Datadog, Inc. Q1 FY2021 earnings

The ongoing COVID-19 pandemic and related economic downturn could reduce IT spending and customer usage. Datadog disclosed it experienced some impact to the rate of usage growth from existing customers during the second quarter of 2020, and management says the extent of the pandemic's impact on results remains uncertain and may not be fully reflected until future periods due to the subscription model.

Datadog had a history of operating losses and may not sustain profitability. For the three months ended March 31, 2021, operating loss was $12.8 million and net loss was $13.1 million, compared with operating income of $3.8 million and net income of $6.5 million for the three months ended March 31, 2020. It expects costs and expenses to increase in future periods.

The markets in which Datadog participates are competitive, with competitors including IBM, Microsoft, Cisco, Splunk, Elastic, and native cloud provider solutions from AWS, GCP, and Microsoft Azure. Pricing pressures and sales through cloud provider marketplaces could reduce direct customer relationships and profit margins.

Data privacy and security laws are stringent and changing. The Schrems II ruling invalidated the EU-U.S. Privacy Shield, the Swiss-U.S. Privacy Shield was questioned, and reliance on Standard Contractual Clauses remains uncertain, which may decrease demand and lengthen sales cycles for European customers. The CCPA and CPRA also increase compliance costs and potential liability.

Datadog has previously been the target of cyber-attacks; in July 2016 an unidentified third party gained unauthorized access to and exfiltrated data from certain infrastructure resources, including a database storing customer credentials and confidential personal information. Remote work during COVID-19 may pose additional data security risks, including increased phishing and spam emails experienced during 2020.

Datadog depends on existing customers purchasing additional subscriptions and renewing. Subscription terms are primarily monthly or annual with no renewal obligation, and renewal or expansion may be impacted by customer business strength, usage, satisfaction, pricing, competing products, and global economic conditions including COVID-19.

The temporary suspension of travel and in-person meetings due to COVID-19 could negatively affect marketing efforts, the length or variability of sales cycles, international expansion, and recruiting. The company also targets enterprise customers, which historically involve longer and less predictable sales cycles.

Recent rapid growth may not be indicative of future growth, and Datadog expects its revenue growth rate to decline as the business matures. Revenue grew 51% to $198.5 million for the three months ended March 31, 2021, but the company says prior growth should not be relied upon as an indication of future performance.

Gross margin decreased to 76% for the three months ended March 31, 2021 from 80% for the three months ended March 31, 2020, primarily due to increased spend with third-party cloud infrastructure providers. Cost of revenue increased 76% over the same periods.

Datadog relies on third-party cloud infrastructure providers to host its products. Any disruption, capacity limitation, or interference could impede onboarding new customers or expanding existing customers, and service agreements may be terminated or require significant re-architecture. Sales through cloud provider marketplaces also reduce direct customer relationships and margins.

Datadog depends on its executive officers, particularly co-founders Olivier Pomel and Alexis Lê-Quôc and CFO David Obstler, as well as key engineers and sales personnel. Competition for such personnel is intense, and equity award value volatility could affect recruiting and retention.

In June 2020 Datadog issued $747.5 million aggregate principal amount of 0.125% Convertible Senior Notes due 2025. Interest expense increased to $5.5 million for the three months ended March 31, 2021 from $0.7 million for the three months ended March 31, 2020. The conditional conversion feature, future indebtedness, and capped call counterparty risk could adversely affect liquidity and dilution.

Revenue from regions outside North America was 28% and 24% of total revenue for the three months ended March 31, 2021 and 2020. Geographic expansion creates operational challenges including regulatory, tax, Brexit, labor, currency, and data residency risks.

The dual class structure concentrates voting control with Class B holders, including executive officers, directors, and affiliates. As of March 31, 2021, Class B represented approximately 76% of voting power, limiting Class A stockholders' ability to influence important transactions.