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

All right. Welcome to this afternoon session. Hopefully, you guys enjoyed Marc Andreessen over lunch. I found that super interesting, especially his comments on software and SaaS valuations. And so what better way to kick off the afternoon portion of Day 1 with one of our favorite SaaS-based companies, Dynatrace. So thank you all for joining us. With us today, we have John Van Siclen, CEO; Kevin Burns, CFO; and Noelle Faris in IR. I'm going to start out with a few questions and -- but like I've been telling everybody, this is your meeting. I can sit here and talk to these guys for an hour. And I think 30 minutes is going to go by awfully fast. But if you have questions, submit them through the portal. We'll get to them as time permits, and I'll mix them into sort of my questions as we go. But we've had really good participation thus far, and I'd encourage you to send your questions. And so thank you all for joining us. It's not quite like being in person like normal, but this will have to do for the time being. So thanks for joining us.

I think, John, I'll start with you. I mean there's been a lot of -- well, let me just say, so in the early innings of COVID, I mean, we sort of had this opinion that we thought the monitoring space in general could be one of the most profound areas that sees a benefit in really is obviously a terrible situation with COVID. And I think we've seen that with a lot of numbers so far. You guys put up a quarter where ARR grew 33%. It did decelerate a bit from prior quarters here. But maybe to set the playing field, could you talk about the selling environment? Can you talk about maybe what's changed post-COVID? And then, fundamentally, how you think COVID is changing how customers consume your technology?

Sure. No, I think -- so, first of all, I think it's important to understand that we don't benefit from a work-from-home environment. There was a little confusion over that, but we do benefit from a remote life environment. And what I mean by that is that we instrument the most important applications in a business, ones that really drive revenue, touch customers, drive loyalty, et cetera. And whenever there's times of challenge, businesses look to their applications, their digital technology stack to deliver more of the revenue stream because it's more cost effective. And frankly, they get a lot more information about their customers, and they can do a lot more with it. So we saw the same thing in 2008, 2009, 2010 and we saw coming with -- via the pandemic this year. Now with it, I'll also say that, comes a little bit of headwind. We have -- and we've been clear with this. We have about 15%, 20% of our customer base in COVID impacted markets, transportation, airlines, hospitality, certain brick-and-mortar customers. So these organizations just basically paused spend. But take the 80% that were not impacted, accelerated digital transformation, which continues to fuel Dynatrace growth at a healthy rate. If those impacted verticals were still growing as they were prior to the pandemic, and they will again, at 12 months, 24 months out, it will be a gradual rise. We -- Kevin and I've done a little bit of math on our net expansion rate from -- in that cohort and believe that's probably a 3% to 4% headwind to our growth at the moment. But when you put it all together in a challenging macro time frame, we're very pleased with the success of the business in growing in that sort of mid-30s kind of range and look forward to a vaccine, so we can get the rest of our market, all growing at a similar rate.

So yes, that's a perfect segue. So effectively, it seems like it's been both a headwind but also a tailwind to certain folks. And so in other words, is it also safe to assume that COVID has fundamentally changed how CIOs think about the importance of monitoring? And therefore, with news of the vaccine, obviously, it's going to take time to work its way through the system. But when we get through that point, one would expect this to be a pretty good selling -- very good selling environment for you guys? So kind of life post-vaccine probably improves a bit.

Well, it is because digital transformation really has accelerated. Everyone wants greater agility, speed and efficiency, and that's what digital transformation is really about and it is widespread. I mean, it's not just this vertical or these top 3 companies in this vertical. I mean, it's widespread through our entire target customer base, which is a Global 15,000, as you know. But with that digital transformation acceleration, it's clouds in -- at the enterprise level, sort of, the dynamic of the clouds that have become the platform of choice to build these digital transformations on. And as those clouds become more complex, as more workloads go on top of them, as they expand further in these enterprises, as the value goes up, because the companies are leaning on their digital revenue streams harder, then observability -- so that monitoring and observability becomes absolutely fundamental. Think about it as situational awareness across the footprint. If you don't have it, you fly blind. And nobody wants to fly blind when it's driving revenue, customer success, loyalty and those kinds of things.

That makes a lot of sense. Yes, I want to spend just a minute on reflecting on your Analyst Day, which wasn't that long ago. And I thought you guys did a really good job presenting, effectively, the building blocks to what you thought would be 25% type ARR growth, I think, you said for the foreseeable future. And obviously, COVID is kind of getting the way of some of that right now. But could you just -- and I guess it could be for both John or Kevin, both perhaps. Remind us again about those building blocks? How you get to that 25% level? And obviously, I think, some of the things that I think investors would like to hear, I think you've already illustrated the 3- to 4-point headwind from COVID but also the perpetual runoff that you guys talked about last quarter and at the Analyst Day. But I want to -- capacity adds, new customer adds, net revenue retention, just how do you feel still about that 25% threshold?

Sure. Kevin, do you want to take that, and I'll add some color?

Sure. So what I'll do is just maybe, Matt, first of all, talk about some of the headwinds and just do a little bit of the comp that John just walked through. We continue to believe that the best indicator for the health of our business is ARR. So we will continue to focus on that. And as John mentioned, if you think about some of the headwinds to the ARR number this quarter, we had about 3 to 4 points related to COVID, and we had about 1.5 points related to this perpetual license runoff -- perpetual license deals we sold 2 years ago, 3 years ago. That COVID will stick around for a little bit. But hopefully, in 12 to 24 months, that will start to be a tailwind to the business. And the perpetual license will -- headwind will be upwards of 2 points in FY '21 and a little north of 3 points in FY '22. So if you, again, add those up, it's 4 to 5 to 6 points of ARR growth headwinds over the next 1 year to 2 years. However, when you think about the tailwinds, we think there's a lot more tailwinds here to business than there are some of the short-term, near-term headwinds. The first is we're investing for growth. We're investing on the innovation side, but, more importantly, we're also investing on the commercial expansion side. Our goal is to grow the sales organization 25% this year. In addition, we're seeing the maturity of the sales organization, which we believe will lead to higher productivity, and we're also doing much better on the cross-sell opportunity. I think we've talked about the attach rate for infrastructure. We're landing with 3 modules and we're doing better on that, which, again, we believe will be a productivity tailwind. And I'd say the third tailwind for investing in terms of ARR expansion is our cloud partner program. We're investing in that as well. We think that can be a meaningful contribution to ARR expansion over time. So if you think about all those different tailwinds of the business, we definitely think those offset more of the -- some of the short-term headwinds that we face. When you put it all together and you think about what are the core building blocks to growing ARR over time, the first is new logo expansion. We do believe we can maintain, over time, the 15% to 20% annual increase in new logos. We've done it historically. This year was a little bit of a pause in the first half related to COVID, but we think we're coming out of that going into next fiscal year. The second is maintaining 120% net expansion rate. As John mentioned, we have a headwind on that number because of COVID. When that comes out, there will be a tailwind, but that 80% that non-impacted verticals has seen a really healthy net expansion rate. So if you add 120% net expansion rate, new logos growing 15% to 20%, mathematically, that gives you a 30% ARR growth over time. We're not guiding to that at this point, right, but we definitely believe we're putting in the building blocks to maintain a really healthy ARR growth trend over time.

That's super helpful. John, do you have anything to add to that or does that kind of summarize the thoughts for you as well?

No. That summarizes the thoughts. I guess I would just maybe make a couple thoughts for investors because those 2 points that Kevin ended with really do characterize the growth building blocks, new logos and net expansion rate. And so growing the sales organization, increasing productivity and expanding that partner program, that will drive new logo growth. Our platform is highly differentiated and with huge value advantages at the enterprise level that we target. And then the net expansion rate comes a lot from our innovation engine. More powerful modules, more mature modules and new modules that are yet to be brought to market. So you put those what's under the hood between those metrics, I think, we're also actioning the business in such a way to drive both of those key vectors for growth.

That's super helpful. Great context. We're getting a couple of questions on competition, as I'm sure you expect and you probably spend a lot of your time answering competitive questions. So in the spirit of asking these questions because I know what's on everybody's mind, one of the question is -- says, "How is the competitive landscape evolved over the last 2 years?" And I guess I'll add into that. Obviously, you guys have a dominant position in enterprise G15K APM, but others are starting to move into observability. Splunk has a suite. Datadog is talking about some APM wins. Can you talk about how the competitive landscape has evolved and how customers look to perhaps standardize on a platform? And what does that mean competitively?

Yes. No, it's good questions. I think the biggest thing from a competitive landscape is it's really driven by the cloud itself and how the cloud has collapsed what used to be distinct use cases into one common set of needs. The cloud is -- the old data center world was very clear between what was network, what was infrastructure, what was application and what was user experience. Those were very separate sets of tooling. But in the cloud, it's all a mass of virtualized software. And with that comes a requirement that you see everything as a whole. And when we reinvented our platform 5, 6 years ago, we knew that these use cases were going to collapse, which is why we started picking up logs, metrics, traces, code, topology, a whole series of things because you need everything at once to really understand the shape and dynamic movement of these complex clouds. So that is one key dimension. The second one that, I think, has always sort of characterized our thinking, but I've noticed how stark the contrast really is, is the difference between the mid-market needs, which are much simpler, much more cost-driven than the enterprise needs, which are much more complex, the scale is much larger and the diversity of tech stack is also a key consideration. They all have hybrid extensions that they want to tie together with their most modern application environments. So these characteristics that define the SMB market and the enterprise market are very different, and that's why I talk about go-to-market is a critical consideration by investors. It's not one big pool and everybody goes after the same customers. They might think that and they might say that, but there are those who have a platform for enterprise-class customers and those that come up really supporting developers or small work groups. We happen to be the platform for the large Tier 1, Tier 2 application environments, and that's a sort of a unique set of characteristics. So I think the collapsing and consolidating of the use cases is a key consideration, but which creates a very big TAM and fast growing but also these go-to markets are really important to understand because it's not like we're bumping into the mid-market guys all over the place because it's really easy to do enterprise. And just like I have a high respect for those in the mid-market space because they have an accelerated go-to-market to go after 200,000 customers. That's not our space. It's not our go-to-market. We're really good at what we do and have shown a disruptive capability of getting new logos, no matter who's already there in an account at the enterprise level.

That's a great perspective. And I know, John, we spent a lot of time chatting over the years. Could you just refresh our memory again about when you're seeing a net new opportunity? How much of that is replacing a legacy vendor? How much of it's greenfield? And when it is greenfield, who do you see the most? I mean, are you starting to see Datadog a little bit more? I think, in the last call, you guys suggested that you're starting to land increasingly in observability type deals. So therefore, I think what's implied is you are probably seeing Datadog a bit more today than maybe you were a year or 2 ago. So kind of talk about when you see deal legacy greenfield and on the greenfield, who's showing up the most these days?

Yes. So slight dynamic differences over the last -- since we went public, 15, 16 months ago. So we're seeing the rise of do-it-yourself increase. And when I say do-it-yourself, these are companies that have already said, the cloud is too complex. It's too dynamic. The old stuff doesn't work. I'm going to cobble it together myself. These are the people that are bringing in sort of Prometheus and some open source, this and that. They might have a little bit of some paid for, whether it's one of our competitors, a Datadog in SMB, some developers have brought this in, they might have this, they might have that. That's a do-it-yourself environment. They don't really have a great strategy. They're a bank. They're an insurance company. They're logistics, They're egov. They don't want to be in the monitoring observability space. That's a perfect opportunity for us to bring in something that's built for enterprise class and bring time to value to them in a very short period of time and continue to expand from there. So that's about, like I said, 40%. That's up from about 30% a year ago. The second area is where there's sort of a primary incumbent. And usually, in the past, because we land in the application layer, the full stack piece, we'd see AppDynamics or New Relic -- Cisco AppDynamics or New Relic there. We're seeing less and less of them over time, as we're starting to see a rise of sort of observability. And so you're right. In observability, we do see some different characteristics. There's a little bit more of a Datadog. We bump into Splunk here and there, still very light. Both of them less than 10% of the time. But as observability continues, I think we'll see them a little bit more. Again, what differentiates us when you get to observability is that's our starting point, not our ending point. What I mean by that is observability -- and you take the data and put it on a dashboard is the endpoint for our competition. We apply analytics across it, so you can understand it, you can predict and you can take action, not just observe. And when you get to complex, high scale, dynamic cloud environments at the enterprise, you need more. They require more. They demand more. And that's why that competitive advantage we have there, I think, is sustainable.