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

Hello, everyone. Good afternoon, good morning from wherever you are. My name is Tyler Radke. I co-head the U.S. software sector here at Citi. Welcome to Day 2 of the Citi Virtual Tech Conference. For the 1:00 p.m. Eastern session, we're happy to have our friends from up north, Dynatrace with us today. We have the CEO, John Van Siclen, joining us virtually. So John, thanks so much for being here with us.

Thank you, Tyler. A pleasure.

So John, I thought we could just start with a brief intro of kind of the Dynatrace's transition from kind of an on-premise platform to subscription and kind of a leader in this modern observability space. Just kind of recap for investors where we are in that transition and kind of what are the big focus areas moving forward.

Yes. Well, that transition is -- the good news is it's history now. It's been history for about a year now. But we did found the company in 2005 and became a leader back in sort of data center application performance management world where things were layered between applications, infrastructure and network. And 7 years ago, we reinvented our entire business, focused on the disruption that the cloud would cause in the sort of monitoring, now what's called observability space and some of the adjacencies. We saw the cloud was going to just collapse all these traditional IT operation management use cases into a single set, and we built a platform purpose-built for that, brought it to market in 2016. Transitioned our base throughout the following 3, 4 years. And now 100% of our customers are on the Dynatrace platform, the new platform. It's a 93%, 94% subscription business now. So a transition from any kind of classic licensing to modern renewable licensing models. And so all that sort of history is behind us. The beauty of it is in the transition we moved from data center to modern cloud. And it's the modern cloud business that's fueling our growth, continued net expansion at 120% plus, et cetera. And so that, like I said, transition behind us, re-platformed to a modern stack, probably the most modern stack in observability today and a great platform for continued growth.

Great. Great. And one of the questions that I frequently get from investors is just trying to understand, obviously, the dynamic of public-cloud adoption, which is a huge catalyst for your customers and your business. But just how does your split today either from a customer or revenue or ARR perspective look between on-premise, private cloud versus public cloud?

Yes. No, it's a great question. And as I said, in the transition, from sort of our classic business to the sort of modern Dynatrace platform business of today, over 80% of our customers use us for their most advanced cloud environments, cloud-native application environments, Kubernetes, containerized environments, public cloud connection with their maybe a hybrid back-end. So it's all extremely modern cloud workloads that we support. We cover for the -- a little over 3,000, Global 15,000 sort of target customer base that we go after.

Right, right. And just to clarify, is that 80% of customers that use some portion of public cloud or private cloud? Or is it -- I mean, what's -- how should we think about that mix?

No, no. It's a really important question because you think about -- so our business is driven by digital transformers. And digital transformers happen to have multiple generations of technology, at least one other, if not multiple. And otherwise, they're not transitioning from anything to anything. So these are the biggest brands and businesses on the planet, $1 billion-plus companies that really drive the global economy, and they're all moving from sort of a traditional stack of things to a modern cloud stack, and most all of them have some kind of an extension from some hybrid all the way through most modern serverless, mesh, cloud-native application environments. And so it's an ongoing migration that they have underway and a continual reinvention of their business more and more and more driven digitally than physically or whatever. And so it's that class of customers that we target. And so we don't think about, well, how much ARR is because of this or that. That isn't -- it's are we in the modern cloud workload zone because everything's moving there. If you're not there, then nobody wants to spend money on you. But if you can support that continuum of migration of more and more business to cloud, then you're in the sweet spot of where the money is being spent, where decision-makers are leaning in and making a value difference, a big value difference for those customers.

Right. And I guess a related question there is because sometimes we see it and certainly, your customers are some of the most complex enterprises out there, right? I mean they may have portions of the business that are making these lift-and-shift migrations. Other times, you could have kind of departmental public-cloud adoption purchases. So I guess how are you kind of ensuring that you're levered to both of those tailwinds where maybe a new line of business could be going kind of cloud native? How are you kind of managing that from a sales perspective?

Every place we go in, we target the most advanced cloud projects as a landing zone because we're unique there. And then more important, the project -- the larger scale of the project, the better our positioning becomes. It just happens to be that once somebody tastes sort of the value there, they go, "Well, my application extends, there's data sources and connective tissue to other areas, can you do that too" and that becomes ongoing expansion. But we don't land in the old part and hope to get to the new. We go after the new, and that usually just extends us back into the rest of the cloud, the hybrid cloud environment that supports the most modern stack elements.

Right, right. And the digital transformer kind of is your target, is that primarily a CIO, a CISO, line of business leader? Give us a sense for who make up that persona.

A lot of the landing zone goes into sort of either cloud architects, which are more sort of platform builders and then the app people come on top the line of business or they're the application architects, the ones responsible for the software development life cycle from DevOps into production and all the way through sort of sunsetting of legacy code. It's 1 of those 2 landing zones are primary. So they're usually lieutenants to a CTO or a CIO and -- but a lot of the expansions, obviously, when we get into the real platform extensions and so on, that rises up. But our landing zone is usually more of a key architect kind of all.

Right. Okay. And just a reminder for investors on the webcast, feel free to submit your questions through the chat and we'll work them in. John, one question that I think -- I'm sure -- you've answered a lot earlier today, but just around the M&A announcement this morning with the SpectX acquisition. Could you just give us a sense for the strategy here and how you're thinking about holding that into your road map?

Sure. Well, so it's not lost on anyone that there's a massive data explosion. All over the planet in all corners of businesses and IT operations is no different. And the amount of data that flows through these observability platforms you might be surprised, is precious. Embedded in transactions, our products, customers, geographies, all the different elements that you would have building blocks for business intelligence and applications and other kinds of customer experience applications and omnichannel applications and so on. So we see this data explosion happening, it's massive. I think the numbers are crazy, like the amount of data is going to double every 3 years continually. And SpectX is an opportunity for us to sort of leap ahead in thinking about how do you parse and analyze in real time, this amount of data flowing through a system in a variety of diverse sets of use cases. So it's really sort of foundational for us. It will emerge in both module capabilities as well as fundamental platform extensibility and scale. So we're excited about it. We thought it was important enough to let the market know that we're continuing to be aggressive in accelerating road maps, in differentiating our platform for sustained value advantage and so that's what SpectX is about. Initial capabilities within 12 months, and it will flow into additional capabilities for years to come.

Yes. Okay. Great. So I wanted to talk a little bit about the recent quarterly results that you reported, and we saw a very strong kind of ARR trends, especially if you kind of normalize for the perpetual runoff. And really, what we've seen over the last couple of quarters seems to be kind of increased confidence in kind of your medium term, I think you call it the building blocks, growth forecasts. Could you just help us understand what's driving that? How much of this is, you think, company-specific dynamics that you're seeing at Dynatrace versus the broader market? I mean, clearly, public-cloud adoption does seem to be accelerating some of your peers, like Datadog in particular, had nice results as well. Just give us a sense for how you're seeing this re-acceleration play through the business and kind of where it's coming from.

Sure. Sure. So we talk about 2 key building blocks for growth, and it's -- there's things underneath the hood that, of course, support them, but the first one is continual increase in new logos. And the second one is driving net expansion at 120% plus. So if we can keep the new logos growing in the 15%, 20% a year range, and we can keep driving 120% plus net expansion. If you do the math, that's pretty much a mid-30s sort of growth rate. And so those are the 2 dimensions we were watching and driving continually. So things like sales expansion, 30% quota carrier expansion, which is the current rate that we're now at, continued partner leverage, really important factor in new logo and expansion. And then just the market itself. It's -- we have a value advantage, a differentiation advantage. The market, we feel, is moving toward us. The more data, the more application load, the more important these application environments become, the more our class of combination of observability plus AIOps capabilities shine. And so we're leaning in to take advantage of it. But those building blocks really are new logo growth, net expansion of 120% and that drives a sustainable growth rate that we've been talking about.

Yes, yes. I'd be curious if you could -- given you are selling to some of the largest companies in the world. Just how have you seen the overall demand environment from an IT spending perspective evolve? Obviously, there's been kind of some ups and downs as it relates to reopening and the new Delta variant. But how are you seeing just overall pipeline and budget that's evolved here?

Every company -- I mean, the pandemic put everyone on notice that they need to be more agile just as businesses. It's not about IT being more agile, the business needs to be more agile. And therefore, IT needs to support that thesis. And part of that agility -- business agility is the ability to deliver applications and new capabilities or different capabilities super-fast with -- at high scale and working as advertised or better than advertised all the time. There's no room for mistakes. So just simple things. In the pandemic, cardless purchasing, the extension of curbside pickup. I mean these are things that happened almost overnight. Those are applications that had to be built and scaled out. And take one of our customers like Kroger, you do curbside pickup for a $26 billion grocery chain that sort of covers the entire Midwest and do that flawlessly and do it in less than a month. Those are the kinds of things that Dynatrace helped support in companies. And we have a number of examples, whether they're health care or this or that or whatever. So anyway, that's sort of the underpinning of some of this. So that accelerated digital transformation is just an outcropping of continual awareness that we have to be more agile. We have to lean into digital. We have to be able to connect with customers even if we can't get them in our stores, and that's definitely been a tailwind for us. But it's a tailwind that doesn't have an end. That's the other thing. These are early days. And if you think about where we're going, whether you start thinking about the automotive business and where is that going to self-driving cars and you think about the insurance business and sort of micro insurance to support these people that don't own cars, but they're still driving or in mobiles kind of thing. It's amazing. It's just -- it's an evergreen kind of world that we're living in and it's a fantastic business to be in and be able to lead in that enterprise segment.

Right, right. Okay. So it sounds like there's no real disruptions on the negative side from...

No. Not at all.

Okay. Okay. So you mentioned AIOps a little bit earlier in the conversation. And I think that is a -- certainly, one of the buzzwords up there with digital transformation and observability. But I guess, what does AIOps mean for Dynatrace? And how do you kind of envision delivering on that vision of platform longer term?

Whether you define the AI as automation intelligence or artificial intelligence doesn't really matter. The idea is that there's advanced automation that helps the humans get their job done faster, smarter, quicker and more precisely. In our case, it's really take people from trying to investigate and guess, add things to just take action because the system has already told you exactly where your problems are, your bottlenecks, your opportunities for optimization. And here's exactly the code that you need to go in and work with. In fact, all the way down to and here's the developer or developers that work on that segment of the code. And when you start thinking about how massive these cloud environments are and to get to that level of precision in seconds, it's across the billions of dependencies in these environments. I mean it's extremely powerful. And that's what we bring. And so if you are a small company that doesn't have a lot of complexity, then there's not a lot of value advantage for Dynatrace. But if you're a $1 billion company, leaning into digital transformation, there's significant value. And so that's a little bit of why do we target the Global 15,000 is because we're really good there. And we bring a unique value proposition, which that automation and intelligence that we provide is vital to being able to stay on your toes as opposed to be on your heels all the time, the way many organizations that we talk to, who haven't embraced Dynatrace yet, that's the world they live in, reactive and on their heels versus Dynatrace customers proactive on their toes.

Yes. Yes. Got you. So I think related to that, I mean, one of the questions we get a lot and we had ServiceNow here yesterday. But with their recent acquisition, a small company in the space, they've talked about kind of getting into the broader observability space. But doing so in a thoughtful way, I think, understanding there is a lot of good technology. How do you see them evolving in the space? Do you find that there'll be opportunities to partner with them? Or where do you think their aspiration will ultimately evolve? And how can Dynatrace potentially benefit from that?

I think they're just trying to be thoughtful as to how do they have to augment various players in order to get the most value for their customers. And we happen to have a good relationship with them, especially with customers in the field who really get a lot of value of connecting Dynatrace and ServiceNow together to modernize their incident management processes or their change management or alert management processes, some fundamental building blocks to any IT organization. So with our level of intelligence and precision, there's not a lot they need to do. But for some of the other products out there or observability sort of players out there, they probably need to wrap a little more blue around them to try to mimic some of the value you get with Dynatrace. But our relationship is good. I don't see an impact anytime soon, if ever, and look forward to continuing to deliver great value to our rising number of joint customers.

Yes, yes, absolutely. Wanted -- and then sticking on the kind of partnership side, what are you seeing from the major cloud providers and particularly Microsoft? How do you kind of look at expanding those partnerships going forward?

Well, I think all the hyperscalers, I mean, that's an amazing sort of market that they're driving. I think I did the math at the end of last quarter. It's like $37 billion worth of cloud spend that they absorbed in 1 quarter, growing at 35% aggregate. So there -- it's -- they're great relationships, they're connected in with where sort of the global economy is headed and driving toward. And so our relationships there, we spend a lot of time with them, not just technically but from a go-to-market standpoint. And our ability to figure out how to sort of leverage their environments to actually scale our business has gotten much stronger. Their marketplaces are much more interesting. Our -- how we interact with their sellers is certainly -- continues to improve and the results are there. In fact, I think I talked about in the last earnings call that our opportunities through the marketplaces have increased considerably, and we see them continuing to increase over time as they start to sort of aggregate enterprise spend in through their marketplaces or private offer environments, in particular. So they're strong, whether it's Microsoft and Azure, whether it's AWS, whether it's Google, whether it's the IBM OpenShift side of the IBM business, all very strong and all growing nicely.

Right, right. Okay. And I wanted to ask you, just kind of a broader TAM question. So I think whether we look at the TAM from the Analyst Day or you can look at other players in the space, the way they define it, a very large opportunity, maybe $30 billion, $50 billion plus across APM, monitoring, logging. Certainly, that's a large number, multiples the size of kind of the combined revenue of the major players out there today. Like how do you see that playing out competitively? Like is this a market that is going to be supportive of multiple winners? Do you find that there will be consolidation going forward? Just help us understand how you're thinking about the market evolving.

Yes. It's -- nobody has a great crystal ball. The one -- the thing that you point out is absolutely true. The market is massive and growing quickly. And there's only a few players when you get right down to it that really provide observability. Everybody wants to talk about it, but who really does it and who does it at scale and who does it across the full breadth of tech stack that's needed for multi-cloud environments. And that gets to be like a pretty short list. There's also go-to-market swim lanes that you need to consider not just sort of the technical pieces of it. So there is a mid-market world, there is an enterprise world and how those dynamics, those have been diagrams as well. And yes, there's some overlap, but it's not as high as it looks based on people's rhetoric. So I just think that there's a lot of room for a handful, maybe a few -- maybe less than a handful to grow really well before there's a lot of collision. And does it really come down to a single winner? Or are there 2 or 3? We'll wait and see. You look at the hyperscalers, you would have thought, well, AWS is running away with it, and all of a sudden, there's 2 more players and now deserve respect. So we'll see how -- whether it's a hyperscaler kind of market or whether it's more of a traditional tech market where there's one dominant player.

Right, right. And as we think about that large market opportunity kind of across the various product suites, I think Dynatrace has been well known for kind of the APM capability. But where do you see kind of the largest opportunity going forward? Is it still kind of in APM? Or is it around some of the newer investment areas, AIOps or even security?

Well, all good questions. And I think maybe the biggest piece is that -- and one of the big transitions that we've seen since we IPO-ed a little over 2 years ago is the uptake of observability, which by definition has multiple pieces in it. It's why people don't want to -- I don't want to buy just application here and log here and metrics here and topology there and that kind of thing. They want it to be brought together. And so it's driving platform opportunity for us. In fact, 3 out of 5 opportunities now for us are observability landing zones, not APM landing zones like they might have been a couple of years ago. So that's a good thing for us, and we're pushing that agenda because we think it favors our unified platform approach anyway. The -- that isn't to diminish the fact that the applications are still the high ground and will continue to be. There's no CIO or CTO I talk to who really wants to talk about infrastructure. They're trying to talk about the applications that drive the business, customer experience that the CEO is driving, risk management which the Board is driving. It's a series of different conversations. The fact that there's infrastructure metrics and network underneath is important to support the apps, but the apps are sort of that high ground. So I like where we are there. We're very good at that layer in the stack. But it's not the only thing that we do anymore. And it's not the only driver of our ARR anymore. It's a good 30% plus maybe 1/3 of our ARR comes from beyond sort of the application full stack load. Security going forward, we think, is a fantastic market opportunity for us. No question observability data is rich and needs to be used more and more effectively for security use cases. And we have an interesting angle on it. We are combining observability data with the application expertise we have and coming in on a modern cloud application security track. And customers are excited about it. It's early days for us, news at 11 in the second half of this year and really our ARR impact in our next fiscal '23, but it's a really important piece when you start thinking about long-term sustainable growth. And just -- it expands the TAM by another $15 billion to $20 billion.

Yes. Well, I think in general, the app security and broader cloud security market is still super early. I mean I think it's hard to find who the kind of leader is in it. I guess with that -- with the market still being in early stages, like how are you kind of balancing organic development there versus future M&A? And in some ways, I imagine there's somewhat of a temptation that do a lot of different deals because there's a lot of tiny objects. But how are you just kind of thinking about figuring out what's real and what's not?

It's -- we always think about where the puck is going, not where it is today. And security is one of those, which is why we sort of targeted a direction and a trend that we think we're uniquely suited to go after. It's not the full $300 billion TAM, but it's a good $15 billion to $20 billion of it and it will continue to grow. There's no question that you cannot ring-fence these dynamic multi-cloud application environments. You're going to have to protect the apps and the workloads from within. And when we have the kind of continuous intelligent observability, we have a code level detail, that's a pretty unique asset to be able to tap into leverage. So we think a lot of this is going to be organic. We think tech tuck-ins are a smart way to go. It's proven to be a smart way to go for, say, a ServiceNow, for example. We think platform is a real key because of that automation and sort of unified consolidated approach that a platform provides. But we'll be -- don't be surprised if we do a little of this and a little of that. In fact, SpectX has an angle in security for us. So we'll be smart with how we balance organic and inorganic.

Yes. And the angle with SpectX is just the different variety and complexity of security data being able to ingest that.

It's a data sort of ingest parse and analyze game. It's just a different set of algorithms and a different set of use cases, but you still have to do it at mass scale, and you have to do it real time. Nobody wants to go off-line and for half an hour or half or day later and do the analysis. If you can do it real time, that's the ideal.

Yes. Yes. Got you. Okay. So going back to, I think, some of the themes from the Analyst Day, I think the bottoms up build for your TAM that you put out there kind of showed the potential for your target customers to spend $1 million of ARR with you on average. Obviously, you see a lot more than that at the high end. But for the typical customer, maybe just walk investors through how they get to $1 million of ARR, presuming you're not landing folks at $1 million. You do have a very good kind of land and expand model. But what are the kind of drivers of that initial land to that $1 million plus?

Yes. So we do have a very predictable land right around $100,000, which is much higher than sort of the mid-market folks. But -- so if you think about a $1 billion company, it's $100,000 for observability into key drive your business applications is not a lot to start with. And so that's our landing zone is right in there. Our average ARR per customer is a little over $270,000, and that's just with additional application expansion or it may be a little bit of cross-selling. But once we hit 3-plus modules, which is about 1/3 of our customer base a little bit more, it's nearly $500,000. So it shows you the path of, oh, okay, so you're going to get app expansion, but you also cross-sell and look at how fast that ARR per customer rises. And now we've added not only is there a lot more room in sort of the infrastructure-only digital experience and full stack application pieces, but we've also added a couple of new modules in cloud automation and then the AppSec, application security side. So it's not that hard to see the path, okay, so what about 4 plus, what about 5-plus modules? Where are you now? When everybody knows, there's still a data explosion that's going on, there's still an application explosion that's going on, and we're in early innings on cloud -- public-cloud adoption. So you put all that together, I think we're being conservative on $1 million per customer. The potential is actually much larger than that, and we have plenty of customers that prove that out.

Right. Right. And I know that you're -- certainly, you do focus on the higher end of the market. But I think you talked about it, Global 15,000. So definitely a good amount of that is kind of commercial, maybe upper mid-market. How are you -- remind us how you're approaching those go-to-market motions between kind of the lower end of that 15,000 target? And how are you finding the expansions -- level of expansions to be different between the two?

We have billion-dollar companies or high hundreds of millions dollar companies that spend as much as $10 billion, $20 billion companies and that potential to spend more. It just depends on how heavily do they lean in to cloud transformation, how important is that to their business. And it's interesting also that some were leaning in a lot, then all of a sudden, they realized, oh my gosh, we need to lean in significantly. And we just had a brick-and-mortar retailer end up making some business transitions at a board -- sort of board, public market level. The CEO says, okay, we're going to have to transform this and that. We're going to move from 30% to 50% online and e-commerce based over the next 3, 4 years. And we need to change the way we're doing things internally in IT and all of a sudden, digital transformation becomes a massive program that needs to be fueled from sort of a low interest to a high interest going from -- in a rapid period of time, and that's happening everywhere. So again, these things are the digital transformation movement, and as I said, it's early. But it's fueling growth. It's accelerating time lines and it's a great market to be in for the long term.

Right, right. Okay. And just on the competitive environment, I know we touched on it briefly just in terms of the scope of the market opportunity. But curious what you're seeing on the legacy side, the BMCs of the world, the AppDynamics? And really, how much of your business is kind of displacement versus greenfield or maybe open-source displacement?

Yes. So there's -- there definitely are the haves and have-nots. If you haven't modernized your platform to be able to deal with the dynamism and the scale of modern cloud environments then you'll fall behind. And it's really hard to catch up because it's rocket science to do this stuff at scale. And you see that, whether that's the CA, BMCs, HPE ended up going over to Micro Focus. You just sort of see that withering of that old -- sort of that old guard, but you're even seeing it in some of the sort of second-generation darlings that ended up being bought elsewhere. It's an interesting market in that you do have to reinvent because the technology changes rapidly, and it's not going to stop anytime soon. And we've proven that we can reinvent and think ahead, anticipate what's next. And I think that that's important, obviously, for sustained growth. But obviously, that's for sustained investment. And so that, I think, is some of the key characteristics of this business is it is constantly moving, and it will continue to move and adapt and change. It's one of the reasons why we spend as much as we do in R&D. I think most people now know we do our R&D over in Central Time Zone Europe, 2 engineers for the price of one. And the most important thing is they're super loyal. Our attrition rate is low-single digits, very, very different than trying to do that in the States. And that's a little bit of secret sauce for us that will keep the business moving ahead and innovating for the long term.

Yes. Great. Well, with that, I know we are a little bit over, but this has been an excellent discussion. John, thanks so much for the time, and thanks, everyone, for participating today.

Tyler, I appreciate it very much. Thank you.

All right. Have a good day, everyone.