The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our condensed consolidated
financial statements and the related notes and other financial information
included elsewhere in this Quarterly Report on Form 10-Q and our 2021 Annual
Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on
February 23, 2022. In addition to historical consolidated financial information,
the following discussion contains forward-looking statements that reflect our
plans, estimates, and beliefs. Our actual results could differ materially from
those expressed or implied by such forward-looking statements. Important factors
that could cause or contribute to these differences include, but are not limited
to, those identified in this Quarterly Report and in our Form 10-K, particularly
those discussed in the sections entitled "Risk Factors" and "Forward-Looking
Statements."
Overview
Datto is the leading global provider of security and cloud-based software
solutions purpose-built for delivery through the managed service provider, or
MSP, channel to small and medium businesses, or SMBs. We enable our more than
19,200 MSP partners to manage and grow their businesses serving the SMB
information technology, or SMB IT, market. Our platform combines
mission-critical cloud-based software, technologies and security solutions that
MSPs sell to SMBs, business management software to help MSPs scale their own
businesses, and marketing tools, content, training and industry-leading events
that cultivate an empowered and highly engaged MSP partner community.
MSPs represent the future of IT management for SMBs. Digital transformation is
driving SMB adoption of modern software and technology, while regulatory and
data protection requirements and proliferating security threats are increasing
the complexity and risk of IT for SMBs. These trends have created an inflection
point in SMB outsourcing to MSPs for IT management. MSPs are equipped with the
IT resources and expertise SMBs lack, providing a single source to meet all of
an SMB's IT needs. MSPs are trusted to select, procure, implement and manage
software and technology stacks that support their SMB customers' business needs.
The number of MSPs continues to grow, with approximately 132,000 MSPs providing
this critical function to millions of SMBs worldwide.
We are committed to the success of MSPs. It is the foundation of our strategy
and culture. We empower our MSP partner channel, creating enormous sales and
support leverage for us to efficiently address the large, but fragmented, SMB IT
market. Our MSP-centric platform enables our partners to generate recurring
revenue through the sale of our solutions to SMBs and to scale and effectively
manage their own businesses. Our relationships are directly with our MSP
partners. We are the leading pure-play vendor serving the MSP market, and
believe our MSP-centric approach is highly differentiating as it aligns our
mutual incentives, creates a motivated and engaged sales channel and reinforces
our position as an integral component of our MSP partners' businesses.
Our cloud-based offerings include Unified Continuity, Networking, Endpoint
Management and Business Management software solutions. Our Unified Continuity
offerings ensure the ongoing availability and security of mission-critical IT
systems for SMBs in both private and public clouds. Datto's business continuity
and disaster recovery, or BCDR, software enables rapid restoration of an SMB's
full IT environment. Datto's SaaS Protection is a reliable, automated and secure
backup and restoration product for data stored on cloud applications such as
Microsoft 365 and Google Workspace. Datto Networking constitutes a suite of
MSP-centric networking solutions sold through our MSP partners to easily deliver
networking as a managed service. These solutions are simple for MSPs to deploy,
configure and manage across their SMB customers through a single portal. Our
Endpoint Management software allows MSPs to remotely manage, monitor and secure
SMB endpoints. Lastly, Datto's Business Management software provides critical
operational tools to MSPs for efficient workflow management and delivery of
end-to-end managed services. Our platform also includes a host of business
development tools, training and content to help MSPs address the challenges of
marketing and selling to SMB customers.
During 2022, we acquired threat detection and response company Infocyte,
extending Datto's security capabilities that protect, detect, and respond to
cyberthreats found within endpoints and cloud environments. During late 2021 we
launched two new cloud-based solutions - Datto Continuity for Microsoft Azure
("DCMA") and SaaS Defense. DCMA is a comprehensive BCDR solution that protects
MSPs and their clients' data in the public cloud in the event of malicious
ransomware attacks, security breaches, and vendor outages. SaaS Defense is an
advanced threat protection and spam-filtering solution that provides MSPs and
their SMB customers with patented technology to proactively detect and prevent
malicious malware, phishing, and Business Email Compromise ("BEC") attacks that
target Microsoft Exchange, OneDrive, SharePoint, and Teams. The product was
built on technology obtained in Datto's acquisition of Israel-based cyber threat
detection company BitDam in early 2021.
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Merger Transaction
On April 11, 2022, Datto entered into an Agreement and Plan of Merger (the
"Merger Agreement") with Knockout Parent Inc., a Delaware corporation and a
wholly owned subsidiary of Kaseya Inc. ("Kaseya"), and certain other parties,
providing for the acquisition of the Company by Kaseya, subject to the terms and
conditions set forth therein (the "Merger"). Under, and subject to, the terms of
the Merger Agreement, Datto stockholders will have the right to receive $35.50
per share in cash, without interest. The Board of Directors of the Company has
unanimously approved the Merger Agreement and the transactions contemplated
thereby and the necessary stockholder approval has been duly executed and
delivered, adopting and approving the Merger Agreement and the transactions
contemplated thereby. The obligations of the parties to complete the proposed
Merger are subject to customary closing conditions, including, among others, the
receipt of applicable regulatory approvals. The proposed Merger is expected to
close during the second half of 2022.
Our Business Model
Our cloud-based solutions are purpose-built to address the needs of MSPs and to
enable the end-to-end delivery of managed services to their SMB customers.
We generate substantially all our revenue from the sale of subscriptions to our
cloud-based solutions and recognize revenue ratably over the subscription term.
These contracts typically begin with a 1-year or 3-year term and auto-renew on a
monthly or annual basis thereafter. For certain offerings, we enable our ongoing
subscription services with an up-front sale of equipment or professional
services, for which we recognize revenue at the time of delivery and
performance. The majority of our partners pay on a monthly basis, regardless of
term length, with some opting to make quarterly, annual or multi-year
prepayments.
Subscriptions for our BCDR products are priced based on service tier, which is
determined by data storage capacity and data retention period. Subscriptions for
Datto SaaS Protection and Datto SaaS Defense (together, SaaS Protection+) are
priced based on the number of Microsoft 365 or Google Workspace employee
accounts at the SMB domains that our MSP partners protect and data retention
period. Networking subscriptions are priced based on the volume and type of
networking solutions ordered. Endpoint Management subscriptions are priced per
endpoint device at the SMB. Business Management subscriptions are priced based
on the number of employees at an MSP that are able to utilize our PSA product.
We employ a highly efficient land-and-expand sales strategy facilitated by
offering products that are reliable, easy to adopt and that drive recurring
revenue growth and margin efficiency for our MSP partners. We sell our solutions
to MSPs primarily through our sales team, benefiting from the reach of our MSP
partners for our sell-through products, and provide them with self-service
options to upgrade service tiers, add additional units and purchase additional
solutions. Our MSP partners often significantly increase usage from their
initial purchase and expand their usage to other products on our platform. We
also provide access to business development tools and content to help MSPs
address the challenges of marketing and selling to SMB customers. We grow
alongside our MSP partners as they deploy our solutions across their existing
SMB customers, add new customers and upgrade service tiers.
As of March 31, 2022, our annual run-rate revenue, or ARR, was $689.3 million,
and our revenue for the three months ended March 31, 2022 was $170.8 million, of
which approximately 94% was recurring subscription revenue. For the three months
ended March 31, 2022, our net income was $7.9 million and our Adjusted EBITDA
was $39.5 million.
As of March 31, 2021, our ARR was $572.5 million and our revenue for the three
months ended March 31, 2021, was $144.9 million, of which approximately 94% was
recurring subscription revenue. For the three months ended March 31, 2021, our
net income was $15.3 million and our Adjusted EBITDA was $46.9 million.
Refer to our discussion of ARR in Key Performance Metrics and Adjusted EBITDA in
Non-GAAP Financial Measures.
Trends and Uncertainties
Impact of COVID-19
While we have not incurred significant disruptions from the COVID-19 pandemic,
there remains uncertainty relating to the ultimate impact of the pandemic on our
business because of numerous global factors, including but not limited to, the
impact on our customers and suppliers, supply chain constraints, labor
shortages, inflationary pressure and other factors.
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Specifically, we may experience impacts from customers deferring purchasing and
activation decisions, reducing expenses and requesting extended payment terms or
relief from payments.
Our condensed consolidated financial statements reflect estimates and
assumptions made by management that affect the reported amounts of assets and
liabilities, disclosures of contingent assets and liabilities at the date of the
condensed consolidated financial statements and the reported amounts of revenues
and expenses during the reporting periods. Significant estimates and assumptions
reflected in our condensed consolidated financial statements include, but are
not limited to, establishing allowances for doubtful accounts, assessing the
recoverability of prepaid assets, including trade shows and other marketing
events impacted by the pandemic, determining useful lives for finite-lived
assets, assessing the recoverability of long-lived assets, determining the fair
value of assets acquired and liabilities assumed in business combinations,
accounting for income taxes and related valuation allowances against deferred
tax assets, valuing stock-based awards, recognizing revenue and the estimate for
sales returns and upgrades, determining the amortization period for capitalized
commissions and assessing the accounting treatment for commitments and
contingencies. Management evaluates these estimates and assumptions on an
ongoing basis and makes estimates based on historical experience and various
other considerations that are believed to be reasonable. Actual results may
differ from those estimates, including as a result of the COVID-19 pandemic. We
will continue to evaluate the nature and extent of the impact of the pandemic on
our business and our consolidated results of operations and financial condition.
Macro-Economic or Industry Trends
As discussed below, we believe continued favorable industry trends will
contribute to the growth of our business, including: i) increased adoption by
SMBs of digital and cloud-based technologies; ii) increasing complexity in IT,
which impacts the ability of SMBs to evaluate, select and implement an optimal
IT environment; iii) increased exposure and vulnerability of SMBs to security
and regulatory risk, including cyberattacks; iv) lack of SMB sophistication to
meet the expanding challenges of IT management; v) the continued trend of remote
work, vi) educational organizations and governmental agencies using MSPs to
provide IT services, and vii) the meaningful and increasing costs of downtime or
data loss. The customer base of our partners continues to expand as a result of
these trends and as evidenced by the anticipated 13.4% increase in available
market reported by Frost & Sullivan during 2021.
Key Performance Metrics
In addition to our financial information presented in accordance with generally
accepted accounting principles in the United States, or GAAP, we review a number
of operating and financial metrics, including the following key metrics, to
evaluate our business, measure our performance, identify trends affecting our
business, formulate business plans and make operating and strategic decisions.
MSP Partners
The number of MSP partners represents the number of MSPs with active
subscriptions as of the end of the period. We use this number to assess our
ability to attract and retain MSP partners and thereby grow our business. As of
March 31, 2022, we had approximately 19,200 MSP partners, a net increase of
approximately 700 since December 31, 2021. Net changes in the number of our MSP
partners are a result of the total new partners added during a period, largely
based on our sales and marketing efforts, and the churn or reduction of existing
partners during the period, which can be affected by the broader economic
environment and factors such as the effects of COVID-19 on our partners' SMB end
customers. As a result of our land-and-expand model, our revenue growth is
driven principally by additional revenue from existing MSP partners. We view new
MSP partner additions as a leading indicator of the health of the business, but
the additions do not immediately drive material revenue growth in our reported
results of operations.
Annual Run-Rate Revenue
We define annual run-rate revenue, or ARR, as the annualized value of all
subscription agreements as of the end of a period. We calculate ARR by
multiplying the monthly run-rate revenue for the last month of a period by 12.
Monthly run-rate revenue is calculated by aggregating monthly subscription
values during the final month of the reporting period from both long-term and
month-to-month subscriptions. ARR only includes the annualized value of
subscription contracts and excludes any one-time revenue for devices or
professional services. ARR mitigates fluctuations resulting from seasonality and
contract term. ARR does not have any standardized meaning and is therefore
unlikely to be comparable to similarly titled measures presented by other
companies. ARR should be viewed independently of revenue and deferred revenue
and is not intended to be combined
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with or to replace either of those items. ARR is not a forecast and the active
contracts at the date used in calculating ARR may or may not be extended or
renewed by our MSP partners.
The table below sets forth our ARR as of March 31, 2022 and 2021:
As of March 31,
2022 2021 $ Change % Change
(dollars in millions)
ARR $ 689.3 $ 572.5 $ 116.8 20.4 %
Components of Results of Operations
Revenue
We generate revenue primarily from fees received for subscriptions to our
products and services, and also from the sale of BCDR and Networking devices and
professional services associated with our Business Management offerings.
Subscription. We derive revenue primarily from security and cloud-based software
solutions sold on a recurring subscription basis. Subscription revenue is
recognized ratably over the subscription term as revenue recognition criteria
have been met. We generally invoice subscription agreements monthly over the
subscription period. Subscription revenue for our Unified Continuity, Networking
and Endpoint Management solutions grows as our MSP partners add more end
customers and as the end-customers of our MSP partners add new subscription
products, upgrade the service tier of their existing subscription products,
increase the usage of their subscription products or add more end-user devices
managed by their MSP. Revenue from our Business Management solutions increases
as we sell subscriptions to new and existing MSP partners who did not have our
PSA solution and as our MSP partners with PSA subscriptions add employees who
require seat licenses and as MSPs purchase Datto Commerce subscriptions.
Device. Device revenue includes the sale of BCDR and Networking devices which
enable us to deliver our BCDR and Networking services to our MSP partners under
a recurring subscription model. Revenue from devices in our Unified Continuity
solution primarily consists of the sale of our proprietary data storage devices.
Revenue from devices in our Networking solution primarily consists of the sale
of wireless access points, switches and edge routers. We recognize revenue at
the point in time when control of the device has transferred to the MSP or upon
activation of the related subscription. Revenue from devices does not contribute
significantly to overall revenue related to our Unified Continuity solutions.
Professional services and other. We derive revenue from professional services
associated with our Business Management and Endpoint Management offerings. These
implementation and consulting services include configuration, database merging
and data migration. Our professional services are generally priced on a time and
materials basis and invoiced monthly, with revenue recognized as the services
are performed, and we frequently discount our services to drive adoption of our
Business Management and Endpoint Management offerings.
Cost of revenue
Subscription. Subscription cost of revenue consists of costs directly related to
our subscription services, including personnel costs associated with operating
our Datto Cloud infrastructure and customer support operations, hosting and data
center related costs, third-party software licenses and allocated facilities and
overhead costs associated with delivering these services.
Device. Device cost of revenue consists of hardware, manufacturing, personnel,
shipping and logistics costs, as well as allocated facilities and overhead costs
associated with the purchase, production and delivery of our devices. Our BCDR
products rely on a mix of off-the-shelf hardware and custom designed hardware.
Our Networking devices generally consist of off-the-shelf hardware, although
some of our devices feature a unique industrial design.
Professional services and other. Professional services and other cost of revenue
consists primarily of personnel costs and allocated facilities and overhead
costs associated with delivering implementation and consulting services. Our
professional services implementations aim to ensure higher software utilization
and positive customer satisfaction, in order to drive greater upsell opportunity
and lower churn over time.
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Depreciation and amortization. Depreciation and amortization cost of revenue
consists of depreciation of our Datto Cloud infrastructure and amortization of
our acquired technology intangible assets.
Gross profit and gross margin
Gross profit, or revenue less cost of revenue, has been, and will continue to
be, affected by various factors, including revenue fluctuations, the mix of
revenue, the timing and amount of investments to expand our Datto Cloud
infrastructure and launch new solutions, the use of third-party software
licenses and stock-based compensation expense.
Operating expenses
Our operating expenses consist of sales and marketing, research and development
and general and administrative expenses as well as depreciation, amortization of
internally developed software and amortization of acquired intangible assets.
Personnel costs are the most significant component of operating expenses and
consist of salaries, benefits, bonuses, sales commissions, payroll taxes and
stock-based compensation expense. Other significant components of operating
expenses include professional fees, third-party software subscription costs,
facilities and overhead costs, events and travel, marketing and promotion costs,
payment processing fees and bad debt expense.
Sales and marketing
Sales and marketing expenses consist primarily of personnel costs, costs for
events and travel, costs of marketing and promotional activities, payment
processing fees and allocated facilities and overhead costs. Sales and marketing
expenses may fluctuate as a percentage of our revenue from period to period
because of the timing and extent of marketing activities, trade shows, and
events including DattoCon and MSP Technology Days, as well as the timing of
amortization of sales commissions and stock-based compensation expense.
Research and development
Research and development expenses consist primarily of personnel costs,
third-party professional fees and allocated facilities and overhead costs.
Research and development expense may fluctuate as a percentage of our revenue
from period to period because of the timing and extent of our investments in
research and development activities, as well as the timing of stock-based
compensation expense.
General and administrative
General and administrative expenses consist primarily of personnel costs across
the corporate functions of executive, finance, human resources, information
technology, internal operations and legal, as well as third-party professional
fees, provision for expected credit losses expense, travel expenses and costs
for facilities. General and administrative expenses also include costs of
operating as a publicly listed company, including increased expenses for
insurance, costs to comply with the rules and regulations applicable to
companies listed on a national securities exchange, costs related to compliance
and reporting obligations pursuant to the rules and regulations of the SEC,
expenses related to investor relations, and professional services fees,
particularly related to audit services and compliance with the Sarbanes-Oxley
Act.
Depreciation and amortization
Depreciation and amortization expenses in operating expenses consist of
amortization of tradenames and partner relationship intangibles, depreciation of
other property and equipment such as leasehold improvements, furniture and
fixtures, and computer equipment, and amortization of internally developed
software.
Other (Income) expense
Interest expense
Interest expense consists of commitment fees under our credit facilities and the
amortization of debt issuance costs, and to the extent we have outstanding
borrowings, interest payments under our credit facilities. Our 2020 Credit
Agreement provides a $200.0 million revolving credit facility. As of March 31,
2022, no amounts had been drawn under the 2020 Credit Agreement. See "Liquidity
and Capital Resources-Credit Facilities" for additional details.
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Other (income) expense
Other (income) expense primarily consists of the net exchange (gains) or losses
on foreign currency transactions, (gains) or losses from our money market funds
and (gains) or losses on the disposal of assets.
Provision for income tax
Provision for income tax consists primarily of income taxes related to U.S.
federal and state income taxes and income taxes in foreign jurisdictions in
which we conduct business.
Stock-Based Compensation
The functional role of the holder determines the financial statement line item
within which stock-based compensation expense is recorded.
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