All right, good afternoon. Hope everyone's had a great lunch heading into the afternoon sessions of day two at the Morgan Stanley TMT Conference. Super happy to have Jim Benson, Chief Financial Officer from natrace, join us at the Morgan Stanley TMT Conference again.
Thanks for having me. I don't know if it's great being the speaker after lunch, but we'll see how that goes.
We'll pump it up. CEO Rick McConnell was supposed to join us. Unfortunately, he got sick with the flu, so we definitely wish Rick a speedy recovery and the best of health.
He might be listening.
Great, yeah, exactly. All right, so if they chime in, give me an answer. Before we get into the conversation, let me go through some disclosures. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.
So maybe, Rick, we just sort of start high level. Let's reflect on fiscal year 2025. It's still in progress, right? We got one quarter to go. As you compare fiscal year 2025, which is still in progress, to fiscal year 2024, where within the business do you guys have more confidence, where you see things getting better, and what are some of still the areas where you feel like you could execute better?
I'd say, reflecting on fiscal 2025 versus 2024, I'd say there's two big areas that we feel really good about. We made some changes in our go-to-market model at the beginning of fiscal 2025. And these changes were all designed to go on the offensive. And so we had a scrappy kind of go-to-market model before, but it was a bit of a one-play model. Go find an application owner, get through a proof of concept, land the deal, and then expand from there.
And our new CRO, after having been in place for about a year, looked at the segmentation of where we had coverage and wanted to design a coverage model that was more oriented to drive scale. And so we looked at the go-to-market model. We made some changes. I think we talked about it in the early part of the year. We effectively moved 30% of our accounts to new reps, which could have caused significant disruption. We focused more on the IT 500. We resourced more there, fewer accounts per rep in that category.
We made some changes in sales plays, so we went from a kind of the sales play that I mentioned to another sales play around tool consolidation and another sales play around cloud modernization, and so we built more sophistication and enablement in the sales model, so whenever you make go-to-market changes, that can lead to disruption. Again, these changes were to go on the offensive, and so we feel very good about the fact that we actually have not seen disruption. We haven't seen the productivity benefit yet from these changes, but in the early goings, the likely possibility is you have disruption. We didn't see that, so we feel quite good about that.
On the product front, we continue to be building out more on the innovation front, and I'd say one of the areas that we're focusing on, again, we talked about cloud modernization, which is extending more the developer persona. There's been a fair amount of activity around better visualizations for developers, better dashboarding for developers, so there's been an orientation where our historical buyer has been the IT operations leaders and extending more to the developer persona and having more of that audience familiar with the Dynatrace product.
They can have an influence in decisions when decisions get made around tools, so feel very good about that. Feel good about logs. With the underpinning of our Grail data lakehouse , looking at logs and kind of context of other data types, we feel very good about traction in that area. So those are areas that I'd say for fiscal 2025 that have gone well. And I think that you should see that extend into fiscal 2026. I'd say the productivity benefits of all the things that we put in place, we're expecting to see that improvement.
I'd say in the area of not everything goes perfect, that on the go-to-market side, we focused on the IT 500, the commercial segment, which is below that. We did see a little bit of softness in the commercial segment. But I view that a little bit as we moved some resources from the commercial segment to the enterprise segment and probably some of your best resources. So some of our new capacity has been added to that segment. But I think I feel pretty good about that. It's just tuning. That's just focus.
I don't think there's going to be radical changes that we need to make. But all in all, we're very optimistic that the ingredients that we put in place, both on the product side and on the go-to-market side, and probably importantly, on the adoption side. One of the things that I probably should have mentioned as well is we're getting tremendous traction with our Dynatrace Platform Subscription model. It's 55% of our ARR. And let's face it, it is a consumption model.
And so there is a drive adoption, drive consumption component to that. And we're seeing that. We're seeing that that model is really allowing customers to leverage more of the platform and leverage more of the capability. So I'd say that has certainly met our expectations. That was something that we wanted to do, and we want to continue to drive that. Those are changes that we expect to continue into fiscal 2026 with driving more adoption across the company.
Yeah. That was fantastic, everybody. We'll probably dive into all of those topics through the course of discussion.
I think we can cover them one, two, three.
Exactly. Yeah, we're done. Any questions? We were talking off stage kind of about the environment that we've been in for the past two plus, call it three years, just a higher rate environment, a more sober spend environment. As we've progressed through that, what's the storyline in terms of how has the competitive environment changed over the last three years?
And then from your guys' perspective, I'm not calling that we're out of it yet, but as we progress out of this era of spending, if you will, what gives you the confidence that you're coming out of it in a stronger competitive position? If it's the same, you always take advantage of a recession or an opportunity. How is Dynatrace coming out of this cycle on a better competitive footing?
So I'd say on your first question around the competitive environment, I don't think the competitive environment has fundamentally changed in any material way. Still a highly competitive environment. There are a lot of providers in the space. I think we certainly have distinguished ourselves amongst providers in the space. And I think that's echoed by industry analysts when you look at different categories, whether it be Gartner or what have you, around Magic Quadrant. So we're very well positioned.
So the competitive environment hasn't fundamentally changed. I'd say possibly three years ago, you could say there were more public companies that were in the observability space. Those companies have gone private, or those companies have been acquired by larger companies. And so I think what that does tell you, it tells you about the importance of the space. I think observability is a large growing market. And I think the fact that you see some go-to-privates and even some takeouts really acknowledge the kind of growing viability of the space. I would say onto your point about emerging stronger, I think you're absolutely right.
I think whenever you enter a recession area or a tight spending environment, you go from go-go days to all of a sudden a period of more scrutiny. I'd say our efforts from a go-to-market perspective in tuning not just the go-to-market model, but working the model around pipeline, pipeline generation, close rates, things of that nature. I'd say we are much more, I would say, on top of things. And I think some of that helps with new leadership. And I'll go back to my point about going on the offensive. All the things that you just said, I think we've learned to live with the environment.
The environment we're in is one where there is budget scrutiny, but they are prioritizing observability for spending. So it is an area that they're certainly spending money on. But all the things that I talked about earlier around the go-to-market changes that we're making, the product changes we're making, these are all oriented to go on the offensive because we think there's significant growth opportunity that we can go capitalize on. And I think the underpinnings of that are we feel really confident with the differentiation of the Dynatrace Platform.
We are a unique platform. I think other companies talk about having a platform, and everyone says that. I mean, our platform is truly unified. It's unified at a data layer. You can look at all data types in context, including logs. And so we have a differentiation in the market. As to where the market is moving, you're even hearing kind of competitors talk about the importance of looking at data types within context. And so I think the underpinnings of the Dynatrace Platform with AI underpinnings that we've had for over a decade, more contextual analytics and automation, that's where I'd say we're in a very good position to capitalize on some of the investments that we've been making.
Yeah, it makes perfect sense. Let's return to the topic of the DPS subscriptions and its sort of impact on the growth equation at Dynatrace. First off, I mean, 1,500 customers on DPS, 35% of the base, North of 55% of your ARR. And those DPS customers consuming at 2x the rate of Non-DPS customers. The emerging dynamic that seems to be at play is that as customers sort of exhaust their commitments, DPS customers exhaust their commitments, they're choosing to go on demand, which is benefiting subscription revenue, but not ARR.
And so with these kind of emerging dynamics in the model, from an investor perspective, what do you believe is the right sort of metric to assess growth in the quarter going forward? Is it subscription revenue? It's ARR? And how do you see that? How do you guys sort of think about pointing investors to which metric is the more durable one to rely on going forward?
Yeah, it's a great question, and I'd say that if you asked me that question probably nine months ago, I would have said ARR. As I say, the phenomena that we're seeing with DPS admittedly has one of the things we knew with DPS, or was the thesis with DPS, was that if you get customers on the DPS contracting vehicle and you make it easier for them to consume the platform and they don't have to go through a sales cycle every time they want to leverage a new capability, that if we were successful, that they would consume more of the platform and they'd consume more capability.
So that was always the thesis. The good news is, to your point, the stats that you talked about suggest that that thesis is playing out. I think our original thesis was, as customers consume their commitments early, that we would see them do an early expansion. And what we've seen is that there are customers that we're seeing are happy to go on demand, to your point, for one or two months. And going back to what's the right metric, I mean, I think ultimately the North Star is going to be subscription revenue.
But that doesn't mean that ARR and NRR and new logos are not important. I'd say they can't be looked at in isolation anymore. They have to be looked at in the context of what's happening with subscription revenue. The good example being we actually saw an acceleration in subscription revenue growth from Q2 to Q3, driven by on-demand consumption. So what it tells you is that there is another kind of growth driver that is not ARR.
I mean, I would say effectively what on-demand consumption is, is deferred ARR. You're going to ultimately see that when the customer does renew, but they're going through a period of time where they're happy to stay on demand. And they do that. We're learning that customers don't like shelfware. And when you have a consumption model, they want to make sure they have 100% certainty that whatever they commit to, they'll spend. But they will budget for more. And so I think this phenomena we're seeing with on-demand consumption, we do expect for it to continue. It is uncommitted by definition.
And so the benefit of ARR is it's committed revenue. On-demand consumption is less committed. But at the end of the day, I keep bringing people back to adoption and consumption. That's what we're trying to drive, make it easier for people to access more of the platform. Whether they do an early expansion or they choose to go on demand, we're somewhat agnostic. It just means that they're getting value out of the platform. If they get value out of the platform, they'll expand at some point.
Yeah. That was actually going to be my follow-up question is like, if you kind of the psychology of the customer's perspective, what are they thinking through in terms of the trade-off between making an early expansion versus continuing to go on demand? And it sounds like you guys are not trying to nudge them to make a new commitment. You're fine with them sort of consuming on demand. Or is it from a salesperson's perspective, from a quota attainment perspective, do they really want to sign that early commitment?
So today, a sales rep gets credited the same for an on-demand consumption dollar as they do an ARR-generating booking dollar. So they get the same amount. We do have a predisposition. Just the way what you manage is ultimately the results that you end up driving. So there is a very significant focus on driving ARR-generating bookings. But from a sales perspective, there's no necessary push.
If a customer is happy to be on-demand consumption, a sales rep gets credit, whether it's an ARR-generating booking. And again, it's a change in the company around driving more adoption, both from a sales perspective. Even though sales may not be driving the adoption themselves personally, they will get alerts. They will get alerts from their customers that they're consuming faster. It results in an engagement, results in a discussion with the customer around would they like to do an early expansion?
Would they potentially, maybe they're leveraging certain aspects of the platform and not others, so it introduces a discussion. It doesn't always yield an early expansion, but again, if you're driving more adoption and they're getting more value out of the platform, how it manifests itself, the sales reps are somewhat agnostic.
Awesome. Let's talk about some of the go-to-market changes and sort of market-to-market where we are. Can you walk us through what the original goals of the go-to-market changes you implemented three quarters ago? And what are some of the early results? Are you seeing the types of behavior that you were looking to incentivize?
So as I said to you from the beginning, that whenever you make go-to-market change, you're worried about disruption. And we certainly, the good news is, we have not seen disruption. And I really credit our sales team for managing very, very well this transition. But the real intent of the changes, we never expected a productivity improvement in fiscal 2025. But what we were looking for was, in particular on the IT 500, establish the relationships, start to build pipeline.
And we have roughly nine to 12-month sales cycles, start to see early traction on close rates. So the good news is we're seeing that. We are seeing growing pipeline in the IT 500. Pipeline in the IT 500 is growing significantly faster than pipeline for the company. And so what we were looking for was pipeline growth. We're seeing that. And we're actually starting to see some close rates of large deals in that area. So those were a big piece of the go-to-market changes. The other go-to-market changes that we made that I didn't talk about that are probably worth mentioning is we made some changes on the partner front where we segmented better.
I'd say we had a bit of a one-size-fits-all model with the partners, whether you were a GSI, whether you were a hyperscaler, or whether you were a regional channel partner. We bifurcated those very different approaches for working with each one of those partner types. And we're seeing an improvement in the influence that partners have on deals. So I think three quarters of our deals in the third quarter were actually influenced by a partner. And ultimately, what we want with partners is more origination. We're seeing an improvement in origination.
I think we have more work to do there. But, so the IT 500 focus, feel really good about that, seeing growing pipeline. So, we're getting traction there. I think on the partner front, we're measuring the partners around how much of their activity are they influencing in a deal, how much are they doing on the originator front, making good progress there. And then I mentioned the sales plays being kind of a third one that we're making traction on the sales plays. So, what we do is we look at pipeline for each one of these sales plays that I mentioned in order to assess whether or not there's an area that we need to kind of tweak.
So, we feel really good about the changes that we're making. And, we're starting to see them manifest themselves. Again, the whole premise of it is these results should yield productivity improvement in fiscal 2026. Obviously, that remains to be seen whether that happens. But I'd say the green shoots of what we're seeing around pipeline, deal origination, deal influencing, and sales plays. We're starting to see traction there. So I'd say there's a growing and building level of confidence within the sales organization.
Awesome. You mentioned in your early answer the focus or just now the focus on the IT 500. The commercial did see a little bit of weakness this year. Can you talk through what sort of the symptoms are? Is this a function of macro, more spending environments ever, or is it more execution-oriented? And what's sort of the game plan to get the commercial business on a better footing?
So I think some of it is honestly that you can only focus on so many things at once. And we were very focused on ensuring we got the IT 500 footprint in place. And so I'd say there were a lot of management eyes on that, Sanjit. And I'd say in the commercial segment, while we did see some weakness in that area, I would argue that it was more a function of we were focused more on making sure the IT 500 was set up correctly. So I don't think there's anything fundamentally wrong in the commercial segment.
There are some things we're doing with the marketing organization to drive more pipeline, to try to drive more pipeline in particular within the commercial segment. There's some territory changes that we're considering. We've been adding rep capacity in the company, probably a low teens growth in reps from fiscal 2024 to fiscal 2025, a fair amount of that oriented around the commercial segment. The way this model tends to work, you're an early rep, you don't produce as much as you progress. We're seeing some of that phenomena within the commercial segment. I don't think it's a radical change in the way we're approaching it. I think it's a maturation of the model.
Understood. Another element of some of the go-to-market changes is kind of move to two kind of six-month sales compensation cycles. To what extent did that change pull forward ARR into fiscal Q2, and to the extent that it did, would the sort of same logic chain kind of apply to Q4 in terms of sales reps looking to bring in deals maybe from the first half pipeline into Q4?
So it's a great question that I would say there were two fundamental reasons why we went to two six-month plans. One was to improve linearity that we did find with annual plans. There's a reason why our business tended to be very skewed towards Q4. So there's a reason why our linearity happened to be more back-end loaded for the company because reps basically had a year to fulfill their quota. So by design, one of the drivers of it was to try to improve some linearity. And I think we did see that.
I think we did see some deal activity in the second quarter that was possibly activity in the past that maybe would have happened naturally in the third quarter. So which is a good thing. That's exactly what we wanted. And so we'll probably see, Sanjit, to some extent that happening, probably not the same in the back half of the year because there always was an incentive for them to do business in the back half of the year. So it was a little bit more on the front end. The other reason why we made the two six-month changes is to the extent you want to tweak the sales model, you can do it in the middle of the year.
We didn't do that this year. But the benefit of two six-month plans is it allows you to introduce modest changes. You can't do that when you have annual plans. It's too disruptive. And so we're continuing. We're going to continue with the two six-month plan design going into fiscal 2026. And we're kind of in the middle of outlining what that is right now.
Yeah. Makes total sense. Maybe last question on the go-to-market side of the house. You guys have noticed that you have greater than 30% of your sales reps having less than one year or tenure. And you sort of framed this year as not necessarily about sales productivity, but sort of putting the.
Building blocks.
The building blocks in place. And so what is ultimately the unlock for sales productivity when that happens over time? Is it just a function of tenure and more tenured reps? Or is there something on the sales operation side, sales strategy side that you guys are looking to do to unlock that greater productivity?
So I'd say it's a little bit of both. I think just in general, having capacity that has more tenure and familiarity with Dynatrace does yield better productivity. So there's certainly an element of just tenure does improve productivity. We've seen it in the past. But I'd say what we've done is we've augmented that with a better level of enablement. So there's more enablement with the sales plays that I mentioned. There's more enablement around value proposition for customers that at the end of the day, some of these sales plays that I mentioned, it's about an ROI.
It's not about who has the best tool because not always the best tool wins necessarily. There needs to be a value proposition for customers that you can either save money, you can increase revenue, you can have a better experience. And so it's both a kind of tenure maturation as well as enabling them from a training perspective. As a matter of fact, I speak at their sales boot camp. And it's a pretty rigorous curriculum that they go through. And so I think the confidence that we have is that you get the reps in place, you train them.
And then as they mature and you introduce some of the things that we're introducing now, you're introducing this notion of strike teams. And so I mentioned that DPS is about driving product adoption. Well, one of the ways you drive product adoption is you have product specialists that are oriented around adoption. And so our sales organization is developing strike teams, one on logs, one on security, and one on digital experience. And so these are kind of evolutionary changes to the model that I think will also allow your sales organization to be more productive because you have teams of people that are going to help customers adopt more.
Adopting more ultimately leads to an increase in consumption, an increase in consumption yields, either an on-demand consumption or yields an incremental or early rebooking. And so there's things that we're doing also on the adoption side to help drive more sales productivity.
That's great. Looking forward to see how that plays out in the business. You mentioned some of the product focus areas. These were originally Rick questions. I promise we'll keep them kind of high level and business focused. But one of the things that we've been coming up in our research is that a renewed importance on getting really good at logs in the category. And you guys have had logs on Grail for a bit now. How much of an upgrade is logs on Grail versus incumbent solutions? And any details you can share about the size of the log business and what are you doing to sort of unlock that opportunity around logs?
So it won't surprise you that we're one of probably a handful of vendors or customers or competitors that you talk to that talk about an opportunity for logs. And that's just because if you generally think of the way logs have been managed in the past, it's been a very significant cost for customers with not necessarily the incremental value that goes along with that. And so it is a huge revenue opportunity. You just look at the incumbents that are in the space today that we have a different approach to it. With our Grail data lakehouse, you have an ability on our model to look at logs in the context of other data types because all a log is another data type.
And using our unified platform, you have a better experience where you're able to look at logs in context with other data types to be able to triage and identify issues quicker. So your path to identification and your path to resolution is better with some of the underpinnings that we have. So we think we have a better kind of mousetrap, so to speak. And then on the pricing front, we have a different model on the pricing front. We have a much more economical model on ingest and retention. There isn't a lot of value in ingest and retention for logs.
The value is on querying. And so our model is oriented around charging less for ingest and retention and charging kind of where the value is, which is on the query. And so I think we also have a different approach to that. Now, one of the inhibitors that we did see as we've been progressing on this journey is some customers not knowing how to control if you're charging per query, if there's not a way to control that, that could be a runaway bill. We introduced in the third quarter a queries included model.
So for those customers that maybe are a bit nervous about that, we do offer a queries included model. And so I do think between one, the product underpinnings, and then two, having an orientation around driving more adoption with these strike teams. And I'd say your sales organization proficiency around selling more into that space that I think we are in a very good position going one, it's the fastest growing product category today. I expect it to continue to be the fastest growing product category. We've talked about a $100 million aspiration for that business.
We are well on track to being able to deliver that in fiscal 2026, and so very optimistic about logs. I think it's a huge growth opportunity for the company and kind of a source of future on-demand consumption and a source of future ARR.
Yeah. That's quite exciting. Maybe as a follow-up to that, and it kind of circles back to the question I had on competition. When you see players in the market go private, do you see that? Do they sort of drop out in terms of the number of opportunities that you guys are competing against in? When you see them, do they focus on certain segments and not as visible in the market? Any sort of storyline around?
Yeah. I mean, it varies based on the player. But I think you are right that when we have seen some of the take privates, I think there is always a period of, call it, settling in where you maybe would see them more in the market. Then they went private. You don't see them as much in the market. So we've certainly seen an element of that. We don't take any competitor for granted. And so while you might see maybe some are focused on maybe they needed to right-size their profitability or something.
And so they're trying to, their focus is somewhere else. We're just trying to drive what we think is something that is important for Dynatrace, which is we think we have something unique. We think we are purpose-built for the enterprise. Regardless of the competitors that are out there and what's happening with them, we think if we can ensure that we are having the right discussions with the right people at a customer level, we're going to win our fair share.
Awesome. We talked about the logs opportunity. Which other parts of the capabilities that product portfolio within Dynatrace do you feel is underpenetrated and could emerge over the next couple of years as drivers of growth?
So I'd say two areas. So I mentioned these strike teams. And I'd say those other two areas beyond logs for security, application security, and digital experience. I do think that those are underpenetrated areas that our prior model, which was a more, call it, think of it as top-line enabling a booking, not a drive adoption model. And application security is a good example that we had security overlay teams that were involved in helping craft and solutioning and working with CISOs and different decision makers.
But ultimately, it manifested itself usually with a DPS contract, which means by definition, they can buy anything on the platform. So they might have sized within their broader DPS envelope they were going to spend some money on security. What we did find is there was a latent implementation of security. I think that with our strike team orientation, they're going to be measured on adoption. The lag that we saw before, I think was largely because the overlay teams were involved in the front end of the deal. Then they left. They weren't involved in the adoption.
Having them more engaged in driving adoption, I think is going to allow us to get better penetration both in security and in digital experience. I'd say the three big categories of growth, obviously core observability, whether it be full stack monitoring infrastructure, those are still going to grow at a good clip. Those will be a function of growing workloads and adding new workloads. But the expansion into adjacent areas, I'd say, are the three areas that we just mentioned with application security and digital experience kind of being areas that we think we can get more penetration.
That makes a ton of sense. Maybe, and this is a question that we've also been getting. So if I think of Dynatrace as a leader in the category, Datadog as a leader category, sort of being the incumbents in this part of the cycle, one of the questions that we're getting is like, hey, we have this GenAI thing happening. And the way applications are getting built is like that sort of reference architecture, that recipe is going to change. And therefore, is there a need for a sort of new mousetrap, an AI-native observability solution?
From your guys' perspective, how do you sort of respond to that? And do you feel like you guys have the platform in place to monitor the next wave of applications under?
I think we do. It's probably a better question for our technical teams. But we have been at AI as a company for over a decade. Obviously, now the advent of GenAI is a new level of AI. We were previously had built causal and predictive AI into the platform. But we announced at our Perform conference kind of an observability LLM observability model so that AI and the advent of AI and the way applications are going to get developed, to your point, leveraging GenAI, I think is something that we're purpose-built to address.
And again, it's a workload. The underpinnings of the workload might look a little bit different. We do have the kind of the telemetry to understand where and how we can tune an LLM model. And so we have familiarity with the way that's going to be working. So I think we're in a good position on that. And I think ultimately, it's going to manifest itself as more workloads get put into production. I think right now, GenAI workloads are relatively modest in production. But I think we're in a good position. When they move that way, it's just more workloads that are going to require observability. And I think we're in a good position to capture that.
Awesome. Well done handling the Rick question. Let's wrap up by some couple of topical questions in the moment. We've got a new administration that's come in. Has there been any, I guess, this signal of a less regulatory environment shown any evidence of unlocking investment in your commercial business? Any signs there thus far?
Yeah. I would say obviously with the new administration, we follow everything that's going on, whether it be new orders, whether it be tariffs, things of that nature. So we're certainly aware of the administration. I'd say that for us, we just got to continue to execute the way we have. Obviously, the environment might change based on administration, whether it be DOGE and efficiency. I think there's an opportunity for us in particular in that particular area because of our offering can provide a level of automation and efficiency, which can help save money.
So that's actually an area we actually think is, even though there's a little bit of current hesitation with what's going on, I actually think it's a longer-term opportunity to drive more penetration in public sector. And so it's an area you got to stay close to. It changes seemingly daily. But we're mindful that the impact on certain customers with tariffs, things like that, that does ultimately impact our end user customer if they're being impacted by those things that it does involve maybe budget constraints that they have to look at for areas of spending.
But I think we are in a good position. I think observability as a category is a growing category where people are spending money. They're prioritizing investment. And we'll stay and acknowledge some of the changes going on in the administration and manage it as best we can.
Awesome. Well, with that, we'll leave it right there. Thank you so much, Jim, for being at the TMT conference and stepping up for your CEO in a big way. And I thought it was a great discussion. Thank you.
Thank you.