Datadog Inc. (NASDAQ: DDOG) witnessed a sharp selloff in Thursday's trading session, with shares tumbling 14.2% to $242.90 by mid-morning. The decline came as investors reacted to news that the company's largest artificial intelligence client has signaled reduced consumption for the remainder of the year, overshadowing an otherwise robust quarterly performance.
The monitoring and analytics platform reported second-quarter revenue of $1.121 billion, a 36% year-over-year increase that surpassed the consensus estimate of $1.08 billion. Adjusted earnings per share came in at $0.65, beating expectations of $0.58. The company also posted a free-cash-flow margin of 25%, with operating cash flow reaching $316 million and free cash flow of $278.7 million—a 68.6% jump from the prior year.
Despite the strong numbers, management's guidance for the second half of the year raised concerns. The company raised its full-year revenue midpoint to $4.46 billion, up $140 million from May's guidance, and lifted its adjusted EPS midpoint by 5% to $2.52. However, the outlook incorporates reduced usage from a key AI customer, which had recently signed a nine-figure contract renewal. The distinction between contract renewal and actual consumption is critical, as the drop in usage is expected to weigh on growth.
Based on the annual midpoint, Datadog's implied fourth-quarter revenue is approximately $1.192 billion, indicating year-over-year growth of around 25%—a significant deceleration from the 36% growth recorded in Q2. The Q3 midpoint of $1.140 billion suggests 28.7% growth, down from 35.6% in Q2. This projected slowdown of 10.6 percentage points by Q4 has spooked investors, especially given that the stock had more than doubled year-to-date prior to this announcement.
The market's reaction was notably more severe for Datadog compared to its peers in the observability and monitoring space. Dynatrace (NYSE: DT) fell 3.5%, Elastic (NYSE: ESTC) declined 1.2%, and Cloudflare (NYSE: NET) dropped 1.3%, suggesting the selloff is specific to Datadog rather than a broader sector trend.
Investor concerns are compounded by the company's customer concentration risk. While the number of customers with at least $100,000 in annual recurring revenue grew 23% year-over-year to 4,720—an acceleration from 21% in the prior quarter—the reliance on a single large AI client for a significant portion of usage creates volatility in a usage-based revenue model. Additional reductions from this client, or others, could further pressure growth unless offset by gains elsewhere.
Analysts have yet to adjust their price targets following the news, with targets ranging from $280 to $315, implying a potential upside of 15% to 30% from Thursday's intraday level. However, these targets are likely to be revised in the coming days as the market digests the implications of the AI client's reduced activity.
Operationally, the quarter was strong by most measures. Non-GAAP operating margin expanded to 23%, up three points from a year ago. Gross margin, however, declined by one percentage point, and stock-based compensation totaled $220 million, representing nearly 20% of revenue. GAAP operating margin remained close to break-even.
Looking ahead, the key test will be whether Q3 growth remains close to the 29% midpoint and whether usage trends outside the primary AI account can offset any further softness. Thursday's drop may represent a recalibration of expectations, or it could be an early warning of a broader slowdown in AI-related spending. Investors will be watching closely for any updates on customer usage patterns in the coming months.
