Earnings Call Transcript - DT Q4 2020

Operator, Operator

Thank you for joining us for the Dynatrace Fiscal Fourth Quarter 2020 Earnings Conference Call. I would now like to turn it over to your moderator today, Michael from Investor Relations. Please proceed.

Michael Bowen, Investor Relations

Thank you, operator. Good morning and thank you for joining us today to review Dynatrace's fourth quarter and fiscal year 2020 financial results. With me on the call today are John Van Siclen, Chief Executive Officer; and Kevin Burns, Chief Financial Officer. After prepared remarks, we will open up the call for a question-and-answer session. Before we start, I'd like to draw your attention to the Safe Harbor statement included in today's press release. During this call, we'll make statements related to our business that may be considered forward-looking within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21-E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact are forward-looking statements, including statements regarding management's expectations of future financial and operational performance and operational expenditures; expected growth and business outlook, including our financial guidance for the first fiscal quarter and fiscal year 2021. 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 January 31, 2020, 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 fourth quarter and fiscal year 2020 earnings press release in the Investor Relations section of our website at dynatrace.com. With that, I'd like to turn the call over to our Chief Executive Officer, John Van Siclen. John?

John Van Siclen, CEO

Good morning, everyone. And thank you for joining us on our Q4 and year-end fiscal '20 earnings call. Since late January, when we last broadcasted a Dynatrace earnings call, the COVID-19 pandemic has dramatically impacted families, communities, and businesses around the world in a way that we never thought possible. It is our hope that everyone is staying healthy and safe and that those who have become ill have a speedy recovery. And of course, our hearts go out to those who have suffered the tragic loss of loved ones. The sudden shift to remote work has caused applications and the clouds they run on to become an even more essential way to provide services, drive revenue, engage customers, and collaborate among teams. We continue to work closely with our customers to help them respond to their rapidly changing workloads and requirements enabling faster innovation, easier collaboration, and greater efficiency without wasted motion. Despite these challenging times, I believe our strong platform differentiation, balanced business model, and world-class team continue to provide us with a durable growth business. I'd like to reinforce three points this morning. First, the success with which Dynatrace has responded to COVID-19 and what we are seeing across our customer base and market at large. Second, as this marks our fourth earnings call and the end of our fiscal 2020, I'd like to update you on the tremendous progress we've made in both our customer conversion and subscription business model transitions. And third, as our platform becomes increasingly robust across all modules and automation and AI become critical success factors for dynamic multi-cloud observability, I'd like to update you on some of the platform advances we've recently made and the success of our cross-selling motion of emerging products. This will be an important growth area for us as we look ahead. First, I could not be more proud of how the Dynatrace team responded to the challenges of COVID-19. With a modern SaaS platform and an agile workforce, we transitioned to work from home almost overnight and did not miss a beat. We made sure we kept running so our customers could keep running. Not only were we essential to assuring the rapid shift to work from home was successful for our customers around the world, we also provided essential situational awareness to ensure business continuity of running the business applications, services, and workloads for banks, healthcare companies, logistics companies, government portals, and more. So despite what was essentially a two-week pause during mid-March as the shock of the global pandemic took hold and many of our customers were focused on the health and safety of their employees and establishing their work-from-home programs, we closed a solid Q4 with ARR up 42% year-on-year and subscription and services revenue up 37% year-on-year. Linearity and close rates were generally in line with prior Q4s. New logos were up year-on-year and our net expansion rate was above 120% for the eighth consecutive quarter. We believe the strength of our results is largely a reflection of the mission-critical nature of our software intelligence platform. Software eating the world has been a powerful multi-year trend that is still in the early innings, and the rapid move to online commerce and work-from-home initiatives made the uptime and performance of the underlying software applications and infrastructure more important than ever. The Dynatrace platform addresses these same points, just fast to deploy and scale with rapid time to value. We believe, and our customers share the sentiment, that this places Dynatrace near the top of the strategic IT priority list. The strong majority of our ARR, roughly 80% to 85%, is outside of industries more challenged by COVID-19. We also have strength in surging markets, such as healthcare, e-learning, communications, and government. Our customer base is highly diversified, and we focus on the top 15,000 largest enterprises around the world. This said, we do estimate that approximately 15% to 20% of our ARR is with enterprise customers that we consider to be in industries facing headwinds due to the health pandemic, such as travel, hospitality, retail, and automotive. It is prudent to expect that new demand from these industries will be somewhat impacted in the near term. However, at the same time, within these industries, we are typically working with some of the largest and financially healthy companies, and our solution is near the top of their priority list. What we have seen over the past eight weeks has shown us that essential applications and transformation projects continue to move forward, even within industries experiencing headwinds. For example, we did a sizable expansion deal in Italy in late March. This energy company wanted to ensure continuous high-quality service throughout the country and proactively address any issues that arose before service was impacted. In the past, reacting after a failure occurred and service was already disrupted was not unusual. You can imagine with COVID and mandatory shelter-at-home, high-quality energy service was imperative. Dynatrace's rapid automatic rollout and unified AIOps approach to identifying service-impacting issues at the time of degradation with precise actionable answers for rapid remediation made the Dynatrace expansion decision straightforward. Another customer example was an oil company, a new logo to Dynatrace. In the midst of maybe the greatest disruption to the oil business in history, this company determined it was essential to revamp and modernize its commodity trading applications and the technology stack it was running on, shifting to cloud for agility and efficiency for a set of revenue-driving applications and services. They chose Dynatrace because of simplicity, advanced automation, and rapid time to value. It's too early to tell what the specific net impact of COVID-19 will be across our overall customer base and target market. But with a solid Q4 close and fast start to our June quarter with April bookings slightly stronger than a year ago, we are encouraged that we can generate solid growth even with the assumption that we will continue to operate within a challenging macroeconomic backdrop. Shifting now to our progress in converting our customer base and transitioning our business model, FY20 was a fantastic year. We are where we hoped ahead of schedule. We now have 92% of our ARR on the Dynatrace platform, with only 8% left on our classic product set. We added over 1,000 new customers to the Dynatrace platform this past year, now over 2,300 customers with the majority continuing to be new logos. As we said before, nearly all these customers use Dynatrace for observing and optimizing cloud workloads. These clouds may be public or hybrid or, what we see more and more often now, they are multi-cloud, multi-public with hybrid back ends where critical systems of record and many run the business applications still reside. More often than not, Kubernetes is used for container orchestration. More and more, teams are utilizing the latest cloud-native techniques to rapidly build, deploy, and manage applications and workloads at scale. With this combination of complexity, dynamism, and frequency of change, only an automatic AI-assisted observability platform that can handle the most complex public and hybrid environments will work. I'm very pleased our customers have chosen to modernize with us, and it's exciting to know that we are now part of their current and future digital transformation initiatives. Regarding our business transition to a more predictable subscription model, in Q4, 98% of revenue was from subscriptions or services. Our transition from a classic license business to a subscription business is virtually complete. And we've done this while increasing gross margin to 83% overall and 88% for subscription. With over 90% of our customers on a release no more than 30 days old, our operations and support teams are extremely efficient, giving us more time to drive adoption and success across the Dynatrace base. With the customer conversion and subscription business transitions now behind us, we look forward to driving a more streamlined one-platform SaaS business in the years ahead. We'll be even more focused, drive more value, and remain resilient and durable. Now to our platform. Simply put, we have never been in a stronger position. As the response to COVID-19 has highlighted, applications need to work perfectly at all times to drive employee productivity, ensure optimal customer interaction, guarantee business and transactional continuity, and so on. Work locations may change, workloads may shift, but applications must run flawlessly. Applications are the high ground; it's where the business meets IT. Over the past month, the industry's leading analyst firm, Gartner, simultaneously released their annual APM Magic Quadrant and APM critical capabilities guide. For the tenth consecutive year, Dynatrace is considered a leader, and once again, we were given the highest marks among all competition. In the critical capabilities guide, our platform differentiation compared to the competition is even clearer with Dynatrace leading in five of six categories. Achieving this separation requires a radically different approach to the challenges of modern cloud observability. We've made bold decisions; reinventing APM was just a piece of the puzzle. In Q4, we announced expanded capabilities for both our infrastructure-only module and our digital experience module. Over the past year, we have gone from approximately 15% of our customers buying three or more modules from us to over 25%, and that's on a rapidly growing customer base. Our cross-selling muscles are getting stronger. Digital experience has been a popular module extension for us for a few years now. Recently, we have seen a surge in demand for mobile monitoring. Part of this is that we have made it easier than ever to instrument native mobile applications, and we believe part of this is a renewed appreciation for ensuring that the full stack of cloud services, a complex layering of virtual services, and processes actually deliver the value to the end user that is expected. One of our banking customers recently saw a surge in mobile traffic as their customer base went to shelter in place. They quickly added licenses to cover the surge. Another bank told me they did not expect to see their surge in mobile traffic reduce much, if any, post-COVID. They said COVID has done more to train their customer base on the power and ease of home banking than any campaign they ever ran. With higher degrees of online mobile use likely to be a major outcome of the new normal, our early investments and outstanding functionality in digital experience, especially for mobile, should continue to pay off for us. Our infrastructure-only module is newer for us; it's now maturing as we expand coverage for AWS, Azure, and Google Cloud Platform services. Unlike alternatives that only place metrics on dashboards, our unique platform capabilities like AI assistance and automation at scale strengthen this module significantly. Though early in the adoption ramp, we are very encouraged by the uptake of infrastructure-only, now used by 29% of our customer base, and they love the flexibility to toggle up or down on their own between our deep full-stack APM mode and the lighter, broader coverage of the infrastructure-only mode at a lower cost. I should point out for those who are new to our story, our full-stack APM module includes both infrastructure monitoring and AIOps fully unified, and our infrastructure-only module includes log monitoring, network monitoring, and AIOps, also fully unified. We package differently than our competition. Rather than fragment our offering into a list of tools, we take a more holistic approach and solve by use case, going after a larger problem set to drive greater simplicity, efficiency, and value for our customers. Let me summarize. I know I've covered a lot. First, our business has performed very well in the face of unprecedented macro challenges. Though a few of our in-markets may face greater near-term headwinds, we've been very encouraged by overall business trends during April. We believe Dynatrace is well-positioned to continue generating strong growth in an uncertain economic environment due to the fact that we have a differentiated leadership position in a category that is considered near the top of the strategic IT priority list. In addition, we are now a one-platform subscription business. We made tremendous progress this past year converting our base to the new Dynatrace platform and completing our transition away from our classic license business. This renewed focus streamlines our go-to-market and builds a more predictable and durable growth business for the long term. With that, let me turn it over to Kevin for a deeper look into our financials and guidance for Q1 and our full year fiscal 2021.

Kevin Burns, CFO

Thank you, John. And good morning, everyone. Before I start, I would like to express my sympathy to all those who have been impacted by this health crisis and a huge thank you to all the amazing people who have been working tirelessly to help the world deal with the crisis, especially everyone on the front lines. The pandemic requires change and adaptation, and we are no exception. Our main objective during this time has been to support our employees as well as our customers and their mission-critical applications. As John indicated, we seamlessly moved to working remotely, and our employees have adapted nicely. From a customer standpoint, we are pleased that our net retention rate remains robust in this environment. In the fourth quarter, we were modestly impacted on the new bookings side during the second half of March, but overall, the fundamentals of our business remain very solid. We had a strong performance in Q4 and have been very pleased with the progress we had made over the last four quarters as a public company, including exceeding the high end of our quarterly and annual guidance. We continue to operate the business with a healthy combination of growth and profitability, a trend we believe we can continue to deliver on for quite some time, given the increasing importance of cloud software and the strength of the Dynatrace platform and the expanding addressable market we operate in. As a result, despite some headwinds associated with the current environment, we are comfortable establishing full-year guidance that calls for a combination of strong growth in subscription revenue coupled with meaningful profitability and cash flow. So let me start with a quick review of the fourth quarter and fiscal year highlights and then move to fiscal 21. Our key financial metric focus on business momentum is annual recurring revenue. As John said, ARR grew 42% year over year to $572.8 million, an increase of $169 million compared to the year-ago period. This was 44% growth on a constant currency basis, and throughout the year, our ARR faced currency headwinds in the range of 200 basis points to 300 basis points per quarter. The Dynatrace platform continues to increase as a percent of total ARR and was approximately $528 million at the end of March, or 92% of our total ARR. The remaining 8% of our ARR relates to our classic offering. We are extremely pleased with the success of our conversion program, and now that the classic base is down to a single-digit percentage of total ARR and shrinking each quarter, we feel there is no longer a need to break out these components. Moving forward, we will no longer be doing so. The two drivers of ARR growth are new logo customers and our Dynatrace net expansion rate. If we quickly break down these two growth drivers, during the quarter, we added 165 net new Dynatrace customers, ending the quarter with 2,373 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, about 60% of our Dynatrace customer count growth has been the result of new logos to the company. As our conversion program winds down, the volume of new customer adds to the Dynatrace platform is likely to decline on a quarterly basis, while obviously, the ratio of new logos will increase. In addition to a steady flow of new logos, our Dynatrace net expansion rate remained at or above the 120% threshold for the eighth consecutive quarter. As of year-end, the Dynatrace net expansion rate was 123%. In fiscal '21, we'll continue to focus on the Dynatrace net expansion rate, but we will no longer exclude the impact from expansion at the time of conversion as we do not expect it to have a significant impact now that the Dynatrace platform is over 90% of our total business and growing. Our Dynatrace ARR per customer continues to trend up and is over $220,000. We continue to believe that there is a large opportunity for further expansion in our existing customer base. The majority of applications at our customers still lack instrumentation; we continue to expand our value proposition in these cases, and our enterprise customers continue to expand their portfolio of cloud-based applications as they digitally transform their businesses. Moving to revenue, total revenue for the fourth quarter was $150.6 million, $2.6 million above the high end of our guidance, an increase of 30% on a year-over-year basis and 31% in constant currency. The acceleration in total revenue growth is being driven by the strong growth in subscription and services revenue, which was $148.3 million in the fourth quarter, an increase of 37% year-over-year and 38% in constant currency. For the quarter, classic license revenue declined to $2.3 million and represented less than 2% of our quarterly revenue. As John said, our non-GAAP gross margin was 83% for the fourth quarter, an increase from 80% in the fourth quarter of fiscal '19. We continue to see a healthy increase in our subscription gross margin percentage, now at 88% as we realize the benefits of winding down the classic product stack. These world-class margins are a result of a highly reliable platform and autonomous SaaS operation; using Dynatrace on Dynatrace is a unique advantage for us. Our non-GAAP operating income for the fourth quarter was $36 million, above the high end of our guidance of $34.5 million, primarily due to the combination of revenue and associated gross margin upside. This led to a non-GAAP operating margin of 24%, up from 22% in the fourth quarter of '19. Non-GAAP net income was $29.8 million or $0.11 per share and so is above our guidance of $0.08 per share. Turning to a quick summary, the financial results for the full year, total revenue was $545.8 million, up 27% year-over-year and up 29% in constant currency. Total revenue growth is driven by the growth in subscription revenue, which was $487.8 million, an increase of 39% year-over-year and 42% in constant currency. Classic license revenue declined by $27.7 million to $12.7 million in fiscal '20. Overall, we believe our two-year model transition to a subscription business is now virtually complete. Non-GAAP operating income for the year was $130 million with a non-GAAP operating margin of 24%, up from 18% in fiscal '19, a very healthy year-over-year improvement in line with our internal expectations. Turning to the balance sheet, as of March 31, we had $213 million of cash, and our long-term debt was $510 million after taking into account a $30 million principal payment in January. In the fourth quarter, we repriced our long-term debt to LIBOR plus 225 basis points, down 50 basis points. We are not anticipating any additional debt principal payments in the near term, and so we want to grow our cash balance to maintain financial flexibility. We think this is prudent given current market conditions. During fiscal '20, we consistently decreased our leverage ratio, which ended the fiscal year at 2.1x our trailing 12-month adjusted EBITDA of about $140 million. This is down over one turn in eight months from our post-IPO leverage ratio of 3.3x EBITDA. Unlevered free cash flow for Q4 was $63.3 million, and it was $149.5 million or 27.4% of revenue for fiscal '20. We experienced two headwinds to this number. There was about one percentage point due to lower classic perpetual bookings and about two percentage points due to higher DSO in Q4 resulting from the macro-environment uncertainty. We continue to evaluate our AR position and have not made any additional provisions for collectability outside of normal parameters. The last financial measure that I would like to discuss is our remaining performance obligation, which at the end of the quarter was approximately $860 million, an increase of 56% over Q4 of last year. The current portion of RPO, which we expect to recognize as revenue over the next twelve months, was $495 million, an increase of 52% year-over-year. Our healthy RPO expansion has benefited from the move to a subscription business combined with an increase in the duration of our new subscription agreements over the course of fiscal '20. Now let me move to guidance. Embedded in our guidance are a few underlying assumptions that I think are noteworthy so you can understand our view of the environment and our opportunity as we move forward in fiscal '21. First, our assumption is that we are going to be operating in a difficult economic environment for the full fiscal year. We expect the greatest COVID headwinds on bookings and renewals in Q1 due to a global economic shutdown, with the headwinds gradually declining over the course of the fiscal year. Second, we expect a little over two points of currency headwinds to continue throughout the year. From a customer standpoint, as John mentioned, our exposure to highly affected verticals such as travel, automotive, and hospitality represent 15% to 20% of our ARR. However, based on the enterprise size of our base and conversations with many of these customers, they view the Dynatrace platform as a mission-critical platform, and, as a result, we expect only a modest negative impact on our renewal rates within this portion of our customer base. As an aside, we have closed new business with customers in some of these verticals so far in the first quarter, which is further support for our expectation of a modest negative impact. From a profitability and cash flow perspective, there are also a few key points to highlight. First, we expect to modestly grow headcount in Q1 as we initially moderated the timing of investments as we evaluated the impact of the health crisis on our business. We have increased the pace of hiring and plan to reaccelerate our commercial and innovation investments later in the fiscal year if the demand environment is playing out as we expect or better. As a result, from a P&L standpoint, you should expect to see higher operating income in the first part of the year and then normalizing as we go into the back half. Finally, with respect to cash and working capital, we believe it is prudent to expect that some customers may request modified billing terms, which does not impact revenue but would serve as a headwind to our unlevered free cash flow throughout the year. With that as the backdrop for the first quarter, we expect total revenue to be in the range of $148 million to $150 million, representing year-over-year adjusted currency growth of 24% to 25%. We expect first-quarter non-GAAP operating income to be in the range of $38 million to $40 million, 25% to 27% of revenue, and non-GAAP of $0.09 or $0.10 per share. For the full year, ARR guidance is $680 million to $692 million, 19% to 21% growth. We expect total revenue to be in the range of $630 million to $643 million, representing year-over-year growth of 15% to 18% and 17% to 20% growth adjusted for currency. Looking at the components of revenue, we assume that classic license revenue declines from about $13 million in fiscal '20 to under $1 million in fiscal '21. Based on the current guidance, we expect services revenue to be down on a year-over-year basis in the 10% range, given that we have moved almost all of our customers to the Dynatrace platform, where the product is automated and needs fewer services, combined with our SI partners doing more services work. As a one-time guidance disclosure, we believe subscription revenue will be in the range of $591 million to $601 million, which is 21% to 23% growth and 23% to 25% growth on a currency-adjusted basis. I would like to also quickly highlight our fiscal 21 expectations with respect to our Dynatrace net expansion rate. As John highlighted earlier and we noted in our earnings release today, we have achieved eight quarters at or above 120%. It continues to be a strong part of our business. However, based on the current revenue guidance, we anticipate we would experience a modest decline in our net expansion rates throughout fiscal '21, resulting in a net expansion rate above 115% for the year. We feel great about the fundamentals of the business and feel confident we have a good balance between both customer net expansion and new logo growth. Moving to the rest of the P&L, non-GAAP operating income for fiscal '21 is expected to be in the range of $146 million to $156 million, which is 23% to 24% of revenue, non-GAAP EPS of $0.39 to $0.42 per share. From a cash flow perspective, in addition to the AR and working capital headwind I discussed, our effective cash tax rate is expected to go from 8% of non-GAAP pre-tax income to approximately 10%, resulting in incremental cash tax expenses of about $5 million. Despite the AR cash tax headwinds, we believe we can increase unlevered free cash flow as a percent of revenue from 27% last year to a range of 29% to 30%, which is $180 million to $190 million. Based on the midpoint of this range, unlevered free cash flow would increase 24% on a year-over-year basis. In summary, we are very pleased with our fourth quarter and full year performance, and with a market leading position, we remain confident Dynatrace is well-positioned for the long term. Most important for our shareholders is that we continue to show our financial profile that we believe is durable and unique, including meaningful scale, strong growth, healthy profitability, and cash flow. With that, we will open the call for questions.

Operator, Operator

Certainly. Matt Hedberg with RBC Capital Markets, your line is open.

Matt Hedberg, Analyst

Well, hi, guys. Thanks for taking my questions. And glad you're well and thoughts go out to everybody as it relates to COVID. John, a lot of good commentary on how you're helping customers navigate this difficult situation really in a world post-COVID where CEOs look to embrace cloud even faster than before. Do you think this ultimately accelerates the importance of cloud-based monitoring and perhaps could it help you even address your TAM faster than before?

John Van Siclen, CEO

Matt, appreciate the question. We do. We also believe that not only will this new normal really highlight and focus the lens on cloud, it will also focus the lens on applications themselves as the high ground for where business meets IT. So I think we're in a really strong position from that standpoint. I also feel that the automation and the AI that we've built into our platform from the ground up will also be essential considerations for IT as they move forward because it's really going to be about how do I take my existing team, my limited resources, and do more with that? How do I move faster? How do I get to more applications? How do I innovate more effectively? And these characteristics of our platform that our customers are currently enjoying, we hope many additional customers will be enjoying in the future.

Matt Hedberg, Analyst

That's great. And then the other thing that really stood out to me, I think you noted 25 customers are now buying three or more products, which is great. I'm wondering though, can you talk about that trend within new customers? In other words, are new customers now landing with a higher cadence of new products than say, let's say, a year ago?

John Van Siclen, CEO

They are, but I don't have all the quant for that, but anecdotally, yes. Some look to add the infrastructure piece and extend the infrastructure environment along with their full stack of APM because they're thinking about laying down a broader cloud platform. Others look to the APM and extend it first with the digital experience piece because they want a complete view of the application stack from the outside in. So they need either from the edge on in through all the virtual cloud layers to make sure that the performance and capability that they're expecting to deliver is actually delivered to that mobile device, or IoT device, etc. So those are the two primary that will go together depending on the point of view of the customer.

Matt Parron, Analyst

Hi, guys. This is Matt on for Sterling. Thanks for taking the questions. The first question was just curious to see did you guys see customers' needs shifting? I'm guessing more of the activity in terms of the uptake was more focused on the cloud versus on-prem. But I just wanted to get some more color on that front.

John Van Siclen, CEO

So first, all of our customers or nearly every one of them is focused on cloud and cloud workloads. Whether they deploy our platform, have us host it, or whether they host it behind their firewall, still the same SaaS platform, exactly the same code. So from that standpoint, we really haven't seen that much of a shift at this point, although we do expect to see a little bit more leaning towards a Dynatrace hosted environment. That said, what we have seen is that customers are shifting their focus to work-from-home for probably four weeks. Actually, they're still doing a little bit more here and there, but those are things where they focused on making sure that employee productivity was optimized, sort of leaned into some of our hybrid extensions like Citrix monitoring and some of our third-party cloud monitoring capability so they could assure Salesforce, Microsoft 365, Zoom and some of these other third-party clouds that they depended on actually performed as advertised to keep their workforce productive. What we're seeing now is a leaning back toward faster investments in digital transformation, and we think that will characterize the post-COVID situation as we enter Q2 and beyond for the year.

Matt Hedberg, Analyst

Great. That's very helpful. And then just one follow-up, maybe for Kevin. So long-term deferred declined sequentially. I was just trying to understand if that was from customers that are doing shorter contracts or if there was something else there that we should be aware of?

Kevin Burns, CFO

So generally, over half of our customers are signing three-year agreements with us, but please keep in mind that our payment terms are annual in advance, so that does not necessarily impact our long-term deferred. What you're actually seeing is the burn down of the perpetual licenses that we've sold primarily sort of two years ago and a little bit last fiscal year. As you may recall, we recognized those licenses over three years, and as we're bringing that down, that's going to have an impact on our long-term deferred, and as you can imagine, that also puts some pressure on unlevered free cash flow for this fiscal year and it will continue to do so in fiscal '21, and then it will alleviate thereafter, primarily. So we sold perpetual licenses two to three years ago. It was pretty healthy, but that has essentially gone to zero at this point, and it's just working down that perpetual license and long-term deferred.

Heather Bellini, Analyst

Thank you for taking my question, and I appreciate John's detailed opening remarks. I have a couple of questions. You mentioned that new logos are increasing, and I would like to know if there has been any impact on the size of these new logos, especially considering the current circumstances. Is there any difference in size that you've noticed, particularly in Q1? Also, thank you for mentioning the NER of 123% and providing insights about next year. I was curious if the 123% figure represents a decline from what you observed in the previous quarter, as this is the first time you've disclosed that exact number. I have a follow-up question as well. Thank you.

John Van Siclen, CEO

Yes, let me start with the new logos. We have consistently seen new logos in the $92,000 to $100,000 range for several quarters. There isn't much to note in terms of changes; if anything, there has been a slight increase. This seems to be due to our sales team becoming more effective at selling multiple modules when they acquire a new customer. However, this increase isn't significant, and we haven't seen any decline. It's a healthy situation. Contrary to some opinions, we are not primarily focused on multi-million dollar deals; instead, we are a high-volume transaction company that emphasizes a land-and-expand strategy. We typically start at $100,000 and gradually expand with our customers as they grow their operations and add more applications, especially with the addition of more modules. We're satisfied with our position and believe it's the right approach for an enterprise-level focus on our global customer base of 15,000. I believe we will maintain this trend in the coming years.

Kevin Burns, CFO

Yes. Heather, on the Dynatrace, the net expansion rate, it was a modest decline from the prior quarter, less than 1% from prior quarter, so relatively flat Q3 to Q4. To put a little bit more color in terms of where they think where it's going in the future, based on what we view as prudent guidance on the top-line and a combination of what we think will be helping new logos, mathematically, obviously, that net expansion rate is dropped from that 120% bar down to 115%. With that said, we're optimistic about a lot of expansion opportunities within our customer base at the low point, and hopefully throughout the course of the year, we will maintain a much healthier net expansion rate. I think one final thing is that Dynatrace net expansion rate had a couple of carve-outs in it. If you looked at our total company expansion rate over the last four quarters, it's been higher than the Dynatrace net expansion rate because we are again backing out some expansion at the time of conversion. So overall, we're very pleased with the retention, we're very pleased with our customers expanding their footprint, and our use case events as John was talking about earlier, involve adding more modules over time as well.

Heather Bellini, Analyst

Just a quick follow-up to the last question regarding long-term deferred. Based on your comments, should we expect that the phase will continue? It seems that the figure dropped from $80 million to $60 million from what I remember, but when we look ahead over the next 12 to 18 months, will that number be significantly smaller than where we just ended?

Kevin Burns, CFO

That's right. You want to think maybe six to eight quarters and that'll be wrapped, but most of it, Heather, in the next six quarters in terms of that long-term deferred wind down and then just wrapping up in eight quarters. So we will always have some level of long-term deferred, but that's the time frame.

Bhavan Suri, Analyst

Hi, guys. Thanks for taking my question. I'm glad everyone's doing well. Congrats on the quarter. A couple of quick questions from me. One, just on the top of the funnel. I know you've talked about the exposure to some of the affected industries and some of your expectations around sales and hiring ramp, but I'd love to understand what you've seen on the top of the funnel. In this environment, it feels like the digital experience thing should be really picking up. It feels like infrastructure and multi-cloud is interesting, but that piece to me seems really interesting as well as some of the AI-related pieces. You said April's off to a good start, but just love to understand what you see at the top of the funnel in terms of what's driving some of those deals coming in today? And sort of how do you think that plays out going forward, say, for the next two, three quarters, which is COVID time-driven and then post-COVID? Do you think logically there might be an acceleration of business? Just want to understand how you think about that coming out of COVID too.

John Van Siclen, CEO

Yes, Bhavan. Thank you. Thanks for the question. So we're not seeing a huge shift in sort of the characteristics; we didn't see that four weeks before we kind of shifted to work from home, and people leaned into different aspects of our product line for employee productivity. But the bulk of our business is really focused on run-the-business applications that run in modern cloud environments, more and more that multi-cloud environment that I articulated, a combination of multiple public cloud with hybrid back ends, and that environment continues to be more prevalent and accelerating. People are really getting sort of the hang of how to manage these large, complex Kubernetes orchestrated environments, they understand how difficult and challenging they are. We have a very unique, highly automatic solution with built-in AI to help them manage these environments and extend them more quickly than ever without the blind spots associated with the do-it-yourself or bag of tools kind of approach, that's sort of the alternative that we see most often out there. So coming out of this COVID-19 situation into a new normal, I really do believe that our automation and AI will become primary drivers for differentiation rather than sort of interesting nice-to-have kinds of characteristics the way they might be in certain sales cycles that we've had in the past. So I like our differentiation, I like where we sit, and I think we're very well-positioned for a new normal and a faster move to cloud with limited resources.

Raimo Lenschow, Analyst

Thank you for your question about infrastructure monitoring. You mentioned our increased comprehensiveness and capabilities, but many people are currently focused on quick solutions as they move to the cloud. How do you envision the understanding of our broader offerings developing? Do you anticipate that we will be adopted as a secondary option once organizations recognize their need for more comprehensive solutions? I would like to hear your thoughts on how this momentum is evolving. Thank you.

John Van Siclen, CEO

We observe different dynamics in customer behavior. Initially, when businesses start moving their workloads to the cloud, they often come from a purely infrastructure perspective, lacking visibility into the applications themselves. Application teams need more insight into what's happening with these workloads in a dynamically managed environment, but they find that existing solutions fall short, especially regarding distributed tracing, which adds significant value at the application level. That's why we often engage with potential customers through an application performance management approach, allowing us to establish a foothold and then expand our services from there. As customers choose to enhance their cloud investments, they increasingly recognize the necessity of solutions beyond just infrastructure monitoring, prompting them to seek out comprehensive observability platforms. In such cases, we engage even before their workload volume increases. Currently, the trend leans more towards customers expressing a desire to expand their cloud workloads while acknowledging existing gaps in visibility. They realize they can't address these gaps with a collection of tools and require a more integrated solution. While this represents our primary focus, we've also noted an uptick in early engagement as customers start to adopt best practices for scaling their cloud operations effectively.

David Hynes, Analyst

Hi. Thanks, guys. Congrats on the results. Hey, John, just in terms of the expansion opportunity, can you just remind us where the average customer is in terms of percent of apps or staff that's being monitored and then maybe where some of your best customers are?

John Van Siclen, CEO

Sure. Well, so many companies are still in that 5% to 10% of their application range. The cloud is driving the need to adopt much higher than some of the old Gartner stats that said, hey, 25% to 30% receiving customers in the 50%, 60% range where they run the business applications and associated workloads around it. We have customers in the 30% to 40% range who want to continue to go up, but that's the minority. The vast majority are really in that 5% to 10% range. There's a lot of room just in the upsell, let alone the cross-sell, which as I said we're getting much stronger in. When you take a look at our landing zone, which is in that $90,000 to $100,000 range, and then you look at our average ARR per customer, which is now a little over $220,000, there's a lot of room to continue growing that average ARR per customer toward a million-dollar ARR per customer, which we believe any global 15,000 company or any billion-dollar company would be willing to invest to assure that their applications that run the business applications run flawlessly all the time.

Walter Pritchard, Analyst

Hi. Thanks. Just a clarification on the hiring. Sounds like you did slow it, you resumed it. Can you talk about sales hiring and how we should think about sales capacity build in fiscal '21 and how's that, any slowing in hiring is impacting the growth rate you're looking for in '21, and then sort of what you're looking for specifically in sales in order to re-accelerate the hiring?

John Van Siclen, CEO

Yes. So we haven't stopped the hiring in sales folks. We did slow it down a little bit, but the focus is still on the gas. And we've been re-accelerating it as we're building more and more confidence in this year, and the current uncertainty becomes a little bit less. So you should expect us to bring our investments back to where they were a year ago, which was healthy investments in sales expansion, also R&D, the innovation expansion, and customer success expansion. Those are the three key vectors for us, and we're leaning into all those currently. Thank you very much, everyone. Appreciate the time this morning. And I hope you can tell we're bullish on the business. Good Q4. Good start to Q1. We're going to continue to run a balanced business, which I know Kevin and I stay focused on to grow profit and scale, and we're excited about the future. We look forward to this year and catching up again in 90 days and talking about how we did in our fiscal Q1. Cheers, everyone. Stay healthy.

Operator, Operator

This concludes the Dynatrace fiscal fourth quarter 2020 earnings conference call. We thank you for your participation. You may now disconnect.