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

All right. Thank you, everybody. The afternoon rolls on, kind of thinking dent in the chair here after a while, but I appreciate everybody for showing up and having interest in Dynatrace. I've known Dynatrace for a long time and have just really, really been inspired by what you guys have done as a private company as a public company and with new leadership, we're happy. This is the first time, Rick, I think you and I have met in person. I think. We've seen each other on Zoom many, many times, but it's great to have -- it's great to have you here. Rick McConnell, CEO and then Noelle down here in IR. Thank you for joining us. Normally, I ask people to give them an overview of what you do. I think most people understand what Dynatrace does. So I'm going to skip that. But maybe just from your perspective, what was it about Dynatrace that excited you about the opportunity? When you looked at -- you had all the things that you probably could have done your life. What was it about Dynatrace here and now that really excited you about the opportunity?

This was a year ago. It feels like -- it feels like 3, 4, 5 years ago that you and I have -- Yes, exactly. Customers, products, financials and people I mean those 3 or 4 things. It's -- I continue to see customer after customer, and they continue to tell me the same story, which is that Dynatrace is indispensable. And this is the story that I got before I took the job, and it continues thankfully, to me the story today. That's great.

Yes. Excellent. So you're coming off a quarter, it was a strong quarter. You did reduce your constant currency outlook for the second time, which I think, candidly, the alternative is raising and on think's going to believe you if you raised. And so I think that level of skepticism is really appreciated by the Street by investors in general. Can you talk about just -- you just -- you sort of mentioned the durability of your end markets. Talk about that. Talk about the durable demand markets, talk about sort of what you're seeing out there as well, which kind of caused you still to take a couple of points of constant currency growth out.

Right. I mean the starting point is the market overall. And the market overall for observability, I think, continues to be extremely strong over the mid- to long range, and it's going to continue to grow based upon overall cloud growth, digital transformation and the other elements. So the long range is very exciting, but I'm very enthusiastic about that. Over the immediate term, the economic environment certainly has an impact. And we saw it especially in Europe last quarter, which is the primary factor of why we brought guidance down a little bit last quarter. That was the primary guidance change that we made in the model.

Yes. So on a go-forward basis, I mean, I think Dynatrace has always been such an interesting story because the building blocks to growth seem very logical to me. When we think about new rep adds from a capacity perspective, new logo adds, NRR. Talk about some of those building blocks that we should think about, despite some of the short-term gyrations?

Yes. The 2 building blocks continue to be new logo growth and NER, NRR growth out of the installed base, both continue to be quite strong, leading to your guidance in the mid-20s ARR, adjusted ARR growth which continues to be quite strong, along with mid-20s operating margins. So as you indicated earlier on, very durable, very balanced operating model with very strong growth. We continue to expect to deliver against -- so those are the primary building blocks we see.

So as -- you've been in leadership roles for a long time. When you put your lens on this environment that we're in now, are there things that you and your leadership team do differently? How do you lean into that experience to guide you through maybe some more challenging economic times?

We've -- I've talked about this as leading in the turns over the last...

You said that last quarter I thought it was fantastic.

Yes, the last quarter so, I really do believe that you win races in [ turns ]. Typically, if you're going around the track, whether it's speed skating or auto racing or whatever it might be, you -- this is the time that you need to really pay attention. We're in a turn. And that turn has resulted in macro uncertainty across the board. We believe that it's an opportunity for ongoing investment in R&D, for example, continue to promote leadership positions in areas such as log management analytics the rail announcement in application security, which I would continue to see very nice growth against. Even in infrastructure, which is relatively new, still module for us a couple of years in, doing now well more than $100 million in revenue, which got to that level even just 8 quarters out. So these are all opportunities for material ongoing growth in the model as we look ahead.

Now leaning into the [ turns ], that was 2 quarters ago. I think he said that I spot on, right?

I mean still true even today. Unfortunately, we're still in...

Still in that big turn.

We're still in a bit of that turn, which is what we're navigating.

The other thing, I mean, I think what always excites me about Dynatrace is just this growth in cloud work over longer term is probably the biggest catalyst to your growth, new applications, new platforms, multi-cloud. There's been a lot of questions though about the growth trajectory of the hyperscalers. Obviously, I don't think anybody questions the long-term trajectory of where cloud infrastructure is going. But how do you think about that correlation between hyper cloud growth and Dynatrace growth?

Well, the -- so last quarter, the 3 hyperscalers, main hyperscalers reported a quarter of $44 billion in revenue, growing at 36% on a constant currency basis. There's plenty of growth with a [indiscernible] enormous number that's in that. The way that I think about it, and indeed, Dynatrace's value proposition to some extent, is that the observability decision has followed by some number of months or years even, the decision for cloud migration [indiscernible]. And what we see happening over the course of time. And in fact, what we're driving at Dynatrace is that those decisions become more simultaneous. Because we really do view Dynatrace as cloud done right. And cloud done right means that you've got Dynatrace in your most critical cloud workloads. And that means that, that should accelerate. The whole point of the story is that the -- it's not just the growth of the hyperscalers that matters in terms of wallet share, it's also the size of that overall spend into which there still is an enormous opportunity for accelerating spending absorbability associated with existing cloud workloads.

Yes. And I think what I've always come to understand, though is, is not even as much about tackling the legacy IT the on-prem applications because that will eventually come at some point. It's about going after those net new cloud workloads.

It is. The vast majority of our new workloads are all cloud. We're cloud native, fully cloud native. SaaS is the majority of what we're seeing in terms of evolution, Grail, our new Data Lake house or log management analytics SaaS only. So we are fully there. We transformed the platform 5 years ago to be cloud native, so we're there.

And so the question that -- I mean, inevitably, when we talk about the visibility, we talked about, it's a crowded market. There's lots of players in there. Now you guys play at the highest end, the G15K level, where the competition isn't quite -- I mean, it's -- you can argue that it's even more of a fight down market. But talk about -- 1 of the things that -- it's a data point from a couple of years ago, but I remember -- I don't remember who shared it within Dynatrace, but like you just don't see a lot of competition in a lot of these deals. Is that still a valid?

The biggest competition for us [ Bar None ] is DIY, and I can just survive a little bit longer, doing it the way that I'm doing. But one thing that I think people don't fully appreciate is it's not just about technology with which we're competing. It is also about existing processes. The existing process being we've got a network operation center with an army of people staring at screens and they're waiting for something to go red. And when something goes red, then I have the oh, no moment where I'm trying to figure out what application is in and or what piece of infrastructure? How do I find the right team to troubleshoot it, how do I work through that process? Because of where Dynatrace sits deep inside your ecosystem across the board in apps, infrastructure, really user metrics, logs, et cetera, we pull all of that together, process it through an AI ops engine to analyze precisely where the issue is, delivering answers and as we say, intelligent automation for data, not just [indiscernible] and that's the biggest differentiator. What that enables is that those network operation centers with those armies of people should be able to be transformed into something over time, it's much more efficient.

So then talk about -- I think one of the differentiation factors of Dynatrace is you sell the platform. In times of the tighter IT budget scrutiny, when maybe there's some questions about a volume aspect of consumption here or maybe a la carte pricing there. How is your pricing strategy resonating with some of your big customers in times of tighter IT spending environments?

There are sort of 2 ways I'd answer the question at first around pricing. The first is that BT was a good example. This is a public example. They came out 6 to 9 months ago at [indiscernible] Dynatrace, major deployment. And they reduced MTTR of major incidents by 90%. And so meantime to recover or repair incidents 90% reduction in MTTR, [ 15% ] reduction in incidents, and they reported that they would save 28 million pounds over a 3-year span from having deployed Dynatrace. So first point is, as customers are looking at pricing, it isn't an aggregate incremental spend. It actually, if you look at it holistically, it can be a reduction spend. So that's one aspect. Where we're driving pricing to is a more cross-module pricing approach that isn't priced module by module by module, and that's going to make consumption of Dynatrace easier as we look to the future. We already have 100-plus customers on this pricing approach. It's called Dynatrace Platform Subscription, DPS as we refer to it, and this is going to become more and more commonplace as our standard pricing model going forward.

Is that additional -- is it a change in sales motion to drive that? Or is it more like customers -- these customers are on like wall-to-wall Dynatrace at this point?

I would say it is representative and indicative of the transformation our customers are making anyway, which is to an end-to-end observability platform approach. Already more than 50% of our existing and new customers are multi-module adopters, which we define as 3 or more modules. So for example, that would be application performance monitoring infrastructure, digital experience, maybe application security. So we already have more than half customers deploying 3 or more modules. They want a pricing model that goes along with it. So the pricing model is really evolving to meet the existing sales process.

What does that -- so if I'm a customer, I move to the new pricing structure, what does that do to my ACV from a spend perspective?

Yes. I mean we -- the typical 3 metrics we look at, we land customers typically around $100,000. And last quarter, it was $120,000. So it varies a little bit, but call it, $100,000 round numbers. the average ARR per customer is about $300,000. And a multimodule average ARR is $500,000. So when we get multi-module customers, we see it show up in ARR directly. .

Yes. Okay. Well, one of the questions I wanted to ask you on, there's things that you can and can't control in a tougher macro. And I'm interested in the stuff you can control. And one of the things that really strikes me is your GSI opportunity. You spent a lot of time talking about how you can get a lot of leverage from these folks. And DXC has come up in a conversation with you guys recently. Talk about the importance of that and maybe even in a time like this when 23 budgets are going to be come under even more scrutiny.

The -- there are obviously a number of initiatives we're working both short term and medium to longer term to drive pipeline, drive ARR growth, et cetera. I'd put the partner, in particular, the GSI work and kind of the medium to longer range category. But I believe it's substantial. And the reason is because there is really an aligned direct overlap, one-to-one correlation between the customer bases or among the customer bases of the GSIs and our target market, which is great. The argument is that they're all deploying -- they're all making cloud deployments as part of digital transformative initiatives, and they are deploying these solutions that are creating explosions of data which is radical resulting in radically increasing complexity of that data. And the way to get your arms around that is deploy Dynatrace to automate response to that much data. And so we really do believe that Dynatrace is, as we say, cloud done right that when you're doing cloud deployment, you should be deploying Dynatrace, especially if you're a local 15,000. So that correlation with the GSIs is really high and why we're spending so much time on it, because I would see over time that Dynatrace really should become part of the reference architecture for cloud deployment for the GSIs, which is really the opportunity, I think, to get the flywheel moving on Dynatrace with the GSI.

So you said think about it as more like a midterm -- it's not a...

Only because -- I mean, I think that we're taking the steps now. We're making significant progress with the GSIs. I'm personally involved in many of the discussions at very high levels in these organizations. So I would say that's probably one of the reasons for my enthusiasm is that we've got, I think, a very significant opportunity here. But GSI is relation, and it just -- it takes a while to really see it in the numbers.

Are there others -- I assume there's others that could be added to your list of GSI.

Yes, I mean you've got Deloitte and DXC, which we've announced, but we're working with the [indiscernible]. We're working through with the majority of them, certainly. And entire levels that we just haven't been able to announce yet.

So how does that play into that growth algorithm of kind of like new level growth and NRR, is this a flywheel?

Exactly, flywheel expansion directly from partners providing more new logo generation. DXC is interesting. I can go into a modest in more detail on that, in that they are actually switching the existing solution out of their Platform X to Dynatrace. And so in that particular case, it isn't, let's get together and prospect together. It is we got a material installed base of many hundreds of customers that through renewal cycles, we expect to move to Dynatrace as part of Platform X. So we're very excited about that. .

So these GSIs, though, a lot of times they want to be sort of -- they could be vendor agnostic, too, in terms of like partnering with other observability vendor. How does that work with some of these relationships with DXC or Deloitte?.

Yes. I mean there are not going to be a lot of contractual exclusivities here. It's not something that we're even asking for or you should expect. But so far, there has been substantial traction in the discussions around the fact that our customer bases are perfectly aligned. And so certainly, I think that in many cases, they would view us as the preferred partner of choice.

Super helpful. In terms of other things that you can control, it feels like we've talked about a few of them. Security, I just -- what are some of the top of mind things that you're like, we're going to lean into these things, and this is going to help power us through a challenging economic time that's maybe Dynatrace specific?

Yes. I mean, you've obviously got the very near term on the go-to-market side with things like sales development rep, lead generation, pipeline construction, which continues to look very healthy. So we can come back and talk about that, if you like, but feel good about all that. Of course, the GSI or flywheel generation mid to long range is great. And the innovation engine is working great to with application security evolution, Grail that we spoke of as well.

And maybe just because you talked about Grail more so this last quarter. How does this -- how does that change the game for Dynatrace?

Grail is -- for those of you not familiar, Grail is a massively parallel processing data lake house. It is think about it providing capabilities as part of our core technology to massive scale in data. This is very much aligned in my earlier remarks of talking about the enormous growth of data as well as complexity and we can then be able to track that with Grail. The first instantiation of Grail is around log management and analytics. And this is where the architecture of Grail, we believe to be game change. And it is essentially enabling us to deliver data that is not doing any reindexing, not to any reintegration -- reintegration means that you're having to pull data out of cold storage. It's very expensive. So we reduce cost of that. Reindexing early avoidance of reindexing means that you get almost immediate real-time access to data and running analytics on those logs, which you can't do today. It takes a long time to wait for the data to index, so you can then run analytics on it. This is a game-changing opportunity provides more scale, better performance, lower cost with much better analytic capabilities. That's with logs alone. The added value -- further added value, I should say, Grail is integrating logs into the end-to-end observability framework that you've got. And that gets very exciting because from my point of view, now having the design trace a year or so, I never quite understood why logs were so siloed. Where are they so independent. Why is the log decision independent of an end observability decision, they really should be integrated. And the reason is because we keep all of this log data in context of all the other data types, traces, routes, release their data, behavioral analytics, et cetera. And by having logs in context, the logs create so much more value to and then observability. So I believe that this all is going to convert.

You've got a bit of a background in security. How would you say the state of the union for Dynatrace app security is today? Is it something that you may fill in with some M&A here along the way, talking M&A? Where are we at?

Yes, it's still nascent, but we've got 250 customers up and running on application security. We have said in the past that we expect it to be on the order of $100 million business in 3 years, and we're tracking to that. So it's a huge opportunity. I really do believe that observability and application security are going to increasingly interoperate and interact in a productive way. So that's what we're really focused on.

I mean there's a lot of talk now about formerly DevOps or SecOps and DevSecOps. What role does Dynatrace have in that whole developer-led initiative, especially when we're talking about adding a security layer to it?

Well, the shift left is definitely real, which is companies that I talk to all the time, want to take what they're doing in observability and move it back into the overall flow all the way back into development. And that's what we're seeing. And that's happening as part of DevOps, DevSecOps. So 10 years ago, 5 years ago, it used to be about monitoring. That was about dashboards and alerts. Observability in our frame of the world really is around automating response to that. The next evolution to that is really around automated [ remediation ] directly in code. And that's where you get into the DevOps, DevSecOps integrations.

And that's -- I mean, when we're talking about the SecOps side of the house, that's a whole another level of competitors and things of that nature. What gives Dynatrace a leg up in those conversations then?

It's really all about the software intelligence platform that we built is the primary differentiator. If you told me that, well, Dynatrace are going to go compete aggressively in AppSec as sort of a stand-alone opportunity, I'd say, credit space, why would we differentiate, this may or may not make sense. But if that is leveraging the value that we have by participating deeply in your ecosystem where we have a position that basically no other vendor has in terms of that level of interaction, deep with our 1 agent deepen your infrastructure. We have visibility of things that the security vendors don't have. So now all of a sudden, if you're bringing AppSec into that, you can add differentiable value. Good example is vulnerability management we do today. Simple example, log [ project ] comes out and our customers have a vulnerability in log project. They want to know precisely where they're making a lot [indiscernible] calls and what's do about them. And we can do that in minutes rather than hours or days. And that turned out to be a huge differentiator for our customers in that area.

I'm going to ask one more question and we'll see if there's some questions around here. But on the margin front, I seem to think there's a substantial margin expansion opportunity not in addition to what could be an accelerating story, too, in a more favorable economic backdrop. Talk about how important margins are, where can they go? And sort of what are the levers of driving margin expansion?

The short form of it is that we did pull our margin guidance up by a couple of hundred basis points on average, about 175 basis points in our last call to mid-20s. That's where we operated historically. We believe we can continue to operate there and continue to grow the business at in an aggressive way. So that's our expectation for the near term. I don't want to get ahead of myself raising operating margin guidance. But suffice it to say that we think it's a highly profitable and high-growth model, and you get the best of both worlds with entries.

So it's the balanced approach to growth in price.

Yes. I think that's our -- from a financial. I mean, there's so much wealth of value here from a market evolution standpoint an opportunity standpoint. But on the financial side, it is that you're getting a balanced growth company. We provide strong growth with strong profitability and free cash flow. High 20s free cash flow is pretty exciting, I think.

Yes. And without sacrificing the growth longer term. Yes. I'm going to pause here for a second. There's a big crowd here. I don't know if there's a question out here. We have a microphone. Yes, go ahead. He can bring the mic over.

I just would like to know your view on AI, and it is its potential next 2, 3 years? And specifically for your company, if any?

Sure. So the question, just to repeat it was what is my view on AI and its criticality to Dynatrace, is that right? The -- it is one of the most, if not the most critical differentiators for Dynatrace. The sophistication of our AIOps engine is what enables us to deliver answers, not dashboards. -- and answers matter because you get away from this army of people looking at screens and you get to automated reaction, much more rapid ecosystem management, a much better situational awareness and ultimately to automated remediation. So AI is substantial self-learning systems to know what good looks like when that ecosystem is working well. so that when it's not working well, you know how it's out of compliance, precisely where it's out of compliance and then you can remediate it. So all of that AI componentry is not only necessary but mission-critical to the rapid resolution and really the enablement of us to achieve that differential value.

Raise your hand if you have one. Otherwise, I'll keep going here. Thank you for the question. We talked a little bit about -- and I forget the acronym for you, what's the Dynatrace you said that...

DPS says the Dynatrace platform subscription. This is the -- this is sort of single committed cross module. This is really what customers are asking for to make sure they -- and by the way, I really do believe that DPS, as we call it, is ARR accretive on a customer-by-customer base.

That's where it was going to go, yes.

Because it really does enable you to now consume more of the platform because before, all right, I bought full stack, and I bought infrastructure. Now I want to buy AppSec and it requires a new commit. Instead, no, you've got an overall committed against the platform. And if you want to consume try out [ abstract ] rail, you name it, you'll be able to do that. So this expansion.

Is this crowding out than other vendors that may have had a legacy relationship with that customer?

Certainly could because it's going to facilitate the incorporation and integration to these other mantras. And so to the extent that you were doing perhaps say vulnerability management with some other vendor, then makes it really easy to try to Dynatrace. And you say, well, Dynatrace is better. I've already bought it already consumed it. Great.

Is there anything from an inflationary perspective. Are you thinking about dealing with pricing to sort of combat inflation?

We raised prices at the beginning of the fiscal year by an average around 7%. And we continue to look at that market. We haven't gotten any notable pushback from that. It's not, I think, out of line with what we're seeing more broadly across the board.

And is that relative to historic, I mean is that like maybe 2x, just kind of give an inflation rate?

It's higher than it's been in the past. .

Yes. Yes. And then anything from a churn perspective, I know we talk about NRR being north of 120%. But from a churn perspective, I would imagine, it's not [ target ].

No. Not -- it's not an issue. And our gross NRR, our net NRR continue to be flat to up off very, very strong numbers. Churn is very, very low. For us, it's -- that's not the -- that's not the issue. The flywheel issue is where we're focused more than churn.

So longer term, is it still the goal -- I don't know, I think in the past, you've talked about wanting maybe half of the -- you think half of the [ G15 key ] customers could be Dynatrace customers. Are you at like very -- I hope 4,000?

Yes. No, it's over 3,000. It's -- but...

Is that like -- is that sort of what we're marching towards?

No. I mean, I don't see why it can't be -- I don't see why it can be the vast majority of the Global 15,000. And I'm sure that there may be 10% that might be carved out for something. But it's interesting. I mean, in -- I've had an amazing, amazing tour over the last 8 weeks or so because we did a customer innovate series, regional customer conferences, Singapore, Sao Paulo, London. And then I was in Europe again last week with customers. And really across the globe, the opportunity is just immense.

In some underpenetrated regions of the world, too.

Well -- and we're solving core problems for these customers, which are we cannot manage the volume and complexity of data, the way that we used to. We need another way, and it's sort of that process evolution along with new technology to make that easier, it gets really exciting, so.

So maybe just to wrap up in the last minute, looking forward to the next couple of years, what do you think -- we talked about a lot of things that could potentially reaccelerate the model. What is sort of the biggest thing that you sit back? Is it digital transformation, just the speed of change going on that's sort of driving that ultimate narrative?

Yes. There is -- my answer probably is a little bit amorphous, but let me describe it this way because it's really what we're after. It is where I started, which is making the observability decision, move from optional to mandatory. If we can do that, then it's going to be an amazing ride. And I believe that there is no reason I can think of that, that move of observability from optional to mandatory shouldn't occur, and over the course of a reasonably approximate period of time. Because companies and digital transformation spending the amount of money they are in the cloud cannot manage, cannot manage their infrastructure the way we have they have been. And what they're doing now is that demand continues to grow, but there are some constraints due to budget based on the macro environment and yet pipeline continues to grow. And so pipeline coverage ratios have gone up when they renormalize then bookings should accelerate.

Awesome. Well, from all of us at RBC, thank you for your attendance and your time and best of luck.

Thanks very much. Appreciate it.

Thank you for coming.