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

All right. We continue on in the morning session of day 1. Thanks, everybody, for joining us. For those that don't know me, my name is Matt Hedberg, I cover software team here at RBC. We are thrilled for this next meeting. And I -- Dynatrace holds a special spot in my heart, and kind of knowing what these guys have -- really the progression of the business and see it just thrive is just -- it's rewarding I think for a lot of us. So with us today, John Van Siclen, CEO; Kevin Burns, CFO. Noelle is on the line here as well. Thank you, first of all, for joining us. [Operator Instructions] So gentlemen, thank you for being with us. We've got a lot to talk about, including some news that you guys had yesterday.

So John, maybe the obvious, we'll start with you. I've known you for a long time, and you never want to see these days come, but you had some news yesterday. After 13 years of really leading Dynatrace through really a series of transitions to put yourself in, I think, such an enviable position, you are -- you announced your retirement. Rick McConnell is going to be taking over from Akamai. Can you fill us in on -- the timing on these things is never probably -- for us, it never maybe makes complete sense. But why is this timing right for Dynatrace, but also yourself?

Yes, Matt, I appreciate you having me on -- Dynatrace on here. And yes, no, it was an important decision, and it was something that I've been contemplating for a while. I mean, I was passing 65 this year, looking at $1 billion in ARR by the end of the -- into the year or close to it, and it seemed like a good time to engage the Board for some succession planning, which they are gracious and took me up on. It took a little while to find just the right person to lead the company to the next level, and we found it in Rick McConnell. Things came together at the end of last week. We made the announcement this week. And like you would expect, the prudent thing as a leader of a company is to try to keep the time frame for transition as tight as possible. If it could have been a day, it would have been a day. It's a month in this case, but I think that's smart for employees, smart for investors, smart for customers and all the rest. So that was really sort of how that came together. And when I think about the business itself, I mean it's firing on all cylinders. We have a great management team. The market is awesome, as you know, and our differentiation and value in it is really strong. So it's a great time for the company, great time to have a new leader with multibillion-dollar scale experience to take the company from the $1 billion today to $5 billion-plus over the next few years. And I think it's an exciting time, like I said, for the company, and it's an exciting time for me as well.

So yes, it's clear listening to your voice yesterday. I think it makes a lot of sense to me. I think for those -- no, no. For those less familiar with Rick, you guys could have had really your pick of the litter in terms of the next CEO of Dynatrace. What was it about Rick that the Board gravitated to? Because I've heard a lot of positive feedback, not knowing Rick all that well. The inbound from investors has been positive. What did the Board and kind of management see in Rick?

Yes, we had 4 criteria going in. And we had to look at dozens of people to sort of find the perfect fit, which Rick represents. But the first one was we wanted somebody that had leadership and success at multibillion-dollar scale. And Rick's done that not just once at Cisco in the unified communications side of the business, but also at Akamai both in web and then in the security side of the Akamai business. So just some great multibillion-dollar leadership experience. The second piece was we wanted somebody with really strong go-to-market experience, which Rick also has both at Cisco and at Akamai, and product and product strategy, sort of building category leaders multiple times over. And that's an art. It's not just winning in a -- being a player in a category, it's really being the category leader. And he's navigated that a couple of times. So those 2 pieces of experience from a business acumen standpoint. And the fourth one, which turned out to be the trickiest of all, it was cultural fit. The Dynatrace culture is very strong. We built it that way early on. We were sort of both sides of the Atlantic from an R&D and a business side. So we always had a very strong fabric of culture. And we wanted somebody that fit that, not somebody who would tear it. And sort of a straightforward results-oriented, passionate, hard driving, but without the ego too much in front. And we found that in Rick, and he's a super solid executive, very bright, very, very quick. And he will fit the culture of this business and with his experience, be able to really take it to the next level. So those were the 4 key criteria, and I can't wait for you guys to meet him. It really...

Yes, I think we're all looking forward to that. And maybe one last question on this topic, and then we'll move on to the business trends. It's -- ultimately, it's Rick and I'm sure the Board's decision. But from your perspective, John, at this point, are there any changes that we should expect in the near term with Rick coming in and sort of this transition?

Yes. No, I don't -- there's nothing at Dynatrace -- and this is sort of a luxury for Rick. There's nothing that needs to be adjusted anywhere. The team is extremely strong, been together for a number of years, executing extremely well. And like I said, the business is in great shape. So he has some time to get with the product team, get with customers, really understand all the dimensions of the market before he puts his fingerprints on it. And that was also something we wanted to make sure we have with somebody who doesn't just bring the playbook. And I like this team. We want somebody that takes the pieces of the puzzle and then takes it to the next level. And again, that's in Rick. And nothing that needs to be done today, tomorrow or whatever. But I'm sure he will put his fingerprints on it, just like you'd hope you would as a new leader of a great company.

And Kevin, we chatted as well. You're not going anywhere. And that brings us a lot of comfort as well that, that continuity from yourself and John continues on. Obviously, the culture. No disrespect, John, but you built a great culture. And I think that culture lives on. And you've really, I think built that. And Kevin, you're a big part of that, too. So we're excited about sort of the next chapter in Dynatrace that we assume is going to be a lot of what we've seen previously. So that's great, John. Thank you for all that. Maybe one sort of high-level question for you, John, and then we'll go to Kevin. This -- the pandemic has really been a profound change for all of us for lots of reasons. But I think for me anyway, it's really illustrated how important this whole movement of digital transformation is and also a bit of a security transformation as well, which is a growth driver for yourself. And Rick brings an interesting perspective to that piece as well, I think, from the security side. Can you talk about some of the trends you're seeing from larger companies that you're targeting in a world where there's a lot of choice, right, for monitoring, for durability, for security? What are some of these trends? And why is Dynatrace resonating so well with some of these, the most biggest, most powerful companies on the globe these days?

Yes. Well, I think we all figured out sort of early on in the pandemic. It was more of a wake-up call. It wasn't just a pandemic. There's climate change. There's this and that. There's all sorts of things that are disruptive forces that are outside of the control of a bank or a logistics company or an insurance company, automotive, et cetera. And everybody needs to be more agile. Everybody needs to sort of -- and the best way to be more agile and more flexible and more efficient is through applications. And so that's why this application explosion is going on, why these new techniques and innovation, development of these applications is going on. And that's just going to continue, and it's going to continue to be rapid, the change and movement and the rest. And so that's sort of underpinning this sort of urgency for digital transformation. Now at the same time, digital transformation is not an event. And I think that's something else that everybody's sort of now figured out, which is these things are journeys. I mean we're going from connected car to self-driving car over a 10-year, 15-year horizon. You -- just explosion of application and workload and scale in that kind of environment. And you could do that in health care, you can do that in logistics, you can do that in financial services. Everything's in evolution mode, and digital is at the core. So that puts a lot of pressure on the absorbability side and definitely puts pressure on the security side. And that's a perfect place to be, to be in sort of this pure play whether it's apps seeding the world, whether it's digital transformations, this CloudFirst, or whether it's the need for AI and AI ops as a fundamental requirement just to deal with the scale of telemetry data and data explosion. So these are sort of the underpinnings and undercurrent of these macro trends that, I think, set Dynatrace up to be such a great long-term opportunity.

That's super helpful. We're going to come back to you in a second, John. You're not done yet. We still got some more time with you. Kevin, pivoting to you for a little bit. The quarter that you guys just reported I thought was strong on many levels, but there was some discussion about new logo adds. And while gross logo adds remain strong, you are seeing some churn on the legacy side of the business. That effectively is planned churn from your perspective. Can you go over that dynamic? And really then remind us again who your ideal customer is? And the potential to take their ARR higher from -- I believe, the average is today about 277,000 higher in the future. Maybe why some of those smaller customers that are churning just aren't sort of right for the future of Dynatrace.

Yes. So as you pointed out, Matt, this quarter for the first half, we had new logo growth that was over 30% on a year-over-year basis. So we continue to grow new logos at a really healthy clip, and our target for the year is to be 15% to 20% new logo growth. But at the beginning of the year, as you mentioned, we identified a small cohort of single product customers that are not utilizing the Dynatrace platform. So we have a couple of hundred customers that we expect to churn out over the next 4 to 6 quarters. The net financial impact is you want to think $5 million to $6 million of potential ARR reduction. So when you put that all together, it's a very small ARR number. It's low-end nonstrategic customers, single-use product that we weren't able to move to the platform. Ultimately, what's going to happen is that will also drive a higher ARR per customer. Right now, we have about $277,000 as our average ARR per customer, and that grew 19%. And we think by eliminating this low cohort of nonstrategic customers, we can continue to ramp up that average ARR per customer over time. When it -- when you think about where can our customers go in terms of average ARR per customer, we always talk about it being $1 million ARR per customer. There's so much opportunity in our installed base with all the modules that we've brought to market. If you look at it, first of all, from an application standpoint, there's a couple of stats that were announced recently. IDC said in the next 3 years, there's going to be more apps that develop than they were in the last 30 years. ServiceNow just said that they expect 500 million new applications to be developed in the next couple of years. I mean these numbers are staggering. So the market is large today, and it continues to grow a lot as well in the future. So if we look at it then from a penetration standpoint, today, we think our customers from the application side are penetrated 20% to 25%. And some of our larger customers are in that 60% to 80%, so long runway to continue to penetrate from the applications side. On the infrastructure side, very similar. Our penetration rate is probably in that 10% to 15% range. And we think for every dollar they spend in full stack, they can spend another dollar on infrastructure with us. So early innings, just that's sort of in our core 2 modules, Matt, when we think about how we can expand. So a long runway just in full stack, a long runway and infrastructure. And I'm sure we'll get into security and some other ones along the way, but a big opportunity to expand ARR over time.

Yes, and I think that's what is so compelling, why Dynatrace has been such a compelling idea for me is you not only have the land, but this what seems like a significant expansion opportunity because, today, you guys you have, what is it, roughly 3,000 customers. Which out of your target 15k, you're only about 20% penetrated just in that alone. And then the expansion in there is significant, right, as you just alluded to. And I think John, when we were doing some virtual marketing a little bit ago, I think what really stood out to me is what's driving this is this digital fuel. Kevin, you just mentioned the ServiceNow comment. We're seeing the hyperscaler growth. To me, these things would be like we're going to be talking about these trends for the next decade, right? And I think in a world that seems like there's a lot of competition, I think the reality of it is this is a rising tide. And especially in the large enterprise, customers are -- they certainly have choice. But I think the realization is for full stack absorbability, which it seems like you guys are increasingly an important piece. There's a long runway for both the new logo adds and the expansion side, and I think that's what's -- which is so encouraging to me. And I guess, am I thinking about that the right -- sort of the right framework about kind of like what's driving these? What -- I presume it's almost even more greenfield deals today than maybe when you went public a couple of years ago.

Yes. No, it's absolutely right. It's a compounding effect between sort of new logos and then the net expansion. And the math we've laid out of new logo expansion at 15% to 20% year-on-year; and then the net expansion rate, 120%-plus yields; long-term, 30%-plus grower. So those are the fundamental building blocks, and our investments underneath are all to fuel those 2 items. So the thesis is certainly clearly there. My thoughts on maybe sort of how we're fueling them, a couple of thoughts for the future. Today on the commercial expansion side, it's sales organization expansion but more and more leverage with partners. And I think the leverage with partners has a lot of headroom to get better. Passing $1 billion gets the attention of all the global system integrators. They're the ones that are implementing all of the major cloud transformation projects right now. So that's an opportunity for the company. And then on the innovation side, it's just a fantastic engine there led by Bernd Greifeneder, the original founder of Dynatrace. Still super passionate about the business, a great visionary, amazing productizer as well. And the company is sort of blessed to have him sort of anticipating the future of where this market goes, certainly for the 1 billion-plus customers. I mean just the fact that we put an AI engine at the core of the platform 7 years ago in anticipation of the telemetry explosion that's going on right now gives you a feel for how innovative and anticipatory their thinking is. So a lot more to go, a lot more room to scale, but those are the fundamental building blocks that the company is investing in aggressively today.

And I think what stood out to me guys was how you guys are building this sort of this layered cake of ARR build in a very -- what feels like to me a very responsible manner. I think the temptation would be let's overgear this on the sales side or let's pour more gas on this fire over here. But I think understanding the cadence of the business in the market, I think you guys have a really good handle on that from my perspective. And so when we think about like the main governors of growth, what -- maybe, Kevin, what are those? I mean how do you think about the right level of new logo adds, the right level of expansion? And ultimately, I want to get to NRR here in a second, but -- and partners clearly seem like another level of -- layer of growth there as well.

Yes. No, I think -- look, I think the products and the modules and the innovation journey we've been on and continue to be on will give us ample product to go out into the marketplace and be super successful. But when you look at it in terms of how we will go and access that, there's a couple of things that I think people should keep in mind. One is we're growing our sales organization. This year, we're growing at 30%. That's up from a 15% to 20% to 25% rate over the last couple of years. We'll continue to step on that gas, but we don't want to break the engine as we go, right? So we need to be very careful. And as soon as we feel super comfortable with that 30% number, which we achieved this past quarter, we're going to step on the gas and grow that more. The other dynamic from the sales organization is we've done a great job of attracting talent to the organization, but also retaining the talent in the organization as well. So as you can imagine when you have a more mature sales organization, that leads to higher productivity and higher attainment over time. So I think that's going to be beneficial to us going forward. So from a sales standpoint, growing the base, but also maturing the sales organization inside our company. And then as John was saying, when we think about the addition that partners can bring to us, that's enormous. And we have been successful in regional with the regional SIs over the last 12 to 24 months. We're getting more and more traction with the global SIs. We do believe in the next 12 to 24 months. That contribution can be a meaningful tailwind to the business as we go forward. So we're not stopping. We're going to continue to expand our direct sales organization. We're going to continue to build out the partner organization. And hopefully, the combination of those 2 can continue to accelerate that ARR number.

The other thing -- that's helpful. NRR, you guys have said it's been over 120. But you did have some challenged verticals during COVID, but you still remained at that plus 120 level. I guess I'm wondering, with the growth drivers that you guys are suggesting and maybe some improvement in some of these challenged verticals, now that we're kind of coming up on -- getting close to that, can you believe, say, 2-year anniversary of COVID here. Does NRR have the ability to work even higher? I mean could that theoretically get to a 130 level here?

So if you actually look at our net expansion rate over the last couple of quarters, it has been increasing. And sort of you can back into the number a little bit. We break out our ARR growth into 3 buckets. And this past quarter just to summarize it, we grew our ARR at 38% on a constant currency basis, excluding the perpetual license headwinds. When you break that 38% growth into 2 buckets, 11 points came from new logos, right? So we added 160 new logos in the quarter at an average land of $100,000. And then our net -- our expansion contributed 27 out of that 38 points. So you can sort of back into, Matt, that net expansion rate there. Ultimately, we did have a 4-point headwind from perpetual licenses. That will go away over time. But we've seen a nice step up over the last couple of quarters. The COVID, previously a headwind for 4-ish, 5 quarters ago, frankly, has turned into a little bit of a tailwind. But I also don't want to think it's a short-term tailwind. I think this is a journey that we're on. It's going to be many years where companies are undergoing these transformations, and we think that all again can be nice tailwinds to that net expansion number.

So it seems to me that -- you guys have been very transparent about some of the puts and takes of ARR, including the perpetual runoff, which still persists next year. But I think you said it's going to exit next year below 1 point of headwind. So to me -- and again, I don't want to get ahead of ourselves from thinking next year, but it feels like the conviction around the durability here feels very robust to me given the levers of what you sort of described in terms of new logo adds, rep productivity, maybe some COVID headwinds diminishing the perpetual runoff going away. To me, it feels like -- again, I don't want to talk about guidance next year. But it does feel like the stability, if not, maybe even a bit of acceleration could be going on here just given the trends in place. So to that point, I guess, inevitably, the question comes up on competition. And I know, John, you've alluded to me that you're seeing a higher percentage of greenfield days -- deals today than you were even 2 years ago, which I think is counterintuitive to a lot of people. The obvious question is Datadog has talked about a lot of success in APM. I think they disclosed 500 million of ARR in APM and walking, growing maybe 100% last quarter. How often do you see competition? And why are you winning in some of these G 15 -- I shouldn't say, why are you winning. Maybe the more point of the question is what is the level of competition? Do you see Datadog in some of these G 15,000 wins when it comes to sort of full stack observability?

It's a great question because everybody, 2 years ago when we first IPO-ed, it looked like everybody is going to collide into this market. And nobody really understood how big or how fast moving the market is. But then you start taking a look now at the combination of AWS, Azure and Google and growing at 35%, 36% year-on-year and annualized spend at about $150 billion in spend, and you started realizing how big is that universe expanding. We're -- I think we're all running as fast as we can, and we're probably still not keeping up with all the applications and infrastructure workloads that are being applied out there in the cloud markets. But it just really is a massive space. I mean we see guys like Datadog in still single-digit kinds of environments. And usually, it's in work groups or departments here or there. The way I sort of think about the market space and what we do, it's a different approach and a different sort of characteristic than some of the other players who are really more sort of start with tooling developers and then work groups. We come in and sort of talk to DevOps leaders or operations or application architect leaders that kind of thing. And if you think about -- I started talking about sort of this music analogy. You have this world of those who work with jazz ensemble, the improv folks. And the jazz are great at sort of the improv world and want their own tooling whenever they want it, whatever they want. But there's a point at which you have too many musicians, and you need to think like an orchestra. So we sell to the orchestra conductor, the one who needs sort of situational awareness across a wide footprint, the ones that need the collaboration orchestration in a lot wider footprint. And that's I think why the overlap of -- competitively is really so different is it's almost a different use case, even though telemetry is still the fundamental piece. It's just at what level do you need the telemetry. And when you need that broader view, that's where our AI ops capabilities come into play, because it really is a much larger, bigger operation that you're trying to orchestrate and work with.

Got it. Got it. Well, we're getting some questions from people. We only have a couple of minutes left. So Kevin, we're going to hit a couple of rapid fire from folks here. One question from a member of the audience is, "Do you expect to get a nice step-up in NRR in your December quarter renewal as you true up consumption growth over the course of 2021?"

No. Consumption growth doesn't kick in. We don't take that into account when we actually calculate our net expansion rates. So no, we don't expect to step up from there. But what we have been seeing, as I mentioned earlier, is over the last couple of quarters, some of the COVID headwinds have diminished and turned into tailwinds. We have seen a net expansion increase over the last couple of quarters. We don't disclose it, Matt, but we're pleased with the progress there.

That's great. That's great. And actually a quick one for John, and the question was, "Did Rick have some particular experience in building out partner programs at Akamai or Cisco that made him attractive from a go-to-market perspective?"

Partners were instrumental to both go-to-market strategies at both places. So he's super familiar with how to take direct sales, augment it with partners and channels and build multidimensional go-to-market engines, absolutely.

Okay. And we -- again, we need to make this longer, but we never really talked about security. But I guess another question was, did Rick have any particular -- or the question said, "Was Rick's experience in security, was that also an attractive in building out your app security portfolio?"

It really wasn't a consideration. The 4 I gave you are really the fundamental. The fact that he has some security background will certainly be advantageous to Dynatrace, but it wasn't a criteria for the decision. It was really more run and leading businesses at scale, multibillion-dollar scale and doing it successfully, a diverse portfolio of skills and then that cultural fit. They were the fundamental ones. But there's no question that if you have some security experience, I'm sure we'll lean a little bit that way. It's early days for Dynatrace and a huge opportunity for the company to add another sort of leg to the stool of growth.

Got it. The last one, and this is from me, but I -- Kevin, for you. When we think about those incremental drivers next year, given your large enterprise focus, could sales reps being a bit more active from a travel and a face-to-face perspective have a positive impact on pipeline build from your perspective?

Sure. So just to level set everybody, we have about 3,200 employees in the company today. We've hired 1,000 employees during the COVID environment. And our offices are open, albeit not everybody is coming in. But we're starting to get that culture back, and that's very exciting for us. People, our sales organization is traveling. Steve Pace is, I think, over in Europe right now with his sales organization. They're all visiting customers. So to the extent that they can get in front of customers, we think that will be beneficial. And I think I'll wrap up by saying we have our Perform customer event in February. That will be in person. We'll do some stuff virtually as well, but we're super excited about that and think that can help the business for sure.

Excellent. Excellent. Well, we're out of time, unfortunately. Thanks for the questions from everybody. If you have follow-up questions, reach out to me. But really from all of us RBC, John, it's been a fun ride. The ride is going to continue. John, you're going to be an observer like all of us. So I do appreciate everything we've done for us over the years. And wish you all the best in trying to shave a couple of strokes off your handicap and spend some time with your grandkid. And really, thank you for everything you've done for us and really the -- for all the shareholders out there as well.

Yes. Well, thank you, Matt. And please know that I'll do everything that you guys would expect me to do to make sure that Rick's transition is smooth and quick, and he can take the reins and run with them.

Cool. Well, Kevin, looking forward to continuing the dialogue. From all of us in RBC, thank you, gentlemen.

Thank you. Bye.

Thank you very much.

Thanks.