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

Thanks for joining us for our next session. Actually, Rick, I'm going to ignore your first, because we have Jim with us.

That happens -- that happens at home as well. So I feel like...

But it gives you some time from water, kind of chill a little bit. Jim, kind of welcome on board.

Like what drove you like -- you have had a long career in tech. We just talked about like you've been on the board of several companies. Usually, people don't come back. They enjoy the gold thing and et cetera. So what did you see in. And that's what we kind of get you out here?

No, it's a great question. You're right. Rick and I have had this discussion on many occasions. I was very satisfied with my career, a very successful career at HP and then a various career at Akamai. But I'm still a young guy, 55. And so when I left, I was in the never say never world of coming back. And interestingly enough, there was a bunch of opportunities that I've looked at in the past and just didn't think they were kind of exciting enough. And one of the things that I really believe is this whole digital transformation has just begun. It's going to continue. And so when I had an opportunity to talk to Rick a little bit about what was going on at Dynatrace, I started to do some channel checks and it aligned. It aligned that I really believe in the market. I believe observability is kind of a next leg and security. And I said, well, I'll have some discussions. I had some really good discussions with the leadership team, Bernd in particular. So I kind of get more excited about the platform and the differentiation. And I'd say the last thing is one of the things I really liked about the company is I really like the story of a balanced revenue growth and free cash flow profit model, which is what I believe in. And so these things aligned, I really enjoyed the people. And I really enjoy Rick. We probably had a very long relationship with Rick at Akamai. He's a tremendous leader. I think this company is poised to do some special things. It's the -- your prototypical $1 billion company that is in a space that can probably be multibillion, but it's about scaling now. I did that when I was at Akamai. And I really enjoyed it, and I'm hoping I can do it again here.

And then the -- a couple of more questions for you. Like if you think about it like HP, Akamai, slightly more hardware tint -- tilt like pure software now like from a CFO perspective, like what's the stuff that you're looking forward to? How it goes?

Yes. Well, I would say HP, I would say, a little bit more old tech. And I was involved in multiple business models, they're hardware, software services. So as a CFO, you're really looking at what the business model is. Akamai is well a different company in a different business than Dynatrace, Akamai is a platform company, Dynatrace is a platform company. So there's a lot of similarities between Dynatrace and Akamai in that. Obviously, this notion of having a kind of a -- everyone is in this annualized recurring revenue model, the subscription model, which is certainly not something you would have had to say at HP. But those are great models, they're sticky models. And as long as you're adding value to customers, it's just a great -- it's a great financial model to kind of work through. So as a CFO, you're looking at what makes the business tick, what are the drivers? Obviously, your investment profile in a software company is a little bit different for R&D, maybe than a hardware company. But it's about understanding that, making sure you're putting dollars that you get you the best return on, whether it be R&D, whether it be go-to-market and managing it within kind of a margin profile that you think is the right margin profile. And so these things kind of line up for me. Obviously, the margin profile of the hardware business is lower than a software business. So you need to make the investments that will fuel growth not just for today but fuel growth in the future.

Okay. And then the last question on kind of more on the finance side for now. It's like the -- kind of the team looks like they said your well, like I remember Kevin's guidance looks pretty kind of nicely conservative, like now yesterday was yesterday when we saw the debt announcement. Kind of what does it mean in terms of the debt, what we saw yesterday in term of...

Yes. I'd like to be the one that could take credit for all of it. To be very frank, I was the beneficiary of it. It's super smart, it was done. The company had some expensive or relatively expensive long-term debt and a small revolver. This is basically an early refinancing of that, paying that down and having a much more flexible capital structure, that is cheaper. So we have liquidity and it's very inexpensive. And it's sized -- the company sized it for a company of Dynatrace's size. So you know that what was in place was -- made sense when Dynatrace was smaller. This makes sense now for the size of the company. And I think you should kind of -- you shouldn't look at this as, oh my goodness, there's a big revolver out there. What are the things they're going to do now? I think this -- you want to be able to put financing in place when you don't need it, not when you need it. And that's effectively what this is.

Okay. Yes, makes sense. And Rick, and over to you more on the technology side. So at the moment, we're at that interesting point in time where we used to have like established markets with established market players like the APM market, and you guys were kind of very well established there. And then at the log market and then a little bit of infrastructure, et cetera, like it's now all coming together. So what's going on there?

Well, first of all, Raimo, if I could just say that Kevin had big shoes to fill in the CFO role. I couldn't be more thrilled that we have you on board, and you all will be the beneficiaries of Jim, I think, as investors in the company, I hope so. Thrilled to have here. So that's good. In terms of the overall market for observability, undoubtedly, it's converging. This notion that it isn't about APM or Infra anymore. It's about the combination of application performance monitoring, infrastructure module monitoring, the application security space, log management and analytics, digital experience, all of these components and customer after customer prospect after prospect, they still tell me kind of got dozens, in some cases, of observability or monitoring tools that they want to consolidate. So that's part of it. But really, what they want is they want a richness of AI ops that delivers automated understanding and situational awareness of their overall IT ecosystem, and that's what Dynatrace can provide. And it is that convergence that really enables that broad-based awareness of your IT business.

And what -- so what changed on the product side for you? Because like I remember like way pre-IPO Dynatrace was like the #1 player in the APM market, now you're playing in a much broader field. So what changed?

I think what changed is that IT ecosystems keep getting more complicated. And the amount of data that's exploding as a result of what Jim was referring to in digital transformation is just is just unbelievable. So you have $175 billion of annualized revenue these days going through the hyperscalers that's still growing in the mid-30s. That is generating boards of data that becomes very, very difficult to manage and monitor and to evaluate. And the process to do so has to be 1 that's leading to automation. And that, in my view, is the biggest change. We're moving from monitoring and dashboarding to AI ops and automation. And that process, especially in our target market in the Global 15,000 is just quite essential to the success of the digital transformation projects in the first place.

And then how did your product evolve to kind of address that?

Well, we really, as you pointed out, Raimo started with APM and really digital experience monitoring. So we had dam and that has a very high attach rate to application performance monitoring around 85% or so. But then we added infrastructure monitoring 2.5 years ago or so. We managed to get infrastructure monitoring to $100 million business in 8 quarters. So growing very fast continues to grow substantially faster than the baseline ARR of the company, which is great to see new modules have that sort of growth rate. application security. We expect to be on about a 3-year, 12-quarter trajectory to hit that $100 million mark. And we believe that with Grail and log management and monitoring, and analytics that can easily follow against the infrastructure growth rate on the order of $100 million in 8 quarters.

Yes, yes. Okay.

So all of this is coming together is essentially an evolution of very, very natural evolution of the underlying value of the Dynatrace software intelligence platform.

Yes. Okay. And then so like take, for example, Grail in the way -- is it like an Elastic or Splunk competitor? Or is it -- do we need to think about it broader?

You need to think about it more broadly because Grail really is underlying foundational technology. It is not a module in and of itself, it's not like infrastructure. The first incantation or use case of Grail is log management and analytics and so that's really where it began. But Grail, for those of you who are familiar with it, is a massively parallel processing data lakehouse that enables management of data at enormous scale that's exactly what is needed in a market that is exploding in terms of digital transformation, cloud migration, cloud deployment to be able to manage just ridiculous amounts of data. . And Grail does so without rehydrating without reindexing, that enables near real-time analytics, first applied the logs. And so with respect to Grail, we believe that we had an opportunity using the technology we developed over the last 4 years to do logs better, more scale, more performance than what's available today, but moreover, bring logs into the observability umbrella, which is equally critical because logs in our view, should not be an isolated data type on the side. it should be a deeply integrated data type with traces and routes and real user data, the other components of the stack and kept in context.

It's funny because like I love listening to here like I always have been kind of -- if you listen to or look at the problem, to me, was always like a big data problem because you're going to put down and data and whoever as a vendor is able to kind of solve that big data problem is probably going to be a winner rather than like someone is good at logs or someone else is that's kind of a fair?

Absolutely. If you have to index logs, it takes a long time before you can actually begin to do analytics by not having to index logs and by being able to enable that through hypergraphing technology we can begin analytics in almost real time, that can lead to 5x to as much as 100x performance improvement in overall log analytics.

Yes. And then you talked already about the infrastructure now like on $100 million run rate, the other products, hopefully, come there soon. How are your customer conversations changing in terms of like thinking more about the broader problem rather than buying point solutions? And as part of that is like how are you changing your organization from a sales enablement, sales approach to be able to kind of actually deliver that message?

The customer conversation is changing in a couple of ways, some of which we've actually referred to or talked about or at least alluded to, and one of which is moving from isolated module, please monitor my applications to give me an observability solution overall. So I think that, that's changing and inclusive increasingly of logs as we've discussed with Grail. So that's 1 element of it that I'd tell you, the other major thrust is really around automation. Picture this, and I'm saying in the network operations center of a large oil and gas company down in Houston, and I'm walked into a network operation center that's got an army of people with a sea of glass, and they're trying to manage alerts. It goes red and then you start playing whack-a-mole. They have no idea about how to manage their overall ecosystem and environment in a creative proactive way. And I get walked in the room and said, Rick, this is what you need to eliminate. This is what you need to radically improve and it is automation, AI ops that enables that. And in order to provide that, you not only need the technology around the AI ops that we've developed over the last decade plus, you also need the data management skill set to be able to do that with all those data types in context. And that is not inconsequential.

Yes, yes. Okay. Perfect. And then the staying on that subject a little bit like from a -- when you joined, there were like the -- I remember the first earnings call, you were like, okay, so we need to invest in the product, log, we need to bring it all together as a platform, looks like you get a tick there. We want to kind of level up marketing a little bit of work format partners. Like where are you on that journey?

Well, the good news is we did precisely what I said we were going to do 4 quarters ago back in January, February of this year. And we needed to complete some things with regard to Grail to get it to market. We needed to complete and evolve AppSec on the R&D front, which is what led to some of that investment. We also needed to expand our "fill development wrap" organization and do some growth in the sales force, which we completed through the first half of this fiscal year as well. So we've made a lot of those changes. The good news is when you're growing as we are at the rates that we're growing, it gives you good flexibility of margin management, which we've, as Jim pointed out at the outside, is something that at Dynatrace, we've always really done quite well to sort of balance growth, not growth at all cost kind of model. And so this last quarter, we were quite confident that we were able to reescalate the margin environment. We took operating margins at the midpoint of guidance back up by 175 basis points into the mid-20s. And we believe that, that's the right business model and the right landing zone for the company. So that's what we're setting and expectations looking at.

Yes. Okay. Perfect. Okay. It makes sense. And then the -- just one last question on that observability, like I'm sure you get that in the one-on-one meetings today. If you talk to investors is like, oh, there's kind of all these different vendors, they're all going to want to win. Like if you look at more of the sale cycles and the sale situation, like, is it like the crazy war out there that for every sales pitch, there's like 5 guys and they're all competing the craft of each other? Or like what do you see in real life?

In real life, it's really about white space and greenfield expansion. The majority of observability today is still done through DIY. We've done through tools that were developed in either internally or using open source tools that were brought in for the majority of apps and the majority of the infrastructure being managed. And that is the environment that's changing -- the environment that's changing is we need more than a dashboard. And as soon as you need more than a dashboard, what you're looking for is automation, automated response, AI ops, these kinds of capabilities, broad-based situational awareness, as I mentioned. And that's when you escalate, you evolve. You mature your approach to this kind of environment to using tool sets and capabilities like we have with Dynatrace.

And then slightly related to that is like if you think about the environment like what's uncertain everyone worried about and the #1 thing that people look at for your spaces to look at the hyperscalers and look at the growth rate there. Obviously, that growth is slowing down. We don't know what trajectory they are on and from here now, but like how linked are you to kind of what you see at AWS growth, Azure growth?

Well, I'm a bit of a contrarian here. in the sense that my view of it is that the wallet share of observability relative to overall cloud deployment and cloud revenue is going to increase over time past because with this data explosion, it's going to come and need to be able to manage that, and it's becoming more and more unmanageable, just continuing to do it the way that it's happening today. . So my expectation is that not only is the growth rate of the hyperscaler is relevant, it is also just the magnitude of the spend that exists today into which observability solutions are getting sold. And so I view the opportunity for an allocation of cloud-based spend to include observability as being absolutely enormous based on the existing spend today. So we really do believe that Dynatrace, we are -- we believe our tagline that we do have an opportunity to represent Dynatrace as being cloud done right. And this is the evolution from, let's just get to the cloud for acceleration of product improvement supply chain, whatever it is that might be driving you there to, all right, now we really need to provide a cloud environment that's world class.

Is it a little bit like the -- if you talk, for example, to the Azure guys, there like what they see is like a little bit of a consolidation phase. But like -- is that in a way then also suggesting in the consolidation phase, you've kind of been growing and growing like crazy. Now it's like in consolidation, like, well, let's think about I only have like a very easy kind of infrastructure monitoring tool, but I don't have anything kind of major. Is that now the time where you kind of go back to, let's do it right in terms of like engaging with Dynatrace, et cetera?

I'd like to think that, that's exactly true, Raimo, that you've got this notion of where companies are going to increasingly take stock of where they are. And they're going to see the explosion of applications, I believe IDC reports and others, you've got tens of millions of apps coming out over the next 5 years, even if that's wrong by a factor of 10. It's a huge number of workloads that will be moving to the cloud that will be unmanageable using today's existing processes and tools. And Dynatrace can make that work. And so I believe there's going to be evolution toward the day where you see cloud deployment and then some number of months or years later, you see the observability decision because it's delayed and companies realize, wow, I need something more automated and then it follows to a point where whether it's in conjunction with hyperscalers, global system integrators and like those decisions are going to narrow in terms of their delta of time.

And do you see that in the type of conversations you have with clients at the moment?

Absolutely. And it's also happening in the discussions that we're having with the mobile system integrators. We announced DXC, we announced Deloitte. We're in conversations with others that we haven't been able to announce yet. But the notion around global system integrators is really quite simple, which is that I want Dynatrace to be part of the reference architecture for their best in class, best practices deployments. And then what you want is you want whenever somebody at a Deloitte or any 1 of the other global system integrators types and observability, it comes back to the right team that says, we recommend Dynatrace because their customer base should be a one-to-one correlation with ours in the Global 15,000.

Yes, yes. Okay. I mean, staying on the subject with kind of leveling it up a little bit, like the -- how do you think about that notion about like 2022 was actually a very good budget year because we're kind of selling into the 2021 budget that was kind of set in September when -- last year when the world was still good. So 2022 has some tougher approval cycles because the CFO wants this money back, et cetera. But 2023 -- yes, they do that, yes. [ 2023 ] will be different because we're setting the budgets now. Like why -- how do you think about that notion? Do you see -- like when you're engaged with customers, what do you see in terms of conversations for what's happening there?

I mean I view that one of my favorite parts of my job is interacting with customers of all types, shapes and sizes headed to Australia this week for customer visits down there. I was in Europe a few weeks ago. And the feedback that I get from customers is that in many cases, budgets have already been cut from what they started the year at. So in 2022, you're making the assumption that budgets you're not making. Yes. I think budgets aren't fixed. CFOs have already recouped and recaptured some of that budget. I believe, based on feedback that I hear from customers that the first half of next year is going to continue to be relatively modest growth, if any, in OpEx cycles generally. But that there's going to be an expectation that you get the second half of the year that hopefully some of that should free up. I think that's -- it's going to vary by sector. It's going to vary by geo by company. But I think a lot of the format of what we're going to see is kind of around that. And of course, as you get into the second half of next year, calendar year, I think that many companies are going to take to as they get into calendar Q2 and try to figure out where are we? And is the economic environment improving or is it not?

And Jim, just as a CFO now with kind of experience in the species like from our perspective, it's very black and white. Like budget, it's $100. If you go IT guys you can spend or take some money back. Like how does it work in real life in terms of like budgeting, being dynamic about it?

Well, yes, I mean it's -- everything is fluid, right? The world is fluid. And so ultimately, the way the budgeting process works is it's you go through a discussion with not just the IT guys, but all the functions around what's required to advance the company and whatever initiatives that they're driving. And more than likely, what we're talking about here is there will still be significant budget dollars applied to digital transformation. Now maybe the rate and pace of it won't be what it was, say, last year. But they will earmark and maybe they'll slow roll some of that. But this gets evaluated all the time, to Rick's point, that. So maybe you get a fixed envelope for the year and then you reevaluate it every quarter. What is -- you look at the company, how is the company performing? What's -- do we need to -- can we invest more? Do we have to dial investment back and then you figure out where do you want to dial back investment. And I would submit to you that these areas that we're talking about are probably not going to be starved for investment. There will be other areas that they will go after first. Now I do believe the rate and pace will slow around maybe some of the workloads, but I believe there will be significant dollars continuing to flow into these areas and maybe away from other areas.

Yes. Okay. And then I don't know how much time you had already to spend on the organization. We like it's always nice to have a fresh pair of eyes coming in and looking. Like how do you think about like the Dynatrace the margin structure, like how you're operating?

Yes. I mean I've been onboard 2 weeks. So take it for what it's worth. So it's somewhat limited. But I certainly did research on the company going in. And Rick had made the point that kind of this mid-20s kind of operating margin profile from what I've seen within the company in just a short while, that's a very viable model for the company to manage to and make the investments that are needed in different areas. So I feel very good about the discipline within the company for 2 weeks, very disciplined management team, very thoughtful about areas that they want to spend with kind of an ROI orientation. So I've been pleasantly -- I wouldn't even say surprise that I would -- what I would say is that Kevin, who I'm replacing did a fantastic job in kind of building what I think is a really good foundation for the company. And now it's really about scaling it. but I think he's really put a very good foundation for us to work from.

Yes. And is it like from your perspective, it's like the same -- like when we talk about Kevin and it was always like, look, you have like a dollar net retention rate and then you have like your new business and 2 of them gives you a mechanical mathematical kind of outcome. Thank you very much.

Well, yes, that's the revenue equation. I think you've done a good job of trying to outline for investors kind of -- how do you get to whatever it is that the company is aspiring to, whether it be ARR? And what are the mechanics of that? Now obviously, you got a new logo component of it, you got kind of expansion within your installed base. I do think to Rick's point, though, what the company is targeting is this global 15,000 kind of enterprise. The company is 20% penetrated in that. So there's a significant opportunity to continue to penetrate more new logos. And then when you think about workloads of the customers that they already have some of this is some in the air guesses because you don't exactly know what workload you have and you don't have. But it would suggest that there's a significant opportunity to continue to expand. And so to me, the challenge of the company is how do you execute against the opportunity. And like Rick said, I think that you have to put some investments in place and I think this partnering with, whether it be global systems integrators or others, you have to try to put these things in motion now. They probably won't give you a return for a little while, but you got to do it now. It takes a while to build these. Rick and I have talked about that you want to try to generate flywheels so that it's not just your direct enterprise sales force trying to bring in a new logo, trying to expand at the installed base. You want to have others that are enabling you. And if the broader ecosystem can grow while you're growing, it's a win-win.

Yes, from both. Okay. I know times are expiring, so like I just have like 1 last question. Like how do we think about cash? I mean, we talked earlier about like that your position is now like different than what it used to be. But if you think about M&A, I did ask in previous sessions about asset prices on the private side. And probably, they're not coming down yet or not enough. But like how do you think about that kind of using M&A as well as a factor?

Yes. Let me start with that, Jim can add to it. We're not looking at transformational M&A. We've been very consistent about that. We are looking at tuck-in M&A. I would say, Raimo, that we are beginning to see some movement in private company valuations. That's a good thing. It was interesting how many private company CEOs or Board chairs you could speak to over the course of the last months and have them say, well, I realize public company valuations have changed, but ours haven't, and that didn't seem realistic. That's beginning to adjust a bit. So tuck-in M&A certainly is something that we will consider in terms of cash allocation as we look at. But no fundamental change in our perspective.

Yes. And -- and like maybe it's for the 2 of you, like how do you think about cash usage? Because like share prices on the public side are very low. So you could think about like share buybacks as a kind of way you kind of company at some point, dividend comes up? Like how do you think about those?

I mean, I'll tell you my 2-week in view is I think that's a bit premature to kind of maybe talking about dividends or things like that. I mean there's so much tremendous opportunity in front of this company. I think the best use of cash is to invest it back in the business to grow. When we don't have ideas, then we'll talk about things that we can return cash to shareholders, but I think there's more than enough ideas. And I agree with Rick that I think M&A will not be transformational, but one of the things I really like about Bernd, the engineering leaders approach is he's been very platform-oriented. So M&A that you're going to see us do, I think there'll be a big push to ensure it gets integrated to the broader platform, and it's not a bolt-on.

Yes. Okay. Perfect. And hey, 9 seconds. I'm getting better every time. .

Thank you very much, Raimo. We appreciate it. Thank you all for coming.

Thank you.