

Okay. Perfect. And then the -- maybe it was just me, but it did feel like you mentioned logs quite a bit on this earnings call. Do you see any change? Like your product is getting more mature and the innovation that is coming through. It's obviously kind of very visible. But do you see a change in the market with kind of recent movements in terms of areas that, that kind of opens up a little bit more from your perspective? And congrats from me as well.

[Olivier Pomel, executive]

Yes. We definitely think there's going to be more opportunity in the future, which is why we're investing heavily both in terms of making logs economical to scale, Flex Logs, in particular. And also going further in terms of the sophistication of the functionality we can offer to customers so they can build very complex processes around those. So we talked about Log Workspaces also in the call. .

Log Workspaces is particularly interesting for customers who have used other platforms and have built pipelines basically that -- process a lot of logs data and so we build that for them. And that's been very well received so far. So all of that is in service of going after these opportunities.

[Operator]

[Operator Instructions] And our next question is going to come from the line of Mark Murphy with JPMorgan.

[Mark Murphy, analyst]

And I'll add my congrats. Olivier, it's great to see the announcement of LLM Observability reaching GA. There -- I think we're all looking at this tremendous wave of hyperscaler commitments they're going to be ramping in the second half of this year. And it's all for training of these next-gen AI models. And since you're more exposed to the -- excuse me, since you're less exposed to that training and you're more driven by the inferencing, I'm wondering if you could just help us understand how the spending pattern or activity changes as the AI models go live and reach the infant stage? Basically, looking for any way to assess how much spending is ultimately going to develop into the inferencing where you have an opportunity?

[Olivier Pomel, executive]

Yes. I mean, look, the -- in general, it's still early. We do see customers that are going increasingly into production, and we have a few of those. I mean we named a couple as early customers of LLM Observability. I think the two win name were -- the fitness plan and the app folio. And we see many more that are lining up and they're not going to do that. But in the grand scheme of things, looking at the whole market, it's still very early.

I would say the best proxy you can get from the future demand there is the growth of the model providers, the AI native, because they tend to be the ones that currently are being used to provide AI functionality into other applications and largely in production environment. And so I would say they are the [ hubbing year ] of goods to come.

[Mark Murphy, analyst]

Okay. And then as a quick follow-up, maybe for David, a couple of the consumption model, software company had recently commented that in June and July, they were seeing more cloud cost control or optimization, specifically among the digital natives. And so your results are solid. I don't think you mentioned that, but could you comment on how the optimization activity is kind of trending out between the digital natives and the enterprises heading into the back half?

[David Obstler, executive]

Yes. As you know, we've said that. So when you look at the time series, the peak of the optimization was in Q2, Q3 last year, and we've had a time series of higher usage growth for our clients month-to-month since then. And that's continued through the first half of the year and into July.

It's -- the usage growth, as we talked about, is stronger in the enterprise and in the larger users, but it has been fairly stable in the SMB. So we're seeing some more -- if you look at the chart in the line, enterprise being usage growth being higher than it had been and SMB being stable.

[Olivier Pomel, executive]

And for us, I would add that the digital natives are largely SMB and mid-market. They're not enterprise. And even when you look at the digital native, there's two stories depending on whether you talk about the AI natives or the others. The AI natives are inflecting in a way that the others are not at this point. So today, we see this higher growth from AI natives and from traditional enterprises and stable growth, but not accelerating from the rest of the pack.

[Operator]

[Operator Instructions] And our next question is going to come from the line of Kash Rangan with Goldman Sachs.

[Kasthuri Rangan, analyst]

Oli, you've mentioned, I think, between -- on the call, there's been repeated in terms of enterprise growing faster than SMB. I'm curious, why is that the case? And is this -- is it something of a change in the trend? Have you seen SMB is actually showing better usage trends in the past? And what could cause the SMBs to start to pick up consumption? What are the things that are holding back that consumption? And what could be the unlocks from there because the enterprises are doing well. So obviously, the product portfolio is being well received. So what's topping the SMBs?

[Olivier Pomel, executive]

Yes. I don't know that there's that much of a trend just yet to look at or there's too much to say at this point. This is just the way the numbers came up in the -- over the past quarter or so.

I would say, look, there's many reasons why the SMBs could be more careful in terms of the macro environment, the fact that there are less -- maybe less -- there's less runway -- immediate runway with consolidation, like things like that compared to the larger enterprises and some of them maybe are further along also in their cloud journey. So the growth there is more tied to their overall growth as opposed to the speed of transition into next-gen Ai and cloud environment. So these are all potential factors.

But look, there's no -- at this point, I wouldn't call it like a major, super important difference. I think we'll see what this looks like in a few quarters.

[Kasthuri Rangan, analyst]

Got it. And one for David, if I could. How strong is the delta between enterprise consumption growth versus SMB? Are we talking orders of magnitude or meaningful percentage or a big percentage?

[Olivier Pomel, executive]

No, no. We're just talking about a few points but different trends. That's it.

[David Obstler, executive]

We're just basically commenting on the line. As we said, they have been round each others. And we're really commenting more on, as Oli mentioned, enterprise, things like they may have been more careful in the increase of spending, consolidation continues to be a factor in going to a common platform.

But as Oli mentioned, these are sort of comments on the way things are evolving, but we still have pretty similar metrics in all the different segments.

[Olivier Pomel, executive]

We know the issue, something that we noted because we -- a little bit counterintuitive in that when you look at the overall market, the enterprise is where we have the most mature competition, the most scaled competition. And we're doing better. That party is getting faster than I would call it the less competitive side of the market. But again, not too much to read into it just yet. We're just informing you of the trends.

[Operator]

[Operator Instructions] Our next question is going to come from the line of Kirk Materne, Evercore ISI.

[Mark Murphy, analyst]

I'll add my congrats on the quarter. Olivier, I was wondering if you could just talk a little bit more about the LLM Observability product that Mark referenced. When people are thinking about bringing on LLMs into their organization, do they want the observability product in place already? Or are they testing out LLMs and then bringing you on after the fact? I'm just wondering sort of a chicken and egg question, wondering if you're someone they want to talk to you before they start running things into production or it's after they get something going, they bring you in after the fact?

[Olivier Pomel, executive]

Yes, I think so -- so the first thing I'd say is we expect this market to change a lot over time because it is far from being mature. And so a lot of the things that might happen today in a certain way might happen 2 years in a very, very different form.

That being said, the way it works typically is customers build applications using developer tools, and there's a whole industry that has emerged around developer tools for -- and playgrounds and things like that for LLM. And so they use not one, but 100 different things to do that, which is fairly similar to what you might find on the ID side or code data side for the more traditional development, which is not a different very fragmented environment on that side.

When they start connecting the LLM to the rest of the application, then they start to need like visibility that includes the other components because the LLM doesn't work in the vacuum. It's plugged into a front end. It works with authentication and security. It works with -- connects to other systems that is based in the services to get the data. And at that point, they needed to be integrated with the rest of the observability.

For the customers that use our LLM Observability product, they use us for the rest -- all the rest of their stack, and you would make absolutely no sense for them to operate the LLM in isolation pretty separately and not have the observability of all applications. So it's fair. At that point, it's a no-brainer that they did everything to be integrated in production.

[S. Kirk Materne, analyst]

That's helpful. And then David, we can kind of infer your sort of implied guidance for 4Q. I was just wondering, some of the elections in Europe have come up in a couple of other calls in terms of anything that have been distractions. I was just wondering if you had any thoughts on how you think the U.S. election might impact usage, if at all? Or if you have any thoughts on that? I realize you guys were a lot smaller last time, w had a presidential election.

[David Obstler, executive]

Yes. I mean we're -- no, we are not forecasters like that. As you know, usage growth has many factors. The effect of the election on the operation of modern cloud applications is not something that has been a very significant change in usage patterns, for instance, in the European elections that we wouldn't anticipate here as well.

[Olivier Pomel, executive]

No, no impact. The only impact on us of the U.S. election is we're trying not to schedule our earnings calls on the same day.

[Operator]

[Operator Instructions] And our next question comes from the line of Fatima Boolani with Citi.

[Fatima Boolani, analyst]

Oli, I wanted to start with you. You and David both talked about improving usage trends. But I wanted to take a step back and ask you, have you seen the quality of the usage improve by virtue of or by extension of your introduction of the cloud cost management SKUs? You talked about the Kubernetes with the Autoscaling and then the original sort of cloud cost management SKU. So I'm wondering if maybe a spurious correlation now that customers have that much more visibility into the mechanics of what they're spending with you, they're actually more inclined to drive usage because it's higher fidelity. Just any commentary on that would be helpful. And then I have a follow-up for David, please.

[Olivier Pomel, executive]

Yes. I mean, look, in general, customers have invested a lot in understanding their spend, whether that's on us or on their cloud providers. And as a result, you can say that there's less, call it, overhang of saying customers are setting they don't understand, which is always bad in the long term. So I think customers understand much better the value of what they're getting in the cloud in general this year than they did 2 years ago before this whole optimization movements started.

And they want more in terms of visibility into what the spend would actually create value for them and where they can optimize in the future. So we -- that's definitely a virtual cycle that we embark on with our customers in terms of being the right products for them.

[Fatima Boolani, analyst]

I appreciate that. And David, as you all kind of rolled out more, what I would call, resource intensive or compute-intensive SKUs like log, Flex Log, Log Workspaces. I'm wondering if you can shed a little bit of light on how some of the gross margin characteristics differ by product pillar? I'm just looking at kind of some of the sequential compression in gross margins. So I just kind of wanted to get a better understanding of what are some of the more resource-intensive products that you're anticipating scaling that could keep a lid on gross margins in the next couple of quarters?

[David Obstler, executive]

Yes. We have -- I'll just go on the numbers first and then Oli, on the engineering side of it. But essentially, what we said consistently is that gross margins have operated in a range. They've operated towards the top of the range. But there will be variability quarter-to-quarter as we launch functionality, often having to do with rolling out functionality and then optimizing it. And so the movement -- slight movements that we've seen quarter-to-quarter have been the result of that, and then turn it over to Oli for more on the sort of engineering.

[Olivier Pomel, executive]

Yes. There's definitely nothing to read into the small movements in the gross margin from a product mix perspective. A lot of what happened is we build new features, maybe some of these new features will have more computing impact and more storage impact or something else. Maybe also they won't be fantastically optimized in their one from efficiency perspective or maybe sometimes we'll focus more on building more things as opposed to optimizing them because they are the same people, same resources and that welcome both.

And so what you should expect to see some ebbs and flows on that number as we keep shipping you feature and then we keep optimizing. In general, we see good about the gross margins we're not constrained in terms of what we can build by the margin profile we have. And also, should we need them, we have many levers to improve these margins as well. So we wouldn't read too much into the small changes and expect some of those more changes in the future. And -- we feel good about that.

[Operator]

[Operator Instructions] And our next question is going to come from the line of Matt Hedberg with RBC.

[Matthew Hedberg, analyst]

Oli, in your prepared remarks, you talked a lot about security and noted data security as a new sort of growth engine from a product perspective. I'm curious, can you talk about how customers might leverage that offering versus maybe other traditional data security offerings maybe like DLP, for instance?

[Olivier Pomel, executive]

Yes. So it's interesting because the -- so in many ways, we've been doing data security for a while now. So we -- on top of our logging product, we started building sensitive data scanning, which is very successful with customers. We extended that to cover Datadog flows inside APM -- that flows between the front end and the back end in real monitoring. And we basically had our customers ask for more. Basically, they wanted to not just see data in transit, but also see where data was exposed at best. And so that's how we extend it to the rest of data security.

So you can see customers coming to that from decent side on our end. One is customers opting on security suite and data security is little by well becoming part of CNAPP and infrastructure security in general. But we also see customers coming to reach from the log and APM side, basically where they start from the applications and they want to track where the date. So it serves both sides basically. And it plays to the strategy we have of integrating both observability and security into one platform.

[Matthew Hedberg, analyst]

Got it. Super helpful. And then as we get into 3Q and kind of the U.S. Fed spending quarter, what are your thoughts on how federal spending just in general, might play out in Q3 relative to kind of your assumptions?

[Olivier Pomel, executive]

Well, we're building up the capacity for it. So we have built up to do on civil side. I mean we have the go-to-market capacity to build. We also are still pursuing more government certifications and government-specific deployments to open up some more of the market there, but that's definitely an area investment for us. .

[Operator]

[Operator Instructions] And our next question comes from the line of Jake Roberge with William Blair.

[Jacob Roberge, analyst]

Just wanted to follow up on the enterprise strength that you saw in the quarter. Are you starting to see enterprises reengage with their cloud migration efforts, which is helping you drive that growth? Or is it -- is the strength more related to just general platform usage and expansion?

[Olivier Pomel, executive]

They never stopped their enterprise migrations. I think maybe some of the users was not growing as quickly for some time. There'll be some short-term optimization efforts were ongoing. But the direction was always the same, like they -- and also they never stop growing with us in the cloud. So we definitely saw that throughout the past couple of years.

Some of the strengths we see today has to do with the fact that to serve their -- in part to -- the emergence of AI has reaffirmed for them the need to go to the cloud sooner rather than later. So they can build the right kind of applications, they have the right kind of data available to those applications. But also, we have more to offer. Like we have -- we can do more and consolidate more of what they were using before and that gives us more avenues to grow these customers in the short term.

[David Obstler, executive]

I think we said over the quarters that one enterprise is very early in their journey. And there's a lot of white space too that we said a couple of quarters ago, the enterprise had started to resume more normal activity of deploying of modern cloud applications. And as Oli mentioned, there's opportunities also for consolidation in the platform -- cloud platform that we've talked about many times..

[Olivier Pomel, executive]

I'd point you to the numbers we shared, I think, 2 quarters ago in terms of our enterprise penetration and the average size of our contracts with enterprises, which are still fairly small. Like there's a lot of runway there. And the growth of those accounts is not predicated on the growth of the enterprise themselves. They're still early in their transformation. .

[Jacob Roberge, analyst]

Okay. Very helpful. And then you've talked a decent amount about the demand you're seeing from AI native customers. But how are you thinking about driving growth with your own AI solutions like Bits AI and LLM Observability? And when do you think those start to layer more meaningfully into the model?

[Olivier Pomel, executive]

Yes. I mean right now, the first area of direct application of Bits AI is incident management and incident resolution. So that is tied more to the SKUs we're selling there in terms of incident management. And -- but Bits AI is not the only ingredient of that product. So part of it is the -- what we have already because of the mechanics of incident management. Part of it is also the new Encore product we announced. And part of it is going to be the smart in bits. And we're integrating all that to have a fantastic end-to-end experience for our customers that almost make them want to have incidents. No, actually, they still don't want it sees, but the point here is it should really help them .

[Operator]

[Operator Instructions] And our next question comes from the line of Koji Ikeda with BofA.

[Koji Ikeda, analyst]

Just one for me. I wanted to ask on the usage growth trends. In the prepared remarks, you said a lot about friends exiting this quarter versus 2Q of last quarter and the first half of this year being better than the first half of last year. But the question here is, how did Q2 this year compared to Q1 this year?

[David Obstler, executive]

Yes, we have -- so we have normal seasonality related to the number of days in the quarter and customer behavior as they launch new applications. So we saw -- we really look at it because of the seasonality over quarter. So the usage growth exhibited the same patterns of improvement over last year's similar period looking at the days as it did in the first quarter.

[Koji Ikeda, analyst]

Got it, David. One quick follow-up if I may here. Then the follow-up would be, I know in the Q, you gave a net new revenue growth split between existing and new. I was wondering if you could get that mix now or maybe at least some color in that mix? Last quarter was 70% coming from net new from existing. Was it higher or lower this quarter from that 70%?

[David Obstler, executive]

It's going to be 75-25. 25% from new, 75%, which would be what we said all along is that as net retention recovers and usage growth is higher than the previous comparable period. As -- if you go back through our history, you will see that the amount from existing customers relative to new logos has generally increased.

[Operator]

[Operator Instructions] And our next question is going to come from the line of Yi Fu Lee with Cantor Fitzgerald.

[Yi Lee, analyst]

Congrats on the quarter. In terms of like the new products that were launched at DASH, a lot of stuff going on LLM, AIOps, et cetera. Like Olivier and David, like which one are you most bullish near term and then longer term?

[Olivier Pomel, executive]

Well, it's always hard to have a favorite child in all of the amazing things that we're shipping. Look, I think the short term is the ones that are going to have the most impact are the ones that relates to the products that they already have scale. So anything we do that facilitate the deployment of API -- scale has a large impact. Everything we do that makes that changes the economics of logs, opens up new market within the legacy, lowering user base has a huge impact. What we're doing with OpenTelemetry has a large impact because it's a big trend in the industry and taking we're making bold moves there.

So longer term, look, we think there's a very opportunity for us to do a lot of automation we have of our customers. And you see that, whether that's on the observability side or on the security side, with all of the various ways in which we are taking action into the product, we are fixing things for customers. We're driving them to take the next step. We are organizing the tracking of the workflows they're running from end to end. So this is a longer deal. But I think in the long way, very large difference in terms of value we can provide to our customers.

[Yi Lee, analyst]

Excellent. And just a quick follow-up for David is like NRR is like at the mid-110 level. What needs to happen in order for Datadog to go back to the above 120 level? I mean it sounds like trends are very, very healthy month-to-month, quarter-over-quarter. So just some commentary around the [indiscernible].

[David Obstler, executive]

Yes. I mean, we don't give that forecast. I mean, the components are the use of existing products and the cross-sell. And so as you mentioned, both of those have been stronger in the first half of this year than they were last year. And we'll see what happens, but we don't give guidance or forecast on net retention.

[Operator]

[Operator Instructions] And our next question comes from the line of Patrick Colville with Scotiabank.

[Patrick Edwin Colville, analyst]

Olivier and David, I mean one of the things you talked about in the past is kind of competitive dynamics in observability. There have been a lot of corporate transactions in the space over the past year. So I guess how are you seeing competition versus your open source peers, kind of platform peers that are now private versus a couple of quarters ago?

[Olivier Pomel, executive]

So in general, the commission is very much unchanged. There's nothing super specific to say about that. I think the -- we have some of the scaled players that are disappearing to a certain extent as a result of the transactions you've mentioned though we expect that to play out more in the midterm than in the very short term in the marketplace.

We do have scaled competition still in terms of public companies that are competing with us on observability. And there's no change in the posture there, and we like the way we're performing. And a number of the large deals we mentioned where displacement or wins against this folks. We feel very good about that.

And then on the low end, there's been pretty much a rotating caps of subscale companies that are going after that market. And that's what also unchanged. That's been the same from the -- throughout the life of the company pretty much. So nothing to report there.

I think largely, when we build products, we build it with customers. We don't build it with competition in mind. The few exceptions being when we see large scale opportunities in the market because of the big changes in big transactions that you mentioned earlier.

[Patrick Edwin Colville, analyst]

Okay. Very helpful. And I guess, David, looking at the 3Q revenue guidance, it looks like the kind of buoyant trends you saw this quarter will continue. Can you just put a fine pin possible on the trends we saw through July and thus far in August.

[David Obstler, executive]

Yes. No, though, I think what we've seen since the quarter, as we mentioned, is a continuation of better usage trends relative to the comparable period last year. So more of -- And in our guidance philosophy, it hasn't changed. We take those trends as much information as we have and applied discount and conservatism given that we don't control the consumption of our clients, we observe it.

So it's a very similar methodology to what we've used in previous quarters and attenuation of the trends we've seen in the first half of the year.

[Operator]

[Operator Instructions] And our next question comes from the line of Taz Koujalgi with Wedbush Securities.

[Imtiaz Koujalgi, analyst]

I have a question for David on your security growth this quarter. So I tried to reconcile the comments you made about the usage growth in this quarter being better than last year. But if you look at the revenue growth sequentially, that's slowed down. I think it's the lowest Q2 sequential growth in the longest time.

And one more question was if you look at the sequential growth for the last 3, 4 quarters, it's been accelerating since your optimization trends ended. Did that trend kind of, I guess -- this quarter because the Q-o-Q growth in Q2 was lower than what you had last year? So just like to reconcile the commentary about usage growth being strong, but then the revenue growth sequentially looks a little bit lighter than last year.

[David Obstler, executive]

Yes. A lot of that has to do with what we saw we said, which is that in the second half of December, clients are not at their desk and new deployments have been frozen. So we generally find that the usage or revenue run rate growth then goes down or is the same. And then we find a recovery as people get back to their desks in Q1. And then we find in Q2, a similar linearity pattern that we see in all Q2s, which is how it's sort of people work. And so we didn't see anything out of the ordinary in terms of the time series of Q4 to Q1 to Q2.

[Imtiaz Koujalgi, analyst]

Got it. And then one -- just one follow-up. And David, you mentioned that revenue is the best metric for your business. You shouldn't be looking at billings and RPO bookings. But I'm just wondering, any color you can provide in the first half of bookings growth this year? It's been flat year-over-year with duration increasing it. That's, I think, the lowest bookings growth again in any first half of your year. Any more commentary beyond what you already acquired, is the renewal base lighter in the first half? Should we expect an acceleration in the second half? Any more color on the bookings momentum?

[David Obstler, executive]

No. If you look at the latest 12 months of all these trends, they all eventually converge around revenues. It has to do with, as we mentioned in every earnings call, when bills go out, whether the deals are multiyear or single year, et cetera. So no, all of that is essentially balances out back to the metrics that we direct you to, which is revenue and then ARR. So no, nothing in it. .

[Operator]

And I would now like to hand the conference back over to Olivier Pomel for any further remarks.

[Olivier Pomel, executive]

Thank you. And just to close the call, I want to thank again everybody who was involved in DASH here. So that means obviously the product engineering teams -- this amazing products and there was for them. That means the go-to-market teams that have relayed the message to our customers, that means the marketing and community teams that did such a fantastic job putting up a show. And of course, that means the customers who showed up in large numbers with enthusiasm and who have been the life of the conference. So thank you, everyone, and we'll see you next quarter.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.