Dynatrace, Inc.

Good morning, ladies and gentlemen. Thank you for standing by and welcome to the Dynacare third quarter 2020 earnings conference call. At this time, all participants are in a lesson-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to turn the conference over to your moderator today, Michael from Investor Relations. Please go ahead.

Thank you, Operator. Good morning, and thank you for joining us today to review Dynatrace's third quarter fiscal 2020 financial results. With me on the call today are John Van Sicklen, 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, including 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 21E 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 fourth 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 latest Form 10-Q, which was filed with the SEC on November 4, 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 third 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 Sicklen. John?

Thanks, Michael. And I'd like to start by thanking all of you for joining us today. Once again, we are very pleased with the company's quarterly performance, which resulted in third quarter financial results that were better than both our top line and bottom line guidance. I'm especially pleased that ARR once again increased by 44% year on year to $534 million, with our new Dynatrace platform now making up 87% of total ARR, up from 61% from a year ago. Fueled by the continued growth in ARR, our subscription plus services revenue, what we see as the best measure of revenue growth on our P&L, increased by 36% year over year. As we look ahead, we remain optimistic about the business as our new Dynatrace platform continues to be adopted by a growing number of new enterprise cloud customers. And each quarter, we are proving our ability to expand rapidly within this growing customer base. Our optimism is reflected in the increased top line guidance that Kevin will detail in a few minutes. We are also proud that our solid growth is complemented by strong operating margins. We run an efficient business with gross margins at 84% and a non-GAAP operating margin of 26% for the third quarter. 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 powerful 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. Now let me turn to four major advancements made in our fiscal Q3. New logo expansion, customer net expansion once they're on our new Dynatrace platform, continued progress moving classic customers to Dynatrace, and finally, innovation highlights around platform expansion and differentiation. I'll take each of these in order, starting with business from new customers. This past quarter, we saw a sizable uptick in new customers on the Dynatrace platform. 380 new customers joined the Dynatrace platform family in Q3, bringing our total Dynatrace platform customer count to 2,208, nearly double from a year ago. Q3 was a strong conversion quarter for us, with twice as many customers converting as we converted a year ago. And even with this strong conversion uptick, half of the customer growth added to our Dynatrace platform came from customers that are new logos to the franchise. Nearly every new customer win, whether net new or converted, is participated 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 run-the-business applications are being deployed into their enterprise cloud while visibility and situational awareness are declining. To regain control and bridge the complexity gap, more and more enterprises are turning to Dynatrace. For example, a large US bank recently became a Dynatrace customer after concluding that its current APM solution could not keep up with the dynamic nature and scale of its microservices-based environment. Prior to Dynatrace, the bank experienced excessive service disruptions in applications running in their AWS cloud, which negatively impacted the bank's business and put their brand loyalty at risk. Like most of our customers, The bank ran a trial of Dynatrace to prove ease of use, scalability, and the value of our advanced automation. The bank was immediately impressed by the Davis AI engine at the core of our platform and its ability to automatically map the entire full stack topology of their hybrid cloud and precisely identify problems and their root cause in real time, right out of the box. At the conclusion of their trial, the bank became a seven-figure ARR customer with plenty of room for expansion over time. I should also mention that shortly after starting with Dynatrace, the bank began to use our digital business analytics module announced in October to understand and reverse its drop in conversion rates for bringing new customers to the bank. This is a great example of the power of our all-in-one approach with end-to-end observability from user experience through infrastructure put in business context to drive better digital business outcomes. As we've said, once customers are on the new Dynatrace platform, we see rapid expansion, which is evidenced by the solid growth in our ARR that I referenced earlier. Once again in Q3, our net expansion rate exceeded 120%. This is the seventh straight quarter we've exceeded this mark. As we're 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 self-adjusting baselines, the automatic problem determination prioritized by business impact all contribute to rapid rollout and the high value for low-effort economics our customers enjoy. In addition, we are 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 US-based SaaS company that standardized on the Dynatrace platform and within two quarters completely replaced their previous Gen 2 supplier who missed the market transition to the enterprise cloud. Earlier this year, the SaaS company was struggling to effectively manage their four different data centers with their previous solution. and foresaw even greater issues with their evolution to a Kubernetes orchestrated cloud. After a successful trial last summer, the company decided to start by switching to Dynatrace in one of their data centers. Based on the rapid deployment of Dynatrace and success they achieved as a result of gaining real-time answers and insights into performance degradations and anomalies, thanks to Davis, they decided to expand their Dynatrace footprint and make Dynatrace the company standard for both the remaining data center migrations, as well as their upcoming move to a dynamic web scale cloud. This expansion came after only two quarters from the initial land deal with Dynatrace. Turning it to our continued progress on the conversion front, which is the movement of our classic APM customer base to the broader Dynatrace software intelligence platform, classic ARR has now declined to $69 million. That's down $25 million from a quarter ago and now represents only 13% of total company ARR. As we've discussed, we started this conversion program in earnest seven 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're 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. While it takes more time to find new stack buyers, it yields a much more valuable customer in the strategic go-forward growth segment of their business, their enterprise cloud. As an example of a converting customer this past quarter, a large U.S.-based airline converted from our classic tooling to the Dynatrace software intelligence platform. As the airline transformed from legacy systems to a modern multi-cloud architecture, they realized that the disparate monitoring tools, both commercial and open source, that they had acquired over the years were costing them precious time, money, and resource. This led to excessive manual configuration, the need to stitch together data from multiple sources, and operating war rooms to get the answers they needed. It's part of an initiative to gain observability into their entire environment. including all airport terminal kiosks, the airline began a trial of the all-in-one Dynatrace software intelligence platform. Again, it was advanced automation and full-stack observability at scale across a wide array of IAAS, CAS, and container technologies that were the key factors in the successful displacement of competing tools. Our all-in-one platform included provides the airline both the modern observability it requires and the real-time precise answers required to address degradations in performance and business impacting anomalies. After a successful trial, the airline converted from our classic tooling to the new Dynatrace platform, and the larger footprint led to an expanded seven-figure ARR contract. We are excited to be well along the way with the conversion process and look forward to wrapping this up over the next few quarters. As I've said before, this is particularly exciting for us for two 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 distraction ends and they focus 100% of their efforts on landing new customers and expanding them across more applications and modules. Let me finish by highlighting several of the innovations we announced recently, which we believe will further improve our ability to win new customers, expand with existing customers, and incent remaining classic customers to convert to Dynatrace. In early December, we announced the extension of our software intelligence platform to support AWS hybrid clouds and provide seamless support across all AWS public regions and outposts. Due to regulatory or data security requirements, many enterprise customers want flexibility with regard to where their observability data resides. With a flexible deployment model, Dynatrace offers a single platform built on cloud-native architecture that seamlessly supports any configuration of AWS hybrid cloud environment, including both VMware Cloud on AWS Outposts and the AWS native variant of Outposts. Dynatrace AWS customers will benefit from the regular automatic updates and automated administration of the Dynatrace platform while still meeting the strict governance, security, and latency requirements of on-premise workloads. This reduces the complexity, costs, and risk associated with alternative cloud observability approaches that do not support the flexible deployment modes of AWS and the other major IaaS and PaaS providers. During Q3, we also announced Keptn, an open source pluggable control plane to advance the industry's movement toward autonomous clouds. Keptn is an outcome of the knowledge and expertise gained as Dynatrace adopted a no-ops environment itself internally. In talking with CIOs and CTOs of many of our enterprise customers, it's become clear that advanced levels of automation and intelligence are required to bridge the growing gap between limited IT resources and the exponential increase in scale and complexity of dynamic enterprise clouds and the growing cloud native workloads now being deployed. We purpose-built our new Dynatrace platform with a powerful, explainable AI engine at the core to identify anomalies and degradations with precise root cause to trigger automatic self-healing actions. But what's been missing has been a simple, repeatable way to harness this potential and leverage it for a true no ops approach. Kepton provides the automation and orchestration of the processes and tools needed for continuous delivery and automated operations for cloud native environments. And we have a growing number of customers now engaged in leveraging Kepton and Dynatrace expertise to advance no ops within their enterprise cloud environments. Finally, Just two to three weeks ago, we announced that we've been collaborating with Google, Microsoft, and other industry leaders on the OpenTelemetry project to shape the future of open standard-based observability. Having been a leader in distributed transaction tracing at scale for years, Dynatrace is contributing know-how and manpower in this area to the project. As OpenTelemetry gains momentum, OpenTel data will serve as an additional data source for that further extends the breadth of our cloud observability, which in turn feeds Davis our AI engine, providing our customers with richer insights and automatic actions across a wider landscape as dynamic multi-clouds continue to evolve and scale. We see this open source standard as a benefit to the market and another potential accelerant to the adoption and expansion of Dynatrace. In summary, our innovation engine continues to differentiate our solutions and expand our market opportunity. Our Dynatrace customer base continues to increase as dynamic multi-clouds and workloads expand and scale. New logos are being added, and existing customers are converting and expanding on the new platform, both at a healthy pace. And our execution across our key performance indicators remains strong. With that, let me turn the call over to Kevin Burns for a deeper review of our financials. Kevin?

Thank you, John, and good morning, everyone. I'll start by providing a more detailed review of our third quarter performance, and I will finish with our outlook for the fourth quarter and our 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. As John said, ARR was $534.5 million at the end of the third quarter, an increase of 44%, or $162 million compared to the year ago period. Of the 44% growth year over year, five percentage points of the annual growth was due to customer expansion at the time our customers converted from our classic products to Dynatrace. And the balance of 39 percentage points of growth came from new logos and expansion in our customer base on the Dynatrace platform. As a reference point, This compares to 44% growth last quarter on a year-over-year basis, of which six percentage points of growth was due to expansion at the time of conversion and 38 percentage points from new logo and Dynatrace platform expansion. The Dynatrace platform continues to increase as a percent of total ARR and was approximately $466 million at the end of December, or 87% of our total ARR. the remaining 13% of our ARR relates to our classic offering. This compares to a mix of 80% Dynatrace and 20% Classic at the end of last quarter. We continue to track the plan on conversions and expect to be substantially complete with moving our customers to our new platform over the next three quarters. As you may recall, we started the conversion program with our sales organization seven quarters ago and to date, we have converted nearly two-thirds of the Classic base. We are actively working with the remaining customers on conversion timelines and continue to have a very good line of sight to completion. We are very pleased with the success of the program and the benefits that have been realized by our customers once they are on our new platform. By the end of our fiscal Q4, we expect Classic AR will be below 10% of total ARR, marking a major milestone for the company. Circling back to total AR, there are two AR 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 two growth drivers, during the quarter, we added 380 net new Dynatrace customers, ending the quarter with a little over 2,200 Dynatrace customers. Consistent with recent quarters, 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, 54% of our Dynatrace customer count growth has been the result of new logos to the company. In addition to a steady flow of net new customers, our Dynatrace net expansion rate remained at or above the 120% threshold for the seventh consecutive quarter. As a quick reminder, our ARR growth is not a result of our customer base converting from classic products to the Dynatrace platform as we do not charge a conversion fee. Our ARR expansion is driven primarily by 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 noted earlier, only five percentage points of our 44% ARR growth occurred at the time of conversion. And in our view, even those five percentage points are true customer expansion. Our current Dynatrace ARR per customer remains north of $200,000 for the fourth consecutive quarter, and we continue to believe that there is a large opportunity for further expansion in our existing customer base. The majority of our applications that are customers still lack instrumentation, We continue to expand our value proposition and use cases, and our enterprise customers continue to expand their portfolio of cloud-based applications as they digitally transform their business. Let's now turn to revenue. Total revenue was $143.3 million, $5.3 million above the high end of our guidance, and an increase of 25% on a year-over-year basis. Total revenue growth was driven by strong growth in subscription revenue, which was $128.5 million in the third quarter, an increase of 40% year over year. For the quarter, classic license revenue was $3.9 million, down from $12.1 million in the year-ago period. As John indicated, from a P&L perspective, we believe the best measure and reflection of our ongoing revenue growth profile is the combination of subscription and services revenue, which was $139.4 million in the quarter, representing 97% of total revenue and an increase of 36% on a year-over-year basis. Before moving to our profitability metrics, I would like to point out that I will be discussing non-GAAP results going forward as outlined in the tables in the earnings press release. Our non-GAAP gross margin was 84% for the third quarter, an increase from 82% in the third quarter of fiscal 19. We continue to see a healthy increase in our subscription gross margin percentage as we realize the benefits of winding down the classic product stack and, more importantly, the benefits of the Dynatrace platform, which has one code base and over 90% of our customers on a version released within the last 30 days, an extremely efficient product. Our non-GAAP op income for the third quarter was $37.5 million, well above the high end of our guidance of $31 million, due to a combination of revenue and associated gross margin upside, and to a much smaller extent, some investments that moved to the fourth quarter. This led to a non-GAAP operating margin of 26%, up from 21% in the third quarter of 2019. We're very pleased with the strong profitability performance for the quarter. However, as discussed before, we remain focused on investing for long-term growth and plan to reinvest some of the upside we realized during the quarter back into the business, which is reflected in our Q4 and full-year guidance. Non-GAAP net income was $26.7 million, or 10 cents per share. This was above our guidance of 6 to 7 cents per share. For the quarter, we had 280.2 million diluted weighted average shares outstanding. Turning to the balance sheet, as of December 31st, we had cash and cash equivalents of $189 million, and our long-term debt was $540 million after taking into account a $30 million principal payment in Q3. Our leverage ratio was 2.7 times our trailing 12-month adjusted EBITDA of $130 million. This is down from a leverage ratio of 8.9 times at quarter end prior to our IPO. Keeping in line with our program to consistently reduce debt, we made another debt payment of $30 million in January, and our gross debt is now approximately $510 million. While on the debt topic, I would like to let you know that later today we plan to launch a repricing of our debt facility. We anticipate that there will be some modest costs in the fourth quarter and our guidance excludes any potential impact. During fiscal 21, we expect to realize a modest benefit related to reducing our interest expense, but it is not material to our overall results and we will provide more color on next quarter's call. Moving back to our key metrics, Unleveraged free cash flow for Q3 was $13.3 million, and it was $161.9 million, or 32% of revenue, on a trailing 12-month basis. As we've discussed, quarterly cash flows can vary due to seasonality, combined with the fact that as we convert our customers from classic to dime trades, it can impact the timing of when we invoice our customers. The last financial measure that I would like to discuss is our remaining performance obligation, which at the end of the quarter was $800 million, an increase of 74% over Q3 of last year. The current portion of RPO, which we expect to recognize as revenue over the next 12 months, was $456 million, an increase of 66% year over year. Our healthy RPO expansion has benefited from our move to a subscription business combined with an increase in the duration of our new subscription agreements. We have consistently stated that we do not view calculated billings as a meaningful business metric in the near term, mainly due to variability created by the timing of our customer conversions and our ongoing shift from perpetual license to a subscription offering. We are very pleased with the success that we've had in moving our business to a subscription model. This shift has no impact on ARR, and it actually has a positive impact over the long term given it's a renewable source. Keep in mind, however, that the shift to subscription has and will continue to put pressure on our long-term deferred revenue balance as annual invoicing for subscriptions is lower than the upfront invoicing for perpetual licenses that are recognized over three years. Moreover, the shift to subscription has happened even faster than expected this year, which we believe is a great thing for our business. It's for these reasons that we have focused on our ARR from the time of our IPO, as we believe it is the most relevant leading indicator of our business momentum and will continue to be the case until we complete our revenue model transition. Now, let me cover our guidance, which has increased due to the strength of our third quarter results, combined with our continued positive outlook and the momentum of our business. For the fiscal year, we are increasing our ARR guidance to a range of $563 to $566 million, representing year-over-year growth of 40%, and an increase from our prior guidance of $550 to $555 million. Total revenue is now expected to be in a range of $542.2 million to $543.2 million, an increase from our prior guidance of $533 to $535 million. We expect our non-GAAP op income to be in the range of $127.5 to $128.5 million, up from our prior guidance of $119 to $121 million, and representing a non-GAAP operating margin of 24% at the midpoint of the range. Non-GAAP net income per share is now expected to be $0.28 per share, assuming approximately 272 million weighted average diluted shares for the year. For the fourth quarter, we expect total revenue to be in the range of $147 to $148 million, representing year-over-year growth of 27%. It is worth pointing out that we expect the combination of subscription and services to once again grow over 30% in the fourth quarter. We expect fourth quarter non-GAAP up income to be in the range of $33.5 to $34.5 million and non-GAAP EPS of 8 cents per share, assuming 284 million diluted weighted average shares outstanding for the fourth quarter. In summary, we are very pleased with our third quarter performance, and our optimism about the future is reflected in our increased guidance for the year. With a large and growing TAM in front of us and a market-leading position, we believe that Dynatrace is well positioned for the long term. Most important for our shareholders is that we continue to show a financial profile that we believe is highly unique, including meaningful scale, strong growth, healthy profitability, and cash flow. With that, we'll open up the call for questions. Operator?

At this time, if you'd like to ask a question, press star one on your telephone. To withdraw your question, press the pound key. Please wait while we compile the Q&A roster. Thank you. Your first question comes from the line of Sterling Howdy with JP Morgan. Please go ahead.

Hey, guys. This is Matt. I'm for Sterling. Thanks for taking my question. So looking at the significant upside in ARR versus what you did in subscription revenue, I wonder if you could comment on the linearity in bookings during the quarter. Thanks.

Yeah, hi, Matt. Thanks for the question. So we obviously track linearity on a monthly basis. What I will say is for our December calendar year and quarter, we typically see a larger percentage of our bookings come in month three. So yes, that Yes, it is a little bit higher in this quarter, but it's consistent sort of with the last few years in terms of linearity.

So no real outliers in terms of the flow of the business. It did come in at such length.

Great. Thanks, guys.

Your next question comes from the line of Matt Hedberg with RBC Capital Markets. Please go ahead.

Oh, hey, guys. Thanks for the question. Great quarter. In addition to the 44% ARR growth, new customer ads, it was really impressive to us. And I think you added 130 more than you did in the year ago quarter as well as last quarter. Can you talk in a bit more detail of why new customer ads were so strong? Has something changed competitively? You know, perhaps, you know, could there be some acceleration in, you know, competitive replacements?

Yeah, Matt, so a couple things. First of all, it was a big conversion quarter. And, you know, we've said that we've been stimulating the base now for a while. We're seven quarters into the program. And the end of the year is always a forcing function for many things. And this just happened to be a big quarter for moving the base, you know, over to diamond trace. So that's a big part of it. But even with that, about half of that growth is still net new logos to the franchise. And that's really coming because the market is now moving much more aggressively to multi-cloud environments or web-scale environments, including the modern workloads, microservice-based workloads and Kubernetes-orchestrated environments that really leave the Gen 1 and Gen 2 tooling behind. And so our reinvention, you know, five, six years ago is now really, you know, playing well in the market. And so there is a competitive tailwind for us as well.

That's great. And then maybe when you look at your customer base, John, can you estimate what percentage of, say, an average customer are monitoring cloud-based app or infrastructure applications? versus, say, an on-premise app or infrastructure? And how do you think that differs versus, you know, sort of the broader competitive landscape?

So from our standpoint, I mean, we've done a little bit of work, you know, looking back into it. And it's about, it's in that 70% to 75% range, our modern cloud workloads and modern cloud environments that the new platform is monitoring. And the way we go to market is we look for those you know, modern cloud teams and stacks. And then as they get the hang of how Dynatrace works and the automation and intelligence built in, creating much greater efficiency for their, you know, sort of limited IT resources, they start bringing it back, you know, further back into their sort of legacy or classic environments. But it's actually, that's a pretty high ratio. And I'd say obviously relative to a Gen 1 or Gen 2 kind of tooling out there, it's much more into the modern cloud environments. So we think it's a good spot to be. I think over time we'll see that percentage continue to climb because we are uniquely positioned in those environments.

Great color. Well done. Well done, guys. Thank you.

Your next question comes from the line of Heather Billany with Goldman Sachs. Please go ahead.

Great. Thank you very much. I mean, obviously, you guys are doing a great job converting the installed base. And, you know, I know you mentioned that you look to be done with the conversion over the next couple of quarters. And you've had some very good success on new customer land. But can you give us a sense, you made a comment on the call that I mean, getting the salespeople not focused on conversions and focusing on new lands will help improve productivity. Are there any changes to the incentives that you're paying the sales force as you move towards the next fiscal year and the conversions become even smaller? And I guess the second part would be when you're going after new customers, how do the size of those initial lands compare to the size of of the initial conversion deals, right? I know you don't charge for the conversion, but kind of what you're getting from those when they convert in terms of the uplift. So sorry for a complicated question, but any thoughts would be very helpful.

Yeah, so first of all, we haven't set our sales plans for the following year. That's in discussion now. But our approach has been to try to move as much of the base across the line and convert it by the end of this fiscal year so that we can free up sales and rework the sales incentive plan so that they can focus 100% of their time on new logo opportunities and expansion of the base, especially cross-selling some of the new modules into the base. So that's still our program. We still have to work through some of the details, but those are our thoughts at this time. Relative to a land versus expand deal, the land deals have been very consistent in the 95K kind of range. I think if you look, we've been talking about 92 to 100K, sort of in that, 92 to 97K, sort of in that range for the last three quarters. So that's very consistent. And the expansion deals, they vary a little bit by time of year. Q3 happens to be a very strong expansion quarter, and so does Q4. So that those times of the year, the expansion deals can be tracked a little bit larger on an ASP basis, and then they come down to a little more of a run rate range in Q1 and Q2 for us in a fiscal year. But overall, there's not a huge difference between the two. We're a transaction-oriented business. We're not a big deal-oriented business. And I think that that, you know, helps us manage, you know, a more effective business over the long term.

Great. Thank you.

Your next question comes from the line of Walter Pritchard with Citi. Please go ahead.

Hi, thanks. A question for John and one for Kevin. For John, just looking at the expansion that you've seen, I'm curious product-wise getting into things like digital experience monitoring, infrastructure monitoring versus just app expansion into new apps. What's been a trend there in terms of product versus sort of footprint expansion as you've continued to put up that NRR number?

I feel like we're still in the early innings of cross-selling. Most of that expansion still comes from more applications being instrumented, mainly because we have such a highly automated way of instrumentation, sort of a self-discovery, very automatic products in about a 5% of app range. We're well over that with the majority of our customers. But we are seeing an uptick in the cross-sell as we start to focus on a little bit more. Digital experience is one that we're pretty used to positioning, so that one right now runs a little bit ahead. But we're seeing a nice uptick in the infrastructure side as well. I think that that's really driven by the fact that folks have realized that all that old tooling really falls away when you get to dynamic enterprise clouds. So with those, we have a lot of optimism in our ability to scale that out as we go into next year, and that's one of the things we're going to focus on as we sort of wind down conversions and wind up cross-selling you know, as we go into our fiscal 21.

And, Kevin, can you just talk about on the investment side, especially as we look into 21, sort of where in Q4 in particular you're investing in the business and then how that pertains to how you're thinking about investing in 2021?

Yeah, I think it's status quo, but when I say status quo,

It's continued focus on innovation, right, building out our organization so we can maintain our leads from a competitive product standpoint.

We've been doing that very well over the last couple of years. So that's one area of investment that we will continue.

And the second big area of investment, again, will be continued investments in commercial expansion as well as some marketing programs. These are two things that we've been doing very well over the last couple of quarters, really the last year, and you'll see a little bit more of that here in Q4, and that trend should continue as we try to continue to grow this business at a really nice level.

Great. Thanks for the color.

Your next question comes from the line of Bhavan Suri with William Blair and Company. Please go ahead.

Hey, good morning. This is David Griffin. I'm for Bhavan. Thanks for taking the questions. Two, if I could. First, just so last quarter you called out pretty encouraging early interest in the new digital business analytics module. I was wondering if you could just give us an update on the level of interest that you're seeing from customers there, and maybe just talk a little bit about how the early partnership conversations with the traditional BI vendors are progressing.

Sure. Well, it's still early. It takes a direct sales organization a little while to pick up sort of new capabilities and introduce them to their accounts, the accounts to trial it, and then start to adopt. But I did talk about one of the customers in my prepared remarks about one that sort of picked it up right away. They were having conversion challenges with some of their new applications and bringing online at the bank, and it fell right in place for them. It was a timely announcement. It was something they needed and dropped right in. So those kinds of examples sort of find their way through the sales organization. I expect over time that the business analytics are going to become a really key piece of our go-forward approach dialogue with customers and opportunity in the market. So I'm pleased with where we are right now, but it is early innings, of course. As far as how this works with some of the other analytics players in the market, mainly those that focus on digital business teams as opposed to the operations teams, we're seeing that the relationships really are driving the opportunity but the fact that we compliment those other analytic, you know, tools, uh, out there, you know, like, uh, let's say an Adobe analytics and be able to light up the entire tech stack underneath, you know, these, uh, uh, you know, some of these environments. So it's not just about, Hey, what's, what's happening with conversion rates, what's happening with, with, uh, with revenue. Why is there a drop off or why can't we or what do we need to do to optimize? We provide the visibility back into the stack as to exactly what to do, you know, to attack some of these things. So it's a great addition for the folks that use those kind of analytics tools to be able to team with the development teams and their operations teams much more effectively to optimize their digital go to markets.

Got it. That's helpful. And then I want to talk about one other recent announcement. So in December, you announced a new autonomous cloud enablement practice that I guess the goals provide things like best practices, hands-on expertise, and automation services to help customers kind of make the transition to autonomous cloud operations, which certainly sounds interesting and an area of need. Can you talk in a little bit more detail just about the practice, kind of how that's different from what you've been doing on the services side previously, and then maybe whether there are any margin implications associated with that?

Sure. The focus of our service organization has always been making sure that customers get the most out of our software platform. As I As customers will tell you and I believe as well, nobody really wants to buy software. They're trying to solve a problem or they're trying to get sort of some kind of a lead in the market. And our services organization has been fantastic in helping customers drive adoption, exploring their use cases, et cetera. With this new announcement and this new practice, what we want to do is be sort of a little bit more proactive and help customers do what we've done ourselves, which is move their sort of reactive, you know, IT organizations, you know, reactive issues, you know, into a proactive, highly automatic or automated state. And so this practice is led by a team that's been very close to some of the work we've done with our open source control plane captain. and the thinking behind that. And they're now taking that to a number of customers who've been asking us for more and more best practices and expertise in this area. And so rather than just try to coach them along the way, we're actually building out a program to help enable them and help do some of the work for them to make sure that they can accelerate their directions and their drive to autonomous clouds, which is really inevitable. you know, place for every customer building web-scale clouds. You know, nobody really wants to have lots of humans running around trying to manage them and deal with them and optimize them and deal with the issues of them. So we're just at the front edge of the sphere on that one for the marketplace, a great place for us to be, and we have a great platform to enable it from.

Great, that's helpful. Thank you for taking the questions and congrats on a solid quarter.

Thank you. Your next question comes from the line of Richard Davis with Canicard. Please go ahead.

Hey guys, this is Luke on for Richard. So we've been talking with a number of interesting vendors in the DevOps space, and it seems like they've finally gained some mainstream momentum. Our question for you guys would be, how do you guys think about this space, and do you envision extending into that ecosystem, presumably on the ops side of things?

Thanks. Sure. Well, we already are in the DevOps world. We've always, you know, thought of performance and, you know, cloud application optimization as something that needs to go upstream, you know, continuous developments. sorry, continuous deployment all the way back into continuous integration. So we already do this, and the value we provide in those environments are fairly straightforward. People have lots of capabilities to drive new function, but very few capabilities to make sure that they have their architectures maintained and the ability to scale, you know, is built into the continuous integration, continuous deployment environment. you know, models. And as we see more and more from a dev standpoint wanting to understand what their new code is doing in production, so visibility actually, you know, into sort of the early production releases, whether they're canary releases or A-B testing and that kind of thing, we see even a broader opportunity to be able to help those DevOps teams, you know, optimize code, drive better quality in those early stages prior to when things get, you know, out into production. The last thing I'll say about it is our autonomous cloud program actually starts with something we call unbreakable pipelines. And, you know, we start there because it's more straightforward with the devs to put all this together with the open source pluggable backplane that we built in Captain. And so we'll be bringing even more sort of focus to the DevOps side of things as we go forward.

That's very helpful. Thanks.

Your next question comes from the line of Jennifer Lowe with UBS. Please go ahead. Great.

Good morning. First question for me, so the commentary around the improvement in conversion was, I thought, particularly interesting. And I wanted to parse through that a little bit more. Can you talk about how much of that was a function of market, i.e., as companies move to these more complex environments, it's just a more pressing issue to modernize their APM and observability practices versus things that maybe you were doing differently from a sales process perspective? versus anything you're seeing differently from a competitive perspective where maybe your win rates were a bit better in the quarter than they've been? If you could just sort of give a little more granularity, that would be awesome.

Yeah, so I don't think it's anything that we're doing differently. It's just a culmination of a lot of work we've done over the last, you know, six, seven quarters. It takes customers a little while to digest something that's new. We're not doing a like-for-like process. you know, this product for that product, you know, kind of a thing. We're actually taking multiple tools and we're now providing a platform. And the multiple tools are all targeted into APM for old stack environments or sort of classic stack environments. And the new platform is targeted at new stack cloud environments, which means sort of a new buyer. So it takes a while. It's a sales process. As I said, we believe that it's been worth all the effort. It's going to pay off because we're now in the mainstream, go-forward part of all these customers' businesses, their enterprise clouds. And this just happened to be a quarter that sort of culminated into a lot of things happening at once, which is great. I think it's a peak quarter for us. The next three quarters will be strong, but not as large as this past one. But I think it's just a culmination of a number of things that we've been doing well. And customers, as you said, sort of realizing that enterprise cloud is a growing part of their portfolios and will become the lion's share of their IT portfolios here over the next 12 to 24 months.

Okay, and maybe just to follow up on that, so if we look at, you know, pipelines versus conversions, is it reasonable to think that the pipeline trajectory has been more steady and now the Delta is really just converting on that pipeline more effectively, or are you seeing pipelines expand as well?

We're seeing both pipelines expand as well as, you know, conversions, you know, remaining strong, you know, across the board. So that's, you know, both bode well. Plus, as, you know, Kevin's pointed out a couple times, we've been expanding our sales organization as well. So we're on track for the 25% increase in our sales rep capacity this year. And, you know, look forward to as they ramp in, you know, they're having some impact and they'll have greater impact as they mature.

Great. Thank you. Your next question comes from one of Keith Backman with BMO. Please go ahead.

Hi, thank you very much. I had two questions as well. The first relates to an earlier question, but as you look out and you see your conversion of legacy being zero or close to zero, does that help hurt or neutral to your ARR growth?

It's a great question, and you need a perfect crystal ball to answer it. three-quarters from now we'll be able to have that little bit of hindsight. But the way we look at it is this. It's great that we're shifting a customer base across, but it's taking a fair amount of sales bandwidth to do it because, as I said, it's really like a new sale because we don't just talk to the team that had our old tooling. We have to find a whole new team on the other side and make sure that they find the value of Dynatrace. for their cloud programs. So we estimate that's anywhere from 20% of sales effort, maybe a little bit higher given various quarters like this past quarter. But going forward when the conversions run off and we have 100% sales focus and the full capacity of the sales organization focus on new logos and expansion, you know, that should give us, you know, sort of a tailwind, you know, from a productivity standpoint in that regard. So, you know, how neutral does that, do those two sides of the equation work? You know, time will tell, but we think it will be relatively neutral.

Now, if you look at that on a net expansion rate, that is below 120% net expansion rate for that customer base when they're moving. So we always talk about Dynatrace has been north of 120%, so you can argue or think that once they are on that new platform, we do believe that they will expand at a much more rapid pace on Dynatrace.

Okay, thank you for that. My follow-up question relates to as your expansion capabilities, or I shouldn't say your your expansion of your portfolio within the context of APM continues to improve. So the pipeline, as you mentioned, is getting richer. Your conversion rates are good. Are you seeing any different changes in attached rates to the infrastructure side?

From a standpoint of cross-selling and what we consider expansion, as we've said before, we We land from a position of strength, as you would expect, in our swim lane, which is the application performance monitoring focused on the cloud workloads. The expansion is increasing. The attach rate of infrastructure as well as digital experience are increasing. It's not something that we disclose at the moment of what does that look like as far as portfolio of emerging products relative to the APM module itself. But going forward, you know, we're looking at, you know, when and how we do that, maybe at the end of our fiscal year, beginning of the coming fiscal year.

All right. Many thanks. That's it for me.

Your next question comes from the line of Remo Lenschow with Barclays. Please go ahead.

Hey, thanks for taking my question. More on a bigger picture one, can you talk about like open telemetry as that kind of goes out, more vendors are doing it, but then some of the Gen 2 guys are not kind of very openly around that. How does that help you in terms of being out in the market with the more modern solution?

It's a great question. You know, OpenTelemetry is a great standard. It's why we've gotten involved in it with Google, Microsoft, and some of the other industry leaders because we've always thought that gathering data is not really where the differentiation or value is going to come in. This is why when we rebuilt our platform, we thought about it with advanced automation and an AI engine at the core because that's where we really see the advancements and the opportunity to drive value. That's where it's more about what you do with the data than it is about gathering it. OpenTEL allows us to gather data over a much wider set of environments, serverless environments, mesh environments, a number of different areas that are just very hard to figure out how you might instrument or self-discover that. And so it enables that big footprint, means that you're going to need a highly scalable engine that can process and analyze lots of data to make sense of it, to allow sort of the IT teams, the limited IT teams to do more and more as these environments get much larger and more complex. So we see it as a great opportunity to sort of shine the light on our automation and intelligence differentiation And we think it's going to be a great sort of tailwind for us as we go forward in the business.

Okay, perfect. Thank you. And then one quick one for Kevin. Can you just remind us on, you kind of mentioned the debt situation on the prepared remarks. What's the ultimate, what's your long-term target on debt leverage, et cetera? Thank you. And well done.

Yeah, so our, as I mentioned on the call, net leverage trailing 12 is 2.7 times EBITDA. The way we're trying to manage this is we're trying to maintain cash around the $150 to $200 million mark, which means we're going to be paying down on a quarterly basis any excess cash or using excess cash to make that payment. So in January, we paid down $30 million. Obviously, given our cash generating capabilities, we can reduce this $500 million of debt over the next couple of years very nicely. So we're going to continue to pay down

consistently on a quarterly basis going forward, as we have done over the last three quarters as a public company.

Good. Thank you. Thank you.

Thank you. Your next question comes from the line of Brent Phil with Jefferies. Please go ahead.

Hey, guys. Thanks. This is Parthivan for Brent. Just a follow-up on the net new ads this quarter. You know, in the half of the net ads that were released, you know, new to the franchise? Anything you'd call it from a vertical or geo perspective relative to past quarters?

So nothing unusual on any of those fronts, really. You know, the digital transformation is really across, you know, all industries. So there's really nothing I could point to that says, oh, this industry is all of a sudden accelerating or this one's decelerating or there's some shift. And the same thing from a geographic basis. I mean, even, you know, the world's sort of flattened these days. It used to be, you know, in Asia Pacific you might think of as, you know, two years behind the U.S. or something. Well, it's a much more level, you know, now. So there's no real shifts in geographic mix. I wouldn't say there's any shift in industries. It's just more a mass movement of digital transformation and the realization that it's going to be cloud first and that the clouds are no longer sort of static, you know, or exploratory. They really are enterprise class, multi-cloud, dynamic workloads. I mean, we're hitting a sophistication level and scale level that we anticipated five or six years ago, but, you know, really starting to hit the mainstream, you know, of the enterprise market now. which I think, again, gives us a little bit of tailwind as we go forward.

Yeah, makes sense. Okay. And, you know, as a follow-up, just when you look at the AWS integration that you guys have just done, how would you guys measure the opportunity, you know, for host expansion with that integration over time, you know, relative to what you're seeing up in the hybrid cloud versus what you've seen, you know, in traditional on-prem environments?

Sure. So the AWS move to outposts is an interesting move because it was a religion two, three years ago that everything was going to come to public clouds. And it's a bit of a realization that hybrid environments can be around for a pretty long time. We built a unique SaaS platform that allows us to run the same software cluster technology, whether it's in the cloud or whether it's behind people's firewalls. Exact same code base, as Kevin's pointed out a number of times, but we're able to use that exact same software to handle sort of both workload environments or both at the same time for hybrid cloud customers. So the fact that AWS has now distributed their cloud so that you can actually run outposts behind a firewall, you know, aligns with the model we've had for the last four years in enterprise, you know, sort of volume production. So it's perfect for us, and it's very hard for somebody with a SaaS-only platform to be able to cover all the workloads because of regulatory issues, because of, you know, data sovereignty or data security issues. And so when we look at it, we think of our TAM as the full TAM of enterprise customers and their workloads as opposed to only the ones that will allow for telemetry data to go to a cloud. So we think the move with AWS is actually going to accelerate sort of our penetration into the AWS enterprise portfolio. It's early days, but we think it's a great move and we're well positioned to to take advantage of that, like whether it's the AWS variant or whether it's the VMware, you know, variant.

That's helpful. Thanks, guys, and congrats. Thank you.

Thank you. Yeah, next question comes from the line of Sarah Inland with Macquarie. Please go ahead.

Yes, hi. Congratulations. That was a great quarter. Just a quick question for you following up actually on a few of my peers. The international opportunity as you discussed, it sounds like there's still plenty of room for you guys to go there. My first question is really how are you thinking about expanding an international especially with the growth in headcount you just mentioned?

We've always had a very strong international presence. Our business is you know, 60%, 55 to 60% in North America and, you know, the balance international. And we've had that footprint for quite a while. So one of the advantages for us is we don't have to build out that sales support, you know, marketing infrastructure on a global basis. We already have it. So when we talk about sales rep expansion, we think about it as pretty much, although there's a little bit more in North America, since that's the front end of the enterprise cloud. But in general, you can think about it as when we say 25%, we mean 25% pretty much in each of four major geographies. We think about North America. We think about EMEA, which is Europe, Middle East, and Africa. We think of Latin America, and then we think of Asia-Pac. So from that standpoint, think about it as we expand them all sort of relatively similarly. And they all have a fantastic opportunity for us, and we're doing well in all those geographic sectors.

Okay, thank you very much. That was really helpful. And as a follow-up, I was wondering if maybe you're seeing a shift. I know you're seeing a lot more protection of cloud-native as you're moving along, but is there any way you can help us to kind of think about the magnitude of shifts you're seeing from on-premise to protected in cloud applications of any kind?

So we don't really think about it as there's a shift from on-premise to cloud to cloud because are built with cloud technology. Virtualized infrastructure is virtualized. We're now in about 85% of our cloud. It's being used to orchestrate across multiple clouds and span across all of those environments. between the old on-prem and... So that's why we talk about them as enterprise... It's sort of everything. All... Technologies and... There is a gradual migration to public... Data sources...

that are required to actually, you know, system and your customer system on site. You're not going to put those data sets in the cloud, but yet all the application, all the mobile, you know, apps and some of the other touch points are all sort of maybe running in a public cloud. So that creates this hybrid environment, which we're extremely well suited for.

Sure. That makes a ton of sense. Thank you. Congratulations on a great quarter.

Thank you very much. I think just in the interest of time, we're probably going to have to cut off the questions now. I'm sorry about that. Thank you all for your interest. We're thrilled with our third quarter out as a public company, and I look forward to talking with all of you again in May when we're back with the end of our fiscal year, our fiscal 20. So thank you very much. Have a good morning, and take care. We'll talk soon.

This concludes this conference call. You may now disconnect.