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

As a direct segue to that, the way you answered the question, curious to get your thoughts, and I think I've asked you this question a couple of times before. And -- what seems to be a cluttered landscape from the investor perspective? What's the best way to think about how Dynatrace is different from, say, Datadog or Splunk or Elastic or New Relic or what have you?

Well, I think there's -- it depends a little bit on who the sort of competitive -- competitor is in the space. But I think that the biggest one relative to sort of the SMB sort of freemium kind of players is we work with customers at a different scale. $1 billion-plus customers, many of them that are digitally transforming have multiple generations of technology. So there's a hybrid component to their multi-cloud environment. Their scale and complexity is much greater. They have hundreds and hundreds of developers, dozens and dozens of applications, all running in one big multi-cloud environment. And that scale and complexity and sort of dynamism and frequency of change, just requires a different set of automation, analytics and intelligence, then if you have a single app, you have the architect who built it, and all he wants is just give me some observability tools so I can see everything that's going on and I'll figure it out. Our customers -- that's beyond what a team can do. So that's a big part relative to sort of the SMB and departmental guys. There are -- somebody that's sort of say larger, that's enterprise focused, most of the ones we see there are, here's the data I have added, let your scientists -- your data scientists go after it. Maybe I'll give you some starting points to help accelerate, but they're not really purpose-built enough to get rapid time to value. And it's -- again, it's okay early in the cloud because you're trying to explore your learning, et cetera. But when you start to scale, you don't want to get bogged down and trying to do it yourself. You really want a platform that automates and accelerates what I already know I need to do. Because I'm a bank or I'm a logistics company or I'm insurance or I'm an airline. I don't want to get sort of bogged down on being a monitoring company, too, or an observability company, too. So again, purpose-built sort of foundational use cases that then I can extend rather than have to do it all from scratch, really powerful. So put those 2 together, sort of automation and analytics plus purpose-built for specific known use cases, you need, whether it's applications or infrastructure, user experience, et cetera, really powerful combination for our enterprise customers.

John, on that note, there's a question that came in from an investor. How do you view Datadog as a competitive threat? And what happens if they can close the technology gap?

Well, so there are several competitors out there that we don't underestimate them. They're good, they're smart, they're successful. Datadog certainly being one of them. The Datadog comes in through sort of development grassroots and tries to come up, which is a great entry point. We used to do it ourselves back 10 years ago. But when it comes to having to provide a common platform for automation and analytics in order to accelerate, there's always this point where complexity just gets -- and scale requires a change. And IT is always known that to collapse tooling and automate are 2 of the most powerful accelerants in their arsenal. And so when we compete, we compete at least 40% now with what we call do-it-yourself. People trying to use various tools to just keep their head above status quo. But if they want to transform, that's when Dynatrace comes in. And so we replace that do-it-yourself group of tools, of which there's a variety of them, including Datadog maybe there. But in the end, it's really -- customers are seeking a different value proposition than just data easily on glass, if you will.

Got it. Another investor question that came in. You announced the cloud automation module this morning. Can you talk about how this module fits into the other add-on modules that you have? And how it addresses the demand for automation/AIOps?

Yes. No, it's a great question. We've been working for the last 2 years with some of our largest customers on how do we accelerate their journey to autonomous cloud. Because no one wants sort of human intervention if they can step back and have the cloud self-heal itself across varieties of use cases. And we realized that one of the biggest opportunities was in the DevOps space. So that's the one we're attacking first with the AI -- AIOps section with full self-healing second. And so the cloud automation, which includes the commercialization of an open source project that we've been working with the CNCF on now for about 18 months called Keptn, we're going to commercialize that sort of a harness for CICD tool chains that automates the process, the release process with various service level -- sort of service level thresholds and understanding what can go through, what can't go through all the way through various release cycles, all with full 360-degree closed-loop remediation, updates of ticketing systems, et cetera, et cetera. So we see it as a huge leap going forward for advancing autonomous cloud operation. And like I said, this is just the first step in our sort of a new module that takes the whole platform automation up another run.

Another investor question coming through. What is the single most important aspect of Dynatrace platform that is still lacking, missing relative to expectations of where the industry is getting?

What's missing? There's always more to do. I think the biggest -- the way I would answer it is this, if you look at our announcements at Perform, you'll see that it's across all the different modules. So there's always something. We enhanced our log analytics capabilities for the infrastructure module. We enhanced some of the mobile capabilities that we have in the digital experience module. We've extended sort of an area we call the hub where all of our technologies and extensions exist, and we're continuing to make that easier and easier for customers not only to find but also to utilize single-click install of an extension for ServiceNow, for example, or F5 cloud load balancers and things like that. So just a broad extension of the platform over time. So I'd say that those -- that's really the way we think about it. And we always keep 20%, 30% of our R&D resource on what's next. And so more things up to sleeve, more things to do. But this is software. There's always more to do everywhere. But I'd say we're pretty darn happy with the maturity of the modules that we've had out for a while. And you can tell we're leaning into a few new ones with the cloud automation and AppSec modules as well.

John, I think that -- maybe the intent behind the question could have also been what is the Street missing? That is, what are we, the Wall Street people, are missing about a capability that is very unique to Dynatrace that is not well appreciated. If you could interpret the question that way, how would be your answer?

Sure. Yes. I'm sorry. If I missed it, I'm sorry. That's a good question. I think the biggest thing is that we're enterprise-focused and the enterprise is different. And if you don't have automation and analytics built in, then you don't have a solution that works. Eventually, the complexity and scale is going to get too great and you're going to get replaced by something that does more. Observability alone is not the answer. It's the start of the answer. And I think that's probably the biggest thing underestimated out there. It's not that everything is vanilla just because you say observability.

Kevin, switching gears to the -- to financials. What are the key takeaways from the last quarter?

It was strong across the board, Nikolay. We were super pleased that we started at our key metric, which is annual recurring revenue in the quarter, that grew, excluding some perpetual license headwinds. That was 33% growth on a year-over-year basis. So super pleased with that. And if you look at the underlining -- underlying building blocks of that, it consists of new logos. So as John mentioned earlier, our new logos, we ended about 189 new logos in the quarter. That was up about 10% on a year-over-year basis despite some of the COVID headwinds that we are facing in the world today. So we're super pleased with that. And then also, our net expansion rate continues to be over 120%. So our cross-sell and expansion and upsell opportunity with our existing customer base continues to shine. If I sort of just break down a couple of other things across the board, we talked about everything sort of stepping up in the organization that support across the board. It wasn't any one specific contributor that drove all of this. It was a combination of factors. And if I think about those, the first, from a sales standpoint, we've been growing that organization about 25%. We're stepping that sales organization's quarter capacity up to 30% as we move forward. So that growth factor number one. We're seeing a nice increase in the maturity of our sales organization as well. And along with that comes higher quotas and higher productivity. We're seeing a little bit of a boost now in terms of productivity because our folks are no longer spending time on converting our bet -- our base from our second-generation product to the new Dynatrace platform. That conversion program is complete. So from a sales standpoint, across the board, a nice execution. And I can continue to go down the list, our marketing organization, funnel development and regen, it's been phenomenal. John talked about all the innovation factors. So across the board, we are super pleased, and I think that also resulted in that what we think is a pretty nice guide in the fourth quarter in terms of 32% growth on ARR, excluding some perpetual license headwind, and that's combined with a nice cash margin as well.

Kevin, I have a follow-up question to Nikolay's question there. When you look at the efficiencies you've gained through virtual selling, can you talk about how much of a continuity do you expect to do that? Because I'm trying to calibrate those comments in light of what John said, and you perhaps said as well that you're looking forward to getting on planes and going to see customers. So how do you see -- is that even a possibility? Of course, we'd all love to get on planes and go see our clients, right? But if you mastered virtual selling, why do you even need to get on a plane? Why not just continue the way it is?

No, you're right. No, I think we've developed the model in our organization from the inside sales to our enterprise sales accounts are very effective in terms of -- especially in terms of how we're landing accounts and doing our proof -- POCs, our proof-of-concepts, and we're executing extremely well in a virtual world. I also think, though, at the end of the day, sales folks like to get in front of customers, and you get that face time with them, and I think that's super important. So I think there will be a return to travel, certainly not to the levels, Kash, that we saw 12, 18 months ago. But I think people just want to get out there and shake some hands and get to know people a little bit better than we can virtually.

The meetings become social and virtual meetings are for getting work done.

Definitely. Fair enough.

To some degree, it's always easier to work with someone that you know and you've met, then it's all sort of one step removed. And so I think the combination will -- it will be different, for sure, much lighter travel, but still some in there, for sure.

And then there's a question that came in from an investor asking, how should investors think about the sustainability of ARR growth uptick? I think you mentioned 32%, that investor is thinking that adjusted number is 37%.

So my 32%, just to be clear, is a constant currency ARR growth rate for the fourth quarter. That is our guidance. If you look at an as-reported basis, that our -- the constant currency -- or the as-reported growth rate would be in that high 30% range. But if we just sort of think about it on a constant currency basis, excluding some short-term headwinds on the perpetual license side, the building blocks are new logos, as we said, in that expansion rate. And we are investing, and we're stepping up the investments in our sales organization and our marketing organization. As I said, we're going to grow our sales organization 30%. We're investing more in marketing. And we're putting in place the building blocks to at least hit 15% to 20% new logo growth, and we absolutely believe we can maintain 120% net expansion rate. You put those 2 together, and that growth rate is going to -- that's a growth rate that's over 30%. And I'm not setting guidance for next year at this point. But we are putting in those building blocks. And we're also putting the building blocks to further accelerate that on top of that. So we think we're making the right investments. The market's there, as John was talking about earlier, our product is shining in the marketplace. We feel like the market is coming to us a little bit, and we're stepping up the investments to make sure we take advantage of that.

On the go-to-market front, another question coming in from an investor, can you please talk about the role of your partnership strategy, GSI, ServiceNow, cloud service providers like AWS, Azure and GCP. What role can they play in driving efficiencies in your go-to-market as you're increasing your investments and your sales headcount hiring up 25%, 30%?

Great. Great question, and it's been something we continue to invest in. In fact, you can see some of the highlights, especially with some of the hyperscaler relationships that we've accelerated over the last 6 months. But we actually see it as 2 big pieces that have to come together. One of them are what we call -- we think of as tech alliances that have a go-to-market component to it. That's obviously AWS, Azure and Google Cloud Platform. But it also includes ServiceNow. It includes the OpenShift team over at IBM, and it includes the Tanzu team over at VMware. We see those as sort of the big 6 influencers in modern cloud dynamics out there where there's sort of opportunity not to gain go-to-market advantage. And there is accelerants through each one in sort of different ways. They're all different characters. But we have a team dedicated to not only the technical links but also the go-to-market side of it. On the other piece, there's the system integrators. These are the ones that actually deploy most of these systems now, that include these different components put together in an ecosystem for modern cloud. So there's a ServiceNow system integrators, AWS, et cetera. And they're global, and they're regional. And we also have been focused on those folks as well. It's that combination that we see as a great sort of opportunity to lift our productivity of our sales organization and accelerate opportunity growth. We're playing at sort of the front end with all these folks. I mean we're heavily invested. It's not a material part of our business at the moment. I'd say sort of partner-originated opportunities are in the 20% kind of range. But there's no question that can't double, with a little more elbow grease over the next 18 months, similar to what it did for ServiceNow when they crossed the $1 billion threshold.

As we wrap up the conversation today, this is a question coming from the investor, what is the Street not giving Dynatrace credit for, in your opinion?

I think I mentioned a couple of them. First, that our platform is highly differentiated and valued for the market segment that we serve, uniquely so. That's one of them. The second one is, I think there's still sort of an undercurrent and sort of perpetrated by our competitors that somehow we're not modern cloud, which is -- which hopefully our relationships and leap aheads with Google Cloud Platform and some of the things we're doing with Azure and AWS sort of put that to bed also because we're at the front edge of everything that's going on out in modern cloud environments, and we're doing it at scale. So those are 2 big ones. I'd say the third one is that we have a balanced business. We thought of it as where -- it's growth, growth, growth. But we're also, what, 25% operating margin, 24%, 25%, maybe a little bit more because of COVID this year, but think of us in that range. Cash flow, unlevered free cash flow in the 28% to 30% range, a little higher this year again because of COVID year. But that's a great balanced business. I mean we'll probably always guide to a rule of 50, but we're executing to a rule of 60 kind of business. And that's pretty rare air.

On that note, I just had a question for Kevin. How do you think about the operating savings you got from T&E. Does that pose a headwind to the next year? How do you, as a company, plan to still deliver margin expansion despite the tough comparables or maybe you go completely virtual in selling, right?

No. As John just mentioned, we're -- we will always run a balanced business. But I think we're going to lean into growth a little bit more. So this past year, last couple of quarters, operating margins have been elevated because of their COVID cost savings across the board. We are working to reinvest those dollars in additional sales capacity, additional marketing programs, continued innovation, and we're going to continue that pace. We are going to try and go as fast as we can from a commercial expansion standpoint, maintain R&D spending around that 15% level. Operating margins will then be about 25 -- 24% or 25% level. That, combined with top line ARR growth, that's been north of 30%. It's a balanced business. We love that balanced business, and we're going to try and go as fast -- as I said, we're going to try and go as fast as we can on our commercial side because the market is as excited as they are, and the product is shining. So we're excited about the opportunity.

Well, thank you. On behalf of Goldman Sachs, I want to just thank you, John and Kevin, for taking the time to present and engage us in this fireside chat with our investors. Thanks again for coming in, and thanks to our investors for dialing to the webcast as well.

Great. Thank you. Thank you, Kash.

Thank you.

Thank you, John. Thank you, Kevin.

Take care.

Bye to you as well. Take care.