Dynatrace, Inc.

Greetings and welcome to the Dynatrace Fiscal Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Noelle Farris, Vice President of Investor Relations. Please go ahead.

Great. Thank you, Operator, and good morning, everyone. With me on the call today are John Van Sicklen, Chief Executive Officer, and Kevin Burns, Chief Financial Officer. Before we get started, please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these factors is contained in Dynatrace's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking statements included in this call represent the company's views on February 3rd, 2021. Dynatrace disclaims any obligation to update these statements to reflect future events or circumstances. As a reminder, we will be referring to some non-GAAP financial measures during today's call. A detailed reconciliation of GAAP and non-GAAP measures can be found on the Investor Relations section of our website. And with that, let me turn the call over to our Chief Executive Officer, John Van Sicklen. John?

Thanks, Noelle. Good morning, everyone, and thank you for joining us on our Q3 Fiscal 2021 Earnings Call. I am pleased to report that we had another strong quarter across all of our key operating metrics. ARR was $722 million of existing customers and an inherently efficient business model. Based on the strength of our Q3 results, we are raising our guidance across the board for fiscal 2021, which Kevin will provide more details on shortly. There are three main factors driving our success in the market and ultimately resulting in our strong financial performance. The first is strong long-term market trends. Second, the investments we're making in go-to-market and commercial expansion are paying off. Third, our commitment to continuous innovation is solving a wider range of problems for our customers and keeping us well ahead of competition. I'll walk you through each of these factors and share why we believe they position us for sustained growth well into the future. First, long-term market trends continue to be in our favor. Companies around the globe and in every industry are undergoing digital transformations at an accelerated pace. And these transformations are happening in dynamic multi-clouds which leverage continuously changing container and microservice architectures. We saw many examples of this during last quarter, such as a large energy provider in the U.S. digitally transforming to a Tanzu hybrid cloud platform to stop coal use and reduce CO2 emissions by 70% over the next 10 years, all while delivering smart home energy services to their millions of consumers. a large brick-and-mortar retailer rapidly transforming to an open-shift Kubernetes platform to drive omni-channel engagement, new curbside services, and new revenue streams like accepting and processing Amazon returns, and state governments and pharmacy chains using DevOps and cloud-native application platforms to rapidly roll out online vaccine information scheduling and tracking services. All these and more are powered by Dynatrace to enable greater speed, agility, and efficiency sought by CIOs and CTOs today as modern cloud complexity and scale stretches beyond their team's ability to keep pace. Automation and intelligence to tame this complexity, free up resources, and speed transformation are becoming requirements. One of our banking customers recently told me that Dynatrace has been the, quote, killer app, unquote, behind their digital transformation, adding value and automation across a wide variety of bank services, applications, and IT use cases. We heard from a new healthcare customer who had been struggling to get a Gen 2 observability solution deployed that Dynatrace has been, quote, a knockout, unquote, deployed over a weekend, providing value across their cloud environment immediately. And a large government customer recently integrated us with ServiceNow and has reported dramatically reduced incident response times for several recurring issues, cutting them from hours to seconds. We invested early in automation and intelligence capabilities to allow digital transformers to do more with less, to gain time for innovation and business advantage, And those investments continue to give us a well-differentiated advantage as market trends move in our favor. Having a well-differentiated solution in a rapidly growing market brings me to the second factor driving our success and strong financial performance. And that is our step-up in strategic go-to-market and commercial expansion investments. We're doubling down in several key areas to take advantage of the market momentum and opportunities. We've talked about growing our sales organization at 20 percent to 25 percent this year, and Q3 results showed that these investments are paying off. We added 189 new logos this past quarter, back above pre-pandemic levels. New logo wins were across a diverse set of industries, geographies, and government agencies, including Hyundai, Edward Jones & Company, the Texas Department of Health, Echo Star, and Denmark Radio. The value advantages enabled by the advanced automation and intelligence of our platform are resonating with customers. Whether they are replacing APM solutions, transitioning to observability platforms, or challenged with the tool fatigue of do-it-yourself approaches, we are winning new logos in all scenarios. In addition, we maintained a net expansion rate above 120% for the 11th consecutive quarter. Expansion deals were equally diverse, including enterprises such as Santander Bank, public supermarkets, 3M, and the Department of Works and Pension in the UK. Upselling our market-leading APM module to support more applications and workloads continues to fuel the majority of our expansions. At the same time, cross-selling continues to gain strength, with 33% of our customers now using 3-plus modules, up from 24% a year ago. And nearly 40% are now using our infrastructure module for non-full-stack workloads that support their cloud operations, such as directories, firewalls, load balancers, and more. We are seeing a steady rise in customers leveraging the value of our platform, for new and expanded use cases and automations as they digitally transform. Given the solid execution of our sales team and momentum in the market, we are now planning to accelerate the growth rate of primary quota carrying reps into the 25 percent to 30 percent range. We've kept our foot on the gas throughout the pandemic and are now scaling up commercial expansion to capture greater share and drive continued strong growth. And while our direct sales force is responsible for a majority of our business today, we know there is an opportunity to grow faster by expanding our leverage and reach through cloud partners. Over the past couple of quarters, we have been focused on expanding our tech alliances with the three major hyperscalers, AWS, Microsoft, and Google. As you know, we've had a longstanding and close relationship with AWS, as a premier partner and continue to scale this out. And I'm pleased with the progress we made to advance our Google Cloud Platform and Microsoft Azure relationships. First, with Google Cloud Platform, we have expanded our strategic partnership to include go-to-market collaboration with joint marketing efforts and a unified go-to-market motion with sales incentives for both teams. In addition, we have streamlined contract and procurement processes by allowing Dynatrace purchases to flow through the GCP marketplace and be applied against GCP pre-committed spend. Second, we have enhanced our partnership with Microsoft Azure as well. Similar to our longstanding relationship with AWS and in line with our expanded relationship with Google, we have expanded our collective go-to-market motion and co-selling arrangements, and we are actively enhancing our frictionless buying experience through Microsoft Azure's console integration. We are very pleased with these strengthened strategic cloud partnerships, and today we believe we are the only observability platform whose customers can use their committed spend through private offers in all three marketplaces. Private offerings in the marketplaces are the preferred cloud buying mechanism for many enterprises, and this allows our customers the flexibility to choose where to deploy Dynatrace and do it easily and efficiently. Before I leave go-to-market investments, let me add a comment on our annual user conference, Perform, which is coming up next week. This year we are expecting over 20,000 registered attendees. That's 10 times more than we had for the physical event last year. Certainly the shift to a virtual event is driving attendance up, but so is the awareness of Dynatrace in the market and the unique benefits of our platform. We're excited to be reaching such a broad global audience, many of whom are prospective customers within our target global 15,000 enterprise accounts. Now to the third factor driving our success and strong financial performance, and that is our continuous innovation. Our highly talented product team listens intently to our customers and turns these insights into a continuous stream of innovation to advance our differentiation and increase our value advantage. Last quarter, we released the fourth generation of our patented PurePath distributed tracing technology. PurePath 4 now provides the deepest, most complete, and fully automatic distributed tracing for modern cloud environments, including those extended with OpenTelemetry and OpenTrace. As modern cloud applications become more dynamic, increase in scale, and explode in complexity, advanced levels of distributed tracing are required for precise understanding and immediate actionability for troubleshooting, optimization, and proactive remediation use cases. In December, we announced our entry into the cloud application security market. As we did with cloud observability, we are leveraging the disruptive forces of modern dynamic clouds to enter this market targeting where the puck is going. As modern cloud DevOps processes accelerate innovation and change, and cloud-native applications sprawl across multi-clouds, there is a growing friction between the speed of innovation and traditional security approaches. Leveraging the power and intelligence of our platform, our new offering solves this challenge to advance DevSecOps for Kubernetes-orchestrated cloud-native applications. As we said when announced, it'll take time for customers to test and validate this new offering, so the ARR impact will be slow at first. But we believe this new offering has the potential to expand our TAM by $18 billion over time, bringing our total addressable market opportunity to over $50 billion. Both PurePath 4 and cloud application security are exciting advances for us. And with our annual PERFORM conference around the corner, you can expect more innovation announcements to come. Before I summarize, I'd like to take a minute to touch on the maturing of Dynatrace as an independent public company. As we look forward to our next phase of growth, we continue to enhance our board and board leadership. I am very pleased to announce that Jill Ward has been appointed chair of the Dynatrace board. Jill has been a strong voice of leadership on our board since 2019 and brings extensive knowledge and experience from her work at a number of remarkable companies. For more details, please refer to the press release we issued earlier today. Now, let me summarize as I've covered a lot this morning. As I said at the outset, we're very pleased with our performance this quarter and it sets us up to finish fiscal 2021 quite strong. I want to thank our global team of almost 2,700 employees for all their hard work and contributions in helping us achieve this success. We continue to prove that we are well-positioned in a growth market and that our innovation engine can consistently differentiate our solutions and expand our market opportunity. Likewise, we continue to see returns on our investments in go-to-market and commercial expansion, which are driving pipeline momentum and growth. Sales execution is strong, our partner engine is revving up, and we are investing. Add to this the growing awareness of and interest in Dynatrace with a reputation for world-class product and expertise for modern cloud-based digital transformations, and we believe we have the ingredients for strong and sustained growth. With that, Let me turn the call over to Kevin for a deeper review of our financials. Kevin.

Thank you, John. Good morning, everyone, and thank you for joining us on our Q3 earnings call. As John mentioned, we delivered a great quarter across the board, driven by strong ARR performance, which was well above our internal expectations. We believe ARR is a key performance indicator of the overall strength and health of the business. ARR in the third quarter was $722 million. That's up $188 million, representing 35% year-over-year growth or 32% in constant currency. We are extremely pleased with the rate and pace of our ARR growth, and it is even more impressive when you take into account the headwinds related to the perpetual license roll-off and COVID-related impacts. With respect to the perpetual license headwind, and as a reminder, when we sold a Dynatrace perpetual license, we would recognize the license revenue radably over three years. About two years ago, we removed perpetual license agreements from our price book, and they were sold on an exception basis only. As a result, we have begun to see the wind-down of these perpetual license agreements, which negatively impacted ARR by roughly $8 million in the third quarter, representing a little more than 1.5 percentage points of headwind to the ARR growth rate in the quarter. So, excluding the PERP license headwind, our adjusted ARR grew 37 percent on an as-reported basis and 33 percent on a constant currency basis. Additionally, roughly 20% of our ARR is with enterprise customers we consider to be in industries that are facing headwinds due to the COVID crisis, such as travel, hospitality, and automotive. And while we haven't seen these customers churn from the platform, their net expansion rates are below the average net expansion rate for the business as a whole. We started to see the net expansion rates for this cohort tick back up in the third quarter with expansion deals in retail, automotive, and oil and gas verticals. This is a promising sign, resulting in an ARR headwind that was roughly half the 300 to 400 basis point headwind that we experienced last quarter. As we have discussed, the building blocks for ARR growth are new logos and net expansion rate. As John mentioned, we continue to see an acceleration in new customers, adding 189 new logos in Q3. This is nine percentage points higher than the 174 new logos we added in Q3 of last year. We expect that growth rate to accelerate further in Q4, putting us on track to overachieve our previously shared plan of roughly 530 new logos by the end of the fiscal year. As a reminder, we had 145 new logos in Q4 of last year. We exited the third quarter with 2,794 Dynatrace customers. Our net expansion rate was above 120% for the 11th consecutive quarter, and our ARR per Dynatrace customer increased approximately 20% year-over-year to $251,000. Our average ARR per customer with three or more modules continues to increase as well. As John mentioned, this cohort represented 33% of our customers in the third quarter, up from 24% last year. with an average ARR of more than $400,000. As more and more customers adopt the platform approach, we continue to believe the average ARR per enterprise customer could be north of $1 million. Moving on to revenue, total revenue for the third quarter was $183 million, $10 million above the high end of our guidance, and representing an increase of 28% on a year-over-year basis or 25% in constant currency. The strength in total revenue growth is being driven by 33% growth in subscription revenue, or 30% in constant currency. Overall, revenue came in well above our guidance due to some FX tailwinds, but more importantly, we saw strength in all areas, including new bookings, strong linearity, and solid retention rates that drove revenue and ARR outperformance. With respect to margins, total non-GAAP gross margin for the third quarter was 85%, in line with last quarter and up over one percentage point from Q3 of last year. Our non-GAAP operating income for the third quarter was $53 million, $8 million above the high end of our guidance due to the revenue and associated gross margin upside. This led to a non-GAAP operating margin of 29%. up three percentage points from the third quarter of last year. We are very pleased with this performance as it shows the operating leverage potential inherent in our business. However, we have shared that we believe in a balanced approach to operating the business, one that delivers strong and durable performance on both the top line and bottom line. Last quarter, I mentioned our strategy to accelerate investments in targeted areas to support the long-term growth of the business. Many of these initiatives were in place in Q3, resulting in a sequential increase of $12 million in non-GAAP operating expense, with R&D increasing 5% and sales and marketing increasing 16% sequentially. Looking forward, we expect another step up in investments in the fourth quarter, and this is reflected in the guidance that I will cover in a moment. From a profit standpoint, non-GAAP net income was $48 million, or 17 cents per share. Starting as a balance sheet, as of December 31st, we had $300 million of cash, an increase of $111 million compared to the same period last year. Our ability to generate cash while investing in the business remains strong. Our long-term debt was $451 million at the end of Q3. That's down $89 million over the third quarter of last year and $30 million sequentially due to a principal repayment that we made early in the quarter. As we have shared in the past, we are committed to reducing our outstanding debt and improving our leverage ratio. At the end of the third quarter, our leverage ratio was well below one times trailing 12-month adjusted EBITDA. We made an additional repayment of $60 million during the month of January, further reducing our debt balance to approximately $391 million. Through January of 21, our principal repayments have totaled $120 million in the current fiscal year. Our unlevered free cash flow for Q3 was very healthy at $74 million. On a trailing 12-month basis, our unlevered free cash flow was $215 million or 33 percent of the trailing 12-month revenue. This margin level is above our previous annual guidance of 29 to 30 percent due to a combination of the health of the top line, COVID-related cost savings, and a tax refund that was more favorable than our original estimates. Turning to our guidance, ARR is expected to be between $756 and $760 million, up 32% to 33% year-over-year, or 29% in constant currency. Our ARR guidance assumes approximately $16 million in perpetual license roll-off, or roughly three percentage points of headwind to growth. Excluding the perpetual license headwind, our adjusted ARR growth rate is expected to be roughly 32% year-over-year on a constant currency basis. For the fourth quarter, we expect total revenue to be between $190 and $192 million, up 26% to 28% year-over-year, or 23% to 24% in constant currency. Subscription revenue is expected to be between $178 and $180 million, up 32 to 33 percent year-over-year, or 28 to 29 percent in constant currency. From a profit standpoint, non-GAAP operating income is expected to be between $44 and $46 million, 23 to 24 percent of revenue, and non-GAAP EPS of 13 to 14 cents per share. This EPS guidance assumes cash taxes paid of $3 million in the fourth quarter, resulting in an annual effective cash tax rate of approximately 7% for the fiscal year in line with previous guidance. Total revenue for the full year is expected to be $697 to $699 million, up 28% year-over-year, 27% in constant currency. Underlying that, subscription revenue is expected to be between $650 and $652 million, up 33% to 34% year-over-year, or 32% in constant currency. Moving down to P&L, we expect four-year non-GAAP operating income to be between $202 and $204 million, and non-GAAP EPS of 61 to 62 cents per share. We are raising our unlevered free cash flow margin guidance to approximately 32 percent of fiscal 21 revenue. That's two percentage points above the high end of our previous guidance due to the top-line strength of the business, combined with COVID-related cost savings, as well as a favorable tax refund of approximately $10 million for our original guidance. This four-year guidance assumes operating margin leverage of roughly five points compared to last year due to our strong business performance and COVID-related cost savings. As I mentioned at our investor day and since then, we are committed to investing for the long term. We expect to increase our sales and marketing and R&D spend as a percent of revenue. As a result of these strategic investments, coupled with a return to a more normal level of employee spend, we expect operating margins will return to pre-pandemic levels over the next year. In summary, we are very pleased with our third quarter performance with strong ARR and top-line growth, healthy profitability, and a proven ability to generate strong cash margins. We believe our unique platform approach will continue to drive new customers to the Dynatrace platform, and our innovation engine will continue to power our net expansion rate. These building blocks provide us with the confidence for sustained growth as we move forward. And with that, John and I would be happy to take your questions. Operator?

Thank you. We'll now be conducting a question and answer session. If you'd like to be placed in the question queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star 1. One moment, please, while we poll for questions. Our first question today is coming from Matt Hedberg from RBC Capital Markets. Your line is now live.

Oh, hey, great, guys. Thanks for taking my questions and really strong third quarter here. John, I wanted to ask you about the expanded GCP partnership. Obviously, you guys had a press release a little bit ago. But I'm sort of curious, can you talk about lessons learned from AWS? Obviously, they were sort of a bigger partner earlier. How did that partnership progress? I'm just sort of trying to get a sense for how it might impact ARR. And then could you talk about the importance of really being the only observability platform with a private offering in all three public cloud marketplaces?

Sure, Matt. Appreciate your comments. So the GCP partnership is, in the past, we've been focused on sort of the technical relationships, making sure our products are automatic and simple to deploy in each of the various cloud environments. But we've seen over the last year a growing opportunity to enhance the go-to-market side with the hyperscalers. as they start to draw more enterprise spend toward them with these pre-commits. And that's provided an opportunity for us to be more aggressive in this area. And we see the GCP opportunity as a great one for us. A number of our customers are either moving from another cloud to GCP or adding GCP as yet another cloud in their portfolio. that they want to leverage for various workloads. So as we've seen that and as the Google Cloud Platform folks are continuing to get more and more aggressive in the market, we saw an opportunity to jump ahead of competition and put this go-to-market relationship together in a meaningful way. And so with that, we've had a great relationship with AWS, of course, and then as well with Microsoft. The GCP addition really does allow our customers now the flexibility to deploy anywhere, run anywhere, and do it easily, smoothly, and efficiently, as well as leveraging pre-commit spends to do so. So we're excited about the combination, for sure. That's super helpful.

And then, Kevin, I really do appreciate you calling out the $8 million perpetual runoff headwind in Q3 and the $16 million expectation for Q4. I'm sort of curious, obviously, you know, this will continue on into next year, and you haven't guided fully your next year, but can you talk about sort of the cadence of that runoff, you know, as we progress through fiscal 22?

Sure. So, For the last couple quarters, meaning Q3, Q2, it was about a point and a half, a little bit more than a point and a half of headwind to AR growth. And then in Q4, our guidance was about 2.7 points of headwind growth. And I think we'll see that trend continue for the course of fiscal 22. It will move up a little bit more on top of where we guided for Q4, so I think a little bit over three points. And then there's a pretty big class at the end of fiscal 22. So, you know, there's not gonna be a large percent of AR remaining as perpetual license, and there will be de minimis from it at fiscal 23.

So the headwinds will diminish as we go out through the course of fiscal 22. Super helpful. Thanks, Lucas.

Thank you. Next question today is coming from Jennifer Lowe from UBS. Your line is now live.

Great, thank you. Maybe just to continue on that last question, You know, if I look at the guidance for Q4, and there are a lot of puts and takes there around currency and the headwinds from the model runoff. But if I back those out, it seems like the guidance implies very little deceleration in AR growth on a constant currency adjusted basis relative to what we saw in Q3. So if I put that in context, should we assume that that sort of reflects easier comparisons versus the impact of COVID kicking in March of last year? Or are you sort of getting more optimistic about the growth in the business outside of those impacted industries? Just any more context there would be helpful.

Sure. I'll start, Jennifer, and then if John wants to add anything. And I think you're right.

If you look at the numbers, the guidance implies 32% constant currency growth excluding the perpetual license headwind, which is fairly consistent actually with Q3 where we ended 33%.

And I think there's a lot of different factors that have given us optimism, you know, as we move forward in the business. You know, if you look at the sales organization, we've been talking about growing that 20, 25%. You know, we're going to be stepping that up. We're seeing, you know, some step-ups in productivity as people, as we've talked about over the last year. So, rolling down that conversion activity and focus on new levels and expansion and We're seeing a nice maturity in the sales organization as well. And then we layer on top of that investments we're making in marketing, lead gen, the market there, combined with, you know, the innovation comments we've made through the course of the year. All those different factors stepped up in the quarter that resulted in, you know, really healthy new logo numbers and a healthy net expansion rate. And, you know, we think those trends can continue as we move forward.

Yeah, I think that's well said, Kevin. The only thing I might add to that is we do continue to see at the enterprise level, the billion-dollar-plus company level, that the market is moving toward us. We're seeing more and more evidence that the difference that we bring to the market with advanced automation and intelligence becoming requirements for the highly complex market and high-scale environments that these large companies have is really starting to resonate, you know, and pay off. And so, you know, that's another factor that I'd add. And I would say, yes, we're feeling, you know, optimistic about the business. Strong Q3 sets us up well for, you know, for going forward.

Great. And maybe just one more from me. You know, you commented that 40% of customers were using the infrastructure-only module. And I'm curious, you know, when you get in the door with that offering, how broad do customers typically go on the infrastructure side? I mean, in theory, you know, you could cover 100% of the enterprise on infrastructure. Are you seeing those sort of wall-to-wall deployments yet, or is it still sort of more contained around, you know, work – environments are related to where they're using APM. Could you add some more context on how broad that can go at this point?

Sure. Yeah, so first, just to clarify, all of the sort of APM module, you know, customers, which is still the majority, that includes the infrastructure, you know, capabilities. But there are extensions that don't require those kind of application workloads, as I pointed out in the prepared remarks. We are seeing customers go wall to wall. It's not a high percentage yet. So the vast majority have plenty, you know, more infrastructure expansion they can do. But we're getting better at it and customers are understanding the value of having sort of a single, you know, source of truth across a much wider footprint, you know, and the automation and intelligence, you know, leverage that gives their digital teams, you know, So, you know, again, not only are more customers, you know, using that capability and exploring that capability, but they're also rolling it out in a broader way as we go, which is, you know, evidenced in our net expansion rate continuing to stay above 120%. Great. Thanks, guys. Thank you, Jim.

Thank you. Our next question today is coming from Sterling Auty from J.P. Morgan. Your line is now live.

Yeah, thanks, guys. Just one question from my side, just back on the partnerships. I think from the outsider's view, from the investor's view, it's kind of hard to delineate and differentiate some of the announcements that we've seen coming out of Datadog and yourselves. Is there a way to differentiate the partnerships that you've established within these public cloud providers and perhaps what kind of impact you expect to see from them on revenue vis-a-vis what else you've seen announced in the market?

That's interesting. It can be a little bit difficult to parse, of course. Each of these hyperscalers are going to play a little bit of Switzerland, so the advantages anyone appears to have is relatively fleeting, I would say. But I think the important thing to take away is this, that Dynatrace has deep relationships with all three. We're a premium partner with all three. we have not only early access to technology to enable customers to benefit from tighter and tighter integrations with the marketplaces and various offerings, but also that the go-to-market, which is becoming, as I said earlier, a bigger and bigger piece of these relationships as these hyperscalers aggregate enterprise spend. These are things that, you know, Dynatrace is at the front of and our customers expect us to be. And the value that they receive from them is, you know, greater efficiency and confidence that we're there with the most advanced services that these hyperscalers offer at the time they offer them. And I think that's really the key takeaway is that – you know, we have the same relationships or better than anybody else in this marketplace. Thank you.

Thank you. Our next question today is coming from Baban Suri from William Blair. Your line is now live.

Hey, guys. Thanks for taking my question. Let me echo my congrats and solid results and hope the snow isn't too much of a disruption for you guys out there. We already had our share in Chicago, so. Um, I guess, uh, let, let me follow up on Sterling's question around partnerships, but not the, not the web scale partnerships, but you've got a lot of other partnerships in our service now. You've got some integrated partnerships, things like that. I guess, John, maybe help us think through the strategy of doubling down on sales, vis-a-vis using the leverage or leveraging the partnerships to drive growth into new, uh, existing accounts or new accounts. How should we think about those investments? And is it so early that you're just going to double down on everything across the board?

At some point, do we see the leverage of the partnerships play out where we don't need to add sales headcount to do that? How have you guys thought about that? Great question. At the enterprise level, it's a little bit different than maybe in the mid-market. At the enterprise level, especially when you have a platform that's quite different, you know, in its characteristics, like the Dynatrace platform is, you know, it's not just in, you know, observability. It includes the automation and and AI to provide understandability, predictability, and actionability, you know, all in one. We believe that a sales organization is required to do that. But at the same time, we definitely pick up acceleration in ramp time and acceleration to full productivity by having these kind of partnerships. And that's what's giving us sort of the combination of of revving up the partnership, seeing the return there at the same time. We're seeing the productivity improvements in sales has given us the confidence that we ought to continue to tap the gas on that sales front and step it up from the 20% to 25% where we've been to the 25% to 30%, which is where we're headed right now. So we're excited about the combination. We think it is that combination that at the enterprise level, you know, sets us apart and will help accelerate, you know, as Kevin and I have talked about, you know, our ARR growth and continued momentum in the business.

Got it. Got it. Got it. Helpful. And then just staying on the sales question for a second, any particular regions or verticals that you're adding on? Are you seeing increased adoption? And I think you talked about sort of retail coming back and hospitality coming back a little bit. Sorry, oil and gas coming back a little bit, you know, sort of post, or as we get, we see the light at the end of the tunnel for COVID.

But as you think about adding the sales headcount, are there specific areas, whether it's like maybe crypto providers, I don't know, that you're seeing greater demand in for understanding and monitoring observability, et cetera? It's really not any specific, you know, area, Bhavan. It really is across the board. It's just that digital transformation around the globe continues to accelerate. everybody's turning into a software company. Everybody needs to make sure they manage that software extremely well, flawlessly, if they can. And we just happen to have a phenomenal platform for those large, more complex environments, as you know. So it really isn't anything on that front. Let me add maybe a couple thoughts as well. and that is that we are getting to the size of the business where we are starting to verticalize in certain areas, which I think also has a little bit of opportunity to accelerate in it, certain geographies, certain verticals. And the second thing is we are seeing an uptick, especially in North America, in state and federal government business as we spend more time and invest more heavily in those areas as well, which we talked about earlier this year.

Got it. Super helpful. Thanks, guys. Appreciate you taking the questions.

Thank you. Our next question is coming from Mohit Gojia from Barclays, Carolina. Is that live?

Hey, guys. Thanks for taking my question, and I will offer my congrats on a really solid quarter as well. So my first question, John, so I was just wondering if you can help us understand the drivers, right, and maybe the relative proportion of sort of like What will drive the AR per customer from a quarter of a million dollars right now to a million dollars that you have mentioned, right? Obviously, that's the long term. But as you go on the trajectory, do you think that it's going to be more about, obviously, your penetration with an APM? So you've talked about application monitoring coverage doubling. You expect that to double over the next few years at the end of this stay last year, right? Is that going to be a bigger driver, you reckon, or do you reckon that your infrastructure monitoring, your cloud application security module, they're going to mature enough and be a driver of land and expand motion as much that that will be a bigger contributor of that AR per customer growth? So just wondering if you can help us give more color there.

Sure. Love to. So first of all, it's important to know that the 3 Plus module is ASP or average ARR for customer is, you know, substantially, you know, higher than the average. Average is around 250K, and the three-plus module, you know, cohort is well over 400K. So that's the first thing. Make sure that you cross-sell. The second thing is that none of our customers are fully saturated on the application side, not even our very, very largest ones. So either the applications continue to grow or they continue to add to them. All of that is consumption-based. We have a consumption-based model, and that means expansion on that application front alone is massive. And then you add to it entering new markets. I mean, we're super early in the cloud app security space, but I don't think anybody questions how valuable that is and how much it's being disrupted by the cloud. We're pretty good at getting it right, listening to customers, figuring it out as we go into a market. We've proven it multiple times now, and I think you're going to see it again in the cloud app security space. So you put those three together of continued upsell opportunity with applications, great cross-sell opportunity with existing modules, and then adding new capabilities, new modules, you know, to the platform, and gives us a lot of confidence and running room, you know, to continue to drive, you know, solid, sustainable growth for the long term.

Great. Thanks. My follow-up question is for Kevin. Um, so great to see that you guys are feeling confident enough to raise the, um, the expectations around how much the sales capacity is going to grow. But Kevin, if I, if I go back to your sort of the, the, um, mid to long term AR growth sort of like a framework you gave us, right? Uh, of 25%. I'm wondering if you can talk qualitatively on as to, uh, if, if that moves as well given that the sales capacity sort of like, uh, a higher sales capacity adds, right? I mean, I'm most convinced not to talk about that. They would like to see sales efficiency and leverage in the model still. So if 20, 25% sales capacity has gone higher, are you sort of like baking in some expectations around that AR growth in the middle long term? That's just on my side, guys. Thank you.

Yeah, no, if you think about the business and the building blocks of the business over time, you know, obviously, and sort of the inputs to that, the first is sales productivity. And I think underpinning some of those are not just the 25% to 30% sales capacity growth that John talked about, but it's also the fact that, you know, we do believe over time we can get higher productivity out of our sales organization as they mature and as they're no longer working on the conversions. So those are sort of underlying that. And then when we talk about the building blocks to AARC, right, and those are two. It's pretty straightforward, right? The first is the number of new logos that we can add to the franchise. Q3, we grew that 10% year over year. Q4, we said that growth rate will accelerate, and we've also talked about a 15% to 20% new level of growth as we move the business forward. You couple that with 120% net expansion rate, you do the math, and that AR number is above that 25%. and long-term target that we talked about. So we're very optimistic about the business. A lot of things moved a lot across the board in the right direction this quarter. Everything sort of stepped up. We're optimistic that that can continue as we move forward in the fourth quarter.

We're not going to come off of our long-term numbers at this point, but we look forward to updating you after our Q4 numbers and talk about the trajectory of the business going into 2022 then. Thanks, guys.

Thank you. Our next question is coming from Andrew Nowinski from DA David's Interline. He's now live.

Great. Thank you for taking the question and a nice quarter. I want to ask about the cloud application security solution. If you could just give us maybe any color around what you see as the competitive landscape in that market, and also is that a different buyer that might be buying that solution when you go into an enterprise to cross-sell it?

Great questions. So what we found when we were doing our sort of due diligence before we even brought the product to market is just playing out as we talk to more and more customers now and additional proof of concepts that are underway. First of all, the folks with the pain are the same cloud application folks that we talked to today. They're the ones that are being, you know, throttled by the security teams and probably rightly so because the security teams need to make sure everything is locked down secure that, you know, runs and sprawls across these clouds. And the common way of doing this is to try to do code scan after code scan. The pre-production, of course, before things are deployed, and then periodic, not continuous, but periodic in production. And what the results are are long lists of false positives. Only a few, like very small number of actual vulnerabilities, but these development teams have to go through everything and triple check them. So that slows innovations. and it's not really what the development teams want to do. They want to innovate. And so we solved that friction between the security requirements and the speed of DevOps by providing not only pre-production scanning but continuous production scanning for vulnerabilities. And we have the intelligence in our platform that eliminates the false positives. I mean, reduces the noise dramatically, making the development teams much more efficient, you know, and obviously the speed of innovation and deployment, you know, much greater. So that's what's playing out. We think it's a, you know, we have a great opportunity. You know, the feedback has been super positive. But like anything that's enterprise grade, especially if it's, you know, going to go through the security gauntlet, it's going to take a little bit of time to validate and verify. but we're optimistic and excited about the first 90 days here, or 60 days, and we'll be talking more about it, of course, as we go in the future.

That's great. Thank you. And then maybe just a follow-up to that as well. You had an integration with, I believe, SNCC, so along the same DevOps line, which SNCC just caught a very high valuation on their last round. So I'm curious as to your views on on where you think that partnership can go and how that helps you in that DevOps market.

Yeah, with Snyk in the DevSecOps space?

Yes.

Yes. Well, you know, they have a phenomenal vulnerability database. They also happen to have very good information for developers as to exactly, you know, how to remediate an issue. So the combination of of our continuous intelligent vulnerability detection combined with their database, which is what we leverage, as well as their information for developers is like a perfect combination for DevSecOps acceleration. So they've been a great partner to work with. You know, we're excited to have our systems, you know, sort of integrated, you know, together. We give them, you know, runtime, you know, sort of view and value, and they give us some fantastic, you know, behind-the-scenes data for leverage. Thank you.

Thank you. Our next question today is coming from David Hines from Canada Corridor Line. Is that live?

Congrats on the results. Maybe I want to follow up on the last question on the security front a little bit. Look, I realize how early it is, and I'm sure there's a bit of price discovery happening in the market now. But if you think, like, looking forward, how much of an uplift to spend could the adoption of security be, right? I mean, if you have the average customer spending, you know, 250 grand with you, Is it 10% uplift, 20, like more? Like any frame of reference there would be helpful as we think about the opportunity.

Well, so our plans include multiple different kind of capabilities in the DevEx for this module. This first capability, the vulnerability detection, you know, we think is, you know, a 10% to 20%, you know, uplift. but there's no reason that based on the plans we have and what we think we can bring to market that our app security module can't be a dollar for dollar with the APM module. I mean, the value is significant, obviously, you know, and it's the kind of solution that gets rolled out in a very broad way, you know, not in a piecemeal way once it's proven. So anyway, that's those are some of the thoughts behind why invest in this versus something else. Not only is it a great disruptive moment, but it's also something we think we can continue to build on and really have a significant ARR impact over time.

Yeah, yeah, makes sense. And then maybe just a higher level question that kind of gets at the triggers for expansion. I think looking backwards, right, over the last couple years, like, you know, the migration of the new platform was a great opportunity for you guys to get in there and get bigger, right? Now that we're past that, like, what's typically the catalyst for expansion in the base, right? Is it just the digital transformation initiatives that you're seeing? Is it new products trigger conversation? Does it just happen at renewals? Like, help us, like, what's the process and speak to that maybe in the context of, you know, sustainability of that you know, 120-plus net dollar expansion?

Sure. Well, so, you know, it really is the couple different, you know, motions. The first one, you know, land and expand motion. The landing zone hasn't changed much, but what's happening is more and more companies are hitting what we call the microservices ball, where the dynamic complexity at the application level gets so great and that blind spots, you know, are vast and sort of, you know, massive, you know, gaps in observability when it comes to sort of multi-app portfolios and large-scale environments. And, you know, there's nothing like, you know, Dynatrace in those environments. And more and more companies are finding that their alternative solutions, whether they were a Gen 2, you know, APM solution, whether they – thought they could do it with an infrastructure approach and maybe that would be enough or whether they're trying to throw a bag of tools at it, open source tools at it. I mean, all those are falling short at the enterprise level. So that's helping us land new logos faster as well as bring new reps up to speed more quickly. On the expansion front, like I said, everybody's putting more workloads on these clouds. As fast as they can rewrite the old apps or add new apps, everyone's doing it.

DevOps is a fantastic thing because companies can move faster at the same time.

Lots of new workloads and services going out in production that need to be observed. observed, understood, troubleshot, optimized, et cetera. And then the cross-sell is just natural for our customers once they get the hang of how our platform works. That's earlier days, as we've talked about, but it's catching on. People are getting the hang of, gee, if I have automation and intelligence, why wouldn't I want more of it across a broader footprint of my infrastructure and services? So I think it's really the combination of all three of those that are driving the momentum, and that's why we're stepping things up, whether it's on the partner front or the sales front. That makes sense. Thanks, and congrats.

Thank you. Thank you. Our final question today is coming from Walter Pritchard from Citi. Your line is now live.

Hi, thanks. Just to follow up on a couple of these questions here, around the sales organization, I mean, you're taking on more partners. You've got the security go-to-market, which is a little bit of a different buyer, and then you continue to rapidly expand the size of the sales force, stepping up that hiring rate, as you talked about. Can you help us understand, as we move into fiscal 22, any structural changes or any sort of evolutions you're making to the sales force just to enable you to sort of keep up this pace of growth and these new initiatives that you've articulated?

Yeah, no, great question, Walter. We plan our sales superstructure pretty well ahead. So I think on the direct sales front, we're in pretty good shape, nothing too dramatic. I mentioned a little bit around some vertical focuses. We're doubling down in state and federal in North America, a couple things like that. that are, you know, obvious and smart expansions, I think. We are expanding our partner, you know, team, both on the Tech Alliance side and on the cloud system integrators. So, you know, that continues under the hood. We've talked about that a little bit, you know, before. And then, you know, we've really stepped up, you know, our marketing efforts. We don't talk about that, you know, quite as much but the entire organizational structure there and sort of, you know, program and program management there toward digital as opposed to physical, you know, has been a big shift for us, you know, over the last 12 months. So all those pieces are in place, and, you know, we're really just stepping up, you know, on what's in place and expanding across a number of areas, but nothing sort of dramatic, right? that we have to do, that we have to prove out. It's just more step on the gas and build on, you know, what we have going right now. Got it.

Great. And just in terms of where you're getting salespeople, as you look towards that acceleration, is there any sort of bend you're making in types of people you're hiring as you look at the future versus the last couple years? No.

Not a lot of changes. I think, if anything, we're spending more time sort of going to adjacent infrastructure spaces as opposed to try to find people with performance, you know, or performance or infrastructure monitoring kinds of backgrounds. We find there's some bad habits there. So we like to train folks new and, you know, We're doing a really good job now, I think, of finding better talent, people not looking for work, but having a reputation for being a fantastic company to work for, especially on the sales front. And I think that that's helping us with talent acquisition, reducing turnover. And as Kevin said, it's a little bit of sort of the secret sauce under the hood with sales right now is that the maturity is increasing quickly. with a lot more reps having been here for two-plus years, and they really get the hang of how Dynatrace is different, who to find, and how to articulate our value advantage. Got it. Great. Thanks. Thanks, Walter. Maybe I can just add real quickly. I know people are going to have to hop. A quick thank you for joining us. You could tell Q3 was a great quarter for us, sets us up for a great finish in 2021, we think. And we're pleased with how the market's moving, how our go-to-market's paying off, the innovation engine alive and well. And we're looking forward to giving you guys an update, you know, in May as to Q4 results and end of year, as well as FY22 guidance. So with that, We're back to execution. Thank you very much, and have a great day.

Cheers. Thank you. That does conclude today's teleconference and webinar. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.