Dynatrace, Inc. (DT) Earnings Call Transcript & Summary

Thanks for making the trip out.

Oh, yes. Absolutely. Good to see you.

Thank you very much. Great to see you. All right. Thank you, everybody. They're resetting the timer, right? That confused me for a second. Okay. Thank you very much. We're very pleased to have Dynatrace next up. We've got John Van Siclen here. He's the CEO of Dynatrace. Joined as CEO in 2008, moved the headquarters to Boston. Is that right?

Yes, we did.

Yes. And then been in the market over 35 years, so a lot of enterprise experience. So thank you for being here. We appreciate it.

Thank you. Good to be here.

So all right. You just reported your fiscal third quarter results. We saw ARR grow 44% again. We saw record number of new customers added to the Dynatrace platform. It's a story where -- I mean it's like the old meets the new, right? So you took the company, you re-architected the product, made it for the modern era. Not everyone may be familiar with the company, so can you kind of walk people through -- you've had phenomenal growth. Walk people through the market that you're going after.

Sure. Yes. So the company that I joined in 2008 was -- it was relatively small at the time, $4 million business. We grew that into a category leader in application performance monitoring. Back in the sort of the java.net stack days, which is -- it's amazing. It wasn't that long ago, but that was super modern, and now that's legacy. But we saw on the horizon, about 6 years ago, that the cloud was going to change things. And we weren't quite sure how. We thought maybe we could evolve our existing platform for the cloud, and so I sent a team off to validate that thesis. And they came back and said, "You may not like this, but we're going to have to rewrite everything from the ground up. Not a stitch of the same code because everything is going to change. And it's not just going to be gradual, it's going to be disruptive." So we talked about how the scale of these cloud environments, where it's not just apps in the cloud ahead, it was going to be the data center shifting to the cloud, that the workloads were no longer be static so that you could instrument them. They were going to be dynamic. So you had to reinvent, make instrumentation automatic, make it continuous. We talked about the frequency of change. How -- it's not going to be released every twice a year, not even 4 times a year. It's going to be daily, multiple times a day. The complexity level is going to go through the roof. So we said, "Okay. Time to reinvent." Made that decision. We -- I spent the last 6 years sort of taking that little start-up inside the business and have it basically swallow up the entire Dynatrace. And now 87% of our ARR is on the new platform. We're closing in on where converting the base from the old to the new is going to be behind, and so it's exciting.

Largely behind you, right? Yes. So -- and that's a big cultural change that the company had to go through. How -- what was the employee base, just out of curiosity, if you go back 6 years ago? And how big is the company today?

So 6 years ago, we're probably about 1,400 people. We had just carved -- it was -- we started the reinvention a little bit before we -- Thoma Bravo took us private. That was in late 2014. And we had to really reinvent the whole business, the culture and all the dimensions of the business as well. It wasn't just a platform. And with that came sort of a cultural shift back toward entrepreneurialism, which was required, and that's helped us tremendously today. In fact, it's one of the reasons our cash margin is so high relative to most software companies is because we learned how to run a super-efficient business under the help of Thoma Bravo along the way, plus a super-efficient new platform to leverage along the way.

Right. So APM's been in market that's been around for a while. But as you mentioned, it's also been evolving pretty quickly. And if you go back to the early APM, the early -- whether it's the AppDynamics or the New Relic, you kind of look back at when those companies were founded, kind of pre-cloud, right, or right around the time AWS was just getting started. So I'm going to -- I've got questions here. We're going to talk about kind of the more kind of newer companies that you might be competing with. But how -- you've rewritten everything from scratch. When you're competing versus the -- call them old guard, they're not that old, but if you say competing versus those other players, what holes do they still have in their product? And I know you don't want to talk about companies maybe specifically. But like, what is the functionality that maybe some of them haven't morphed to the modern day?

Yes. It's a great question. So put it in sort of the categories that we reinvented the business because of some of these trends that we saw. So take instrumentation or sort of the ability to sort of observe what's going on in the cloud. If you have to manually configure or even write scripts, it's just -- it's impossible to do in sort of the modern sort of dynamic Kubernetes-orchestrated kind of environments. The scale of these environments are 100x what they were 5 years ago. So to think that you're going to take data and just put it on a dashboard and say, "good luck," op center just doesn't really work. Just a number of sort of architectural characteristics like that. So when we look and talk to customers, they're struggling. They're having more and more blind spots with these dynamic multi-cloud environments. They're trying to put -- add more cloud-native workloads on top, and the blind spots are rising. At the same time, the importance of these applications is rising. And they don't have more resources to throw out the problem. So the combination is creating this dilemma, this pain that's acute and gives us the opportunity to -- even if there's an incumbent there, to actually leapfrog into the new workloads and -- which is where the new banks are being built, where the new insurance companies are being built, the new logistics companies are being built, et cetera.

Are there a large number of customers that are multi-APM, like people might be multi-cloud but multi-APM where maybe they've got a certain percentage of the APM that they're doing is with those older players that maybe haven't re-architected, but where they're starting to put -- where they're putting -- where they're kind of just introducing APM into their installed base? Maybe they're using someone else so there's a conversion path over time?

Yes. There's plenty of customers. The old world was a world of lots of tooling. And you could put a different set of tools on one stack of apps, and then there's another stack and another stack. That was when the data center had everything sort of siloed. But with the cloud, all of a sudden, you have a shared infrastructure. It's virtual network, virtual infrastructure, et cetera. And so as you move to the cloud, what we're seeing customers do is they want more of a platform approach as opposed to a tool-by-tool approach. So we'll still see customers that have their legacy set with sort of these legacy APM players, including our old Classic products even. But when they want to get to the new, modern cloud environments they're headed at, with data center to the cloud, that's where it starts to standardize much more quickly for one source of truth, one common view across a very wide, complex landscape.

And what would you say -- what's your best guess on APM penetration at enterprise customers? What percentage of apps are actually monitored? And what percentage maybe should be or could be monitored? Is it -- it might not be 100%, but what's the real -- what are you really playing for?

Sure. So Gartner had a status about 18 months ago, 5% of applications being monitored in a normal enterprise. And that's pretty much what we saw with our Classic that because it did take manual work to instrument the environment. When there were changes, you had to tweak your instrumentation and your scripts or whatever. And so you just ran out of people to do the work. So people only did them on the very -- most precious Tier 1 applications. What we've seen, since we've re-architected in our customer base, is we break that barrier because our instrumentation is automatic. And so we're seeing a much higher rise, which helps our net expansion rates, of course. But penetration rate now with the cloud, it used to be -- people talked about 20%, 30%, wanting to be instrumented. Today, I think it's more like 50%, 60% because the way the enterprise clouds are architected, the workloads run on shared services, and you can have a noisy neighbor anywhere. So you really have to see a much wider set of apps than ever before. And we're just in the early days, I mean ourselves, sort of early innings of fanning out through all these applications. And maybe a data point that I actually use, we had our user conference last week. But IDC came out with a stat just a few months ago, that in the next 3 years, we're going to build and deploy as many applications as had been built and deployed in the last 4 years. And even if they're half right, that -- it's massive sort of evergreen market space that we're in. And they're all getting bigger and all getting more important. So great place to be.

So if we switch to kind of -- there's also other entrants, recent entrants, into the APM market or maybe it's the perception that these people are in the APM market, how do you think about kind of the current generation of APM players? And how do you see your footprint as being different? The one that I'm referencing that comes up quite often is Datadog comes up. And we've talked about this even recently, kind of, if you were to do a Venn diagram before the overlap is, what it looks like, but maybe if we could hear it from you.

Sure. So the cloud really does collapse the IT infrastructure and operations management use cases because everything turns into software, okay? It's not hardware layers, it's all software. And so it allows companies that we built a full-stack view. So we thought about it through the APM lens, but we knew that infrastructure issues like CPU status saturation or storage issues or whatever or virtual network, packet loss, those kinds of things, can affect the workloads up above. So we built the full-stack view. So we always had the idea and knew that this collapse would happen. But what it does is it creates -- other people are seeing the same thing but from other swim lanes, okay? So the infrastructure guys are saying, "Oh, maybe we can move over toward apps because, look, it's all software." And so that sort of created this thought that, "Oh, everybody's going to collide tomorrow." But remember, the TAM also jumped with this collapse or jumps with this collapse. So whether you think it's a $20 billion market, I think some of the other competitors think it's $30 billion or more, it's big. So it's not the little APM market that Gartner talks about. So when you put that in perspective, then the other thing that I really believe, because we actually see it in how often we see competitors, is I think the go-to-market matters. So it's not just a technology swim lane, it's the go-to-market. And we have an enterprise go-to-market similar to a ServiceNow or a Splunk as opposed to a freemium inside sales go-to-market like some others. And so our overlap, based on the go-to-market, is actually a material difference. So even in the APM swim lane, we see some people much more who focused on the enterprise versus those who are really mid-market.

Right, right. You mentioned your user group conference last week. What were the key messages from your customers in terms of what they were excited about in terms of the announcement?

Great. We did make several announcements. So we think about our platform as sort of an all-in-one common data model with multiple monetizable modules, APM being one. It's where we land. But we also have expansion: infrastructure-only is an expansion, digital experience is an expansion, Digital Business Analytics is an expansion. And so there was a lot of excitement about how we were generalizing the platform to scale out in a more expansive way because they're starting -- the customer base is starting to trust our AI engine. It's always worked for them, but they're realizing that it's not just all right some of the time. It's actually right all the time. And there were lots of stories of people not believing it, and then they went back and said, "Well, what did Davis," which is what we call the AI engine, "What did it say?" And sure enough, there it is, boom, here's what it is, and here's exactly what to do to fix it. They say, "Gosh, I could have done that in a minute instead of taking an hour with a bunch of people." So as they change -- so once people get the hang of that's changing the way they work, they want it everywhere, touches many things as possible. So that was a big piece of excitement. And one of the key messages we wanted to get across was this idea of automation. Once you trust an AI engine -- and we call it explainable because it gives you the breadcrumb trail, so you can follow it. Once you trust it, why do you need to notify a person to take action? Why don't you notify a machine to take action to increase the amount of automation because nobody has resource to do the same thing over and over again? So think about runbooks going to 0 and only being sort of machine-to-machine. So that's a path we're on and a push that we're making because we believe we have an engine that allows that to be a reality.

So the customers that moved from Classic, right, to the Dynatrace platform, is -- do you think -- they needed to get there first, right? They needed to make that journey. And is it after they've started using it that they start asking the questions about Davis, for example? So I guess I'll stop there to hear your answer, and then I've got a follow-up.

Yes. So very few of them believe that the AI engine was ever going to change anything for them. They figured that was sort of a bonus if it really worked. They just wanted automation, and they wanted visibility into these new cloud environments. But then when the AI engine actually works, that's what's changed the way they work, to be much more proactive, and they don't even look at dashboards anymore. They just get -- the call comes in, maybe it's sort of routed through a PagerDuty or ServiceNow or whatever. And they -- here's exactly what to go do, and then they take action on that. But it's always with secondary item for their value proposition at time of original acquisition of the product or migration of the product.

So you guys have talked about this in the past, but as you convert people from Classic to Dynatrace, what is the -- again, it's kind of a new RFP. It's like you're competing for a new win, right? So in a way, you're competing for a new win, but there's also a very big uplift as people do convert, if I go back to what you've been seeing. So what does the evolution look like? You're almost done with the conversion at this point, but just in terms of -- how often was it people actually doing an RFP? And then what the uplift looks like as people were going through it?

Yes. So it's a great question. Rarely was there an RFP. Didn't mean people wouldn't look around on what else was there. But we allowed customers to convert their Classic products to the new Dynatrace dollar-for-dollar of ARR for the same basic footprint. So it meant that they already had a residual asset, so that was a like...

Yes. Hard not to try.

That was like a discount ticket to move across. So it was very rare that anybody would go anywhere else because why would I? Trusted supplier, fantastic product. By the way, if the product wasn't as good, the new platform wasn't as good, that would have been a lot harder. But that's big advantage. And maybe one thing to clarify is that when we talk about a sort of expansion at time of conversion, it's really an expansion. People go, "Oh, you mean, here's how it works." They try it out. They go, "Well, gee, we need it in these 3 or 4 places."

Right. So you expand your footprint.