Dynatrace, Inc. Q3 FY2021 earnings

COVID-19 has materially affected how Dynatrace and its customers operate, and MD&A says the extent to which the pandemic may impact future financial condition or results remains uncertain. The filing warns of possible curtailed customer demand, pricing discounts or extended payment terms, reductions in subscription contract amount or duration, and increased customer attrition rates.

Dynatrace disclosed that it uses SolarWinds Orion software and took action after the SUNBURST malicious code cyberattack; the full extent and consequences may not be fully understood and systems or data could be compromised. It also noted a small number of email phishing attacks that compromised a limited number of email accounts.

The company identified a material weakness in internal control over financial reporting related to accounting for income taxes and realizability of deferred tax assets. It hired an International Tax Manager and a Vice President of Tax and plans enhanced review, but cannot predict whether remediation will succeed, and will need auditor attestation for the fiscal year ending March 31, 2021.

Dynatrace faces significant competition from application performance monitoring vendors such as Cisco AppDynamics, Broadcom and New Relic, infrastructure monitoring vendors such as Datadog and Nagios, cloud providers including AWS, Microsoft Azure and Google Cloud Platform, and others with greater resources or bundling ability. Competitive pressure could cause pricing pressure, reduced margins and loss of market share.

The filing notes sales cycles can be long and unpredictable for large enterprises, ranging from several months to over a year, with Dynatrace's third fiscal quarter typically its largest and a significant portion of transactions closing in the last two weeks of a quarter. Delays or cancellations of large purchases could cause significant revenue variation.

Customers have no obligation to renew maintenance, SaaS or term-license agreements, and may renew on less favorable terms or not at all. Dynatrace also depends on expanding sales to existing customers, so failure to renew or expand could harm future revenue and operating results.

Dynatrace depends on senior management and highly skilled technical, sales and marketing personnel, with research and development concentrated in Europe where competition for talent is intense. Loss of key personnel or inability to hire and train sales personnel could impair execution.

At December 31, 2020, Dynatrace had approximately $500.0 million of aggregate indebtedness, including $461.1 million outstanding under its first lien term loan, and its Credit Agreement contains covenants limiting dividends, investments, capital expenditures and other actions. A default or inability to generate sufficient cash flow could accelerate repayment obligations and harm liquidity.

Dynatrace relies on partners, including strategic partners, resellers, system integrators and cloud providers, to sell and distribute its solutions, and partner agreements are generally non-exclusive. If partners do not perform, choose competitors, or terminate with little notice, the company may need to expand its own services organization and growth could be harmed.

Subscription revenue grew 34% for the nine months ended December 31, 2020 to $472.3 million and total revenue grew 28.3% year to date to $507.0 million, but risk factors state recent growth rates may not be indicative of future growth. Growth depends on new customer acquisition, retention, platform adoption, conversion from Classic products and international expansion.

Market adoption of software intelligence solutions for application performance monitoring, digital experience monitoring, infrastructure monitoring, AIOps, business intelligence and analytics and application security is relatively new and may not grow as expected. If Dynatrace's solutions do not achieve widespread adoption or demand declines, purchases, renewal rates and revenue could fall.

Dynatrace's success depends on its platform interoperating with third-party operating systems, applications, cloud platforms, data and devices it does not control, and these technologies update rapidly. If it fails to maintain compatibility or customers do not install recent updates, installations could be delayed or canceled.

Thoma Bravo beneficially owned 29.8% of Dynatrace common stock as of December 31, 2020 and can exert significant influence over board composition, mergers and other stockholder matters, with rights to nominate directors. This concentration could delay or prevent a change of control and sales of large blocks by Thoma Bravo could reduce the market price.

Dynatrace is transitioning to combined multi-year contracts with a single anniversary date and away from perpetual licenses, which may increase variability in billings, deferred revenue and remaining performance obligations. As of December 31, 2020, remaining performance obligations were $1.05 billion, up 31.3% versus the prior-year quarter.

Dynatrace is subject to income taxes and non-income taxes across the U.S. and foreign jurisdictions, and tax authorities may challenge its interpretations. It also does not collect sales and use, value added or similar taxes in all jurisdictions where it has sales, creating potential tax assessments, penalties and interest.