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

Hi. Good afternoon, everyone. Thanks for joining us today. I'm Jen Lowe with the UBS software team, and it's my great pleasure to have the team from Dynatrace here with us today. We have John Van Siclen, the CEO; Kevin Burns, the CFO; and Noelle Faris from IR. So really excited to hear what they have to say. Maybe to start off, I know Dynatrace has been public for some time now, but it's still a new name for others. So maybe, John, if you could just kick it off, could you give us a 2- or 3-minute overview of the company, where you sit in the market and the types of problems you solve for customers?

Sure, sure. So the way we describe the focus of the business is that we're -- that we've been defining a new category of software that's beyond what most people talk of or think of as observability or monitoring. We think about it as in a broader context, we call software intelligence. It includes observability and with yesterday's announcement that we made, also includes some new security use cases. And it really targets some of the disruptive capabilities or characteristics of the cloud. It set us apart, because we do -- we add automation and we add intelligence, AI-driven intelligence and unify that together to solve the advanced cloud observability use cases. And as I said, some of the new security use cases that are emerging around these sort of dynamic multi-cloud environments. To give you maybe some examples, we target the Global 15,000. So we're an enterprise-focused company. And those are companies digitally transforming, driving more and more of their revenue through their digital channels, whether those are banks, whether those are logistics companies, automotive manufacturers, e-gov portals, down the list is quite a horizontal opportunity for us. We have 2,600 of our target 15,000 today. So about 15%, headed toward 20% of that park. And the way we think about the cloud sort of project or what's changed in the landscape because of cloud disruption is that there's a dynamism in the cloud, sort of dynamic Kubernetes orchestrated environments. There's a scale that's off the charts relative to the old data center world. There's a frequency of change driven by DevOps and a complexity that's through the roof. And as these challenges that create a dynamic where the cloud is radically different, old tooling approaches don't work. And we have seen a great opportunity to expand our business, take it public as you point out 18 months ago. And we've been driving it at a mid-30s ARR growth since then.

Great. You touched on a few different things, but maybe starting a little bit with the history of the company, you noted the current cloud environment, how dynamic it is, how it requires sort of always-on monitoring and management in a different way. But certainly, that's not where the original Dynatrace started out. So maybe we could just touch on that quickly. The decision to kind of rebuild everything 4 years ago, that -- or launch and rebuild product 4 years ago, what were some of the themes or some of the breakpoints that you were seeing with the prior generation of technology? And where are you at that point in the newer Dynatrace platform migrating the base over to that?

Well, we were a -- in prior generations, the technology stack, the old data center world, things were in very nice, organized layers. You had your network layer, you had your infrastructure server, kind of tiers and layers and you had your applications that ran on top of them. And that was all nicely organized by IT. When we start to take a look at what the cloud was going to do to this landscape, we saw that, first of all, instead of this nice layering of physical with software, it was all going to be software. Networking would be software. Infrastructure would be software. Applications are obviously software. And that there's a user experience layer on top that also required all software, what we call a full stack of software. The second thing that we saw was that these clouds would not be static. They don't change once a year. They're changing all the time. In fact, these clouds are automatically changing and being orchestrated automatically to scale up and down depending on workloads, et cetera. The scale, as I mentioned, would go through the roof and the frequency of change, of course, with DevOps teams, adding code on an hourly basis rather than a couple times a year basis, was going to radically sort of shake the foundation of the old IT organization, change management programs and security programs. So with that, we realized that to try to evolve our tools, our existing set of what we call classic products for this new world, this radically different world, we could try to cobble it together. But sooner or later, we'd hit a wall. So we decided to reinvent from the ground up, do an innovator's dilemma approach. That was 5 to 6 years ago. We've now been scaling out in the last 3 to 4 years at enterprise scale, which is a whole another level up from trying to do it for workgroups or mid-market. And today, we're seeing the efforts that we put in 5 years ago, the market really coming toward us. The fact that our instrumentation auto discovers everything all the time, a requirement into dynamic multi-cloud. Everyone else requires scripting and manual configuration, everyone else. The fact we leverage an AI engine at the core of the platform to make sense out of everything that's going on. The dependencies we -- for many of our customers in their environments are in the billions, and no human can deal with that just by dashboards and data. So these kind of characteristics that we put in place, that we foresaw 5 years ago are now playing out in the market. It's definitely giving us an advantage, whether it's with new logo accounts or whether it's this -- with the speed of expansion. And you see that in our numbers. [Technical Difficulty]

All right. Let's see if that comes back. Sorry. [Technical Difficulty]

I think I better dial back in if it's cut [indiscernible]

All right. Okay. I think we're good. John, are you still there?

Hey, Jen, the line is on. I think he's dialing back in.

Okay. Perfect. No worries. Sorry about that everyone, we're -- remote work. If we're all face to face, we wouldn't have these types of challenges. But like many things, we'll get through it.

All right. I believe we have John here, and Noelle here. Jen, can you hear us?

I can. John, are you back on? All right.

I'm back.

Awesome. So luckily, I'm taking good notes. I know exactly where we left off. So we we're talking about sort of the challenges of cloud infrastructure and all of the dependencies and the complexity, that's just very different from the current environment or from the legacy environment. I notice following on that theme, I think a lot of the other companies that have been at the conference this week have talked about digital transformation, how the current environment is maybe accelerating some of these migrations to the cloud or into forward-leaning technologies that are well suited for the world we're working in right now. And maybe just sort of look at it through a Dynatrace lens, when are customers or companies typically at that point, where they bring in Dynatrace, is it usually attached to those cloud and digital transformation initiatives? What are sort of the things that get you in the door, given this focus on the more complex environment of hybrid cloud?

Rarely do people bring us in when they're first putting their toe in the water with cloud. We come in usually when there's -- they hit a complexity wall, where their existing tooling, could even be names you're familiar with, that are in this observability space to come in sort of much earlier in a cloud sort of evolution or it could just be, when somebody ends up putting more sophisticated workloads on the cloud platform that they've laid out. But sooner or later, they hit a complexity wall. And it's at that point, they realize they have too many tools. And nothing gives them sort of a situational awareness across their entire landscape. And that's when we come in. That's when the Dynatrace value really shines. And no matter what kind of tooling is there, it's -- that gets replaced and often, it's multiple tools in the scenarios we see. So think about it as a digitally transforming business that's partway into their journey, that is now sort of expanding or sort of they're putting their foot on the gas on their digital transformation and realize that they just don't have the visibility, the awareness, the understanding of what's going on in this complex environments and need something more.

And sort of taking that to today, to the extent that there does seem a bit more immediacy around these digital transformation initiatives, is that -- are they at that point where it's starting to really translate to meaningful business for you? Or is that still kind of on the come at this point?

Well, we've done some surveys recently of our customer base. Let me start here and what's characterizing sort of the $1 billion-plus companies that we target is, that they're all moving to a Kubernetes or containerized environments, dynamically orchestrated with multiple DevOps teams driving code and change for competitive advantage for their companies, but driving it on a everyday update or faster, more rapid kind of pace. And so as this dynamic multi-cloud environment has now become the platform of choice for the digital transforming enterprises, it's a great spot for us to be. Things that we used to talk about and people sort of give us a -- look at us sideways, like why they needed continuous automation in their instrumentation and understanding what was going on or they were going to need AI-powered answers because we would -- the clouds would outstrip human ability to really sort of deal with the complexity. These are now becoming requirements. So the pandemic has certainly thrown some headwinds into certain verticals that we work with, but it's also given us tailwinds in the acceleration of and the complexity within these digital transformations that everyone is engaged at.

John, are you still there?

I'm still here. Jen's not there. Shall we try again?

Sorry, I was on mute. All right, human error. I was on mute. Apologies. So I was going to ask about competition comes up a lot in discussions I have with investors because -- Dynatrace is really the first to identify this need for a fully integrated stack, but other players in the application performance management space have made similar moves over the last couple of years. So now that -- there was a sort of view that the end-to-end integration was a point of differentiation. Now it feels like others have the same message. Where are still the opportunities to innovate or add value outside of that integrated stack approach?

Well, we've never believed that observability or sort of the gathering of the data was the end all. We've always thought it was the beginning of the value. And so those who are still trying to pull the observability together in our view are just at the beginning. It's really what you do with the data that sets you apart, sets Dynatrace apart. So while others are talking about observability, we talk about automatic understanding, predictive analytics, actionable, very precise actionable data. Today, we give it to humans to drive remediations. In the future, it will be machine-to-machine. These are the layers of value that we add on top. So that's why, at the beginning, I said we think about this as a software intelligence opportunity, not just an observability opportunity. Now that can be different if you're in the mid-market, and it's less complex, maybe a single application or a couple. You may not need the level of sort of sophistication of a Dynatrace platform. But if you're a $1 billion company, digitally transforming and your revenue streams and these applications are more and more important to your success as a business, then you're going to look for what's the best platform to provide me more than just the data on dashboards. And that's the way we -- our customers view the world. That's what's made us successful to date. And I do believe that it's a sustainable advantage, the fact that we are invested in and are continuing to advance the analytics capabilities of our platform to automate and drive answers and insights faster, better, smarter across a wider landscape than our competition.

And just looking at the footprint you have within your existing base, one of the challenges that Gartner and others talk about with the traditional APM market is, it's applicable to a certain subset of workloads, but maybe not every workload, 5%, 10% is kind of the historical number. As you're getting into these hybrid cloud environments that are more complex, what do you think the potential penetration of those APM type capabilities are over time within those use scenarios?

Well, we've seen -- so first of all, let me just step back. That 5%, which was quite accurate 5 years ago and still is with many accounts today is the fact that all other tooling requires manual intervention, some kind of scripting, some kind of ongoing support from development every time they release code and so on. And so very few applications have been able to -- or companies have been able to afford the manpower to really deal with those Tier 1 applications effectively. With Dynatrace, since it's so automatic, we cover a much wider application landscape than anyone else quickly. So our penetration rates are in the 15% to 20% range probably on average. And so we really are covering a much wider footprint within those enterprise customers than has ever been covered, giving us some fuel for our net expansion rates, et cetera. But in saying that, we also see customers now that the cloud is collapsing so many sort of pieces of the puzzle and that there's a relationship between the various services and applications at a -- in sort of an accelerated level, everything is intertwined. And as everything becomes intertwined, companies are realizing that instead of supporting with deep instrumentation, 20%, 25% of their environment, they need it to be more like 60% to 70% of their environment, and we see people headed that direction. Nobody is there yet, because this is -- every time they think they -- they're [ hitting ] most of their apps, they develop new ones. It's a wonderful market space that way, almost evergreen in how it works. But that is what we see as the cloud is driving a requirement, they instrument a lot more than was required in the old data center. And that's obviously good for us. You might be on mute.

Yes. I just had -- my screen just switched off for some reason. But I'm okay now. So just following on that, so you've had this success with the full stack offering. Not too long ago, you also launched an infrastructure-only module, how does that sort of fit into that world view of the 60% to 70% that could be relevant for full stack? Is infrastructure designed to attack the other 30%? How should we think about that fitting into the product strategy?

Great question. There's actually -- it's partly that, that there are -- there's some Tier 2 and then Tier 3 applications, employee productivity kind of applications and internally facing only kind of applications that most CIOs don't really think of as requiring the level of instrumentation and attention as the Tier 1 and some of the Tier 2 applications. So there's certainly that extension that the infrastructure-only module allows us to go after. But even in the full stack environment, there's a number of hosts that don't need application or full stack view and customers don’t want them within their purview because they do influence that environment. Take a directory services, for example, take firewalls and load balancers, things that we wouldn't have thought about in the past of sort of being part of that instrumentation model, all of a sudden become sort of vital to the way those environments work, when it's all software. And so some of these -- those kinds of environments are also extensions for us. That's why we talk about the infrastructure module, providing over time, sort of a dollar for dollar with a full stack. There's a lot more of the infrastructure-only world, even at a lower price point, there's a lot of them, and we see a great opportunity, obviously, not to just cover the full sort of landscape for an enterprise customer, but also drive additional ARR for Dynatrace as we do it.

And kind of speaking in that theme of expanding the product portfolio, there is a new announcement yesterday of the Application Security Module. It's something you hinted about on the last earnings call, but can you just give us a quick overview of what the new module does and how that fits into the product strategy?

Love to. Yes. No, it's an exciting step for us. And it's our first step into what's a very large TAM expansion for us. We estimate it being about an $18 billion TAM expansion on top of the $32 billion we look -- we see today in observability. So it's a big space. And our entry is in the RASP area, the runtime application vulnerability and remediation area, okay? This has been an area that in sort of the classic data center world, has been a firewall kind of protection. Sort of think about it as ring fencing to protect your applications. In a dynamic containerized world, you can't do that effectively. And so a number of companies have sort of seeing the opportunity, but they're attacking it with sort of start-up functionality. Palo Alto with Twistlock and Rapid7 with, I think, tCell. And several other ones and there's some new start-ups that have targeted this runtime application of containerized environments. But because we have code level detail of everything that's happening in the cloud and all the applications, we have an engine that can watch continuously for any change or add in production, and we can do it at mass scale. And we have an AI engine that can -- is very precise with what matters and what doesn't, to reduce false positives. We can bring a security module to market in this RASP space for dynamic clouds. It is very hard and frankly, totally underserved by any other alternative. So the requirement is there, the market is there. But there's no good alternative. So we see it as a great greenfield opportunity, where we can leverage the power of our platform with some added security expertise that we've been developing over the last couple of years and bring something really unique and powerful to market that literally for our customers is a flip of a software switch. So we're being conservative, I think with our -- sort of our guide as far as when the ARR impact really starts to hit, I mean we have an enterprise customer base, and they will take time to make sure everything works and probably check it twice before they put things into production. But at the same time, it's set up to be not only a powerful offering, but be able to sweep through the customer base at a pretty rapid rate because of the simplicity of upgrade.

And maybe just looking at that through the lens of the potential footprint, what I thought was interesting was in the announcement yesterday, there's a comment that it was an uplift to either the full stack or infrastructure-only, which implies that this has value even in environments where maybe, it didn't make sense to pay for the full -- to the full stack. Can you just comment on that a bit? I mean is this similar in that it can cover every point or every host within the organization, potentially?

Well, security is one of those things that you want it to cover everything. And it will take us a little bit of time to mature the module for that, to that point. But that's the program. That is the focus. And the customers we've talked to, that have helped us sort of been guides along the way. We do this with every new product we bring to market and new capabilities, customers are the best guides. They all see if you can do this across my entire cloud landscape. That's a huge advantage because I do have to cover everything. I can't just cover part of it and think I have done the job. And it is one of those things -- security is one of those areas where, if you're a public company and you know you have vulnerabilities or blind spots and something arrives that can solve them, can remediate them, identify them and allow you to remediate them, then it's not really an option to let it go. It's sort of a public company requirement to make sure that you're as secure as possible.

And maybe just to round that out, for the traditional full stack -- or at least for APM and infrastructure, there is always discussion around you're selling to the developer, you're selling to IT ops. With something like security, you're signed to another audience within the organization, at least the traditional security model. Does this require your sales force to kind of deepen their relationships within the IT department or form new relationships? Or is this still something that you think ultimately gets pulled in through the DevOps organization?

No, it's a great question. It actually comes through the DevOps organization, the requirements. And which is why there's this movement toward DevSecOps. Same cloud architects, same app architects, the same sort of fundamental requirement. We got to get new capability out there faster, how do we do it? It's outstripping the sort of security protocol. And the security protocol therefore needs to step in, it's slowing things down. So if you can keep things moving at the pace of DevOps, that's what these -- what digital transforming companies are looking for. At the same time, so that's a familiar audience to us. But it does require another stakeholder step in to approve anything that fits security related. And that's the CISO and the CISO office. It also is where the budget is. So what we're doing is, we have a specialty overlay team of security specialists who know the conversation, know the CISOs that will be -- that's part of the sales organization to help the territory and relationship, sales execs, sort of navigate that part of the sale. And we think that's required, we think it's smart and we think it's efficient to be able to, like I said, create an overlay team, a little bit lower cost but give you that same muscle to deal with that new stakeholder that's coming to the table along with the familiar stakeholders.

And since you touched on the sales organization there, one of the things that I think has come across in the last couple of calls is, as you get greater visibility and comfort with the current selling environment, it's given you some confidence to lean into the sales hiring. Maybe first, can you just sort of walk through the trajectory of hiring broadly and then, specifically, in sales this year? And then secondly, are you still confident that, that's the right move and seeing a demand come through as you add capacity?

Yes. So we started the year being a little conservative, thinking about 20% sales capacity growth. We've since stepped that up to 25%. We may go a little faster because we are seeing, first of all, you got to find the talent and bring them on board. We know how to do that. We're finding some great talent, which has helped us sort of gain the confidence to go faster. Our onboarding is on track. We weren't sure how that would go. It's all Zoom-based, right? So that's going well. And the thing that gives us the most confidence is that we really are seeing the digital transformation accelerate, and we're seeing the differentiation of our platform, that automation and AI approach that's unified in to our platform, resonating at a much deeper level with the senior IT folks than ever before. And that combination is telling us to go faster, go faster, don't break anything as we do it, but go as fast as we can without breaking things. So far, so good.

Great. I don't know, Kevin managed to make it on. I know we're having a lot of issues at the outset. But I'll throw it out there and hopefully he's there. One of the questions I've been getting is looking at ARR through the year and the seasonality in the business. And Q2 was a great quarter, you raised guidance for the year on ARR, but some people are looking at kind of comps in Q3 and Q4 and a little nervous that you have a really great Q3 last year, can you do it again? I'm just curious to see if there's anything we should be watchful for or if it's normal seasonality as we think about the trajectory on ARR through the back half of the year.

And unfortunately, Jen, Kevin was not able to get on the line, but I know that John can answer that question as well.

Yes. So I was waiting to see whether Kevin was going to jump in. So the -- you're right, we did have a great Q3 last year. The December quarter is always our strongest quarter. There's a big rise. And part of that is having a big -- a strong global footprint and the European side of the business definitely picks up in the December quarter. But we're still -- we're seeing demand strong. We don't see delays or extensions of sales cycles despite the spiking of the pandemic. We and our customers have figured out how to do everything over Zoom. And we have -- we do have some headwinds in the business. We've been open with -- impacted verticals due to COVID, like travel and hospitality being sort of solid from a renewal standpoint, but not really growing. So there are a few headwinds here and there. But we're happy with where the business is, confident in the sales organization, the pipelines we see and quite bullish on the resilience of our value proposition.

Great. Well, I think we are at time. Again, apologies for some of the technology difficulties. But hopefully, next year, we'll get to do this again in person and we won't have strange messages playing in the background for a change. Thanks for the time today.

Thank you very much. Thank you, everybody. Cheers.

Bye.