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

Welcome to our next session. I'm really happy to have the team from Dynatrace here, two East Coast teams coming together to [indiscernible] for the West Coast to kind of deliver, but that's good.

Rick, I'm starting with you like to get everyone back on the same page and seems like a lot of events happened in the last [indiscernible], we had a lot of off-cycle earnings as well just to kind of bring everyone back on track, like you had really good Q2 results. What were the highlights from your perspective?

Thanks, Raimo for having us. We're delighted to be here. We had an outstanding fiscal Q2. We delivered 24% constant currency ARR growth, 30% operating margins, very strong free cash flow. So the numbers were good. We beat and raised. This was in an environment before the latest month or so that, that wasn't quite as common. This was a good set of results we're very proud of. On the development side, we continue to innovate at good speed with new releases, new capabilities go-to-market front. We announced partnerships with Accenture and Kyndryl. So those -- we also viewed are very positive. And the market overall for observability continues to be very vibrant and growing rapidly. And I imagine you'll ask some more questions about that as we go. But overall, a very, very strong quarter. We're very pleased with it.

Yes. Okay. And then I know Jim has us very well trained in terms of thinking about the growth drivers in terms of existing customers expanding and new logos. Rick, staying with you like a little bit like what are we seeing on the new logo front? And I'm asking as well like given them that the market are a little bit uneven, like new customers making still new decisions, like how do we think about it.

It is very much the case that an increasing number of larger customers are making what I would call architectural decisions. They're making a tool consolidation decisions. They're discovering that one department or one business unit is using one tool for absorbability, another one is using other tool, another one is using another tool. And it doesn't result in very good cost economics. But it also doesn't result in a very good outcome more for observability benefit. And you can really centralize around getting answers with not just dashboards, not just alerts. But true answers based on architecture wide or enterprise-wide decision for absorbability. That's incredibly impactful. So we -- CEO, I would say, more CIOs, more CFOs wanting to make these consolidating decisions and, Raimo, from our perspective absorbability gently is gaining more and more momentum, interest and knowledge as a market. And whereas before, it was an internal development team to put a dashboard built on open source. It is, that's not enough. And frankly, Gen AI initiatives are making it even hard because Gen AI as it is infused in the code development, is going to result in more applications, more infrastructure to manage and observe. And automation and AI oversight these expanding to be increasing.

And Jim, do you want to add some numbers like in terms of new logo, what are you seeing there?

So I guess what I'd add, one, I completely agree with Rick, that we're seeing much more in the way of new logo pipeline related to customers that their existing tools could be DIY tools, could be competitor tools just couldn't scale. So they reached a point where they needed to make a decision around some of the tool consolidation or a recon architectural consolidation. And one of the things we've seen that we've kind of shared over the last several quarters is our average land size renew logos continues to grow. So with only 4 quarters ago, our average was a little bit less than [ 120 ] now over [ 140]. And so we're seeing growing land size, and we're seeing it one because I think we're focusing more where our sweet spot is and our sweet spot really is large complex environments. And to Rick's point, we're starting to land very large deals. And so we talked in the quarter that we land in [ 10 7-figure ] [ DCV ] [ needles ], 8 of which were competitive takeouts. So I'd say the theme of consolidation, as Rick said, is very true. We're seeing it manifest itself in growing ASPs per deal. And in particular, a growing number of very large deals. And it's not always a competitive takeout. But in this case, of the top 10 deals that we had over $1 million, 8 of them were considered to take out.

Yes. And then, Rick, are you doing anything different. I mean, there's one is the market is moving and one is like would you as a company do to kind of entice movement or like just do more in terms of new logos, like how you -- are you setting up the sales force slightly differently, the marketing message changes for you? Like how do you kind of been in this type of market?

Maybe I just give you a couple of examples, Raimo. The first is it is pretty clear that it did get bigger in terms of customers and expand motion. The expand motion of large customers is even bigger than smaller customers, as you might imagine. So the increased sales force ground continuing to lost the evolution of major accounts, global accounts is one key element. A second key element is just the partner activity. We're talked about [indiscernible] mentioned [indiscernible]. These are additive to the relationships we have with [indiscernible]. So these are our exceptional opportunities. And each of the cases that I just mentioned, the reference architectures for observability or orientations have been constructed around Dynatrace. That's really powerful. And one might imagine that the sales process that we used to go through even a couple of years ago when I first started was a cloud modernization, cloud integration initiative would happen used [indiscernible] in conjunction with the hyperscaler. And [indiscernible] years later [indiscernible]. I really need observability, this isn't -- I'm not -- too many incidents. Too long to fix the issues. So I'm getting my arms around it. The engagement with these partners, get size, in particular, we expect to dramatically accelerate the observability decision to the point where the cloud migration is [indiscernible]. So we have an opportunity to reap upward the [indiscernible]. I think that's quite powerful.

And then the -- obviously, in your space, there has been quite a bit of consolidation over the last few kind of quarters now, like [indiscernible] -- yes. That's the question like, do you see an impact from that already? Or it doesn't take time to work out like obviously you [indiscernible].

Yes. I mean I would say, I certainly don't want to go ahead of us here and that this has resulted in a substantially increased pipeline. And that's definitely not like way too premature for that. What I would say is that disruption creates opportunity and as has uncertainty. And clearly, these kinds of events for [indiscernible] response and others create some uncertainty.

Yes, yes, yes. And then this year, you talked a little bit about observability and customers thinking more broader in that respect. How do you think about like euro lending spot? Like you know who would have thought 2, 3, 4 years ago, would have been like, yes, you're the APM guys and you're trying this. Like how has that evolved over the last few years?

I mean I think certainly, you're right. You started kind of in the space of APM and kind of branch [ mode ] that started in infrastructure and then kind of branched out I'd say right now, when we're dealing with customers that it is a bit of a full package. When you're buying something, 2/3 of our customers are buying we modulate more and those models tend to be APM infrastructure and some level of digital experience monitoring, maybe you'll get some [ upset ]. And so I think what you're starting to see is, and it's continued. It's growing. They're landing with multiple modules. They're landing just with one and then expanding. [indiscernible] landing with multiple modules and then there growing, either growing existing work or you're adding new workloads based on whatever their cloud migration journey is. And I think that's the new norm.

Yes, yes. And then Rick, out of that access of being broader is obviously product evolution for you guys. Like talk a little bit about like what you guys are seeing in terms of like maturity around infrastructure, gray yield, like how you're kind of doing more on [ logs ] as well, et cetera, like? Talk a little bit what we -- how to [indiscernible] be able to address all these products.

Sure. Well, infrastructure managed to get to $100 million in 8 quarters, and this was quite a strong evolution of our product base and continues to grow it on the order of double our APM business with obviously bigger. So it continues to be very strong. Application security is clearly an area of strength. It's now well over 400 customers. We believe that there's an area of ongoing penetration opportunity, log management on rail or long-term rail as we call it as a [indiscernible] acceleration. So the way that we see the lens with the NRR for expansion of the installed base is, number one, in existing workloads. Number 2 is the extension of what people are buying today, new workloads. And then the third pillar is expansion to new market [indiscernible]. And we see each of those representing strong pillars for future growth.

Yes. And then Jim being on NRR a little bit if you think about it like you have more [ calling ], but also then you have macro where they had been on top of that. Like talk a little bit, maybe you unpacked the NRR number a little bit fast where we are in that journey [indiscernible] thinking where is -- where we go again.

Yes. I talk out with the environment that we are in is kind of an uncertain environment. It's not worse, not better, it's all been consistent, I would say, probably for the last 3 to 4 quarters. But consistent means a lot of deals could be lot of budget scrutiny, sales cycle help elongation in deals [indiscernible] funnel. And so that's just the environment we're in. The good news is that we have a sales organization that's adjusted to that. So their ability to call the [ ball ], so to speak, around pipeline average things of that. So predictability is pretty good. But relative to your question around expansion, not surprising that it has pressured expansion. And the priority for our existing customers is especially as they have their own budget pressures is, to Rick's point around the growth pillars that they're prioritizing their existing workloads. So those existing workloads are growing. More than likely, they are very mission-critical applications that we're monitoring. And those -- and that volume is growing as far as we did. And so we need to buy more from us with that. So if you think about it from a customer perspective, there is finite budget spend. Yes, there are a lot in all observability, it's important. The first priority is growing growth existing workloads. And then as this budget dollars available, that's where it's like, all right, I can add new workloads or introduce a cross-sell. Now I'd say that is that those last 2 areas are the areas that obviously are pressure from [indiscernible] because you have to prioritize your existing workloads first. And so the opportunity to kind of grow beyond that is [indiscernible]. And just I think kind of cycle through the environment and where there is just continued scrutiny. The one thing I think that [ savor ] is we've proven from a use case, which we continue to work on this with a customer that when you deploy Dynatrace, you can actually get cost benefits. Now it's obviously a lag effect between introducing Dynatrace, getting nation, getting insights that these are IT operations seem much more productive, you need less of them. And so there is -- we've seen customers that they actually as the business base is Raimo that getting more use cases that they realize when you introduce Dynatrace to TB, some cost benefits thereafter. So it's a bit of investment upfront and maybe the return comes later. So I think we're cautiously optimistic that we're in a really good place. We're highly differentiated unless we kind of want this cycle that we believe there's significant room to expand on the rate side.

And the -- if you look at mechanics are like an element of being lagging numbers like -- so like if you think about like the -- what you see in there and what we are seeing is probably slightly different. Do you think we are already at trough or like head to head [indiscernible].

[indiscernible] whatever word you want to use. I would say that we look deeply at expansion, right? And you anything that has [indiscernible], but also need to remember, to your point, that [indiscernible] expand somewhat of a trailing metric. So you're locking off kind of orders in the past that were quite significant from an expansion perspective. So we also look in court. We'll look at in quarter and I don't want to call it as a trend, but the last couple of quarters would have suggested that the end quarter trends have actually improved. So Q1 and Q2, even though those expansion quarters and they are because of expansion between tend to happen around renewal. Both of our renewals happened in Q3 and Q4 -- so -- but looking just at Q1 and Q2 that cohort and you annualize that, you actually saw an improvement to the expansion rates. So yes, I want to call that a trend, but I would say that we're cautiously optimistic that what we're seeing is customers continue to apply dollars to observability a bit more of how you contribute.

And then you talked about the broader product set that you have. So in theory, once we come out, how do you think about the level of NRR you want to kind of achieve again?

Well, I mean, I'm not going to provide guidance here, but one of the things just to level set, you'll probably talk about it. Further is we did step up some investments. I did step up some investments in the back half of the year around go to market and something that you might want to cover a little bit further. So specifically, investments in more sales reps, investments in the GSI partnerships that we mentioned investments and better customer success to drive more adoption. And so we have decreased investments in those areas. And we did that because we saw our pipeline health continue to improve. So our pipeline is growing faster than the rate of ARR in the company. And so then some signals that would suggest that the environment. I wouldn't say we're like go-go days by any means, but it's improving. And by the way, to Rick's point about tool consolidation architecture decision, we want to make sure we're in a position to be able to capitalize on that. And so we always plan to do this, just so you know, within our internal plan. We had planned to do it in the back half because we said, "Hey, there's a bit of uncertainty in the macro environment because less kind of at least stabilize things in the first half. We have a CRO who now has -- he's been in the seat 120 days. And he has a kind of view around where he wants to apply resources. So we're increasing the investment there. And to your point about expansion rate, our expectation is once we lap kind of some of the headwinds on the macro side, we should be able to get an acceleration. I'm not going to call what the pacific is, but there's certainly a significant opportunity in the market. We're not nearly penetrated we talk about our Global 15,000 customers. We have less than [ 4,000 ] customers. So significant opportunity to grow to customers. And then within our existing customers, even some of our largest customers they only have, call it, 20%, 25% of their applications having observability. And so plenty of opportunity to grow within the existing customers. And we have a huge opportunity to grow new customers. So if you look at these 2 things, I don't think we're opportunity constrained. And as you know, one of the benefits that you get it's always been the case and it was one of the reasons why I came here is this consistency of balanced growth and profitability we get [ older ]. And we're very mindful of that. We're very busy.

And then the -- I mean the other thing to think about is, I guess, is also if you do sales hires, they take 9 to 12 months to get [indiscernible] think ahead a little bit.

Well, this is a really good point, Raimo, because from our perspective, our year began April 1, it's easier to do things like territory planning, partner account allocations these in beginning of fiscal year. We're not calling the end of the acreage out that we've been in like [ stress ] at some ingoing and we clearly want to be positioned for success when that happens. And the good news is we are making these investments is a really important point. I think making these investments while having increased our operating margin guidance -- so we're not investing ahead of future [ role ] to reduce operating margins. We actually improved the operating margin guidance for [ 5 ] basis points while making these incremental.

Yes. Yes. Yes. That's a good point. That's really a good point. [indiscernible].

Balance growth and profitability is what it's all about.

I wanted to switch gears a little bit and the AI has come up a lot. You mentioned it is like potentially like a tailwind. I love to speak about it is like AI, short term, like it also take investments, [indiscernible] through AI [indiscernible]. How do you see that playing out? Like, first of all, by short-term budgeting kind of thing, but then more like longer term, like how do you -- how is AI playing out? What are you doing there?

Let me start with the answer in a modest higher level with -- what our biggest [indiscernible] Dynatrace, what have they been for the long term, is a broadly unified platform. We integrate through [ rail ], all observability data types, logs, trade metrics, routes, behavioral analytics, real user data, et cetera, that we use in process through our second major differentiator, which is our AI engine called Davis. And this is not something that we devised 6 months ago, 9 months ago, 12 months ago with the advent of Gen AI, this is something that we've had for more than [indiscernible]. And then the third is automation. They would need to deliver automated results. Now let's double click on AI. So from our perspective, AI is a major factor in doing observability right and we are in our view uniquely situated in this area. And the reason that, that is we have 3 different AI techniques that are critical. We have [indiscernible] AI, predictive AI and generative AI. Cause on predictive AI [indiscernible] for a very long time, very much worked for us. [indiscernible] AI find a root cause analysis, environment evaluates an outage tells you precisely where that out of current without entering dashboard and manual tagging and all sorts of other challenging approach? [indiscernible] and takes that one step further to learning to anticipate in these before they happen and then resolve them. Generative AI that it's really all about front, but generative AI is oriented to only be used to it as the underlying data -- and [indiscernible] cases if you use [indiscernible] you're relying upon the underlying data source. And the underlying data source is the data we store is the cause of own predictive [indiscernible] It is determined. So therefore, it can be trusted. AI, Natural Language Interface is access to interacting with these other names of AI. And it is this notion through these 3 different AI technique met the Dynatrace AI platform, so valuable and is not a big differentiator for us.

And you mentioned Davis, and I think the co-pilot is going to next year. Like what are you doing there? And why is that so important?

So Davis go by it generative AI is what I just described or predictive AI. We're adding generative AI, it is perfect for pilot. It [indiscernible] first half of next year and limited availability in tech preview before.

And then as of the year you basically then -- that helps you to run period, et cetera. One thing that comes up a lot -- I talked to other [indiscernible] like that we might see like an explosion of AI upcoming at us, which basically means the more [indiscernible] cloud that kind of need to get kind of an observed [indiscernible] Is that kind of also something I guess, I think we're like that for [indiscernible]?

Hugely excited, yes. And just to be clear, I think you sort of have to avoid deflating 2 areas particular in the generative AI. One is has nothing do in some sense, we have cost producing a generative AI solution [indiscernible]. Has to do with the exclusion of workloads in AI or because of generative AI and that is going to resolve more workloads that aid observability. So we were whether we did generative AI with Davis co-pilot and the explosion about driven in part on generative AI, initiatives to observe the day of work. And if you've got customer support bought that is running, we enabled the company to reduce the number of customer support. And that's providing end-user customer service, imagine if that goes down. You've got a major crises until that has to work and observability enable that to happen. So at one category is just observing generative AI and workloads. The second then is in the observability space, main observability data more accessible. So instead of writing Dynatrace query like series, which can [indiscernible] currently. Now some imagine if I can just ask through Natural Language Davis co-pilot, show me all of the servers in AWS that are running at 80% forecast. You didn't have to query -- road to query for you. Maybe the answer is it's going to expand like radically, the end production, the number of people who actually can efficiently access data within the Dynatrace or the Dynatrace platform.

And then Jim, that's the CFO question now, like how do you monetize all of that then if you think about that.

So we're still evaluating the monetization model. I'd say, initially, the module for all things that Rick just said, everything that you just said is about leveraging the tool, leveraging the tool means you're working with the tool. Easier to work with the tool, you're clearing. We're going -- we're going to monetize based on queries. And so I'd say the initially, you're going to see volume, you actually want people to be leveraging the tool. You can actually have a tool to Rick's point, that even nontechnical starts [indiscernible], you'll be able to get more people leveraging the tool, more leverage of the tool means more queries, more queries that we do monetize. Now whether we then charged up, I think it seem like is there on a premium chart, therefore being able to access it. I think more than likely initially kind of want to have access to the tool. And so this is not going to be something that I initially I think it will be monetized on theory. And then from there, we'll evaluate whether or not this is separate monetization, like specifically for like there's some up charge being [indiscernible].

Perhaps. Sorry, I'm not doing the pricing of any number like that. You know you're kind of doing a lot more platform pricing. And how do you call -- and remember how you call your platform now. [indiscernible]

Just to level set the [indiscernible] platform subscription is effectively a model with customers. It's somewhat similar to the hyperscaler model, we commit to a dollar amount and then what you get is you get access to the full platform and you get a rate card, every one of our capabilities. What we talking about, one of those capabilities obviously is leveraging, whether it be -- let's use logs as an example. So you're going to get a capability that will allow you to get logs, you can get a capability that will allow you to store the logs. You're going to get a capability that will allow you to do queries. So these are all monetization components with a rate card. So everything that we're talking about with the Dynatrace platform subscription will allow you to get a consumption model with that. So think of it as you commit to a full year or 3 years. And then you consume on the platform, frictionless experience, you don't have to have a recontracting process. And as the customer consumes they're a lot in dollars, that ultimately will give them alerts around you're consuming faster or slower or whatever. And then ultimately, the expectation is that as customers consume, they'll recontract because if they consume faster, they'll recontract because they'll get better unit prices range. So we actually think it's the best of both worlds. It's a consumption model, but it provides us and customers consistency and flexibility.

Yes. And I really enjoyed our conversation. I'll give you a 40-second question and then my time is up. And [indiscernible] was like a big shareholder, and it's now pretty much out. I'm not going to ask you when they sell the last stake, but it's more, what do you see in terms of other shareholder conversations. Now that, that situation has kind of been resolved? Do you see because of people showing more interest? Or has that kind of come up in conversations at all?

I mean I think there's I'd say, holistically, there's general interest in the company and growing interest in the company. I don't think [indiscernible] position has really affected that in any way.

Yes. Okay. Perfect. Time is up. Thank you.

Thank you.

Thank you.