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

Are we good there? Okay. All right. So we -- so thank you all for joining us. I'm Erik Suppiger, the infrastructure analyst for JMP. Thank you very much for being here in person. It's great to see a nice crowd here. And for this presentation, we're going to have a virtual presentation from the management for Dynatrace. And on the screen here, we have Rick McConnell, CEO for Dynatrace. And we have Noelle Faris, VP of Investor Relations. Rick, do you want to raise your hand there? We -- it's still on a small -- all right. There we go. And so before I start, again, I just want to encourage all of our audience participants to please do feel free to ask questions. The goal here is to give you the opportunity to take care of any questions and concerns. And so I'd love to field any questions.

And so let me kick it off. Rick, it's great to have you at the helm here. Would you talk a little bit about anything that has surprised you? What is different than what you thought when you did your diligence ahead of joining Dynatrace?

Well, hello, Erik. Hello, all. Sorry, I couldn't be there in person for this one, but thanks so much for having us. Delighted to be here with you. Delighted to be at Dynatrace. I'm now coming up on, geez, I don't know, approaching day 85 or something like that. So it's still pretty short term in tenure, but very pleased to be in the role. Not that many surprises to be honest, Erik. It is an exceptional company performing really well. Anytime you can get to adjusted ARR growth in constant currency of mid-30s with mid-20s operating margin, that performance is just great. Operating at a rule of 60 puts us in an elite cast of companies. So very excited about that. And then I think my challenge is not so much a surprise, it's just what do we do to find ways to accelerate that through the course of time when the market seems to be right for that type of acceleration. So that's my job as we look to the future over the coming quarters.

Okay. Then maybe you could comment a little bit about the areas of strength and what areas you think are prime opportunities for improvement.

You bet. Well, on the product side, one of the reasons I joined Dynatrace in the first place is really just all about product leadership. In our target market and segment in the Global 15,000, we have such a strong portfolio of offerings ranging from our application performance monitoring, APM solutions, to infrastructure capabilities, to our real user monitoring and digital experience capabilities all the way to application security. So the product leadership is really a core driver. We continue to invest in ways to ensure ongoing leadership there and to be making targeted investments to grow further in other areas like logs and application security in particular. So I think those are the areas in which we can supplement our APM growth with additional growth into the future.

Okay. So after you reported, stock traded off some, and I think it was concerns over expenses. And I'm not sure if it was real clear where things fell out from a growth perspective. Can you talk a little bit about what your investment plans are? Talk a little bit about the expected growth. You've grown in the 30 -- mid-30s for a while. Talk a little bit about as you take up investments, what can investors expect from a growth perspective?

Sure. Well, this is a company that -- in Dynatrace that's operating the mid-30s growth is, as I mentioned, at the outset and, Erik, that you mentioned as well, and we -- our anticipation is we'll be able to continue to operate at that. What we're trying to do is figure out very targeted investments to make to find ways to give us an opportunity to accelerate that investment as we move to the year or look to the end of FY '23 headed into FY '24. And that's -- we believe that the market is very much there for that kind of growth expansion. And that's what we want to achieve. Now the areas in which we're planning to invest are very targeted, and for what it's worth, very modest in terms of the incremental OpEx. We indicated something like 200 to 250 basis points of operating margin allocated to this, and it's going to ramp into that OpEx as well through a coming few quarters. It doesn't happen immediately. On the product side, it really is in the areas that I described earlier. We have an opportunity to accelerate infrastructure. Our infrastructure module is around about $100 million today, but it's growing at 75%. We think that there is an opportunity for that to be a 1:1 ratio relative to our APM ARR, and yet ARR today is 5x infrastructure. So there's a lot of runway to be had in infrastructure. Logs. We've been investing aggressively in logs based on graphing technology, looking to the future through the latter half of FY '23 where we expect to release our solutions in this space. And that is another area where we believe that there is a material expansion opportunity based on the feedback that we're getting from customers. And we talked a little bit about AppSec. But obviously, in the macro world that we're in today, application security is key, and we really hit a nerve in vulnerability management where the Log4j vulnerability that came out in December really highlighted the need for our solutions there. We went from a couple of dozen POCs to more than 350 in a several week span based on what we provide in vulnerabilities. So those are 3 areas on the product side for incremental investment. On the go-to-market side, partnerships are really core to the expansion opportunity beyond just direct selling. Been growing our direct sales force at around 30% for this year, but we believe that partners can provide added acceleration opportunity there. Brand visibility and brand awareness, what we want to do is we want to have Dynatrace to be associated with cloud ecosystem deployments. You're doing a digital transformation project. You're a Global 15,000 customer. Best practice is deployment should be with Dynatrace, and we want to narrow the gap between the digital transformation deployment initially and the Dynatrace deployment as we look ahead. So those are some areas of investment on the go-to-market side in addition to lead generation. So it's very targeted specific investments, and again, at a very modest level incrementally through the course of the next few quarters.

So let me understand the context or some perspective around estimates a little bit. Right now, the Street is forecasting about 27% growth in ARR. You've been growing mid-30s. You're hoping to invest with a longer-term perspective of accelerating above that. Is it prudent for the Street to be at 27% to provide some degree of cushion? Or is there a disconnect in terms of the way investors are currently looking at the models?

Well, look, we're not on this call giving FY '23 guidance. So I'm not going to provide an update on that. What I would say is, obviously, we want to exceed expectations as we go through the course of FY '23. And our goal is to continue to operate in the mid-30s, as we have been, and through some of these targeted investments with modest incremental operating expense, find ways through the coming quarters to accelerate that growth. So that's our game plan.

Also, too, just to jump in real quick, Erik, I just want to make sure it's understood by investors, too, just that we're talking apples-to-apples that the number that you're talking about from a consensus perspective is like -- is as reported. And so when we talk about mid-30% growth, we're talking about constant currency ex perpetual license. So just so that we're all clear.

Yes. And I think that -- Noelle, that consensus on that number, just apples-to-apples right now is 28%, not 27%. So that's a modest move, but...

Okay. That's very helpful. First off, let me just check, are there any questions from the audience? All right. Let me keep going. You've been growing. I think in fiscal '22, you've projected growing the sales force 30-ish percent. Is that going to be the long-term growth rate if we look into fiscal '23?

That is the -- that's the current plan that as the sales force gets bigger and the hiring environment gets more difficult, that becomes, of course, more challenging. I think I'm not communicating anything that would surprise anybody and -- in that regard. But the good news is Dynatrace is growing very rapidly, and it's a place that people want to be. And we have a good pipeline of people to bring on board. So for now, the plan is continue to grow at 30%. But obviously, as much as possible and per my earlier comments, to leverage the partner community as much as possible. Hyperscaler is a great example. This -- the hyperscaler ARR generation during the third quarter was more than -- up more than 3x year-over-year for Q3. So we believe that there is a substantial opportunity with hyperscalers. It's a material number already. And that growth can fuel significant growth in the company's ARR overall. So that's an example of an area that -- it isn't a pipe dream. It's working already today. And what we want to do is we want to find ways to, of course, further leverage that growth amidst larger numbers.

Okay. Let's talk a little bit about the partnering strategy. One, how much of your business is direct? And then, two, you've talked about partnering more aggressively. Talk about who you're going to be partnering with. I know you partnered with the hyperscalers. What are you doing to expand?

Well, more than 50% of new logo ARR is now coming from partners. And so this is continuing to accelerate and a material percentage of overall ARR is now coming through partners. So this is, of course, an opportunity for substantive ongoing growth. In terms of who I mentioned the hyperscaler, certainly that is one area where we're investing materially to continue to provide growth. Another area is in the global system integrators, where I think that there is a substantial opportunity, although that will take longer to gestate in fairness, but one of the areas where we're going to be investing. And the thought process there, Erik, is just that, obviously, the global system integrators are doing megaprojects around digital transformation. And to my earlier points, we really want Dynatrace to be part of those projects from the outset. And so that's certainly a goal is to get in that -- in those sales processes and those client processes earlier on.

Okay. Are there unique aspects to your hyperscaler partnerships? I know they're a crucial part of partnering. How do you think that your relationships, is that a differentiator or a strategic advantage at all?

Well, I think it's a strategic advantage relative to our customer -- our target customer base. We -- thinking of a deal we just closed a few weeks back that was a very large transaction through hyperscalers, and that is -- that's how they wanted to buy. That's how this particular customer wanted to buy. And if they want to buy through that channel, then we, of course, want to enable the acceleration through that channel. The other element is, of course, we want to be encouraging in whatever way we can the sellers of the hyperscalers to have Dynatrace be top of mind. And so that's another area where we're investing. And then finally, I would simply say that I'm personally involved in those partner discussions and opportunities in order to escalate the relationships to be even more strategic than they've been in the past.

Okay. Discuss a little bit about the steps that need to be done or the execution that's required in order to drive your average revenue per customer from what is now around 290,000 to what I think has been suggested should be around $1 million. And that's a longer-term objective, but what do you think has to be done to get that revenue per customer up?

Well, certainly, just to clarify the numbers, what we would have said -- I think what we would have said is that every customer -- virtually every customer we have has the potential of being $1 million ARR customer, not that it necessarily should be, but that every customer has the potential. So I just want to level set on that. The other factors are that our average ARR, you're exactly right, is around $300,000 per customer right now. The average land size is around about $125,000 or in that sort of range. And the average multi-module customer, multi-module being 3 modules or more, which would include, say, our full-stack capabilities in APM plus infrastructure, plus our digital experience module, those multi-module deployments are about $0.5 million of ARR. And so one way is breadth that you simply deploy more modules, at which point you get to that multi-module deployment and you're around about $0.5 million on average. A second way, though, is that we believe that we're only in today maybe 20% or 30% of the average workloads of our existing customers. So we believe that even in an APM -- on application performance monitoring, module deployment of an existing customer, there's a ton more runway for just adding new workloads for that customer. Maybe we get the most critical applications, the most critical infrastructure, but I've talked to now dozens of customers, and they keep coming back saying we have too many tools, too much D-I-Y and too much sprawl, and what they want to do is they want to narrow that down, and they like to do it. These are all Dynatrace customers, so it's self selecting a little bit, but they're telling me, please help me do that. Please help me consolidate on Dynatrace, and that's what we want to achieve.

All right. We talked a little bit about new logos. Your new logo growth in the last quarter was about 9%. Your target is around 15% to 20%. Was that in line with your expectations? And why -- what's it going to take to get that back up?

Yes. It was in line with the expectations for the quarter. We had some dynamics from year-over comps associated with COVID candidly that move those numbers around. And in any case, new logo growth on a transaction by transaction or a number of new logo basis on a year-over-year basis is always going to be a little bit lumpy. So I think that people just need to expect that. Question is whether we're operating at 15% to 20%, which is our targeted range sort of on a regulated or a normalized basis. We have been -- if you look at the last 4 quarters, we were 22% up year-over-year. If you look at ARR, it's north of 30% over the course of the past year in terms of ARR growth from -- specifically from new logos. So we're doing just fine on the new logo front and remain confident in our ability over a 4-quarter horizon to be growing in the 15% to 20% range that we stated.

As you take up investments, is there a thought process that new logos would drive -- would go north of that?

We're not going to set expectations north of 15% to 20% on the new logo front because I think that these investments obviously play to a net expansion rate as well for existing customers, both in terms of breadth of number of modules as well as depth in terms of number of workloads. So I wouldn't say that we're ready to take that outside the 15% to 20% range. The other thing I would say is that the average land, we're pretty happy with it in the range that it's at because we very rapidly do expand customers once we get them landed. And so we don't want that growing so high in terms of the land ARR that it actually slows down the sales cycle. So pretty happy with that range now in terms of both the target average ARR per new logo as well as the range for new logo growth rate year-over-year on a normalized basis.

Okay. Again, any questions here for Rick? I see we got a question.

How significant of a contributor can you take the cybersecurity opportunity [indiscernible]?

Could you hear that, Rick?

No.

How significant of an opportunity do you think security will be for Dynatrace?

The -- it's very nascent for us today, single-digit, millions of dollars for FY '22, but it's an area that we believe will grow rapidly at least on a multiple basis as we look to FY '23. The way that I think about sizing it, at least the way that we think about internally, this should be a $100 million business for us over a few year time horizon. And we'll have to figure out what the growth rates translate to on an annualized basis there as we look through those 3 years, but this is a material opportunity. Observability and application security really should go hand-in-hand in terms of deployments of customers. We're very excited about the opportunity that we've seen just from the vulnerability management capability that we have in the module today. And we're excited about the growth opportunities as we look over the coming years.

Okay. Additional questions?

[indiscernible] that one. When you think about the value cost of [indiscernible] or security versus partners [indiscernible] how do they make sure [indiscernible]?

So following up on security, this is with regards to your partnership with Snyk. How do you think of your value proposition and your ability to maintain the relationship or control the relationship with the customer versus working with Snyk?

Well, Snyk is a solid partner. They provide great input to us. We then factor that into knowing a ton about the infrastructure of the company with which we're working. So it's very symbiotic. We certainly drive value from Snyk, and they don't have the view of the infrastructure that we have that spans all the capabilities that really delivers answers around utilization of code bases in certain parts of the overall IT ecosystem. So I actually think it's pretty symbiotic today, and I think it's -- we certainly can leverage each other in a productive way.

Okay. Any more? So let's talk a little bit about the competition. This is a very competitive market, great growth opportunity. You have a number of players -- larger players that are coming into the market. Talk a little bit about how you see the market evolving over the next year and over the next 3 to 5 years. Is this a market that's going to fragment? Is this going to consolidate? How do you think the competitive dynamics are going to evolve?

I don't know if it consolidates in terms of M&A. I can't speculate on that. I could certainly say I think it's going to -- the growth -- overall growth and I think leadership positions and market shares are going to consolidate in probably a couple of players. Where we're focused on leading is where we lead today, and we're going to continue our expectation is continue to lead in the Global 15,000 space. That is a space where enterprise are making -- enterprises are making typically enterprise-wide decisions that they are getting deployed on an observability platform that they want to factor in and incorporate it into their overall IT ecosystem fundamentally, and that's what we do. And these are cases in which through hybrid cloud, multicloud, complex ecosystem deployments. Data is explosive in terms of overall quantity. It's just enormous and not manageable through simple dashboards and alerting. It's got to be delivered through an AIOps engine that's telling you precisely what's wrong, when it's wrong, why it's wrong and how to fix it. And that's something that Dynatrace does uniquely through our tracing capabilities that we believe are clearly leaders in product in the market in those areas. So that's where we stake our claim. Others are focused on the SMB space or other areas, which have different growth dynamics and different overall factors and are more oriented toward dashboarding. That's fine. And I think that those who are in our space, for example, like an AppDynamics or others, those opportunities are -- present great expansion opportunities for us in terms of the evolution of our market opportunity overall.

Okay. Then the last couple -- or last 1.5 minutes, let me ask, you have some R&D in Eastern Europe or Middle Eastern -- mid- to eastern part of Europe. And I don't know what kind of sales exposure you have to that region as well, but can you talk a little bit about your thoughts on the conflict in Ukraine?

You bet. So first and foremost, the feelings throughout the Dynatrace company has just got incredibly heartfelt for the Ukrainian people. Obviously, very difficult set of circumstances. We did post today that we'll be withdrawing a business from Russia. The impact is we have 0 employees in the Ukraine and Russia. Today, we do have 24 or so people who have families in those countries with whom we're working, but no employees. It amounts to about $5 million to $6 million of ARR for us at the moment. So against the number that's approaching $1 billion, it's quite modest. But certainly, we would say that ARR is at risk. And it's this decision, but we believe firmly that it's a strong -- the right thing to do from a moral ethical point of view in support of the sanctions that the global community is exercising and what we've chosen to proceed with.

Okay. With that, I think we're going to have to wrap it up. But Rick, thank you very much. And Noelle, thank you. And again, thank you all for joining us. It's great to see you here.

Thanks very much, Erik.

Thanks, Erik.

Much appreciate the time, and thank you all for joining.

All right.