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

Good morning. Thank you all for being here at the William Blair's 40th Annual Growth Stock conference. It's a huge milestone for us, 40 years of doing this. Anyway -- and I haven't been here 40 years, just 14. But my name is Bhavan Suri. I'm the analyst that covers Dynatrace at William Blair and you can find all the appropriate disclosures on our website at www.williamblair.com. It is a great pleasure to have 2 friends of mine, John Van Siclen, who is the CEO; and Kevin Burns, the CFO of Dynatrace, with me today. I was just chatting with them earlier, and I remember meeting them, I forget, 4, 5 years ago. And John had just built and fully launched the new platform, which was kind of built from ground up, and it just lit up infrastructure. So it just shows you where everything is and without any tooling or doing anything. And I sort of was blown away by sort of that technology, and so it's great. It's been a journey. They've been an incredibly successful public company. And so I'm going to turn it over to John here. It's going to be a fireside chat, and I'm just going to walk through some questions. But John, Kevin, thank you both for being here.

As a start, I'd love to just get a brief overview of what Dynatrace does. We have a lot of investors that might be new to the story, so just a sense of where you came from and what Dynatrace does? Let's start there.

Sure. So we're defining a new category of software that we call software intelligence and you can think about it as the combination -- a powerful combination of observability at scale, which has taken over where monitoring has left off; automation and what Bhavan was just alluding to a quite an advanced set of automation where there's no configuration necessary throughout the entire system to make it much easier and more automatic for our customers to scale out. And the third piece is we built an AI engine at the core. So observability at scale, advanced automation and AI at the core, so a unique combination. Maybe give you an example of how this works for our customer. Let's take a large grocery chain became a very essential part of our economy over the last 3 months. They made a decision a couple of years ago, actually, probably 3 years ago now, to shift from their traditional data center environment to a multi-cloud environment with Kubernetes as the orchestration layer for a dynamic multi-cloud environment. And when they did that, they found that all their tooling, all their old tooling was obsolete. Nothing worked. They knew who we were. They upgraded to our new platform, and they took off. They now have hundreds of applications that actually use Dynatrace to understand sort of that -- what they think of as situational awareness across an entire cloud stack and all the workloads that run on them. They're able to innovate much more efficiently. Their operations are able to now be proactive instead of reactive, which makes them much more efficient, and their business outcomes are really transforming. Recently, they had to shift their applications from people coming into the stores as their only vehicle to having it out -- to really building out their online applications so that they could handle remote order and parking lot pickup. They did that in a matter of a couple of weeks flawlessly and scaled this out through all of the states that they cover in the Midwest. So really a great customer and a great advocate of the Dynatrace platform, what it's been able to do to change the way they do business.

Yes. That's a good start. I think, John, you also mentioned a story, because you're one of the very few software companies that successfully navigated some of the innovators' dilemma, right? You've re-platformed and remained a leader. Typically, if you look at what Salesforce did to Oracle, you don't see Oracle coming back with a CRM or sales cloud that's really comparable, but you've doubled on that. Just a little bit about Dynatrace's journey and what you did in terms of moving from a classic product suite to the new platform sort of when you did it, why you did it and sort of how you did it, a little bit of sort of the magic sauce here.

Yes. So it was about 6 years ago now, maybe a little bit more than 6 years ago when cloud was just people could sell it, but they didn't really know what it meant and put a team to my product specialists and CTO and founder of the business, Bernd Greifeneder, on the project, why don't you come back and tell us how we're going to evolve our platform for the cloud? And they came back. This team of 12 came back and said, John, you may not like this answer, but we need to totally reinvent the entire platform from the ground up, not a lick of the same code because the cloud is that disruptive. And they explained that, first of all, instead of physical network, physical hardware and applications running on top, everything was going to be software, virtual network, virtual -- and not only would it be all software, it's going to be all virtualized and dynamic. So it's all going to be changing at the same time. Then the frequency of change for applications is going to go from months to minutes, and so that's going to just totally throw IT out of control. And the scale of these environments, we're not talking about an application-by-application kind of instrumentation. We're talking about an entire data center move to the cloud and see that entire stack and all those workloads at one time because anything can trip up anything else, and the ripple effect can be unpredictable and unanticipatable. So that drove us to totally reinvent why we put an AI engine at the core for the scale and the volume of velocity of data that we were going to have to handle, why we had to automate everything because the cloud is dynamic, ever-changing, and there's no room for manual configuration or scripting or things like that. And the change management elements, you're going to have to deal with the entire life cycle and the scale of the charts, of course. So we had to reinvent to a thousand times the size, handling workloads, a thousand times the size of what we were doing. And I think that really sets us apart today and what our customers appreciate is not only that it was a bold move, but it actually works as advertised and really does take them much further than any other platform that they can put in place. So it's not just the application layer, which is what we're best known for. I mean that's still our landing zone. But we now have multiple modules that we put in place that expands our TAM from the $4 million-ish application sort of TAM to well over a $20 billion TAM, just by working up from the ground-up kind of estimates. Some talk about it as a $30 billion-plus TAM. And it's growing, as you know, like ridiculously fast, as fast as the cloud players are growing, 30% plus year-on-year.

Yes. No. I think that's super helpful. And you sort of led into my next question around TAM. If you think about the 3 kind of macro trends, right? So you've got this digital transformation piece. You've got the huge sort of paradigm shift to clouds like hybrid, call it what you want, the new architecture that you and I have talked about, and you've got sort of this micro services server-less pieces, all laden with a business need for increasingly delivering a better customer experience and customer service and customer management. If I was to think about those trends, where do you think we are in the shift to those, both from a technology piece and a business piece? And then we'll talk about the penetration segment. Let's just start with where do you think we are in the shift of those trends? I mean they're obviously past the chasm, but where do you think we are?

Well, so I think we're in early innings. I mean the move of the infrastructure from traditional data centers to the cloud is -- I think if you ask Amazon or Microsoft or Google, they say it's still in early innings. There's trillions of dollars' worth of spend over the last 30 years is now moving in a decade to these platforms. And because we focus on the lens of the application down through the infrastructure, we tend to come in, in a Phase 2 rather than Phase 1. When you're first standing out to the cloud platform, it's about the platform. And then once you have the platform, you put the workloads on it. So we might even be one step behind even that. And you can see from our net expansion rates of 120% plus over the last 8 quarters or our ARR growth, which is 40% plus over the last, I think, 6 quarters that we're growing quite well with this new platform against this kind of massive TAM that we have in front of us.

Yes, yes. If we really don't change it differently and think about penetration and future expansion, both from new logos and existing customers, what percentage of workloads would you say today are being monitored with not just prone scripts and kludgy stuff, but like real-world technology? And where do you think that is in 5 years?

So when we approach the market in a sort of a traditional sort of legacy data center world, we were seeing probably 70% of the enterprise customers that we target. I mean we target the global 15,000, so think $1 billion company and larger. 70% of them already had something in that application layer. Of course, they have some things in infrastructure and network as well. They're fairly sophisticated. But the minute you move to the cloud, all of that's disrupted because of the changes I just went through. So now they're all trying to find alternatives, which are used for this, which are used for that. And they're realizing that going to the old tooling way of thinking, which is I'll have a tool for my virtual network, a tool for my virtual infrastructure, I'll have a tool for apps, I'll have a tool for this, it doesn't work because the cloud is a layer of virtualized software, but it's always changing. And you have to see the whole thing at once in order to have a prayer of understanding how to optimize it, how to troubleshoot it, how to really get true business outcomes without getting tripped out. So that changes the dynamic and sort of that the world that we see. So we're -- we now see probably 30% to, I would say, I really have something and 70% now in these new dynamic multi-clouds, and they're trying to call it together sort of a do it yourself, if you will. And so it's -- the competitive landscape's changed quite a bit as more and more people move to dynamic multi-cloud environments, which we see now emerging in over 80% of our base.

Yes, yes. So let's touch on competition, right? It's a really big TAM. It's the shift. And you think about yourself as a leader in sort of, let's call, a small group to gen 3.0 vendors out in the space. I'd love to understand how you think about competition because, obviously, the legacy vendors are trying harder to close a gap, and they may ultimately fail. So I'm on odd now because by that. So you've also got some newer entrants in that space, not newer, like one which is just a wrapper and what I believe is older technology but some of the newer place. I'd love to understand how you think about the competitive environment and then the sustainability for your growth rates longer term.

It's a great question, I get a lot, of course. The first thing to understand is that the market really is massive and growing fast, okay? I know Gartner talks about growth rates in the 10%-ish kind of range, but that's because there's the old world's going down, while the new cloud world's going up, and this cloud world is growing at 30% plus. And that's just the side, of course, that we're on. So that's a key part of thinking about it. The second part is your go to market. So you have swim lanes of my landing zone's infrastructure, my landing zone is logs or my landing zone is apps. And then you have who goes direct sort of top-down and who's going freemium developer up. And you can create almost like a 3-dimensional map of, okay, so you have, what, 4, 5, maybe even 6 companies you can put on a map like that, nobody really doing in this kind of IT op management use case environment, more than $500 million, $600 million. And yes, they can all grow fast into this $20 billion to $30 billion TAM before the swim lanes and the go to market start to collide. And I think that's part of what you see. Now as you go forward and you roll the movie out in sort of like, okay, sooner or later, you do start hitting each other. Now what? And I really like our differentiation in the market, and I'll anticipate a little bit of questions maybe about post-COVID world. Now I really believe that automation and AI assistance are going to be fundamental requirements of platforms. Not nice to have, not something you're going to bolt on, but it's something that's fundamentally built into the way the platforms work because that kind of automation and AI provides you -- gives you time back, makes your -- all your resources that much more efficient, do more or less. And you save so much money that's today sort of wasted in repetitive manual work that -- who has that to burn in a post-COVID world. So I really do believe that those kinds of -- that kind of foresight that we had 5, 6 years ago when we reinvented our platform still has yet to pay the bigger dividends which are yet to come.

No. Yes. Let's touch on COVID. As you already anticipated, lots of questions around COVID, but why don't we start off with the first one? You witnessed sort of a modest impact on new bookings in Q4. But obviously, the overall business remains very sound fundamentally. Business trends in April are encouraging. I guess we're now in early mid-June. Just love to get an update on what you're seeing and hearing from customers around their spend and their behavior now that we sort of got over the panic and we're understanding there's a whole new normal. And you guys, congratulations, just I think you went to the office, so you're opening up. But love to understand what you're hearing from customers.

That's right. It's day 2 in our office here in Waltham. It's probably all 15 of us, we're now in the office out of however many, but it is. It's nice to sort of be back and be able to do this from the office here. But let me give you sort of a little bit of a view. So you know that at the end of our fiscal year, which ended in March, we closed a really strong Q4 despite the March perturbations as everybody's disrupted themselves and worked to make sure their employees were safe and work from home. So -- and we supported that effort with our customers, and we closed a great -- a really strong Q4. The -- in April and in May, we actually were pleasantly surprised with the ongoing closing of business, not just in the new and growth area, which the sales folks drive, but also in renewals, in cash collections. All 3 areas, we anticipated could be impacted by COVID. And I think that really points to the fact that, first of all, digital transformation is considered essential. And the ability to understand these digital, these applications that are driving digital change for these organizations, you just have to invest in that kind of observability, in the ability to optimize, the ability to troubleshoot and tune to become more proactive. I mean people are just investing in those applications. So we need to give you some simple stories that maybe help with bringing this home, we have a number of banking customers that came back to us in April and May and just said, our mobile home banking apps are going through the roof, because nobody's going to the branches. Nobody wants to go to a branch. We're going to do that from home. Everybody is going to do it from home, and they're not just seeing like doubling of the workloads. They were seeing like 400%, 500% increase. So they wanted more instrumentation and more visibility into those layers. And of course, that drives some fuel. Some of the health care folks, they're not processing as many medical claims because nobody is going to see the doctor. But their video conferencing was going through the roof, and they've never really instrumented that, and so they have to lean into that. So as people see different changing workloads or they see more remote work on their publicly facing environments, that's fuel to us. And I just think that that's helping to drive some of this essential -- Dynatrace as essential spend out there. I will say that when we gave our guidance, we thought about it as let's divorce ourselves from what we're seeing in the early weeks of a quarter when we still have a spike going up in COVID cases around the world, and let's divorce ourselves from the cautiously optimistic view. And we're going to go with a more pessimistic view, set a floor for annual guidance that we can then build back up off of. And so we try to like separate the 2. And I think that's a smart way of doing it, and I think that was a prudent approach to the way we thought about guidance. Like I said, so far this quarter, I'm pleasantly surprised. We'll see how we end, and we'll be back in July to talk to investors about what calendar Q2 actually look like for Dynatrace.

Yes, yes, yes. Let's touch on the business model, John, for a second. If I was to look at your business model versus some other vendors in the space, you focus on the enterprise, the PLC-driven direct sales approach, and the guys have got a bottoms-up kind of trial-based approach, targeting some different segments, but there's some overlap in some of the customers. I guess just walk us through the go-to-market playbook and sales motion because you are a company that's got great margin. And you've done well leveraging -- you're not spending 50% of revenue on sales and marketing. So walk us through the go-to-market approach and sort of how you built that efficiency out.

So we -- for the last decade, we've been continuing to perfect an enterprise-class land-and-expand model. So what I mean by that is we don't try to bite off an entire multimillion-dollar platform footprint. We just want to find the most advanced workloads where the most challenges are and land. And so that landing zone for us is in the application area we're best known for. We're clearly differentiated there. We look for the cloud-native workload. It's also probably Kubernetes orchestrated and land there. People are always having pain there, and that's about a $95,000 land. That's been our average for the last 2 years. It's a great landing zone. It's enterprise class. It's not the few thousand dollars that the freemium folks get, but it's a good solid landing zone for a direct sales organization. Then we scale it up quickly because the platform is so automatic, then we just add more workloads as well as cross-selling more modules. So our average ARR per customer today is 220,000. And so that's what we mean by land and expand. We have many customers over $1 million in ARR. We believe our customer base, think about it, you got a $1 billion company digitally transforming, who wouldn't pay $1 million a year to make sure their most important applications work flawlessly all the time? So we believe we have that headroom. We believe we have the modules to deal with, the technology team to do it with. And so that's our program, add more new logos, enterprise logos and expand the ARR per customer over time, not dissimilar to ServiceNow. And you can quickly do the math and figure out that, hey, if you're successful at it, you can run and build a really good-sized, high-growth business over the long term.

Yes. One comment, and I think it's worth talking through a little bit. You touched on sort of being prudently conservative. I think when you look at your net dollar retention rate on a dollar basis, you were sort of pretty conservative with the guidance, too. I'd love to drill down on that because one of the questions we get a lot from investors is you seem to have dropped pretty dramatically. And what's driving the drop? And I'd love for you guys to talk us through two things. One is, obviously, the move of customers to the platform which has driven not necessarily a -- it wasn't a dollar expansion, but they bought more stuff, which was part of it. And that trend is going away. And the second piece is conservatism. So just walk us through that particular thought process you look to what that net dollar retention rate will be or should be.

Right. Well, so we believe that we have the platform footprint, the monetizable modules and the size of customers. We're all digitally transforming, and they are in their early innings of doing it to be able to drive 120% net expansion rate or greater over the long term, okay? When we did our guidance, we thought, well, what if there's a U-shaped curve? What if there is a second wave? What if Q3 is as bad or becomes worse than Q2? Then what? And so that's how we thought about the guidance. What we're seeing is actually that because of the essential spend and the fact that digital transformation seems to be not just weathering the storm but maybe even accelerating that there's not even a V-shaped curve, sort of flat and then up, which is very different than the way all of our mindsets were, I think, in early April, which is sort of when we were thinking about setting an annual guidance, okay? I remember our fiscal year started April 1, not January 1, so we weren't updating. We were setting, and we thought an important set annual guidance for our investors. And so -- but that we do it prudently conservative, I think so.

I think that makes a ton of sense, and I appreciate it. We probably have got time for one or two more questions, but one of the questions that has come up in recent conversations is around the role of open source. And so you've got guys like open telemetry, which has a place for it. And I'd love to understand how you think about the open source. Obviously, you acquired sort of a platform around an open-source control plane that's kind of really cool. So, A, your thoughts around sort of the role of open source. And then as you think about capping, how you were -- how are you seeing interest attraction? Well, that's obviously relatively new. I'd love to understand that.

Well, so first of all, data -- any kind of data that we can get into our system just makes the AI engine that much smarter. And as we go in this world where you're looking at server-less or you're looking at mesh architectures and some of these new environments, they're going to need to provide their own telemetry data because they're not instrumental in a traditional way. And so that's where open telemetry comes in. It's why we were one of the founding members of that with Google and Microsoft is because we see that as great additional data to bring in to our total environment, topology map and AI engine, as I said. So big fans, and so we're continuing to -- whether it's open trace or open telemetry, we're leaning into those. I think those are great efforts. In general, open-source play is a really important role and an increasingly important role. We have been developing some of our own open-source technologies, as you pointed out. This control plane or pluggable back plane, the way we think about it to enable a more common DevOps environment as sort of the first phase of building autonomous clouds we think is a really sort of important effort for the entire industry and one that we are uniquely suited to be able to bring to market because of how intelligent our system is and this sort of expanse of its nervous system for clouds. And when you think about where we're going as an industry, who doesn't want an autonomous cloud? In fact, maybe another way to think about it is in 2025, are you really going to still have humans doing all the work to keep them up and running? Or are they going to self-heal themselves? And if you believe that because they have to self-heal themselves, they're too big and valuable, then you're going to have to go to an autonomous approach, a no-ops kind of approach, and we see that as an opportunity for us because of the precision of our AI engine to actually have a really key role in that kind of movement.

Yes. I know it's a really interesting conversation you have separately around the area of [indiscernible], and it's good to self-healing because we've got pieces of it, but it's never really played out. You still have people doing provisioning, right? It's -- even on Amazon or Google or Microsoft, it's not easy to go automatically provisioned based on a set of metrics. And hopefully, you're picking up from a product like Dynatrace that allows you to say, okay, this is where we are, and this is the capacity we're going to need, et cetera. It's kind of cool in 2025, interesting, John. One quick last one I'll squeeze in here. AWS hybrid clouds Outposts, you've announced expanded support for that, seamless support across all of AWS. Just what are you seeing in terms of customer excitement and demand for the capability? And then more importantly, what are you hearing from enterprise customers to the extent that they find to leverage AWS hybrid cloud environments over the next couple of years?

Well, there's no question that AWS is sort of the gorilla in that space. I mean Microsoft has made some great inroads. Google's, as you know, now on the move. But AWS is the large player. And every enterprise has AWS. There's many regulated industries that want that cloud behind their firewall. We built a hybrid SaaS environment 4 years -- 4, 5 years ago with the reinvention for those kind of regulated industry customers, and we have just a hand-in-glove fit in those environments with AWS and AWS Outposts now. So it's a great combination, especially for the larger AWS customers who are our target customers. We've seen some great traction. It's still early, but a great opportunity for us to get much closer to AWS, and of course, their most important customers and go-to-market partners.

No, no. It's really cool. I think we are at time. So John, Kevin, thank you, guys. Appreciate it. I'm glad you're all safe and well. And you're opening office, hope that goes well. And hopefully, we'll see each other in person maybe over a meal or something but really good to see you guys.

Bhavan, thank you very much. And thank you everybody.

Thanks, guys.