Datadog, Inc. annual report, FY2020

Datadog, Inc. 2020 Form 10-K Summary

Business context and reporting period

Datadog provides a cloud-based monitoring and analytics platform integrating infrastructure monitoring, application performance monitoring, log management, security monitoring, user experience monitoring, network performance monitoring, incident management and continuous profiling. The filing covers the fiscal year ended December 31, 2020, with comparative results for 2019 and 2018. The filing also includes unaudited quarterly information for the fourth quarter ended December 31, 2020.

Datadog had approximately 14,200 customers in more than 100 countries and 2,185 employees at December 31, 2020. Revenue outside North America represented approximately 25% of total revenue.

Financial performance and key metrics

Metric	2020	2019	Change
Revenue	$603.5 million	$362.8 million	Up 66%
Gross profit	$473.3 million	$273.8 million	Up 73%
Gross margin	78%	75%	Up 3 percentage points
Operating loss	$13.8 million	$20.1 million	Improved by $6.4 million
Net loss	$24.5 million	$16.7 million	Loss increased by $7.8 million
Operating cash flow	$109.1 million	$24.2 million	Up $84.9 million
Free cash flow	$83.2 million	$0.8 million	Up $82.4 million
Cash and cash equivalents	$224.9 million	$597.3 million	Down $372.4 million
Marketable securities	$1.293 billion	$176.7 million	Up $1.116 billion

Fourth-quarter 2020 revenue was $177.5 million, up from $113.6 million in the fourth quarter of 2019. Fourth-quarter gross margin was 77%, and fourth-quarter net loss was $16.2 million, compared with net income of $0.9 million in the fourth quarter of 2019.

Research and development expense increased 89% to $210.6 million, sales and marketing expense increased 46% to $213.7 million, and general and administrative expense increased 75% to $62.8 million. Stock-based compensation expense rose to $74.4 million from $19.0 million.

Revenue growth was approximately 59% from existing customers and 41% from new customers. Customers with annual run-rate revenue of at least $100,000 increased to 1,253 from 858, representing 78% of ARR versus 75% in 2019. Dollar-based net retention exceeded 130% at both year-end 2020 and year-end 2019. Approximately 72% of customers used more than one product, compared with approximately 60% a year earlier.

Liquidity, debt and cash flow

Cash, cash equivalents and restricted cash totaled $228.7 million at December 31, 2020; cash and cash equivalents alone totaled $224.9 million.
Marketable securities totaled $1.293 billion, with substantially all classified as current assets.
Operating cash flow benefited substantially from $69.8 million of increased deferred revenue and significant non-cash charges, including $74.4 million of stock-based compensation and $18.7 million of amortization of convertible-debt discount and issuance costs.
Investing activities used $1.153 billion, primarily reflecting purchases of marketable securities, capitalized software development costs of $20.5 million, capital expenditures of $5.4 million and a $2.4 million acquisition.
In June 2020, Datadog issued $747.5 million of 0.125% convertible senior notes due 2025 and received approximately $730.2 million of net proceeds. The notes had a $575.9 million carrying value at year-end because of the unamortized debt discount and issuance costs.
Datadog paid $89.6 million for capped calls intended to partially offset potential dilution from conversion of the notes. The initial conversion price was approximately $92.30 per share and the initial cap price was approximately $151.04 per share.
Contractual operating lease and purchase commitments totaled $278.8 million, including $184.2 million of purchase commitments primarily related to cloud hosting and software services.
Management stated that existing cash, marketable securities and operating cash flow should fund working capital and capital expenditure requirements for at least the next 12 months.

Material changes versus the prior comparable period

Revenue growth remained strong at 66%, but the company continued to report a GAAP net loss.
Gross margin improved from 75% to 78%, primarily because of revenue scale and cost savings from third-party cloud infrastructure providers.
Operating loss narrowed despite substantially higher investment in research and development and sales and marketing.
Net loss increased because of $30.4 million of interest expense, including significant non-cash amortization associated with the 2025 Notes.
Operating cash flow and free cash flow improved materially, while cash balances declined because proceeds were shifted into marketable securities and used for investing activities.
Customer count increased from approximately 10,500 to approximately 14,170, and product cross-adoption increased substantially.
COVID-19 affected the rate of usage growth from existing customers during the second quarter. Datadog moved most employees to remote work, suspended non-essential travel and shifted events to virtual formats.
Stock-based compensation increased materially, and outstanding unrecognized compensation cost totaled approximately $342.1 million at year-end, including $60.6 million for options and $281.5 million for RSUs and restricted shares.

Guidance, outlook, commentary and unusual items

The 10-K does not provide a clear quantitative revenue or earnings forecast. Management expects continued growth but cautions that revenue growth rates will decline as the business scales. Planned investments include product development, infrastructure, sales and marketing, international expansion and public-company compliance.

Management expects continued expansion within existing customers, broader product adoption, new product development and international growth.
COVID-19 creates uncertainty around customer usage, sales cycles, industry events, recruiting, operations and future IT spending. The filing states that the full impact may not be reflected immediately because of the subscription model.
The company expects gross margins and quarterly results to fluctuate based on cloud infrastructure costs, headcount, usage-based revenue, customer purchasing cycles and investment levels.
Datadog has a history of operating losses and states that it may not achieve or sustain profitability.
The company early adopted ASU 2020-06 on January 1, 2021. Adoption is expected to reduce interest expense related to the convertible notes and decrease opening accumulated deficit by approximately $16.8 million.
In February 2021, after year-end, Datadog agreed to acquire Sqreen, Inc. for approximately $260 million in cash and stock, subject to customary adjustments, and completed the acquisition of Timber Technologies. Purchase price allocations were still being evaluated.
The company released a $5.6 million contingent federal payroll tax liability in 2020 after the applicable statute of limitations expired. This reduced operating expenses and was a non-recurring benefit.
No current legal proceedings were identified as expected to have a material adverse effect, and the company reported no off-balance-sheet financing arrangements.

Principal risks and contingencies

COVID-19, economic weakness and reduced customer IT spending could reduce usage, new bookings, renewals and expansion.
Customer retention and expansion are critical because subscription terms are primarily monthly or annual and customers have no obligation to renew.
Cybersecurity incidents, data breaches, ransomware, service outages or failures by third-party cloud providers could result in liability, reputational damage and customer losses.
Competition includes large technology vendors, cloud providers, specialized monitoring companies, open-source projects and customer-built systems; competitors may have greater resources and pricing flexibility.
Rapid growth may increase infrastructure, personnel, support, compliance and cloud-hosting costs and could pressure gross margins.
The company remains exposed to convertible-debt repayment, cash-settlement and potential dilution risks, although capped calls are designed to partially offset dilution.
Privacy and data-transfer regulations, including GDPR, Schrems II, CCPA and evolving international data-residency requirements, may increase costs or restrict sales.
Datadog's dual-class structure gives Class B holders approximately 80% of voting power at December 31, 2020, limiting Class A stockholders' influence.

Important facts for investors to verify

Reconcile the reported $603.5 million revenue, 78% gross margin and $24.5 million GAAP net loss with the company's growth investments and non-cash expenses.
Assess the sustainability of $109.1 million of operating cash flow and $83.2 million of free cash flow, including the contribution from deferred revenue and stock-based compensation.
Review customer retention, ARR expansion, the number of customers above $100,000 ARR and the percentage using multiple products.
Evaluate the economic and dilution implications of the $747.5 million convertible notes, the $575.9 million carrying value, conversion terms and capped calls.
Monitor gross-margin trends as cloud-hosting costs, usage-based revenue and infrastructure scale change.
Quantify the effect of stock-based compensation, future equity grants and the approximately $342.1 million of unrecognized compensation cost.
Review the subsequent Sqreen acquisition, the Timber Technologies acquisition and the related purchase price allocations.
Track COVID-19 effects on customer usage, sales cycles, renewals, international expansion and operating costs.