DYNATRACE, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that could impact our business. In particular, we encourage you to review the risks and uncertainties described in the section titled "Risk Factors" included elsewhere in this Form 10-Q and our Annual Report on Form 10-K. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends. Our fiscal year ends onMarch 31 . Our historical results are not necessarily indicative of the results that may be expected for any period in the future, and our interim results are not necessarily indicative of the results we expect for the full fiscal year or any other period. Overview We offer the market-leading software intelligence platform, purpose-built for dynamic hybrid, multicloud environments. As enterprises and public sector institutions embrace the cloud to effect their digital transformation, we designed our unified platform to address the growing complexity faced by IT, development, security, and business operations teams. With automation and intelligence at its core, our platform delivers precise answers about the performance and security of applications, the underlying infrastructure and the experience of all users to enable teams to innovate faster, simplify cloud complexity, collaborate more efficiently, and secure cloud-native applications. We designed our platform to allow our customers to modernize and automate IT operations, develop and release high quality software faster, and improve user experiences for consistently better business outcomes. As a result, as ofJune 30, 2022 , our products are trusted by more than 3,300Dynatrace customers in over 90 countries in diverse industries such as banking, insurance, retail, manufacturing, travel and software. We market Dynatrace® through a combination of our global direct sales team and a network of partners, including cloud service providers (Amazon, Microsoft, and Google), resellers, and system integrators. We target the largest 15,000 global accounts, which generally have annual revenues in excess of$1 billion . We generate revenue primarily by selling subscriptions, which we define as (i) Software-as-a-service ("SaaS") agreements, (ii) Dynatrace® term-based licenses, for which revenue is recognized ratably over the contract term, (iii) Dynatrace® perpetual licenses, which are recognized ratably over the term of the expected optional maintenance renewals, which is generally three years, and (iv) maintenance and support agreements. We deploy our platform as a SaaS solution, with the option of retaining the data in the cloud, or at the edge in customer-provisioned infrastructure, which we refer to as Dynatrace® Managed. The Dynatrace® Managed offering allows customers to maintain control of the environment where their data resides, whether in the cloud or on-premises, combining the simplicity of SaaS with the ability to adhere to their own data security and sovereignty requirements. Our Mission Control functionality automatically upgrades all Dynatrace® instances and offers on-premise cluster customers auto-deployment options that suit their specific enterprise management processes. Dynatrace® is an all-in-one platform, which is typically purchased by our customers with the full-stack Application Performance Module and extended with our Infrastructure Monitoring, Digital Experience Monitoring, Digital Business Analytics, Application Security, or Cloud Automation Modules. Customers also have the option to purchase the infrastructure monitoring module where the full-stack APM is not required, with the ability to upgrade to the full-stack APM when necessary. Our Dynatrace® platform has been commercially available since 2016 and is the primary offering we sell. Dynatrace® customers increased to more than 3,300 as ofJune 30, 2022 from approximately 3,000 as ofJune 30, 2021 . 14
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COVID-19 Update
We continue to monitor, analyze, and respond to evolving developments regarding the ongoing COVID-19 pandemic which has had significant impacts around the globe and in many locations in which we operate. While the impacts have not caused a material adverse financial impact to our business to date, the future impacts remain uncertain. The extent to which the COVID-19 pandemic may impact our business going forward will depend on numerous evolving factors that we cannot reliably predict. These factors may adversely impact business spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. While our revenue, customer retention, and earnings are relatively predictable as a result of our subscription-based business model, the effect, if any, of the ongoing COVID-19 pandemic would not be fully reflected in our results of operations and overall financial performance until future periods. Throughout the pandemic we have continued to make investments to support business growth and product development, including investments in research and development as we continue to introduce new products and applications to extend the functionality of our products, sales and marketing to support customer growth, and other critical functions to ensure the highest levels of customer service and support as well as ensuring that we maintain the required infrastructure to be a public company. We expect to continue to make these investments.
See the section titled "Risk Factors" included under Part II, Item 1A for further discussion of the possible impact of the ongoing COVID-19 pandemic on our business.
Key Factors Affecting Our Performance
Our historical financial performance has been, and we expect our financial performance in the future to be, driven by our ability to:
•Extend our technology and market leadership position. We intend to maintain our position as the market-leading software intelligence platform through increased investment in research and development and continued innovation. We expect to focus on expanding the functionality of Dynatrace® and investing in capabilities that address new market opportunities. We believe this strategy will enable new growth opportunities and allow us to continue to deliver differentiated high-value outcomes to our customers. •Grow our customer base. We intend to drive new customer growth by expanding our direct sales force focused on the largest 15,000 global accounts, which generally have annual revenues in excess of$1 billion . In addition, we expect to leverage our global partner ecosystem to add new customers in geographies where we have direct coverage and work jointly with our partners. In other geographies, such asAfrica ,Japan , theMiddle East , andSouth Korea , we utilize a multi-tier "master reseller" model. •Increase penetration within existing customers. We plan to continue to increase penetration within our existing customers by expanding the breadth of our platform capabilities to provide for continued cross-selling opportunities. In addition, we believe the ease of implementation for Dynatrace® provides us the opportunity to expand adoption within our existing customers, across new customer applications, and into additional business units or divisions. We sustained our Dynatrace® net expansion rate at or above 120% for seventeen consecutive quarters. •Enhance our strategic partner ecosystem. Our strategic partners include industry-leading global system integrators, software vendors, and cloud and technology providers. We intend to continue to invest in our partner ecosystem, with a particular emphasis on expanding our strategic alliances and cloud-focused partnerships with global system integrators, including Deloitte and DXC, and hyperscaler cloud providers, including AWS, Microsoft, Azure, Google Cloud Platform, and Red Hat.
Key Metrics
In addition to ourU.S. GAAP financial information, we monitor the following key metrics to help us measure and evaluate the effectiveness of our operations: June 30, 2022 2021 Total ARR (in thousands)$ 1,031,284 $ 823,222 Dynatrace® Net Expansion Rate 120%+ 120%+ Annual Recurring Revenue "ARR": We define annual recurring revenue ("ARR") as the daily revenue of all subscription agreements that are actively generating revenue as of the last day of the reporting period multiplied by 365. We exclude from our calculation of 15
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ARR any revenues derived from month-to-month agreements and/or product usage overage billings, where customers are billed in arrears based on product usage.
Dynatrace® Net Expansion Rate: We define the Dynatrace® net expansion rate as
the ARR derived from the Dynatrace® platform at the end of a reporting period
for the cohort of Dynatrace® accounts as of one year prior to the date of
calculation, divided by the Dynatrace® ARR one year prior to the date of
calculation for that same cohort. We present Dynatrace® net expansion rate on a
constant currency basis to provide a framework for assessing how our business
performed excluding the effects of foreign currency rate fluctuations.
Key Components of Results of OperationsRevenue
Revenue includes subscriptions, licenses and services.
Subscription. Our subscription revenue consists of (i) SaaS agreements, (ii) Dynatrace® term-based licenses which are recognized ratably over the contract term, (iii) Dynatrace® perpetual licenses that are recognized ratably over the term of the expected optional maintenance renewals, which is generally three years, and (iv) maintenance and support agreements. We typically invoice SaaS subscription fees and term licenses annually in advance and recognize subscription revenue ratably over the term of the applicable agreement, provided that all other revenue recognition criteria have been satisfied. Fees for our Dynatrace® perpetual licenses are generally billed up front. See the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates-Revenue Recognition" included in Part II, Item 7 of our Annual Report for more information. Over time, we expect subscription revenue will increase as a percentage of total revenue as we continue to focus on increasing subscription revenue as a key strategic priority.
License. License revenue reflects the revenues recognized from sales of
perpetual and term-based licenses of our Classic products that are sold only to
existing customers. Our Classic products were sunset as of
Service. Service revenue consists of revenue from helping our customers deploy our software in highly complex operational environments and training their personnel. We recognize the revenues associated with these professional services on a time and materials basis as we deliver the services or provide the training. We generally recognize the revenues associated with our services in the period the services are performed, provided that collection of the related receivable is reasonably assured.
Cost of Revenue
Cost of subscription. Cost of subscription revenue includes all direct costs to deliver and support our subscription products, including salaries, benefits, share-based compensation and related expenses such as employer taxes, third-party hosting fees related to our cloud services, allocated overhead for facilities, IT, and amortization of internally developed capitalized software technology. We recognize these expenses as they are incurred.
Cost of service. Cost of service revenue includes salaries, benefits, share-based compensation and related expenses such as employer taxes for our services organization, allocated overhead for depreciation of equipment, facilities and IT. We recognize these expenses as they are incurred.
Amortization of acquired technology. Amortization of acquired technology includes amortization expense for technology acquired in business combinations and the Thoma Bravo Funds' acquisition of the Company in 2014. To the extent significant future acquisitions are consummated, we expect that our amortization of acquired technologies may increase due to additional non-cash charges associated with the amortization of intangible assets acquired.
Gross Profit and Gross Margin
Gross profit is revenue less cost of revenue, and gross margin is gross profit as a percentage of revenue. Gross profit has been and will continue to be affected by various factors, including the mix of our subscription, services and other revenue, the costs associated with third-party cloud-based hosting services for our cloud-based subscriptions, and the extent to which we expand our customer support and services organizations. We expect that our gross margin will fluctuate from period to period depending on the interplay of these various factors. Operating Expenses
Personnel costs, which consist of salaries, benefits, bonuses, share-based compensation and, with regard to sales and marketing expenses, sales commissions, are the most significant component of our operating expenses. We also incur other non-personnel costs such as an allocation of our general overhead expenses.
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Research and development. Research and development expenses primarily consists
of the cost of programming personnel. We focus our research and development
efforts on developing new solutions, core technologies, and to further enhance
the functionality, reliability, performance, and flexibility of existing
solutions. We believe that our software development teams and our core
technologies represent a significant competitive advantage for us, and we expect
that our research and development expenses will continue to increase in absolute
dollars as we invest in research and development headcount to further strengthen
and enhance our solutions.
Sales and marketing. Sales and marketing expenses primarily consists of
personnel and facility-related costs for our sales, marketing, and business
development personnel, commissions earned by our sales personnel and the cost of
marketing and business development programs. We expect that sales and marketing
expenses will continue to increase in absolute dollars as we continue to hire
additional sales and marketing personnel and invest in marketing programs.
General and administrative. General and administrative expenses primarily
consist of the personnel and facility-related costs for our executive, finance,
legal, human resources and administrative personnel; and other corporate
expenses, including those associated with our ongoing public reporting
obligations. We anticipate continuing to incur additional expenses as we
continue to invest in the growth of our operations, as well as incur ongoing
costs of compliance associated with being a publicly traded company.
Amortization of other intangibles. Amortization of other intangibles primarily
consists of amortization of customer relationships and capitalized software and
tradenames.
Restructuring and other. Restructuring and other expenses primarily consists of
various restructuring activities we have undertaken to achieve strategic and
financial objectives. Restructuring activities include, but are not limited to,
product offering cancellation and termination of related employees, office
relocation, administrative cost of structure realignment and consolidation of
resources.
Other Expense, Net
Other expense, net consists primarily of interest expense and foreign currency
realized and unrealized gains and losses related to the impact of transactions
denominated in a foreign currency, including balances between subsidiaries.
Interest expense, net of interest income, consists primarily of interest on our
term loan facility, and amortization of debt issuance costs.
Income Tax Expense
Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management's best assessment of estimated current and future taxes to be paid. We are subject to income taxes in boththe United States and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense. Our income tax rate varies from theU.S. federal statutory rate mainly due to (1) foreign earnings taxed at rates higher than theU.S. statutory tax rate, (2) the inability to realize certain tax benefits subject to a valuation allowance in theU.S. , (3) foreign withholding taxes, partially offset by (4) the foreign derived intangibles deduction, and (5) the utilization ofU.S. foreign tax credits generated in the current year. We expect this fluctuation in income tax rates, as well as its potential impact on our results of operations, to continue.
Internal Revenue Code ("IRC") Section 174
For tax years beginning on or afterJanuary 1, 2022 , the Tax Cuts and Jobs Act of 2017 ("TCJA") eliminates the option to currently deduct research and development expenses and requires taxpayers to capitalize and amortize them over five years for research activities performed inthe United States and 15 years for research activities performed outsidethe United States pursuant to IRC Section 174. AlthoughCongress is considering legislation that would repeal or defer this capitalization and amortization requirement, it is not certain that this provision will be repealed or otherwise modified. If the requirement is not repealed or replaced, it will increase ourU.S. federal and state cash taxes and reduce cash flows in fiscal year 2023 and future years.
Share-based compensation
The tax effects of the accounting for share-based compensation may significantly
impact our effective tax rate from period to period. In periods in which our
share price differs from the grant price of the share-based awards vesting or
exercised in that period, we will recognize excess tax benefits or deficiencies
that will impact our effective tax rate. The amount and value of share-based
compensation issued relative to our earnings in a particular period will also
affect the magnitude of the impact of share-based compensation on our effective
tax rate. These tax effects are dependent on our share price, which we do not
control, and a decline in our share price could significantly increase our
effective tax rate and adversely affect our financial results.
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Results of OperationsThe following tables set forth our results of operations for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.
Comparison of the Three Months Ended
Three Months Ended June 30,
2022 2021
Amount Percent Amount Percent
(in thousands, except percentages)
Revenue:
Subscription $ 249,558 93 % $ 196,520 94 %
License - - % 50 - %
Service 17,715 7 % 13,170 6 %
Total revenue 267,273 100 % 209,740 100 %
Cost of revenue:
Cost of subscription 32,738 12 % 24,982 12 %
Cost of service 15,168 6 % 10,021 5 %
Amortization of acquired technology 3,892 1 % 3,830 2 %
Total cost of revenue (1) 51,798 19 % 38,833 19 %
Gross profit 215,475 81 % 170,907 81 %
Operating expenses:
Research and development (1) 48,482 18 % 34,725 17 %
Sales and marketing (1) 105,015 39 % 80,482 38 %
General and administrative (1) 36,321 14 % 26,922 13 %
Amortization of other intangibles 6,573 2 % 7,540 4 %
Restructuring and other (10) 26
Total operating expenses 196,381 149,695
Income from operations 19,094 21,212
Other expense, net (4,425) (1,546)
Income before income taxes 14,669 19,666
Income tax expense (12,555) (6,372)
Net income $ 2,114 $ 13,294 (1) Includes share-based compensation expense as follows:
Three Months Ended June 30,
2022 2021
(in thousands)
Cost of revenue $ 3,890 $ 2,652
Research and development 7,285 3,967
Sales and marketing 10,076 7,608
General and administrative 7,444 5,025
Total share-based compensation $ 28,695 $ 19,252
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Revenue
Three Months Ended June 30, Change
2022 2021 Amount Percent
(in thousands, except percentages)
Subscription $ 249,558 $ 196,520 $ 53,038 27 %
License - 50 (50) (100 %)
Service 17,715 13,170 4,545 35 %
Total revenue $ 267,273 $ 209,740 $ 57,533 27 %
Subscription
Subscription revenue increased by
Service
Service revenue increased by$4.5 million , or 35%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 . We generally recognize the revenues associated with professional services as we deliver the services. Cost of Revenue Three Months Ended June 30, Change 2022 2021 Amount Percent (in thousands, except percentages) Cost of subscription$ 32,738 $ 24,982 $ 7,756 31 % Cost of service 15,168 10,021 5,147 51 % Amortization of acquired technology 3,892 3,830 62 2 % Total cost of revenue$ 51,798 $ 38,833 $ 12,965 33 % Cost of subscription Cost of subscription increased by$7.8 million , or 31%, for the three months endedJune 30, 2022 compared to the three months endedJune 30, 2021 . The increase is primarily due to higher personnel costs to support the growth of our subscription cloud-based offering of$3.5 million and increased cloud-based hosting costs of$1.7 million . Also contributing to this increase were increased allocated overhead costs of$1.0 million , higher travel costs of$0.8 million , as well as higher share-based compensation of$0.4 million .
Cost of service
Cost of service increased by$5.1 million , or 51%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 . The increase is primarily the result of higher personnel costs of$2.9 million and higher share-based compensation of$0.8 million . Also contributing to this increase were increased travel costs of$0.5 million .
Amortization of acquired technologies
For the three months ended
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--------------------------------------------------------------------------------Gross Profit and Gross Margin
Three Months Ended June 30, Change
2022 2021 Amount Percent
(in thousands, except percentages)
Gross profit:
Subscription $ 216,820 $ 171,538 $ 45,282 26 %
License - 50 (50) (100 %)
Service 2,547 3,149 (602) (19 %)
Amortization of acquired technology (3,892) (3,830) (62) 2 %
Total gross profit $ 215,475 $ 170,907 $ 44,568 26 %
Gross margin:
Subscription 87 % 87 %
License - % 100 %
Service 14 % 24 %
Amortization of acquired technology (100 %) (100 %)
Total gross margin 81 % 81 %
Subscription
Subscription gross profit increased by $45.3 million , or 26%, during the three
months ended June 30, 2022 compared to the three months ended June 30, 2021 .
Subscription gross margin remained consistent at 87% during the three months
ended June 30, 2022 and the three months ended June 30, 2021 . The increase in
gross profit is primarily due to the growth of the Dynatrace® platform by new
customers combined with existing customers expanding their use of our solutions.
Service
Service gross profit decreased by$0.6 million , or 19%, during the three months endedJune 30, 2022 compared to the three months endedJune 30, 2021 . Service gross margin was 14% for the three months endedJune 30, 2022 compared to 24% for the three months endedJune 30, 2021 . The decrease in gross profit and gross margin is primarily due to higher share-based compensation of$0.8 million . Operating Expenses Three Months Ended June 30, Change 2022 2021 Amount Percent (in thousands, except percentages) Operating expenses: Research and development$ 48,482 $ 34,725 $ 13,757 40 % Sales and marketing 105,015 80,482 24,533 30 % General and administrative 36,321 26,922 9,399 35 % Amortization of other intangibles 6,573 7,540 (967) (13 %) Restructuring and other (10) 26 (36) (138 %) Total operating expenses$ 196,381 $ 149,695 $ 46,686 31 % Research and development Research and development expenses increased by$13.8 million , or 40%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 . The increase is due to a 27% increase in headcount, resulting in increased personnel and other costs of$5.4 million to expand our product offerings and higher share-based compensation of$3.3 million . Further contributing to the increase were increased allocated overhead costs of$2.3 million to support the growth of the business and related infrastructure, higher travel expenses of$0.9 million , and higher cloud-based hosting costs and subscriptions of$0.8 million . 20 --------------------------------------------------------------------------------
Sales and marketing
Sales and marketing expenses increased by$24.5 million , or 30%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 , driven by a 30% increase in headcount, which resulted in an increase in personnel costs of$12.2 million and related share-based compensation of$2.5 million . Further contributing to the increase were$6.1 million of travel expenses primarily related to our annual sales kick-off event held in person, higher costs related to partner fees and enablement of$2.3 million , increased allocated overhead costs of$1.3 million to support the growth of the business and related infrastructure, and higher information technology costs of$1.0 million .
General and administrative
General and administrative expenses increased$9.4 million , or 35%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 , primarily due to a 37% increase in headcount, which resulted in an increase in personnel costs of$4.5 million , as well as share-based compensation of$2.4 million . Further contributing to the increase were higher professional fees of$1.9 million , higher IT and facility expenses of$1.9 million primarily related to new offices and expansions, increased cloud-based hosting costs and subscriptions of$1.2 million , other employee-related expenses of$1.2 million , and increased travel expenses of$0.5 million .
Amortization of other intangibles
Amortization of other intangibles decreased by$1.0 million , or 13%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 . The decrease is primarily the result of lower amortization for certain intangible assets that are amortized on a systematic basis that reflects the pattern in which the economic benefits of the intangible assets are estimated to be realized and the completion of amortization on certain intangibles.
Other Expense, Net
Other expense, net increased by$2.9 million , or 186%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 . The increase is primarily the result of foreign currency transactions, partially offset by lower interest expense on our term loan as we had less principal outstanding compared to the same quarter last fiscal year.
Income Tax Expense
Income tax expense for the three months endedJune 30, 2022 of$12.6 million represented a$6.2 million increase as compared to an expense of$6.4 million for the three months endedJune 30, 2021 . This increase was primarily due to effects of the new requirement under Section 174 of the IRC to capitalize and amortize research and development expenses in theU.S. , generating current tax expense with no offsetting deferred tax benefit due to our valuation allowance position. Liquidity and Capital Resources As ofJune 30, 2022 , we had$571.3 million of cash and cash equivalents and$44.6 million available under our revolving credit facility. Since inception, we have financed our operations primarily through payments by our customers for use of our product offerings and related services and, to a lesser extent, the net proceeds we have received from sales of equity securities and borrowings on our term loan facilities. Over the past three years, cash flows from customer collections have increased. However, operating expenses have also increased as we have invested in growing our business. Our operating cash requirements may increase in the future as we continue to invest in the strategic growth of our company. Our historical expansion with customers has typically been achieved by executing additional contracts, each with unique pricing and anniversary dates. We are transitioning to a program that combines these contracts into one single, often multi-year contract per customer with one single anniversary date, which may result in variability in the timing and amounts of our billings which could impact the timing of our cash collections from period to period. Our material cash requirements from known contractual and other obligations consist of our long-term debt agreements, rent payments required under operating lease agreements, and interest obligations on our term loan. As ofJune 30, 2022 , total contractual commitments were$349.2 million , with$21.2 million committed within the next twelve months. For further information see Notes 6 and 7 of the notes to the condensed consolidated financial statements in this Quarterly Report. 21 -------------------------------------------------------------------------------- Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the risks detailed in the section titled "Risk Factors" under Part II, Item 1A in this Quarterly Report and our Annual Report. However, we believe that our existing cash, cash equivalents, funds available under our debt agreement, and cash generated from operations, will be sufficient to meet our cash requirements for at least the next twelve months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the continued expansion of sales and marketing activities, the introduction of new and enhanced products, seasonality of our billing activities, timing and extent of spending to support our growth strategy, and the continued market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition would be adversely affected.
Our Credit Facilities
As ofJune 30, 2022 , the balance outstanding under our first lien term loan was$251.1 million and is included in long-term debt on our condensed consolidated balance sheets. We had$44.6 million available under the revolving credit facility after considering$15.4 million of letters of credit outstanding. All of our obligations under our term loans are guaranteed by our existing and future domestic subsidiaries and, subject to certain exceptions, secured by a security interest in substantially all of our tangible and intangible assets. AtJune 30, 2022 , we were in compliance with all applicable covenants pertaining to the First Lien Credit Agreement. Our credit facilities are discussed further in Note 6 of the notes to the condensed consolidated financial statements in this Quarterly Report.
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