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

Everyone, thanks for joining. I'm Robert Majek, Infrastructure Software Analyst at Raymond James. It's the first session of Day 2 of our Tech Conference, and I'm excited to be here to chat with the management team from Dynatrace. So with us here today is John Van Siclen, CEO; Kevin Burns, CFO; and Noelle Faris, Investor Relations. I'll be leading your fireside chat format for about 40 minutes, and I have a number of topics I want to make sure we hit. But at the same time, I also want to make sure the session is interactive. So please, if you have any questions, e-mail me at [email protected]. And I'll try and weave them into the conversation. So John, Kevin and Noelle, thanks for joining us today.

John, maybe to lead us off here, can you just kind of talk about how COVID-19 is impacting your business today? I mean you've put up great results, but just would be great if you could just elaborate on the demand environment that you're seeing today?

Sure. Ever since the spring, we've been quite resilient as a business. Our brand, sort of an automatic and intelligent brand of observability, is an essential part of any cloud rollout and the clouds underpin digital transformation, as we all know. So once everyone sort of settled down from the work from home, it's really been quite a robust environment for us. We flipped to selling from remote, product works great. You can demonstrate it, you can proof-of-concept it, you can roll it out, you can expand it all remotely. So we really haven't missed a beat. So demand has been good and our ability to execute in this environment has been good. Even with the recent spikes around the world in COVID-19, digital transformation continues to be a cornerstone of the way companies think about driving agility, speed and efficiency going forward. And we don't see a slowdown or a pause anywhere in there.

So that's good to hear, John. I guess the follow-up question I was going to ask you is another large IT vendor recently announced that they were seeing lengthening sales cycles and that CEOs were being a bit more careful about signing larger deals in this environment. So that's something that you're not necessarily seeing?

No, we're not seeing it. I think that there's -- and I've said this before, there's sort of the haves and have nots. And the have nots are the ones still selling into sort of core IT use cases, whereas those on digital transformation and where the IT environment is going in the future are the haves. And that's where the money is going. So it really depends on what your focus is. If you're a modern cloud, and that's 90% to 100% of what you do, things are good. If you're not, it's a challenge. And I think that's more what -- maybe what we're seeing out there. But we're not seeing that kind of impact or lengthening of sales cycles any more than usual for enterprise-class software.

And how has COVID changed in the way that CIOs view their monitoring and observability spend on either an absolute basis or a relative basis to the rest of their IT spend? And as we exit COVID, what sort of tailwind impact can we expect?

Well, I think that there's a couple of things that we've seen. COVID really has heightened the awareness around sort of the need for automation and the need for some kind of intelligent assistance. I mean AIOps has become an extremely hot topic in the market. We just happened to have unified AIOps with observability early, and it's resonating more and more higher up in the organizations, which is helping us, obviously, land new logos, back to sort of what similar levels to a year ago as well as drive net expansion rates, which continue to be strong. So it's a combination really for us of not just the need for visibility into these growingly complex clouds, it's also the automation and intelligence to allow strapped IT teams to do more with less.

And if we take a step back, I'm just curious, as I view the mark over the next 5 or 10 years, what percentage of applications in servers and workloads are customers monitoring today? And how might that figure look, again, 5 or 10 years out?

Gosh, it's a great question. And I often refer to this market that we're in as sort of an evergreen space. Evergreen as in the minute you think you've covered all the applications, there's a whole new slew of them, and every application that's successful expands even further. And as applications then expand, the infrastructure underneath has to expand. And as the applications and infrastructure expands, all the user experience components of how people are interacting from all over the globe with these applications is exploding. So really is an amazing market. I think it was IDC did a study, I think it was early winter 2020. And they came out and said that over the next 3 years, there'd be more applications built and deployed than in the prior 40. I mean it's just like blows your mind how rapidly expanding -- infinitely expanding this digital transformation and, in particular, application workload -- cloud application workload area is.

And we've seen a shift to hybrid and multicloud, a shift towards microservices and containers. So you just have a lot more IT complexity today than you used to. And then at the same time, some customers are shifting to a multi-silo approach. Can you just talk about those dynamics and the impact that they're having on your business?

Yes. No. Again, it's a pretty common trend that we see -- what -- the cloud brings great agility, speed and efficiency, but at the same time, the complexity goes through the roof. And we're seeing more and more businesses that thought they were under control with their cloud transformations realize that the minute they go to dynamic containerized environments, normally Kubernetes, they go cloud native as the primary application model. They go DevOps with 2-week sprints and code hitting production daily -- new code hitting production daily. That level of complexity and change is extremely challenging. And so I go back to my point of why are companies leaning toward, I need observability, it's because the cloud has made all prior technologies obsolete and it's made things so complicated. Humans can't place instrumentation. They can't deal with the volume velocity of data coming at them from these systems and that's why automation and AIOps are so popular as topics right now. And as I said, we've been doing it for 5 years. So we really have the most robust enterprise-proven platform for that combination, that unification of observability, automation and AI. And it's been a great, sort of, like I said, boom to our business. Gives us a really solid new customer growth plus net expansion, which is what's driving the 30-plus percent ARR growth year-on-year.

And then you touched on being container native. Just -- I have a bunch of questions on differentiation, but maybe we could start there. How important is that for you? And I know some of your competitors are building container support into their product, but they're not container native. So can you just maybe elaborate on that a little further?

Yes. Well, so -- we -- about 5, 6 years ago, we remember having the conversations with the R&D team of why we needed to rebuild from the ground up our platform, that the world was going to be radically different than the monolithic application environment that had preceded it. So with a fresh platform, we built in sort of native containerized support and not just to understand container dynamics, but actually the workload dynamics inside those containers. What are those services doing? What calls are they making? How is that application actually interacting? That reinvention of the entire model for instrumentation and observability has been a big boom, more complexity, the more you need to understand the interaction of the full stack of all those services and processes at any one time. And so -- from our perspective, if we didn't redesign from the ground up, we wouldn't be able to do it. And I think other organizations are finding, they're trying to bolt it on or try to tweak this or that, doesn't work. So you even see some of them throw up their hands, give up on trying to reinvent their instrumentation and just say, "I'll just wait for open standards like OpenTelemetry, maybe that will save me at the other end." So -- we believe OpenTelemetry is a critical component and expands our offering greatly, but it's not the only thing people are going to need for the next 5 to 10 years when they really try to deal with these dynamic multicloud environments that span generations of technology.

So building on that question, what are the top reasons that customers choose Dynatrace over competing tools? You just talked about being container native, the redesign that you went through, just what capabilities are kind of really driving those net new wins for you?

Well, it's a combination of things. But the first thing is, can I get visibility across my entire footprint, what I would consider my cloud environment, and clouds aren't just public cloud extensions. They reach back into data sources of record, whether you're an insurance company or a bank, you're in entertainment, logistics, whatever, they reach back into data sources of record that are critical to tie together with those front-end cloud environments -- public cloud environments. So that's one. We provide that sort of situational awareness across a very broad footprint, which is characteristic in billion-dollar-plus companies, which are our target customers. The second thing is the automation. One command line auto discover everything and do it continuously. Not just as set up, you have to do it continuously. If you don't reinvent to be able to do that, then it's manual configuration, teams of people trying to manage these things and you never really get them scaled out. And then the third one is the AI. What the AI does is it takes observability into whole new level. It provides understanding, it provides predictability and it provides actionability. It takes sort of a basic level of data and turns it into action. And people want that kind of action in minutes, not in hours, days, more rooms of people for a week, they need it now. So you take an airline, if you remember those. I like airlines now because I think we all wouldn't mind getting back on one, but there will still be a little time. But we might not -- we might like to do that one of these days. Take an airline. If it takes more than 30 minutes to resolve an issue, you ground planes, you ground passengers and everything backs up. So to be able to solve things in minutes versus hours or days, it's priceless. And that's the kind of modern cloud environment you'll find us in whether it's retail, insurance, as I said, banking, et cetera.

So that's really helpful here. A question I have from an investor, John. Your core has always been in APM, but now you're really much more focused on selling the full stack offering. Are you starting to see broader adoption of the infrastructure and log monitoring capabilities that you're selling as part of that full stack offering?

Yes. Well, you brought up sort of the de-siloing of these tools or what we think of as more of a consolidation, but the consolidation is a reaction to the need to have a full stack view of these clouds. And the clouds are a combination of things like code you can instrument in an application kind of way, but it's also metrics and logs that you need to get to other sources of data that make up that full stack of the cloud. So for the last 5 years, again, we've been doing that full stack, auto discover of metrics, logs and traces as well as code, topology, user experience, et cetera. So the de-siloing, absolutely, a main theme for these modern clouds, the collapsing of ITOM use cases. But I wouldn't say that it's somehow related to, I want to save cost. It's related to I need to drive speed, efficiency and agility. And so to have that kind of wide understanding at all times, situational awareness at all times, is what drives that consolidation of the tooling so you have a single source of truth. So are we seeing log and metric adoption going up? Yes, but it's going up because our platform is expanding wider than just the cloud application environment. So it's expanding into directory services, load balancers and firewalls, into different kinds of environments that don't have application workloads where it's an infrastructure-only view, even some of the lower end application tiers that never had and probably never will have sort of an APM level monitoring. That's fueling this wider expansion of our platform. And we've talked about it before. It's now in more than 30% of our customer base. It's growing quickly. It's the fastest sort of new contributor to ARR growth outside of the APM landing zone that we're best known for. But it's a big and important extension for us, and we see continued rise of that as part of our overall net expansion going forward.

John, how should investors think about Dynatrace's pricing relative to competitors? Why do customers kind of willingly pay Dynatrace a lot more than if they went with a cheaper alternative?

Well, they get more value. So we've always been a premium brand. And that premium comes, as I said, because we don't just provide here's the data on dashboards. We actually provide the understanding automatically, the predictive analytics and the actionability on top. And so it's that full package of value that allows us to command higher price. What we see customers looking for at the enterprise level at the billion-dollar-plus company level is from a pricing standpoint, predictability and transparency. They don't want to be surprised during the budget cycle that all of a sudden they have a bunch of overages. And they also want to know that if I buy more, will my price continue to trend down per unit. And so as long as we provide those views, just like Amazon does, just like Azure does, just like MongoDB, go down the list of cloud kind of environments, so familiar environments, then we're in a great place. I really think that those who focus on pricing is if it's the #1 thing that drives demand, are really in a different market segment than we are, downmarket, mid-market, lower end of the market, sort of that long-tail, high-volume space as opposed to ourselves, who are really focused on that billion-dollar-plus company, 15,000 of them around the planet, and really go after that segment with a purpose.

So I have a few questions on -- from investors on New Relic. And you just kind of touched on it there, but we've seen New Relic make some recent price changes. I know they tend to target smaller customers. Are you seeing any impact from that change from them?

Not at all. Not at all. Like I said, it's -- pricing is -- our customers look for value and a fair price, okay? So to the extent that pricing has to be fair and sort of relevant to something, some anchors, then it holds us in a reasonable zone. But that's -- it's no different than it's been for the last 15 years in this space, 12 years, I've been the CEO. It's always been a fairly competitive space. But as long as you bring value, you can command a premium. And that's what -- that's the way we focus our R&D efforts. That's why we talk about sort of innovation being a central component to us. And I think I've already been through some of the key differentiators that drive real sustainable value and differentiation for us, as the cloud gets more and more complex and more and more people drive digital transformation efforts.

Yes, absolutely. You touched on earlier the importance of Davis and of AI monitoring. How does Dynatrace stack up against competitors around AI capabilities?

Yes, I think this topic is going to become sort of more and more important as more people really look to AIOps for advantages. IT executives look for advantages. So there's really been -- there's really 3 different avenues for AI in the IT space. One of them is correlation. If events happen within a certain period of time, I'm going to assume they're somehow correlated and I will give you all of these events and say, these are probably correlated. Humans, you go figure out where the root cause is, but maybe I've reduced the noise by 1/3, maybe 50%, but there's still a lot to sort through. The second one is black box AI. Nobody in IT is going to trust a black box to do work for them. Then there's explainable AI, which is what we employ. You understand exactly what it's doing because we give you the breadcrumb trail of how it figured things out. It's just algorithms and knowledge. But it's applied across a known state of the cloud at any one point in time. We keep a topology model, a dependency model of entire cloud. Millions of dependencies, some of our customers have billions of dependencies. So we're not guessing at what it looks like. We know what it looks like, which gives us a huge precision advantage over correlation and a huge sort of understanding and trust advantage over black box. And I think that, that ground up sort of thinking that we went through to develop our AIOps approach and bury it right at the heart of our platform is going to be a huge advantage for us over a long term as people realize that I can't just -- I can't stop with just the data. I need the understanding, predictive analytics and actionability, and that's what Dynatrace already provides. And as I said, that's a key part of our value prop and what's driving the momentum of our business today.

I'm curious your take -- I heard this from a customer. Does a strong base for infrastructure monitoring solution actually reduce the need for APM coverage, just perhaps on kind of Tier 2 or Tier 3 applications? And maybe that distinction is less important as we shift to a full stack observability offering here?

So the answer is, there are applications layers in enterprises where they don't need to spend the money for sort of the same thing they do with their Tier 1 or some of their Tier 2 services. They're just not part of the run the business environment. They might be employee productivity environments, maybe things that can't be instrumented, as I said before. But from where we sit today, we can handle the full stack application piece, but we can also attack the wide infrastructure extension pieces without the overhead cost and burden of the full stack piece. That's what the infrastructure module is about. So we have access to that entire footprint. It doesn't really matter whether a customer says, hey, I only want 25% of my estate with full stack. Next year, it might be 35%. We're seeing customers up to 60% who said that they'd never be past 20%. So like I said, this is an evolving market space. As the cloud evolves, as these cloud stacks and environments sort of are intertwined within an organization and operation, things will change. And the good news is they're not changing for less things need to be monitored deeply, it's more things need to be monitored deeply. And either way it goes, wherever a customer is in their journey, is fine with us. We'll take them forward whatever pace they want to head into modern dynamic clouds.

That's great. And so a multipart question here. But just kind of curious, I wanted to ask about market structure and competition here. So how should investors think about how structure might play out and what Dynatrace's size of the pie could be? On one hand, investors keep talking about multi-silo convergence and market consolidation, but on the other hand, it's a really large and complicated market, lots of different customers, use cases, niches. So can you just kind of talk to me about competition market share and how things might balance out here over the next, call it, 5 years?

No, it's a great question, and none of us really have a crystal ball, but the way I describe it is this. First of all, it's a very large market whether you take our numbers where we've done a ground-up TAM in the $30-plus billion range, some others are in the $40 billion, $50 billion, they call it. Whatever size, it's huge. And it isn't really that competitive. No much -- no different than it was 10 years ago. It's just there's a bunch of companies that have dropped away and some new ones have jumped in. But to maintain consistency, I'll get to in a minute, which we've been able to do. But it's a big market. The second thing about this market is there's different go-to markets. And those go-to markets align with sort of a segment of the market. And so it's really important to understand who's enterprise-focused and who's mid-market-focused. Mid-markets freemium, tens of thousands of customers, low ASPs, talk about price a lot and a lot of customers. Great market space, don't get me wrong, is different than what we focus on, okay? So if you put a 3-dimensional cube of size and go-to-market together, you'll start to see that these companies, all around $600 million, $700 million right now, have a long way to go before they start colliding in a major way in this market space. A lot of running room for everyone. I do think that over time, however, as these clouds need single sources of truth in order to really understand what's going on in them, there's going to be less separate tooling and more platform approach, and that's what we're seeing in our customer base. I want to eliminate this volume of tools and start to trust one common source, one platform of truth. And we have a great position, I believe, in that market space.

And so you just walked us through some of your SMB competitors who you aren't seeing, but at the same time, there are some competitors of yours whether it's Splunk or Sumo or Datadog, who have been discussing pushing into multi-silo and into the enterprise market. So I guess maybe just taking a step back, who are you up against most on new deals these days?

Well, so maybe a couple of comments on that. First of all, I do think there's a difference between a platform where things are unified and silo of tools where everything is just, I can buy it from the same vendor, but it's still a bag of tools. And that means the IT teams have to put it all together, okay? As opposed to a platform that's already put together and they get to extend it and connect it into their environment and into their unique business processes, which is what we do, okay? That's more purpose built. That's more out-of-the-box value or time to market value for customers, and I think that there's a difference there. Now back to who do we see most? Because we still land and focus on that full stack microservice container sort of observability space, we're going to land in the application zone most often. Now that zone really is a high ground. It's where business meets IT. You won't find the CEO asking about the infrastructure. You'll find the CEO asking about the apps that drive the business. So that landing zone, we're experts in, we're well-known for. And therefore, we'll see the Cisco, AppDynamics folks more often, some New Relic more often, but that's more -- and we still see a fair amount of Broadcom CA still out there in enough places that as those organizations modernize, they realize those old tools don't work. They try to find something new. That's a great entry point for us as well. So it's still in that application zone. Over time, will there be some new landing zones for Dynatrace? Yes, there will be. But right now, it's a super efficient one and everybody is struggling with that dynamic application environments, and we're so well suited for it. It's a great sort of sales efficiency play for us at this point.

John, I was going to ask you about the increasing overlap between observability and security in your road map there. And of course, this morning, you've announced the launch of a cloud application security module. So could you just talk about that module? The importance of the initiative? And I know it's really early, but just how additive it could be to your growth rate?

Sure. Yes. No, we're extremely excited about it. We've been a performance and observability-focused company for the last 15 years and built quite a company out of it, fast-growing profitable business. And this is our first entry into the cloud security market, one that we see can increase our TAM by more than 50%. So it's a big market opportunity, and we have a very sort of interesting entry point, bringing RASP-type capabilities to the dynamic cloud sort of Kubernetes-focused environment, an environment that's underserved with tooling today because of the speed and complexity of the environment. You cannot ring-fence it. It's very hard to understand the actual application workloads. As I said earlier in the conversation, people sort of working with containers, but they don't know what's going on inside them and how they're talking and how they bring application functionality forward. We do understand that at code level detail. So we already have a platform that provides us the data we need to do this kind of RASP, drive these RASP use cases. And we really see it as an additive capability for any one of our customers to add and need to add because it provides full continuous run time coverage of production for vulnerability detection as well as the preproduction environments. So a great new entry. We're super excited about it. At the same time, we have enterprise customers. They're all going to want to test drive. They're all going to want to make sure everything is just so. They'll have to budget, they'll have to do all those kinds of things. So we have a modest expectation really for the next 6 to 12 months before we believe it really starts to sweep in and have a material impact on our ARR per customer. But we do see it as a great opportunity for the business. It's just -- every customer really needs it, and it's as simple as a little toggle switch in the software to turn it on, literally for any customer. It's already there. The capability just needs to be turned on.

And John, can you just clarify what existing solutions this module replaces or complements?

Well, it complement -- so the category of RASP in modern cloud environments, it's a pretty light group. And everyone -- and the ones that are there are trying to attack it in preproduction via 100% scans of their -- the -- of the software. And just because you do a 100% scan doesn't mean you understand how the code is actually going to be used in production. So you end up chasing a lot of false positives that may never -- have ever been exposed in a production environment. So what we do is we provide, like I said, a continuous run time view preproduction and production, eliminate huge amount of false positives, allow people to focus on what matters and have a continuous view so there's never a vulnerability in -- out in those production environments. And it allows our customers to actually deliver at the speed of cloud, the speed of DevSecOps without concern of introducing new vulnerabilities, as I said, as they roll out these -- the rapid changes, new applications or expanding applications in production. So again, it's a capability that's been extremely popular and required in traditional environments. It just breaks down because of modern cloud. And we provide -- and this is why we talk about it and we will talk about it as a greenfield opportunity for us going forward because there really isn't competition in this space, certainly not to the degree that we deliver across the preproduction, production environments.

I have a few questions here from investors. One is just what role does standardization via OpenTelemetry play for you and for your industry? And can that lead to commoditization of the ingestion layer, I guess, at some point in the future here?

I guess you could think about it as maybe somewhere way, way out there. That would assume that IT gives up generation -- up on generation of technology that they've always maintained. And everything is 100%, the most modern serverless-everything world. But as long as there's companies that depend on a series of generations to deliver their cloud applications, you're going to need a lot more than OpenTelemetry to be able to understand that full stack environment. So the way we see it is a great adder to drive a more efficient approach to our instrumentation in new environments like serverless mesh and others that you can't instrument, you have to be able to gather the metrics or logs or whatever is available from the technology providers themselves. But we don't see it eliminating the need for automation, AI and some of the other central components of our platform that really enable, like I said, resource strapped IT organizations to do so much more with less people. I mean efficiency is always going to be a critical part of IT operation value.

And John, maybe just putting it all together here, you've already given us some of your longer-term financial targets. Would be great if you could just remind investors about your growth trajectory in terms of net-adds and ARR growth? And then maybe with 2 minutes left here, any closing remarks you just want to leave investors with here?

Sure. Well, let me try to summarize some of this with -- around the business. So we've been now a public company for a little bit less than 18 months. We've been growing the business between 30% and 40% ARR growth per quarter now for quite some time. The business is built around 2 key thoughts. One of them is new logo additions to the franchise, which we're sort of bringing onboard in the 100 to 175 new customers per quarter, sometimes more, and net expansion rate which we talk about at 120% or greater. It's that combination of new logos and net expansion rate that drive a significant growth business over time. One of the other things about our business that we believe is very important is that it's a balance between growth and profitability, a very nice balance. Our operating margins are in the mid-20% range and have continued to be there for quite some time. And it's just we run an inherently efficient business. It doesn't throttle our ability to invest in growth and innovation, but we believe it makes them for a more durable business. So new logos, net expansion rate and a balance between growth and profitability, those are the characteristics of the financial model in the business that Kevin and I have been building. And we believe, as I said, it makes for a high-value software company over a long period of time.

That's great. Thanks a lot, John and Kevin. This has been great. Thanks a lot, everyone, for listening in. See you, everyone.

Appreciate it. Thank you very much.

Thanks, Bob.