(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10- Q and our audited consolidated financial statements and the related notes and the discussion under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, or the Annual Report. This discussion, particularly information with respect to our future results of operations or financial condition, business strategy, plans and objectives of management for future operations and the potential impact that the worldwide COVID-19 pandemic may have on our business, includes forward-looking statements that involve risks and uncertainties as described under the heading "Special Note Regarding Forward-Looking Statements" in this Quarterly Report on Form 10-Q. You should review the disclosure under the heading "Risk Factors" in this Quarterly Report on Form 10-Q for a discussion of important factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements.
Datadog is the monitoring and analytics platform for developers, IT operations teams and business users in the cloud age.
Our SaaS platform integrates and automates infrastructure monitoring, application performance monitoring and log management to provide unified, real-time observability of our customers' entire technology stack. Datadog is used by organizations of all sizes and across a wide range of industries to enable digital transformation and cloud migration, drive collaboration among development, operations and business teams, accelerate time to market for applications, reduce time to problem resolution, understand user behavior and track key business metrics.
We generate revenue from the sale of subscriptions to customers using our cloud-based platform. Our paid subscriptions are available in Pro and Enterprise tiers. The terms of our subscription agreements are primarily monthly or annual. Customers also have the option to purchase additional products, such as additional containers to monitor, custom metrics packages, anomaly detection and app analytics. Professional services are generally not required for the implementation of our products and revenue from such services has been immaterial to date.
We employ a land-and-expand business model centered around offering products that are easy to adopt and have a very short time to value. Our customers can expand their footprint with us on a self-service basis. Our customers often significantly increase their usage of the products they initially buy from us and expand their usage to other products we offer on our platform. We grow with our customers as they expand their workloads in the public and private cloud.
As of March 31, 2020, we had $198.2 million in cash, cash equivalents and restricted cash, and $600.4 million in marketable securities. We generated revenue of $131.2 million and $70.1 million in the three months ended March 31, 2020 and 2019, respectively, representing year-over-year growth of 87%. Substantially all of our revenue is subscription software sales. Our net income
Since December 2019, a novel strain of coronavirus, which we refer to, together with other related strains of coronavirus, as "COVID-19", has spread to multiple countries, including the United States and other countries in which we and our customers, partners, suppliers, vendors and other parties with whom we do business operate. The extent of the impact of the COVID-19 pandemic on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, its impact on industry events, and its effect on our customers, partners, suppliers and vendors and other parties with whom we do business, all of which are uncertain and cannot be predicted at this time. To the extent possible, we are conducting business as usual, with necessary or advisable modifications to employee travel and employee work locations, and cancelling or holding virtually Datadog marketing events. We will continue to actively monitor the rapidly evolving situation related to COVID-19 and may take further actions that alter our business operations, including those that may be required by federal, state or local authorities, or that we determine are in the best interests of our employees, customers, partners, suppliers, vendors and stockholders. At this point, the extent to which the COVID-19 pandemic may impact our results of operations and financial condition is uncertain. Furthermore, due to our subscription model, the effect of the COVID-19 pandemic, if any, may not be fully reflected in our results of operations until future periods.
Factors Affecting Our Performance
Acquiring New Customers
We believe there is substantial opportunity to continue to grow our customer base. We intend to drive new customer acquisition by continuing to invest significantly in sales and marketing to engage our prospective customers, increase brand awareness and drive adoption of our platform and products. We also plan to continue to invest in building brand awareness within the development and operations communities. As of March 31, 2020, we had approximately 11,500 customers spanning organizations of a broad range of sizes and industries. Our ability to attract new customers will depend on a number of factors, including the effectiveness and pricing of our products, offerings of our competitors, and the effectiveness of our marketing efforts.
We define the number of customers as the number of accounts with a unique account identifier for which we have an active subscription in the period indicated. Users of our free trials or tier are not included in our customer count. A single organization with multiple divisions, segments or subsidiaries is generally counted as a single customer. However, in some cases where they have separate billing terms, we may count separate divisions, segments or subsidiaries as multiple customers.
Expanding Within Our Existing Customer Base
Our base of customers represents a significant opportunity for further sales expansion. As of March 31, 2020, we had 960 customers with annual run-rate revenue, or ARR, of $100,000 or more, up from 508 as of March 31, 2019. We define ARR as the annual run-rate revenue of subscription agreements from all customers at a point in time. We calculate ARR by taking the monthly run-rate revenue, or MRR, and multiplying it by 12. MRR for each month is calculated by aggregating, for all customers during that month, monthly revenue from committed contractual amounts, additional usage and monthly subscriptions. ARR and MRR should be viewed independently of revenue, and do not represent our revenue under generally accepted accounting principles in the United States, or GAAP, on a monthly or annualized basis, as they are operating metrics that can be impacted by contract start and end dates and renewal rates. ARR and MRR are not intended to be replacements or forecasts of revenue. We believe that our land-and-expand business model allows us to efficiently increase revenue from our existing customer base. Our customers often expand the deployment of our platform across large teams and more broadly within the enterprise as they migrate more workloads to the cloud, find new use cases for our platform, and generally realize the benefits of our platform. We intend to continue to invest in enhancing awareness of our brand and developing more products, features and functionality, which we believe are important factors to achieve widespread adoption of our platform. Our ability to increase sales to existing customers will depend on a number of factors, including our customers' satisfaction with our solution, competition, pricing and overall changes in our customers' spending levels.
Sustaining Innovation and Technology Leadership
Our success is dependent on our ability to sustain innovation and technology leadership in order to maintain our competitive advantage. We believe that we have built a highly differentiated platform that will position us to further extend the adoption of our platform and products. Datadog is frequently deployed across a customer's entire infrastructure, making it ubiquitous. Datadog is a daily part of the lives of developers, operations engineers and business leaders. We employ a land-and-expand business model centered around offering products that are easy to adopt and have a very short time to value. Our efficient go-to-market model enables us to prioritize significant investment in innovation. We have proven initial success of our platform approach, through expansion beyond our initial infrastructure monitoring solution, to include APM in 2017, logs in 2018, user experience and network performance monitoring in 2019, and security monitoring in April 2020. As of March 31, 2020, approximately 60% of our customers were using more than one product, up from approximately 30% a year earlier. We believe these metrics indicate strong momentum in the uptake of our newer platform products.
We intend to continue to invest in building additional products, features and functionality that expand our capabilities and facilitate the extension of our platform to new use cases. We also intend to continue to evaluate strategic acquisitions and investments in businesses and technologies to drive product and market expansion. Our future success is dependent on our ability to successfully develop, market and sell existing and new products to both new and existing customers.
We believe there is a significant opportunity to expand usage of our platform outside of North America. Revenue, as determined based on the billing address of our customers, from regions outside of North America was 24% for each of the three months ended March 31, 2020 and 2019. In addition, we have made and plan to continue to make significant investments to expand geographically, particularly in Europe, the Middle East, Africa and in the Asia Pacific region. Although these investments may adversely affect our operating results in the near term, we believe that they will contribute to our long-term growth. Beyond North America, we now have sales presence internationally, including in Dublin, London, Amsterdam, Paris, Singapore, Sydney and Tokyo.
Components of Results of Operations
We generate revenue from the sale of subscriptions to customers using our cloud-based platform. The terms of our subscription agreements are primarily monthly or annual, with the majority of our revenue coming from annual subscriptions. Our customers can enter into a subscription for a committed contractual amount of usage that is apportioned ratably on a monthly basis over the term of the subscription period, a subscription for a committed contractual amount of usage that is delivered as used, or a monthly subscription based on usage. To the extent that our customers' usage exceeds the committed contracted amounts under their subscriptions, either on a monthly basis in the case of a ratable subscription or once the entire commitment is used in the case of a delivered-as-used subscription, they are charged for their incremental usage.
Usage is measured primarily by the number of hosts or by the volume of data indexed. A host is generally defined as a server, either in the cloud or on-premise. Our infrastructure monitoring, APM and network performance monitoring products are priced per host, our logs product is priced primarily per log events indexed and secondarily by events ingested. Customers also have the option to purchase additional products, such as additional container or serverless monitoring, custom metrics packages, anomaly detection, synthetic monitoring and app analytics.
In the case of subscriptions for committed contractual amounts of usage, revenue is recognized ratably over the term of the subscription agreement, generally beginning on the date that our platform is made available to a customer. As a result, much of our revenue is generated from subscriptions entered into during previous periods. Consequently, any decreases in new subscriptions or renewals in any one period may not be immediately reflected as a decrease in revenue for that period, but could negatively affect our revenue in future quarters. This also makes it difficult for us to rapidly increase our revenue through the sale of additional subscriptions in any period, as revenue is recognized over the term of the subscription agreement. In the case of a subscription for a committed contractual amount of usage that is delivered as used, a monthly subscription based on usage, or usage in excess of a ratable subscription, we recognize revenue as the product is used, which may lead to fluctuations in our revenue and results of operations. In addition, historically, we have experienced seasonality in new customer bookings, as we typically enter into a higher percentage of subscription agreements with new customers in the fourth quarter of the year.
Due to ease of implementation of our products, professional services generally are not required and revenue from such services has been immaterial to date.
Cost of Revenue
Cost of revenue primarily consists of expenses related to providing our products to customers, including payments to our third-party cloud infrastructure providers for hosting our software, personnel-related expenses for operations and global support, including salaries, benefits, bonuses and stock-based compensation, payment processing fees, information technology, depreciation and amortization related to the amortization of acquired intangibles and internal-use software and other overhead costs such as allocated facilities.
We intend to continue to invest additional resources in our platform infrastructure and our customer support and success organizations to expand the capability of our platform and ensure that our customers are realizing the full benefit of our platform and products. The level, timing and relative investment in our infrastructure could affect our cost of revenue in the future.
Gross Profit and Gross Margin
Gross profit represents revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of revenue. Our gross margin may fluctuate from period to period as our revenue fluctuates, and as a result of the timing and amount of investments to expand our products and geographical coverage.
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation expense and sales commissions. Operating expenses also include overhead costs for facilities and shared IT related expenses, including depreciation expense.
Research and Development
Research and development expense consists primarily of personnel costs for our engineering, service and design teams. Additionally, research and development expense includes contractor fees, depreciation and amortization and allocated overhead costs. Research and development costs are expensed as incurred. We expect that our research and development expense will increase in absolute dollars as our business grows, particularly as we incur additional costs related to continued investments in our platform.
Sales and Marketing
Sales and marketing expense consists primarily of personnel costs for our sales and marketing organization, costs of general marketing and promotional activities, including the free tier and free introductory trials of our products, travel-related expenses and allocated overhead costs. Sales commissions earned by our sales force are deferred and amortized on a straight-line basis over the expected period of benefit, which we have determined to be four years. We expect that our sales and marketing expense will increase in absolute dollars and continue to be our largest operating expense for the foreseeable future as we expand our sales and marketing efforts. However, we expect that our sales and marketing expense will decrease as a percentage of our revenue over the long term.
General and Administrative
General and administrative expense consists primarily of personnel costs and contractor fees for finance, legal, human resources, information technology and other administrative functions. In addition, general and administrative expense includes non-personnel costs, such as legal, accounting and other professional fees, hardware and software costs, certain tax, license and insurance-related expenses and allocated overhead costs.
We have incurred, and expect to continue to incur, additional expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a national securities exchange, costs related to compliance and reporting obligations, and increased expenses for insurance, investor relations and professional services. We expect that our general and administrative expense will increase in absolute dollars as our business grows. However, we expect that our general and administrative expense will decrease as a percentage of our revenue as our revenue grows over the longer term.
Other Income, Net
Other income, net consists of income earned on our money market funds included in cash and cash equivalents and on our marketable securities.
Provision for Income Taxes
Provision for income taxes consists of U.S. federal and state income taxes and income taxes in certain foreign jurisdictions in which we conduct business. We maintain a full valuation allowance on our federal and state deferred tax assets as we have concluded that it is not more likely than not that the deferred tax assets will be realized.
Results of Operations The following table sets forth our consolidated statements of operations data for the periods indicated: Three Months Ended March 31, 2020 2019 (in thousands) Revenue $ 131,248 $ 70,050 Cost of revenue (1)(2) 26,479 18,950 Gross profit 104,769 51,100 Operating expenses Research and development (1) 40,824 22,815 Sales and marketing (1) 45,215 30,107 General and administrative (1) 14,952 7,840 Total operating expenses 100,991 60,762 Operating income (loss) 3,778 (9,662 ) Other income, net 2,896 230 Income (loss) before provision for income taxes 6,674 (9,432 ) Provision for income taxes (195 ) (59 ) Net income (loss) $ 6,479 $ (9,491 )
(1) Includes stock-based compensation expense as follows:
Three Months Ended March 31, 2020 2019 (in thousands) Cost of revenue $ 231 $ 99 Research and development 5,847 786 Sales and marketing 3,074 729 General and administrative 2,908 831 Total $ 12,060 $ 2,445
(2) Includes amortization of acquired intangibles expense as follows:
Three Months Ended March 31, 2020 2019
The following table sets forth our consolidated statements of operations data expressed as a percentage of revenue for the periods indicated:
Three Months Ended March 31, 2020 2019 (as a percentage of total revenue) Revenue 100 % 100 % Cost of revenue 20 27 Gross profit 80 73 Operating expenses Research and development 31 33 Sales and marketing 35 43 General and administrative 11 11 Total operating expenses 77 87 Operating income (loss) 3 (14 ) Other income, net 2 1 Income (loss) before provision for income taxes 5 (13 ) Provision for income taxes (1 ) (1 ) Net income (loss) 4 % (14 %)
Comparison of the Three Months Ended March 31, 2020 and 2019
Three Months Ended March 31, 2020 2019 Change % Change (dollars in thousands)
Revenue $ 131,248 $ 70,050 $ 61,198 87 %
Revenue increased by $61.2 million, or 87% for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The increase in revenue was primarily due to growth from existing customers, with the remaining increase attributable to new customers.
Cost of Revenue and Gross Margin Three Months Ended March 31, 2020 2019 Change % Change (dollars in thousands) Cost of revenue $ 26,479 $ 18,950 $ 7,529 40 % Gross margin 80 % 73 % 7 %
Cost of revenue increased by $7.5 million, or 40%, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. This increase was primarily due to an increase of $5.5 million in third-party cloud infrastructure hosting and software costs, $1.1 million in personnel expenses as a result of increased headcount, and $0.9 million of depreciation and amortization, credit card processing fees and other fees, and allocated overhead costs as a result of an increase in overall costs necessary to support the growth of the business and related infrastructure.
Our gross margin increased by 7% in the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily as a result of increased revenue and cost savings from our third-party cloud infrastructure providers.
Research and Development Three Months Ended March 31, 2020 2019 Change % Change (dollars in thousands) Research and development $ 40,824 $ 22,815 $ 18,009 79 % Percentage of revenue 31 % 33 %
Research and development expense increased by $18.0 million, or 79%, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. This increase was primarily due to an increase of $15.7 million in personnel costs for our engineering, product and design teams as a result of increased headcount, and an increase of $3.0 million in allocated overhead costs necessary for supporting the growth of the business, partially offset by a decrease of $0.7 million in cloud infrastructure related investments.
Sales and Marketing Three Months Ended March 31, 2020 2019 Change % Change (dollars in thousands) Sales and marketing $ 45,215 $ 30,107 $ 15,108 50 % Percentage of revenue 35 % 43 %
Sales and marketing expense increased by $15.1 million, or 50%, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. This increase was primarily due to an increase of $10.8 million in personnel costs for our sales and marketing organization as a result of increased headcount and increased amortization of deferred contract costs related to increased variable compensation for sales personnel due to increased sales, an increase of $2.5 million in allocated overhead costs as a result of increased overall costs necessary to support the growth of the business and related infrastructure, an increase of $1.0 million in hosting for free trials, and an increase of $0.8 million in marketing and promotional activities.
General and Administrative Three Months Ended March 31, 2020 2019 Change % Change (dollars in thousands) General and administrative $ 14,952 $ 7,840 $ 7,112 91 % Percentage of revenue 11 % 11 %
General and administrative expense increased by $7.1 million, or 91%, for the . . .
May 12, 2020
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