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

Hey, welcome to our next session. I'm really happy to have the team from Dynatrace on with me. Kevin, thanks, and good to see you again.

Let's start maybe with the elephant in the room, it is a bit of a funny day, we had like 2 COO transitions announced on the same day. Yours looked a lot more organized. Can you just talk a little bit maybe about the background on the retirement?

Sure. And first of all, thanks, everyone, for having us. We appreciate it. [Audio Gap] on retirement last week. And the Board, as a good Board has -- always does always thinks about succession planning. And we've been public for 2.5 years, and that's just been part of what they do. John talk to the Board earlier in the year about his plans to at some point, retire, and we started to undertake a search at that point. And went through a pretty exhaustive user third-party senior level headhunting firm and covered the world really for a great leader. And we're fortunate enough to have Rick McConnell joining us. He's currently over at Akamai and we're super excited. So his start date is on Monday and really looking forward to him starting.

[indiscernible] And what about the criteria that you were looking for in the [indiscernible]?

Yes. No, that's a great question as well. So there were 4 main criteria that the Board looked at. The first was, they -- we were looking for somebody that had leadership at scale. So multibillion dollars, $1 billion going to $2 billion or $3 billion or $4 billion and something like that. Obviously, that's the trajectory that Dynatrace is on. And we wanted to see if we could find somebody to come on and fill those shoes. And Rick's done that at a little bit smaller scale, I think Akamai is $1.5-ish billion in terms of the security business, but over at Cisco, that business that he managed grew to a $5 billion business, I think, over time. So that was 1 criteria, leadership and success at scale, and that was great. The second piece, which, as I'm sure [indiscernible] you go to market expertise. When we think about the growth drivers for our business, it's the commercial engine and its innovation. And we needed somebody who had that go-to-market expertise and Rick ran sales at operations at WebEx before become a GM and he drove a go-to-market business for the security business over at Akamai. So that was the second 1 was the go-to-market success. The next 1 is product strategy, the ability to innovate, right, the sort of forward thinking where is the world going 3 years down the road, 5 years down the road. And Rick has shown that he's been able to build a category leader. He's been able to execute and navigate the world as he continues to build out a great product strategy. So we have a great product engine, innovation engine today, as -- I believe, as you know, and that was super important. So the commercial piece, the product -- the ongoing product innovation and the fourth one, which is a little bit harder to sort of to measure what's the culture. Dynatrace, we believe, has a great culture. We -- people love to work here. People love to come to work here, and we have great retention rates in our organization as well when it comes to employees. So somebody who comes on -- would come on board fits seamlessly into the culture. And overall, Rick fits all those 4 criteria. So I'd say those were the 4. There are some other softer ones around the side, but it was unanimous at the Board level and for the executives at Maidenhead that Rick would fill the shoes, greatly.

Yes. Yes. Yes. Okay, makes sense. And then the -- I mean the 1 thing that always comes up a little bit is if you have those transitions is like -- is there going to be -- what's the level of change? Because that's what investors are kind of worried about or thinking about. So if you think about it, would -- should we kind of expect like any major changes in strategy, go-to-market or whatever? Or is it more like, look, yes, we need to continue to scale. So it's a more continuation rather than like, okay, we need to do something differently?

Sure. So I think the first one, let me hit that first -- for a different 1 slightly, Raimo, which is the leadership team. I've gotten a lot of questions on that as well. And the leadership team is in a great spot. I don't -- there aren't many of us who have led a company from $1 billion to $5 billion or a multibillion dollar growth strategy. So we're looking forward to Rick coming on board. Everybody is super excited there. So I do expect ongoing stability in our leadership team that people do that -- ask that question. When it comes to our commercial engine and our innovation engine, the question is, can we move faster. It's not, hey, how are we going to slow things down at all? It's -- can we, as we've been doing for the last couple of years, innovate a little bit faster, bring products to market a little bit quicker. And can we grow our sales engine faster than a 30%, 35% clip that we've been doing in the past and how do we step on the gas prudently, right? So I don't think overall, the direction strategy is going to change significantly over the next couple of years, but I'm sure Rick will put some fingerprints on the business. Whether it takes 3 months or 6 months in that time frame as he gets to know the culture of the organization and some of those levers we need to start to adjusting to accelerate.

Yes, yes. I mean, and then -- as you said, like you were very, very consistent, like 30%, 35% grower. So it's like, and it's funny. I always had the discussion with John and you as well, like, and I'm sure you had since the IPO was like what can you do to make it faster, what's driving? What are the factors here? Yes, really interesting to do that.

That's right, yes.

Let's unpack a little bit the drivers of grower, and I just -- you're very methodical in your approach, which I kind of really enjoy. So let's just unpack a little bit by step by step. So let's talk a little bit about like dollar net retention. What are you seeing in terms of upsell opportunities with new products, et cetera? What's going on there for you guys?

Sure. So we're doing a great job just from a numbers standpoint, as I'm sure you know, our net expansion rate has been over 120% for the last 14 quarters. This past quarter, our ARR grew 38% in constant currency, excluding the perp license headwind. And we actually break that out into 2 buckets. 27 points of that 38% came from expansion in the base. So you can sort of back into a little bit what our net expansion rate is and then the 11 points came from new logos, but focusing on the 120-plus percent net expansion rate. It came across the board. First of all, we're doing a great job of landing new logos with multi modules. We can talk about that in a little bit. But the expansion in our base is not only additional apps and infrastructure that are being monitored, but we're cross-selling to more modules as well. So over 45% of our customers today have 3-plus molecules. That's -- I think that's up 900 customers on a year-over-year basis. It's up pretty substantially. The average ARR for those customers that have 3 plus modules is at $500,000. The average ARR for our entire customer base is about $300,000. So it's great. If I then I prior look at where is the growth coming, the infrastructure module that we brought to market about 6 quarters ago, that's about a $100 million ARR business today. So that traction has been great. The attach rate to full stack. The way we think about it is for every dollar of full stack, there should be another dollar spent on infrastructure. Right now, that's about $0.15 that our customers are spending. So it's still early in terms of penetration in our customer base on infrastructure. And as I mentioned, there's still a lot of customers that were going and looking at cross-selling the infrastructure-only product. And then DEM would be the next one. We've always been super -- very successful selling our digital experience monitoring forecast solution, real user monitoring, things at the edge, mobile devices, that's really been driving that. So that continues to be a super healthy attach rate and growing. So when we think about the business going forward, ample opportunity to scale each 1 of our existing customers from $300,000 to over $1 million over time. That's excluding security, which we can cover at some point as well if you'd like. And that's by additional applications and additional infrastructure and then expanding to new modules, including cloud automation and digital business analytics as well.

I mean if you think about it, then on that net expansion, if you kind of put the growth drivers together like that expansion motion should kind of work for quite a few years to come then for you guys? Because I like infrastructure is still small. You've been mentioning [indiscernible] as a number of things you're going to think about digital experience security. So you must be pretty happy about that.

Very happy. It's ServiceNow, McDermott said the other day, I think there's going to be 500 -- he said 500 million new applications developed in the next 3 years. Gartner says there's going to be as many applications that developed in the next 3 years as they were in the last, I think, 30 or 40 years. So it's not only further penetration in their existing portfolio of applications and infrastructure but it's somewhat of an evergreen market with a number of applications and workloads that are getting spun up and cloud environments as well. So the market opportunity, I think everybody appreciates is very large.

Do you -- and are you -- where are you on that, the 120 plus [indiscernible] was like a good number that everyone gave. Is there like are you reviewing that annually? Or is that kind of set in stone for you guys? Because like the numbers are kind of clearly going in the right direction.

It's -- we'll review it annually. We -- as an enterprise business, we made the decision when we went public back if we can maintain 120-plus percent net expansion rate and add another 10-ish points, 10 to 12 to 14 points of growth from new logo that's a long-term sustainable 30-plus percent ARR growth business, and that's a great sort of trajectory to set. Does it mean that we're -- are we pushing and do we want to go faster? Absolutely. I'm not sure, Raimo, at this point, we're going to step those numbers up. But we definitely believe there's the opportunity and if we continue to execute to accelerate the business.

Yes. Yes. Yes. So you won't do that at this conference. Okay. No.

Not right now.

Let's shift over on the new customer side. Like you talked about -- I think your new logo was like more like a higher number than the 11%, 12%, it's like more like 15% to 20% on new logo. But then I guess they are kind of landing on the smaller ticket item and then you upsell there. Is that the right way to think about it, like in terms of like a new logo business?

That's right. So generally, the trend rate right now is we're adding about 600 new logos a year generally, and the average land is about $100,000 per land. So we're adding about $60 million of ARR every year just based on our sort of our current run rate business. Our target this year that we've communicated to the Street is new logo growth of 15% to 20%. I will say that the growth for the first half is north of 30% year-to-date. It's an area that we know we need to continue to be successful in and we need to continue to step that up. We're penetrated. We go after the global 15,000 enterprise accounts, the largest accounts in the world. We have a little bit over 3,000 customers today. So we're only about 20% penetrated in our target market today. And we do think, at least for the next handful of years, 3 years, 4 years, 5 years, there's ample opportunity in that customer base to continue to expand. And hopefully, we can get that new logo growth rate up over time. It-- takes some motion. It takes a couple of quarters for that to happen in terms of getting that thing north of 20%. But it's definitely one of our target areas that we want to continue to focus on. It is a core building block for this business because we've proven once we get a customer landing at $100,000, we have a really proven track record of expanding them in 6 months or 9 months and then growing these people into $300,000, $400,000, $500,000 customers in a relatively short period of time. The product is super sticky. They love it and when it goes in, they get tremendous value.

Yes. And if you think about that the -- where are those customers coming from? Obviously, -- it's a [ Global 2000 ], but like if you think -- are they kind of guys that didn't really look at [ APM ]? Is that like legacy guys kind of finally giving up and coming to a more modern platform like it? What's that land motion kind of -- what's the typical land motion?

The land -- it's coming from everywhere. It's not 1 vertical. We do look at our ARR by the verticals, and there are certain verticals like banking is a very, is a higher percentage of ARR than some of the other ones. But generally, it's coming across many different industries, many different verticals. I'd say the key thing is it's those CIOs, CTOs or organizations that have said we need to transform. Our old way of doing business is not going to work. We need to increase our digital presence. We need to be more efficient. We need a better customer experience, and they know their existing applications aren't nimble enough, and they say, "Hey, we're going to go cloud first, so we're going to do a multi-cloud strategy. We need to build cloud native applications and really reinvent our technology stack and the applications that we deliver." And then also have the ability to continue to innovate very at a rapid pace going forward. So those are our customers. Those customers who have said, "We need to transform." It's not the legacy companies in the world who are complacent and they've got data on-prem. 85% -- 80%, 85% of our business right now is coming from customers who are monitoring cognitive environments, doing things in multi-cloud environments as well. So this is -- these are all the new workloads that we're going after that our customers are going after because the existing technology from a monitoring standpoint is just not getting it done for them.

So then it does sound more, more like greenfield, like if you go in there, it's like -- people in the cloud or going to the cloud because in the cloud, the old tools don't work. And so they need to kind of look around and so then you guys come in. Is that a fair way to think about it?

Very fair, very fair. I think we talk about the market coming towards us a little bit. I think we talked about that on our last earnings call, and that's exactly right. It's -- I think people realize some of the second-generation monitoring tools aren't working. CIOs then have a decision, build it themselves or trying to find a company that can suit their needs. And today, we've been successful marketing the company. And I think we were getting more opportunities and times at that. But we're also dealing with CIOs who frankly haven't heard about Dynatrace or we haven't gotten in the door successfully, and they try to build their own monitoring solution. They -- some instrumentation here. They get a database, they try to correlate at all maybe put some AI together, they realize that it's just not going to work. And then we have one of the largest retailers in the world went down that path and they downloaded the Dynatrace platform, 90 days later, we had -- it was an 8-figure ARR deal after we proved out the value. And now they are installed in well over 100,000 hosts around the world, and it's that scalability, it's that platform approach where people see the value. So to answer your question, it's a do-it-yourself competition environment at the enterprise level. We're not seeing some of the legacy providers there, as often as they were 2 years ago. They just are slowing down pretty significantly.

Yes. I mean leading me to my next question in a way like in terms of -- I'm sure as a CFO, you kind of do track a little bit like deals, win rates, et cetera, to see like where things are going. Have you seen a change in terms of who you're running into there, who you're winning against over the last few years? And I'm asking like there used to be the APDS even older the Wileys and that sort of stuff of the world. And then now we have like more the Datadogs and maybe even some of the like elastic or whatever. Like has that changed? Or is it still very much the same?

Well, I would say some of the legacy providers, the Broadcoms, the Wileys, the APDs, who missed the tech cycle from an innovation standpoint, I think generally, those were our biggest competitors, as I mentioned 2 years ago. We saw them in 80% of the deals. They were at the enterprise level with us. And whatnot, but the world changed and they can't -- given the dynamic environments and micro services and containers, they just -- they hit that tech that wall and they can't get over it. So they're there a little bit. But from a win rate standpoint, our win rate to continue to increase pretty nicely. And then the times that we see them there Raimo, has significantly decreased as well. We see some of the open-source folks more in the do-it-yourself environment. And so I think we would put them into that bucket. And then there's Datadog as well, and I think they've done a really good job in that SMB mid-market, simpler environments to monitor, simpler used cases. But at the enterprise level, we've not -- we really haven't seen that much there. On occasion, we do see them there, Raimo. But it's a different go-to-market motion. And we believe customers are looking for something a little bit more larger-scale platform-based and provides visibility across the enterprise, whether it's in multi-clouds or on-prem or wherever the data may be stored. They're looking for that flexibility. So not seeing them too much.

I mean, it does feel like -- and I'm sure you get it in the one-on-ones today or in one-on-ones in the past. It does see a little like we -- on our side, we don't think, oh my God, like it's highly competitive and oh my God, they're going up to the same thing now, and it's going to be 1 crazy thing with like 6 guys and a [ bit of ] and they all kind of -- go all crazy about each other. It does sound more like it's a very broad world where a lot of people can win, and you're still seeing a lot more do-it-yourself and try to tool yourself [ prove ] it in like you having to replace someone that is there for like 5 years and the customer is happy, still try to convince them?

I think that's right. First of all, if you look at it from an addressable market standpoint, just in observability, we think the market is $30 billion-ish. I think the range is out there anywhere from $20 billion to $40 billion. So call it $30 billion, and its early days in terms of penetration, and it's an evergreen market. So that $30 billion issue has grown pretty nicely every year. And then the second thing I will say is you're absolutely right. Investors, I would say, over the last few year, thought the market always believe this market is super competitive. There are so many different companies. The reality is a lot of companies talk about observability. But when it comes to actually delivering what enterprises are looking at, there's -- you can count it on a couple of fingers in terms of actually true organizations that can deliver value to their end user customers on a consistent basis. So we don't view this market as competitive. Frankly, we view our biggest challenge is execution. It's more -- it's really about continued innovation and continued commercial expansion. This market can -- at the end of the day, this market can sustain multiple companies. I don't think -- we don't see multiple companies becoming a multibillion-dollar enterprise over the next couple of years, we do believe we can be 1 of those companies. And we think everybody has their own swim lanes right now. I'd put some -- there's the SMB mid-market swim lane. There's an enterprise swim lane and I don't think those are going to converge for quite some time because there's ample opportunity for companies in those spaces to continue to really -- to grow very nicely over the next handful of years, just an observability as well.

Yes. Yes. Yes. I want to switch gears a little bit on the product side. You mentioned security a year earlier a little bit like. It does feel like a whole new emerging -- kind of opportunity set there. But the 1 thing that people -- that investors struggle when I talk with them is like. So are you guys starting to become more competitive with them? Like how do I have to think about like security and observability and how that fits together? And you were going to say now like, oh, I'm the CFO, what are you talking about? But that's actually the good thing because we're kind of probably more on your level than a technical level.

Good, good, also hopefully I won't mess this up then, Raimo. Look, we've been talking internally. We've been talking about security for the last couple of years. We've been working behind the scenes on some things in security as well for the last couple of years. And it's a very, very exciting market for us. And we're not -- our approach is not to go into this market and try to displace some excellent security incumbents in different segments. But we're trying to look at this as where some of the pain points that our customers have and how can we leverage the Dynatrace platform in the near term to get into that security business? And our initial foray into security is going to be all about the applications. And the applications haven't been sort of a huge area for some other security folks to focus on. It's been hard to instrument. It's been hard to monitor, and it sort of puts the security umbrella around that. So our thesis is our belief is we're taking the Dynatrace platform with the 1 agent that we have already distributed all across our entire customer's portfolio and instrumented and we're capturing data all the way down to the core level. So we've got a great starting point in security. And so then we talk about, okay, so what's going to -- what are those modules going to be that you're going to bring to market over the next couple of years? The first is to find vulnerabilities in the product. So we've -- vulnerability detection. So the first is take all the information we require, match it up against known vulnerabilities for different components of the software code and then prioritize so that its security organization or the developers understand you have 50 different vulnerabilities in this code before it goes into production. Here are the top 3 that you really need to address because they're high risk. So that's -- that's Phase 1. That's a monetizable asset that's in the marketplace today. We landed a $500,000 deal in that segment for 1 customer recently. So we're pretty excited about that initial step into that market. The next step with [ light well ], and we haven't announced sort of product specific product modules at this point. But the next step will be making sure that, that code that code doesn't get into production. so you identify the vulnerabilities and then you need to protect your applications. So it's similar to the RASP concept Runtime Application Self-Protection. So making sure you identify it, and then you stop it from going into production. And then the next piece over time, maybe the remediation component around that as well. So that's how we think about it. And if we think about that opportunity alone, I mentioned a $500,000 deal that we just won, and that's exciting. that's just for the detection piece. So the way we think about it is for every dollar our customer spend over on the full stack side. There's another $0.20 for detection -- for the vulnerability detection there's another $0.20 to $0.40 for the protection and then remediation can be on top of it. So just with what I talked about there from a security standpoint, we're looking at an opportunity in our existing customer base of about $0.60 to $0.80 attach rate to full stack. So it's pretty compelling. And I'm sure, as you can imagine, Raimo, there's a lot more going on behind the scenes in terms of things further down the product road map. But those are some of the things that get us very excited. I'll finish it by saying the other thing that investors need to keep in mind is why did RASP not take off to begin with? It was because it was providing -- it was so much overhead on the system. You got a monitoring in there, you had security in there. And we have 1 agent and it's low overhead and we can do it in preproduction, we can do it in production and customers don't even see it. So it's really exciting.

I mean, the good thing there, I guess, now I understand Rick's hire even more because he has a lot of the security background as well. So that's not necessarily a bad thing, I guess, for him.

It's additive. I will say. It was not 1 of the criteria that the board looked at and said, "hey, we would like to find somebody that has a security background." It's great that he has that experience. I think brings it to our planning initiatives over the next couple of years. So that will be exciting for him to get on board and hopefully add some value there as well.

Yes. No, exactly. Okay. Kind of the last couple of minutes I want to talk a little bit about margins. So if you look, you always have a kind of very balanced approach, like very, very good solid growth, but also very good profitability. Maybe just from a start, is that kind of private equity ownership that kind of ingrains that and you can't just go out and spend like a drunken sailor for growth? Or like -- give me -- a little bit of background because that helps people understand like the mindset that people have.

Yes. So historically, we've been operating our organization at sort a of a rule of [ 60-plus ] with a relatively even balance between ARR growth and profitability -- unlevered free cash flow rate. They were both over 30%. So operating at rule [ 65 ], not trying to change guidance and projections and things like that, but we definitely believe balanced business makes sense. What we also believe is there's significant opportunity in the marketplace to expand the new logo growth rate and to expand our net expansion rate in our customer base. Today, we spend 34% to 36% of our revenue in sales and marketing. We've been stepping on the gas. And maybe under Rick's leadership, we may step on that gas a little bit more. And I think the feeling in the organization is let's try to see if we can go faster. And we've been trying to do that -- we've been doing that for the last couple of years. But if we take another couple of points and our op margins go from 25% or 26% down to 22%, but we can accelerate the topline, we believe that's a great investment to do. And those are some of the things that I think we're looking at internally, continue to look at it and how do we go faster. It's a great market. And I think -- and it also holds true, Raimo, on the R&D piece. Today, it's our R&D organization is very efficient. As I've said to people before, if we had that infrastructure in the U.S., we would be spending 30%, 35% of revenue in R&D. We're fortunate enough to be doing it over in Central Europe, where we're able to attract and retain great talent over there. So that's great. But can we accelerate some of the things we're doing. We've done a couple of small tech tuck-ins. I think that's how you want to think about the strategy there going forward. But can we accelerate our R&D headcount growth from where it is today at 30%, and go to 35%? And maybe take -- maybe invest a little bit more there as well. So at the end, to answer your question, a long way around to answer your question is, it's a great market. our product, we think, is in great shape. And can we accelerate growth? Those are the initiatives that we're looking at to, and that will come at the expense in the near term of some op margin. But fundamentally, it's such an efficient business, we're still going to have a pretty healthy operating income margin. You add a couple more points of sales and marketing, a couple more, point or 2 more to R&D you grow the top line, the top line spend growing 30%. That's a lot of money to invest in accelerating growth and innovation.

Yes. Yes. Yes. Actually, it's funny, Kevin. That was a -- our time is up, but it was a very good closing statement. I know I didn't even ask you for one. But it's exciting. It's exciting to continue to follow your story. It's like really good. I'm looking forward to the next chapter with Rick as well. So thanks for joining us here.

Thanks for having us, Raimo. Have a great day.

Thank you, you too.

Bye-bye.