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Edited Transcript of DT.N earnings conference call or presentation 30-Oct-19 9:00pm GMT

Q2 2020 Dynatrace Inc Earnings Call

Nov 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Dynatrace Inc earnings conference call or presentation Wednesday, October 30, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John Van Siclen

Dynatrace, Inc. - CEO & Director

* Kevin C. Burns

Dynatrace, Inc. - CFO, Treasurer & Secretary

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Conference Call Participants

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* Bhavanmit Singh Suri

William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications

* Jennifer Alexandra Swanson Lowe

UBS Investment Bank, Research Division - Analyst

* Matthew George Hedberg

RBC Capital Markets, Research Division - Analyst

* Matthew Melotto Parron

JP Morgan Chase & Co, Research Division - Analyst

* Parthiv Varadarajan

Jefferies LLC, Research Division - Equity Associate

* Raimo Lenschow

Barclays Bank PLC, Research Division - MD & Analyst

* Richard Hugh Davis

Canaccord Genuity Corp., Research Division - MD & Analyst

* Walter H Pritchard

Citigroup Inc, Research Division - MD and U.S. Software Analyst

* Xiaocon Liu

Goldman Sachs Group Inc., Research Division - Research Analyst

* Michael George Bowen

ICR, LLC - MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Dynatrace Second Quarter 2020 Earnings Conference Call. (Operator Instructions)

Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Mr. Michael Bowen, Investor Relations. Please go ahead.

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Michael George Bowen, ICR, LLC - MD [2]

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Thank you, operator.

Good afternoon, and thank you for joining us today to review Dynatrace's second quarter fiscal 2020 financial results.

With me on the call today are John Van Siclen, Chief Executive Officer; and Kevin Burns, Chief Financial Officer. After prepared remarks, we will open up the call for a question-and-answer session.

Before we start, I'd like to draw your attention to the safe harbor statement included in today's press release. During this call, we'll make statements related to our business that may be considered forward-looking within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21-E of the Securities Exchange Act of 1934, as amended.

All statements other than statements of historical fact are forward-looking statements, including statements regarding management's expectations of future financial and operational performance and operational expenditures; expected growth and business outlook, including our financial guidance for the third fiscal quarter and full year 2020.

Forward-looking statements reflect our views only as of today. And except as required by law, we undertake no obligation to update or revise these forward-looking statements. Please refer to the cautionary language in today's press release and to our Form 10-Q, which was filed with the SEC on September 5, 2019; and our other SEC filings for a discussion of the risks and uncertainties that could cause actual results to differ materially from expectations.

During the course of today's call, we'll refer to certain non-GAAP financial measures as defined by Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed and a reconciliation of the differences between each non-GAAP financial measure and the comparable GAAP financial measure can be found within our second fiscal quarter 2020 earnings press release in the Investor Relations section of our website at dynatrace.com.

With that, I'd like to turn the call over to our Chief Executive Officer; John Van Siclen. John?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [3]

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Thanks, Michael.

And I'd like to start by thanking all of you for joining us today. We are very pleased with the company's performance in the second quarter, which resulted in financial results and were better than our top line and bottom line guidance. I'm especially pleased that ARR increased by a robust 44% year-on-year to $471 million, with our new Dynatrace platform now making up 80% of total ARR, up from 75% a quarter ago.

Fueled by continued strong growth in ARR, our subscription plus services revenue that we see as the best measure of growth on our P&L, increased by 37% year-over-year, up from 36% last quarter. As we look ahead, we remain optimistic about the business outlook as our new Dynatrace platform continues to be adopted by a growing number of new enterprise customers, and each quarter, we are proving our ability to expand rapidly within our growing customer base. This optimism is reflected in the increased top line guidance that Kevin will detail in a few minutes.

We're also proud that our rapid growth is complemented by strong operating margins. Not only did our top line results exceed our Q2 guidance, our bottom line delivered stronger-than-expected results as well. We run a very efficient business with gross margin at 83% and EBITDA at 25%. We continue to be cash flow positive on an operating basis while investing across the board in growth.

As we've said before, we believe in running a balanced business, a unique combination of growth and profitability at scale. We believe this balance, combined with our focus on investing aggressively in commercial expansion and continuous innovation, provides Dynatrace with attractive durability over the long term.

Let me now turn to 4 major advancements made in our fiscal Q2. New logo expansion; customer net expansion once they are on our new Dynatrace platform; continued progress moving Classic customers to Dynatrace; and finally, innovation and highlights around platform and TAM expansion. I'll take each of these in order, starting with business from new customers.

Once again, during the quarter, over 200 new customers have joined the Dynatrace platform family. We are now left to 1,828 customers on the new platform, an increase of 250 from a quarter ago, and more than double from a year ago. Consistent with prior quarters, a majority of these customers continue to be net new logos to our business. Nearly every new customer win is precipitated by the realization that their cloud program is disrupting their ability to keep up with the accelerating complexity of the ecosystem supporting their digital transformation. More and more running the business applications are being deployed into the enterprise cloud while visibility and situational awareness are declining. To regain control and bridge the complexity gap, more and more enterprises are finding us through word-of-mouth or via our frictionless free trial.

For example, a major insurer in the U.K. has been in the process of digital transformation. They are leveraging a multi-cloud environment that includes new go-to-market customer applications. After looking at a number of cloud monitoring solutions, the insurer selected Dynatrace as they've determined that it was the only platform that could show them the cost of outages in the context of application performance and how degradations and performance impacted their call center operations.

During their proof of concept, something we do with all new customers to demonstrate the Dynatrace difference, they discovered the power of Dynatrace's explainable AI engine, Davis, which continually learns what normal performance is, processing billions of dependencies in real time to serve up precise answers that were beyond their team's ability to quickly identify. Davis' ability to provide precise root cause problem identification for faster decision-making, greater optimization of IT resources and better business outcomes led to the selection of the Dynatrace software intelligence platform.

Once customers are on the new Dynatrace platform, we continue to see rapid expansion, which is evidenced by the rapid growth in our ARR that I referenced earlier. Once again, in Q2, our net expansion rate comfortably exceeded 120%. This is the sixth straight quarter we've exceeded this mark.

As we are still in the early innings of Dynatrace adoption, most of our expansion is driven by customers deploying our platform into new application stacks. The automatic continuous discovery and instrumentation, the automatic self-adjusting baselines, the automatic problem determination prioritized by business impact all contribute to rapid rollout and high value for low-effort economics our customers enjoy. This is something that we expect to continue benefiting from in the foreseeable future as we've barely scratched the surface of cloud application expansion.

In addition, we're also beginning to see increased adoption of additional platform modules as customers recognize the power of our broader platform capabilities.

Let me share an example of one of the many meaningful customer expansions during the quarter. A large U.S.-based consumer products company that completed a 7-figure expansion just 5 months after their initial land purchase of the Dynatrace platform. After a bad experience with their previous supplier, a gen 2 player who missed the market transition to the enterprise cloud, the company acquired its initial licenses for Dynatrace in the second quarter of this calendar year for an initial set of applications running in Azure. This first purchase was to prove the value they saw in Dynatrace in the proof of concept and to test our digital experience module for mobile and web use in production. Five months later, after a very successful initial rollout, the customer completed a 7-figure deal for our broader set of Tier 1 applications that included expanded use of our DEM module. Based on cloud optimization savings alone, the company calculated a payback for their Dynatrace investment of less than 6 months.

On the conversion front, the movement of our Classic APM customer base to the broader Dynatrace software intelligence platform, conversions continued to accelerate. Classic ARR has now declined to $94 million down $17 million from a quarter ago and now only represents 20% of total company ARR. As we've discussed, we started this conversion program in earnest 6 quarters ago with approximately $200 million in ARR to convert. We've been successful in moving our Classic customer base to the new Dynatrace platform because virtually every company has new enterprise cloud initiatives.

We are not simply upgrading from one product set to a new version. Our conversions typically involve a shift from legacy stacks to new stack cloud environments and a move from perpetual licensing to more predictable subscriptions. While it takes more time to find new stack buyers and transition licensing models, it yields a much more valuable customer in the strategic go-forward growth segment of their business, their enterprise cloud. We believe the added sales time and effort we've been spending on a near-term perspective is well worth it over the long term as we have transitioned our own business to drive sustainable growth and predictability.

As an example of a converting customer, this past quarter, a Fortune 100 brick-and-mortar retailer and customer of our Classic product set signed a mid-6-figure contract to convert to the Dynatrace software intelligence platform with plenty of opportunity to grow in the multiple 7 figures over time as they expand their cloud initiative.

Previously, the customer had a low urgency to change as our Classic offering was serving their needs well for current enterprise applications. But when new management came on board and prioritized digital transformation, their needs and urgency quickly changed. The company rapidly transitioned from third-party-developed applications run in a traditional data center to in-house-developed applications run in a new enterprise cloud. Dynatrace not only fit the new stack requirements perfectly, it proved invaluable to the company in getting up and running quickly and successfully across a very large hybrid e-commerce cloud environment at all layers of the stack: network, infrastructure, applications and user experience.

The Dynatrace platform's automatic install, self-learning baselining and in-product chat enabled the company to meet a tight time frame for implementation for its new applications and underlying enterprise cloud. This story and many more like it illustrate that as every company becomes a software company and transitions from old stack to new stack, the demand for Dynatrace to enable this transformation continues to grow.

We are very pleased that we are over halfway through the conversion process and believe we will substantially complete this process over the next 4 quarters. This is particularly exciting for us for 2 reasons. First, we've proven our ability to expand rapidly with customers once they are on the broader Dynatrace platform. And second, we believe the completion of this process will further improve the productivity of our sales organization as the conversion distractions end and they can refocus on landing new customers and extending them across more applications and more use cases.

Let me finish by highlighting the expansion of our Dynatrace platform itself, which we believe will further improve our ability to win new customers, expand with existing customers and incent Classic customers to convert to Dynatrace.

Earlier this month, we announced an important new purpose-built module to the Dynatrace all-in-one platform, Digital Business Analytics. Monitoring cloud infrastructure and applications is not simply about metrics, logs and traces. It's about assuring better business outcomes by adopting measure by user experience, conversion rates, increased revenue or enhanced brand loyalty. With Digital Business Analytics, Dynatrace now connects best-in-class cloud infrastructure and application observability with key business analytic data such as conversion rates, revenue by product and geography, segmentation by channel, abandonment rates by page or path and more.

And with our powerful AI engine, Davis, at the core of our platform Dynatrace Digital Business Analytics instantly surfaces answers to degradations and anomalies with precise problem determination across the entire delivery chain so that human action can be taken rapidly to resolve issues before users and revenue are impacted.

A number of our early-adopter customers are using this functionality today, including fashion retailer outlets. They have publicly shared how they've been able to get real-time insights, and how business outcomes such as product in-cart, checkout review, and shipping and billing are impacted by application performance. Dynatrace provides answers to the underlying issues affecting user journeys, enabling them to optimize user experience and improve conversion rates. Don Hall, Talbots' manager of e-commerce support, summarized the outcome as, "This has changed how we work, with our operations team now working closer with the merchandising team and other parts of the business to drive improved business outcomes."

While others are still working to pull together full-stack observability, we delivered full-stack observability at enterprise scale 4 years ago and are moving ahead to higher levels of business value as we extend the capabilities of our software intelligence platform. We're excited about the initial reception to and adoption of this new business analytic module, and we plan to further build out a complete set of analytics and integrations with adjacent business analytics players over the next several quarters. Over time, we believe Digital Business Analytics will extend our total addressable market by several billion dollars as we enter the $24 billion analytics and business intelligence market as defined by Gartner.

In addition to adding new modules to the Dynatrace platform, we continue to extend existing platform capabilities as well. One of the most powerful brought to market in Q2 was a doubling of capacity of a Dynatrace cluster, which now scales to 50,000 hosts per cluster. And we also added support for the clustering of clusters, including cross-cluster distributed tracing or scalability without limits. Web-scale environments, which were a novelty just a couple of years ago, are becoming commonplace as enterprises shift from static on-premise data centers to dynamic multi-cloud architectures with highly distributed microservices workloads.

A number of our largest customers from financial services, health care, e-commerce and technology are enjoying rapidly scaling Dynatrace environments without compromising high-fidelity observability, smart automation and real-time intelligence. It really is a tribute to our world-class engineering led by Bernd Greifeneder, our CTO and Founder, and the next-generation architecture he and his key architects reimagined 5 years ago. And we continue to raise the bar for software intelligence at scale.

So in summary, our execution across our key performance indicators remain strong. We are consistently winning new cloud business against all competitors. We continue to build on our track record of rapidly expanding with customers once they are on the Dynatrace platform. We continue to run ahead of plan on moving Classic customers on to the Dynatrace platform. And as I just described, our innovation engine continues to deliver highly differentiated product value for our growing enterprise customer base.

Before I conclude, let me say that it's more than just great product and a rapidly-growing market that makes a sustainable world-class company. It's also the team you assemble around you. We've been blessed with the exceptional stewardship from Thoma Bravo. Your counsel, guidance and support have been invaluable to our success.

As we go forward, the role of outside counsel, guidance and governance will shift to independent board members. At time of IPO, we added 2 outside Board members, and Steve Lifshatz, CFO of Lytx, and prior to that, Fleetmatics; and Mike Capone, CEO of Qlik, both accomplished businessmen and directors. We also recently added Jill Ward to our Board. She serves on the board of HubSpot and served as a Director of Carbon Black and Adaptive Insights, among others.

I look forward to their ongoing contributions as we drive value and success for our customers, our shareholders and our employees.

With that, let me turn the call over to Kevin Burns for a review of our financials. Kevin?

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Kevin C. Burns, Dynatrace, Inc. - CFO, Treasurer & Secretary [4]

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Thank you, John, and good afternoon, everyone.

I'll start by providing a more detailed review of our second quarter performance, and then I will finish with our outlook for the third quarter and increased full year guidance. Following my remarks, we will open the call for questions.

Our key financial metric focused on business momentum is annual recurring revenue. For the second quarter, ARR was $470.9 million, an increase of 44% year-over-year. The Dynatrace platform continues to increase as a percent of total ARR and was $376.8 million at the end of September, which was 80% of our total ARR. The remaining 20% of our ARR relates to our Classic offering. We continue to track very well here and expect to be substantially complete with moving our customers to our new platform in the next 4 quarters.

As you may recall, we started the conversion program with our sales organization 6 quarters ago, and to date, we have converted more than 50% of the Classic base. And we are actively working with the remaining customers on conversion programs and time lines. Overall, we have had a very good line of sight to completion, and we are very pleased with the success of the program and the benefits that have been realized by our customers once on the new platform.

Circling back to total ARR. There are 2 ARR growth drivers in our business. The first is new logo customers, and the second is our Dynatrace net expansion rate. If we quickly break down these 2 ARR growth drivers, during the quarter, we added 250 net new Dynatrace customers, ending the quarter with 1,828 Dynatrace customers. Consistent with recent quarters, net new customers were a healthy balance of adding new logos to the franchise as well as Classic customers moving to the Dynatrace platform. Over the last 12 months, 58% of our Dynatrace customer growth has been the result of new logos to the company.

In addition to a steady flow of net new customers, our Dynatrace dollar-based net expansion rate remained above the 120% threshold for the sixth consecutive quarter. We will continue to confirm this net expansion rate on a quarterly basis, and we plan to share this actual net extension value at the end of the fiscal year.

As a quick reminder, our ARR expansion is not a result of our customer base converting from Classic products with the Dynatrace platform as we do not charge a fee. Our ARR expansion is solely the result of footprint and product expansion in our customer base. We have been very focused on moving our customers to the Dynatrace platform because from there our customers can expand their use cases and footprint in ways that were not possible with our Classic products. As a result, all of our ARR expansion is either product expansion or adding new logos to the business.

Our current Dynatrace ARR per customer is north of $200,000, and we continue to believe that there's a large opportunity for further expansion in our existing customer base. Considering the fact that the majority of applications at our customers still lack instrumentation, we continue to expand our value proposition and use cases, as John discussed earlier, and our enterprise customers continue to expand their portfolio of cloud-based applications as they digitally transform their business.

Turning to revenue. Total revenue was $129.4 million, $5 million above the high end of our guidance and an increase of 27% on a year-over-year basis. This represented an increase from 25% growth last quarter and 17% growth in the previous quarter. The acceleration in total revenue growth is being driven by the strong growth in subscription revenue, which was $115.8 million in the second quarter, an increase of 41% year-over-year. For the quarter, as expected, Classic license revenue was down to $2.7 million and represented only 2% of our quarterly revenue as we wind these products down.

As John indicated, we believe the best measure and reflection of our ongoing revenue growth profile is the combination of subscription and services revenue which was $126.6 million in the quarter, representing 98% of total revenue and an increase of 37% on a year-over-year basis.

Before moving to our profit metrics, I would like to point out that I will be discussing non-GAAP results going forward, unless otherwise stated, and that our non-GAAP measures exclude stock-based compensation, amortization of acquired intangibles and other items as outlined in the tables and in the press release.

Our non-GAAP gross margin was 82.5% for the second quarter, an improvement compared to 80.5% in the second quarter of fiscal '19. We are seeing a nice step-up in subscription gross margin percent where we are realizing the benefits of winding down the Classic stack and, more importantly, the benefits of the Dynatrace platform, which has 1 code base and over 90% of our customers on a version released within the last 30 days, an extremely efficient product. As a result of these changes, total gross margins have increased, as I just mentioned.

Our non-GAAP operating income for the second quarter was $29.4 million, above the high end of our guidance of $25 million, primarily related to the revenue and gross margin upside during the quarter. We also realized a modest upward expense leverage in the second quarter, and therefore, non-GAAP operating margin was 23%, up from 17% in the second quarter of '19. With that said, we remain focused on investing for long-term growth and plan to reinvest some of the revenue upside we expect for the full year back into the business which is reflected in our guidance.

Non-GAAP net income was $17.3 million and $0.06 per share. This was above our guidance of $0.04 per share. For the quarter, we had 270 million diluted weighted average shares outstanding.

Turning to our balance sheet. As of September 30, we had cash and cash equivalents of $211.7 million, and our long-term debt was $569.8 million. Our leverage ratio was 3.1x. Our trailing 12-month adjusted EBITDA of $117.4 million. Since the end of the second quarter, we paid down $30 million of debt, and our current debt balance is $540 million. Going forward, the business will continue to naturally delever due to our healthy cash margins, and we expect to steadily pay down debt over time which we believe will continue to create value for our shareholders.

The last financial measure that I would like to discuss is remaining performance obligation, which at the end of the quarter was $653 million, an increase of 83% over Q2 of last year. The current portion of RPO, which we expect to recognize as revenue over the next 12 months, was $380.5 million, an increase of 70% year-over-year. Our healthy RPO expansion has benefited from our move to a subscription-based news combined with an increase in the duration of our new subscription agreement.

Finally, unlevered free cash flow for Q2 was $27.2 million, and it was $174.7 million on a trailing 12-month basis. As we've discussed, quarterly cash flows can vary due to seasonality, combined with the fact as we convert our customers from Classic to Dynatrace, can impact the timing of when we invoice our customers.

Before moving to guidance, I'd like to review a few items that impacted our GAAP results for the second quarter as previewed in our Q1 call. First of all, we incurred onetime fees of approximately $14.9 million primarily related to the IPO and mainframe spend as well as the minimal restructuring that hit the P&L in the second quarter.

Second, as a result of the spinoff of the mainframe business, we recorded a spin tax charge of approximately $256 million. In the second quarter, we paid approximately $254 million for federal and estate taxes, and we currently expect to pay the remaining spin tax obligation by early calendar '20.

Please keep in mind that we received $265 million from the mainframe business pre-IPO and that these funds are being used to pay the federal and state taxes related to the spin. As a result, we have removed the impact of the spin tax from our non-GAAP net income and unlevered free cash flow calculations.

Finally, we recorded stock comp expense in the quarter of $155 million, of which $145 million was a onetime mark-to-market stock comp charge related to the conversion of our preexisting equity awards at IPO.

Now let me turn to our guidance, which has been increased due to the strength of our second quarter results, combined with our continued positive outlook and the momentum of our business.

For the fiscal year, we are increasing ARR guidance to a range of $550 million to $555 million, representing year-over-year growth of 36% to 38%. Total revenue is now expected to be in a range of $533 million to $535 million, an increase from our prior guidance of $521 million to $524 million. We expect our non-GAAP operating income to be in the range of $119 million to $121 million, up from our prior guidance of $112 million to $115 million. Non-GAAP net income per share is now expected to be in the range of $0.23 to $0.24 per share, assuming approximately 275 million weighted average diluted shares for the year.

For the third quarter, we expect total revenue to be in the range of $137 million to $138 million, representing year-over-year growth of 19% to 20%. It is worth pointing out that we expect the combination of subscription and services to grow over 30% in the third quarter. We expect third quarter non-GAAP operating income to be in the range of $30 million to $31 million and non-GAAP EPS of $0.06 to $0.07 per share. This assumes approximately 282 million diluted weighted average shares outstanding for the third quarter.

In summary, we are very pleased with our second quarter performance and remain focused on building a strong track record as a public company. We believe Dynatrace's financial profile is highly unique, including meaningful scale, strong growth, healthy profitability and cash flow. With a large TAM in front of us and a market-leading position, we believe the company continues to be very well positioned.

With that, we will open the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question will come from the line of Sterling Auty of JPMorgan.

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Matthew Melotto Parron, JP Morgan Chase & Co, Research Division - Analyst [2]

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This is Matt on for Sterling. Congrats on the quarter. So the first question is just wanted to kind of get a sense of the traction that you're getting from customers that are buying those 3 main solutions of the APM infrastructure and logging. And the follow-up is just in regards to pricing structure in logging, how do you guys feel about that given where Datadog is and also, the changes being made at Splunk?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [3]

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Sure, Matt. So from a competitive landscape perspective, we haven't seen much change, honestly, since we last talked. The -- what we see in our world, as you know, we land with APM sort of as a core strength, the application, user experience segments. That serves us well. The market is in need of our kind of platform for dynamic web-scale workloads. And where we're seeing more and more customers hit what we call the microservices wall as we go forward where they have just classic tooling that just can't keep up with the scale or dynamism of those environments.

So our competitive position continues to be very strong. We continue to win against all competition in that area and as evidenced with the new logo growth as we go forward.

The other modules are what we've talked about is expand plays and the cross-selling into the infrastructure-only hosts, which we consider also part of logs going to that offering for us. That is starting to expand well. But most of our expansion, as I've said before, continues to come from just more Dynatrace into more application workloads -- cloud application workloads because they're so underpenetrated, it's a very straightforward expansion opportunity for us. So that continues to be the strongest.

Maybe the last thing I ought to say in the competitive landscape front is we really don't overlap, certainly not yet, with some of these other competitors coming out of the infrastructure space. They're still trying to bring together their observability solutions, something we've had for the last 4 years. And we continue to increase the value of our platform, driving better business outcomes with things like user experience capabilities, and as I noted in my comments earlier, Digital Business Analytics.

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Operator [4]

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And our next question will come from the line of Matt Hedberg of RBC Capital Markets.

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Matthew George Hedberg, RBC Capital Markets, Research Division - Analyst [5]

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Congrats on the quarter. Certainly, seeing ARR accelerate at scale is impressive, and I think in your prepared remarks, you're clearly having success converting Classic customers. But I guess on the new customer front, can you talk about what percentage of those are greenfield wins versus competitive displacements?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [6]

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Sure. The -- in general, the greenfield is about 1/3 of what we see. We see more competitive displacements, whether that's actual head-to-head sort of bake-off with someone or we're replacing sort of a combination of tools in more of a do-it-yourself kind of set-up. So it's -- and that's been consistent for us over the last year, couple of years.

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Matthew George Hedberg, RBC Capital Markets, Research Division - Analyst [7]

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That's great. And then seeing the net expansion north of 120% is great. And I guess I think on the roadshow, you guys talked about maybe 5% of the industries is currently monitoring their apps. Kind of I guess I'm wondering, when you look at some of your more sophisticated customers, do you have a sense for sort of what percentage of their apps are being monitored?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [8]

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Our best estimates are even at the high end, they're in the 20% to 30% range with the Dynatrace, but they all want to get to 50-plus. So there's plenty of headroom. And those at the very top end, most customers are really are in that 5%, probably on average, a growing number getting up to 10% because the expansion of our new platform is so easy. But still early days, and there's still a lot of headroom just on that application side before you even get to the cross-sell into additional ITOM use cases.

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Operator [9]

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Our next question will come from the line of Heather Bellini of Goldman Sachs.

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Xiaocon Liu, Goldman Sachs Group Inc., Research Division - Research Analyst [10]

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This is Caroline on for Heather. I was just curious about the retention rates of the customers that have been converting over to the new Dynatrace platform. Curious as to how that has been trending. And then also, are you seeing those customers add additional workloads as they convert over?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [11]

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So from a conversion standpoint, the new platform is extremely sticky. The use cases are wider. The value is quicker to realize. The connective tissue between sort of the infrastructure and application monitoring with driving better business outcomes is more clear and straightforward. So that's been -- it's been a great advantage to us as we move people across on to the Dynatrace platform.

The second part of the question?

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Kevin C. Burns, Dynatrace, Inc. - CFO, Treasurer & Secretary [12]

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Second part is just in terms of the renewal rate, and I'll take it, Caroline. So if you look at where we've been, we've moved about $100 million off of the Classic stack over last 6 quarters of the member sales organization. That's translated at time of conversion to about $123 million on to the Dynatrace platform. So we're seeing those customers, when they move off of Classic, expand on to the Dynatrace platform. That's true foot for an expansion. Included in that math is churn -- is a little bit of churn. And I'd say, we're in line with sort of industry-standard churn rates.

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Operator [13]

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Your next question will come from the line of Jennifer Lowe of UBS.

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Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [14]

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I wanted to go back to some of the earlier conversation in the prepared remarks about big digital transformation project as an opportunity for Dynatrace to come in and really help customers execute on their vision with moving applications into the cloud and then having the sophistication to manage and monitor those applications. And given that there's a lot of players usually involved in those types of digital transformation projects, be it SIs or hyperscalers or other platform solutions, I'd just be curious where in the process Dynatrace comes into those types of transactions. And are there any relationships that help you get in the door to discover where those opportunities exist?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [15]

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Sure. No -- good question. The -- sometimes, we do come in with system integrators. They are responsible sort of as the general contractor for a lot of the larger projects, and they look for the variety of pieces that they need in order to do a proper migration and then scale out of these enterprise clouds. So we have some very good relationships with the global SI base as well as regional cloud integrators that have sprung up around what is OpenShift or Cloud Foundry, AWS, Azure, et cetera. So that is an important part of our go-to-market portfolio, but we still find the majority of our opportunities through our direct sales organization.

And we -- as we talked about before, we target the global 15,000 enterprises. We're -- we now have about 1,800 of them penetrated, so a little over 10%. But still a lot of headroom to go. But it's the direct sales organization that finds the cloud architects and application architects coming in through, whether that's DevOps or the operations side of the business, and brings Dynatrace in usually at the time of scale-out of an enterprise cloud. Not when the first applications go into AWS or Azure, but when the company actually has a strategic initiative to build out a much -- a broader multi-cloud strategy.

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Operator [16]

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Your next question will come from the line of Bhavan Suri of William Blair.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [17]

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I wanted to touch first on the infrastructure monitoring SKU. Obviously, the end-to-end value proposition of the platform is obviously compelling, but there are some organizations that may want to start out using the infrastructure-only. You offer a separate SKU there, obviously. Can you talk about what level of interest you're seeing and uptake in the infrastructure-only SKU? And then I guess, in cases where you sold it, how successful have you been in migrating those guys up to the full platform?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [18]

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So Bhavan, the -- we rarely land with infrastructure-only. We use that to expand. The reason a customer -- first, the reason integrators or sales folks land, they will land in the application side -- full stack application side where folks have sort of a high pain. We have the industry-leading solution there. So it's pretty obvious that they're going to focus there first.

The reason people come to us for the infrastructure-only host extension is because once they get the hang of the value of our integrated AI engine, Davis, they realize that to see that live topology all at once and have it all sort of monitor 24x7 by an intelligent assistant, it makes their life so much easier across a much wider landscape.

So that's how we go-to-market today. Maybe that will change in the future, but I don't think that's dissimilar to some of our competitors, land in a position of strength and expand from there.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [19]

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Got it. That's helpful. Maybe touching on one other product, the DEM, obviously. You talked about the digital experience, seeing attach rates ticking up. I think we talked about it last quarter. I guess as you think about that, just an update on what you're seeing there as people have come back sort of out of DMPs, especially their transition to the cloud. So just trying to get some of the color on what you're seeing there, too.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [20]

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That's an interesting one as well. A couple of years ago, there was a low demand for digital experience as everybody were just standing up their clouds and they were spending more time just trying to figure out how to make the infrastructure itself work and try to get it in shape for business critical workloads. But now we see the workloads starting to hit the cloud platforms at an accelerated rate. And with this, the appreciation of understanding user experience has climbed dramatically. Our attach rate's up considerably over a year ago and the scale-out of the digital experience module continues to get great traction in our customer base.

I gave an example just a few minutes ago of 1 customer, but pretty much anyone who has some kind of an e-commerce or some kind of an important customer-facing application is a great candidate for extended DEM use from Dynatrace.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [21]

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That was really helpful. If I could squeeze one more product one in. You obviously announced a new product. I'm focusing on product just today, as you can tell, but the new Digital Business Analytics module obviously sounds really interesting. You've obviously had AI, but just, a, can you just talk a little bit about module, who you sell it to; and the pricing and interest from customers.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [22]

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Sure. So the -- currently, the folks -- the landing zone is really with the operations folks who want to connect with the digital business owners and provide more value and service to that group. Over time, as we build out the analytics and some of the integrations with some of the other business analytics tooling that the business folks use, we're hoping to actually break into the business budgets as well. And that's a key part of driving full TAM expansion in this area for us as we go forward.

The way we're pricing this module initially is through data ingestion. But over time, we'll expand that monetization opportunity, as I said, some additional analytics become available and some other pieces that we have on the road map to extend our functionality in this area to fit the business user needs.

As we just said -- let me just add real quick that this is a product extensionary that we've been eyeing for a while. We're really excited about it. Customers are excited about it because it gives them a direct connection between some of these sort of metrics and problem determination, items under the hood directly with business outcome metrics. And that connective tissue to be that tight is something that every customer looks for as they try to drive their digital business initiatives forward.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [23]

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Especially in real-time, yes, yes.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [24]

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Yes. Especially in real time, exactly.

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Operator [25]

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Our next question will come from the line of Richard Davis of Canaccord.

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Richard Hugh Davis, Canaccord Genuity Corp., Research Division - MD & Analyst [26]

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Clearly, the analytics AI engine will sell because it has a name Davis, so we'll just leave it at that. I appreciate that part. So in any case, I've been talking to a bunch of investors lately. So one of the things that they get confused on is that sometimes they think Dynatrace and other firms like Google are kind of like an either/or decision. And in our field checks, at least what we found and I think you guys have said the same thing, is that this is not the case. And so could you kind of flesh out how like a Google Analytics and a Dynatrace are complementary not competitive? I'm just trying to help people understand the difference on that.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [27]

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Sure. Well, our business analytics are directly connected with performance, user experience, and connected all the way down into infrastructure and virtual network elements that may or may not be affecting performance issues. So what we do is we surface and connect this digital business data with that entire full-stack footprint. And nobody does that. Everybody sort of sits on the surface and sort of bubbles along, Google, Adobe, et cetera.

What I was alluding to as far as integrations with some of these other solutions that the business side of the house utilize day to day, I'm alluding to the sort of tighter integration with some of these other tools like a Google, where they're complementary with each other and brought together and connected, they can be a lot more powerful than each one sort of separate on their own. So that's still for us to do. But as you pointed out, we see them extremely complementary. No head-to-head overlaps there.

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Operator [28]

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Our next question will come from the line of Walter Pritchard of Citi.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [29]

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Wondering if you could help sort of quantify the order of magnitude increase when you're selling Business Analytics into a customer. Maybe not initial sale, but how do you see that opportunity progressing relative to what those customers who bought it, either DEM or ACM plus subscription on logging.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [30]

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Well, today, I would say that from the sort of -- if you're asking what's the order of magnitude of the monetization, I'd say that it's in the sort of a 10% of sort of host unit, maybe probably not $1 per $1 with DEM. DEM is sort of more pervasive and -- at the moment. But over time, it should be equivalent to what the DEM module brings, which is -- think of it as maybe $0.50 on the dollar of host units. So that's the way we think about it.

That's what we believe we can achieve as we build out the functionality in this area. The value is certainly extremely high when you can bring business metrics tied with performance and user experience together in real-time for digital business owners. So that's the way we see it today, and that's why I say over time, it's going to continue to scale out in monetization as we add additional value to the solution or to the module.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [31]

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Got it. Okay. And then let me just touch more kind of a question on -- you saw a nice uptick in new customers in the quarter versus last quarter and well above where you were in 4Q. Wondering if that incremental customer count was more attributable to the brand-new customers or the conversions. I think you mentioned pretty healthy new customer activity, but just curious if you can quantify that and especially in the context of the acceleration in customer adds.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [32]

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Yes. Well, so new customers, net new logos to the business continue to be the majority of the Dynatrace growth, quarter-over-quarter growth. And the stat that I think Kevin gave you, which is 58% -- over trailing 12 months, 58% of the new customers added to the Dynatrace platform, somewhere a little over 900 customers there, 58% have been new logos to the business.

So we have a healthy sort of new logo expansion going on in the company, and that's even with a little bit of distraction in our sales organization on the conversions, which we figure is taking about maybe 20% of their time right now until that's behind us. So healthy new logos, as you point out, and room to increase that rate as we free up the sales organization in 4 short quarters here.

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Operator [33]

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Your next question will come from the line of Brent Thill with Jefferies.

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Parthiv Varadarajan, Jefferies LLC, Research Division - Equity Associate [34]

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This is Parthiv on for Brent. Just to follow-up on to Walter's question, the new platform customer uptake for the quarter, maybe -- is that maybe a new marketing motion or some sort of new initiative that maybe is yielding early results? Maybe a little bit more color there will be helpful.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [35]

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No. I don't think it's that. I think what we're seeing is -- are a couple of things. Obviously, we have an expanding sales organization, so that certainly helps. But what we're also seeing is that the gen 1 and gen 2 monitoring solutions are not just working okay in the dynamic clouds that are now sort of scaling out in production at enterprise level, they actually just don't work. And so customers are in a scramble. And I think it's what's creating the buzz around this concept of observability.

And we've been talking about the fact that the cloud will disrupt everything, and that's why we reinvented our platform for this moment. And we're starting to see it play out in growing scale. And it's -- we're sort of lining up with the scale on Kubernetes in some ways because of this. That's why we call it the microservices wall because that's what customers hit. So as that continues and that trend continues, I do think our new logo expansion to the franchise will continue to be robust.

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Parthiv Varadarajan, Jefferies LLC, Research Division - Equity Associate [36]

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Okay, got it. And then good to see a strong net expansion, but I wanted to ask about the initial land motion. Maybe what are you seeing in terms of the number of APM hosts deployed on that initial land in the recent cohort of customers relative to what you saw in the past.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [37]

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The initial land is very consistent with where it's been, in the 90,000 to 100,000 initial land. I mean it's healthy versus a lot of competitors out there that land in very small mid-market footprints. But for us, and you start thinking into enterprise-class customer, that's a pretty modest bite to start with.

The exciting thing is that the -- while the land is nice, it's the expansion that has accelerated for us versus our Classic product world. And we're seeing that in the net expansion rates being healthy, and I believe we'll continue to see that over time as we get more comfortable and sort of the cross-selling of some of these other modules into the customer base.

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Operator [38]

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Your next question will come from the line of Raimo Lenschow of Barclays.

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Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [39]

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Congrats from me as well. A quick one. If you -- John, if you've -- like a lot of the questions on the call were obviously around like product and how -- observability because you have so many different players. But then you guys are just offering something that is very unique in the market because none of the other APM guys have really rewritten, and you guys are solving one of the most complex issues out there.

Where is -- the question is now like where are their customers in terms of understanding that in terms of like the microservices wall that you're talking about and that eventually a lot more stuff has to come to you. Are we still in the early innings of that, and hence, your confidence about just kind of growing the customer base coming your way?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [40]

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We are in the early innings. And it's as fast as we can get out there and have customers to suspend disbelief just long enough to believe that something else, something out there could actually do all this. And it's why we do a proof-of-concept with every customer. It's to show them, not just the Dynatrace advantage, but show them that it actually is true. So -- but it's a key part of our sales motion.

The other thing I just wanted to sort of point out here before the call is over is I know there's this talk about how suddenly competitive this space seems to be. I got to tell you that the monitoring space has had dozens and dozens of companies in it for decades now. It's always been a competitive space. It's just that you've sort of forgotten about the fact that they all got swallowed up a handful of big players and turned into sort of suites of tooling. But Dynatrace has competed in a noisy, competitive market for over a decade quite successfully and built a category leader because we think and build product differently. We don't just try to put more metrics out than somebody else. What we try to do is actually solve customer problems and help them drive better business outcomes.

So I think that you're right. We're in a good competitive position. We don't just do observability, we actually do automation and intelligence, which drive greater business value. And I'm really excited about where we are in a competitive position at the right time in the market as this transition to enterprise cloud and the dynamism of these orchestrated workloads -- microservices workloads really hit production at a high level.

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Operator [41]

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There are no further questions at this time. I'll turn the call back over to the presenters.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [42]

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Yes. Well, thank you very much for your time this evening. I appreciate it, and I look forward to catching up in 90 days.

Thank you, everyone. Cheers.

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Operator [43]

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And this concludes today's conference call. You may now disconnect.