Dynatrace Holdings LLC (DT) Q3 2021 Earnings Call Transcript

Dynatrace Holdings LLC (DT 1.06%)
Q3 2021 Earnings Call
Feb 03, 2021, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Dynatrace fiscal third-quarter 2021 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Noelle Faris, vice president of investor relations. Please go ahead.

Noelle Faris -- Vice President of Investor Relations

Great. Thank you, operator, and good morning, everyone. With me on the call today are John Van Siclen, 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 3, 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 Siclen. John?

John Van Siclen -- Chief Executive Officer

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, up 35% year over year.

Subscription revenue was $170 million, up 33% year over year. And unlevered free cash flow was $74 million, bringing year-to-date unlevered free cash flow to $151 million or 30% of revenue. These very strong results were driven by a solid combination of new logo additions to the Dynatrace platform, the continued expansion 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: this 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. Our 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 micro-service 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 OpenShift Kubernetes platform to drive omnichannel engagement, new curbside services and new revenue streams like accepting and processing Amazon returns; and state governments and pharmacy chains that are using DevOps, and cloud-native application platforms to rapidly roll out online vaccine information, scheduling and tracking services.

So 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 teams' 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 "killer app" behind their digital transformation, adding value and automation across a wide variety of bank services, applications and IT use cases. We have heard from a new healthcare customer, who had been struggling to get a gen two observability solution deployed, that Dynatrace has been "a knockout" 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 a bit less, to regain 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 our 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 opportunity. We've talked about growing our sales organization at 20% to 25% 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 and Co., the Texas Department of Health, EchoStar and Denmark Radio.

The value advantages enabled by the advanced automation and intelligence of our platforms 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, Publix Super Markets, 3M and the Department of Works, and Pension in the U.K.

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 three-plus modules, up from 24% a year ago. And nearly 40% are now using our infrastructure module for some 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 this 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% to 30% 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 long-standing and close relationship with AWS as a premier partner and continue to scale this out. I'm pleased with the progress we've made to really 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 precommitted spend.

Second, we have enhanced our partnership with the Microsoft Azure as well. Similar to our long-standing 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 now 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 about 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 the 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, and 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 have 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 the traditional security approaches.

Leveraging the power and intelligence of our platform, our new offering solves this challenge to really advance DevSecOps for Kubernetes-orchestrated cloud-native applications. As we said when announced, it will 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 a potential to expand our TAM by $18 billion over time, bringing our total addressable market opportunity to over $50 billion. Both PurePath 4 and the 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 have to 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 the 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?

Kevin Burns -- Chief Financial Officer

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 now $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 ratably over three years.

About two years ago, we have 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% on an as-reported basis and 33% on a constant currency basis. Additionally, roughly 20% of our ARR is with enterprise customers we consider to be in industries that are also 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. And 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 around 9 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. So, 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 than that, 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 1 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 our revenue and associated gross margin upside, and this led to a non-GAAP operating margin of 29%, up 3 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 now also 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 $0.17 per share. Turning to the 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 very 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 time 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 around $74 million. On a trailing 12-month basis, our unlevered free cash flow was $215 million or 33% of the trailing 12-month revenue. This margin level is above our previous annual guidance of 29% to 30% 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 million 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 3 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 million 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 million and $180 million, up 32% to 33% year over year or 28% to 29% in constant currency. From a profit standpoint, non-GAAP operating income is expected to be between $44 million and $46 million, 23% to 24% of revenue and non-GAAP EPS of $0.13 to $0.14 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 million to $699 million, up 28% year over year, 27% in constant currency. Underlying that, subscription revenue is expected to be between $650 million and $652 million, up 33% to 34% year over year or 32% in constant currency. Moving down the P&L, we also expect full year non-GAAP operating income to be between $202 million and $204 million and non-GAAP EPS of $0.61 to $0.62 per share. We are raising our unlevered free cash flow margin guidance to approximately 32% of fiscal '21 revenue.

That's 2 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 versus our original guidance. This full year guidance assumes operating margin leverage of roughly five points compared to last year due to our very 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. So, 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 these new customers to the Dynatrace platform, and our innovation engine will continue to power our net expansion rate. These building blocks provide us with confidence for sustained growth as we move forward. And with that, John and I would now be happy to take your questions.

Operator?

Questions & Answers:

Operator

[Operator instructions] Our first question today is coming from Matt Hedberg from RBC Capital Markets. Your line is now live.

Matt Hedberg -- RBC Capital Markets -- Analyst

Hey, great, guys. Thanks for taking my questions and really strong third quarter here. 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?

John Van Siclen -- Chief Executive Officer

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 this growing opportunity to enhance the go-to-market side with the hyperscalers as they start to draw more enterprise spend toward them with these precommits.

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, and 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 relationships together in a meaningful way. 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 to do it easily, smoothly, and efficiently as well as leveraging precommit spends to do so. So we're excited about the combination, for sure.

Matt Hedberg -- RBC Capital Markets -- Analyst

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

Kevin Burns -- Chief Financial Officer

Sure. So for the last couple of quarters, meaning Q3, Q2, it was about a point and half -- a little bit more than a point and a half of headwind to ARR growth. This -- and then in Q4, our guidance load was about 2.7 points of headwind growth. 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 the pretty big cliff at the end of fiscal '22. So we -- there's not going to be a large percent of ARR remaining as perpetual license, and it will be de minimis going into fiscal '23. So the headwinds will diminish as we go out through the course of fiscal '22.

Matt Hedberg -- RBC Capital Markets -- Analyst

Super helpful. Thanks a lot, guys.

Operator

Thank you. Next question today is coming from Jennifer Lowe from UBS.

Jennifer Lowe -- UBS -- Analyst

Great. Thank you. Maybe just to continue on that last question. If I look at the guidance for Q4, and there are a lot of puts and takes there around currency and the headwinds, but if -- from the models runoff.

But if I back those out, it seems like the guidance implies very little deceleration in ARR 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.

Kevin Burns -- Chief Financial Officer

Sure. I'll start, Jennifer, and then if John want to add in, he can. 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 end at 33%.

And I think there's really a lot of different factors that are giving us optimism as we move forward in the business. If you look at the sales organization, we've been talking about growing that 20%, 25%. We're also going to be stepping that up. We're seeing some step-ups in productivity as people, as we've talked about over the last year or so, wind down that conversion activity and focus on new logos and expansion.

And we're seeing a nice maturity in the sales organization as well. So then you layer on top of that investments we're making in marketing, lead gen, go-to-market there, combined with the innovation comments we've made through the course of the year. All those different factors stepped up in this quarter that resulted in really helping new logo numbers and helping that expansion rate. And we think those trends can continue as we move forward.

John Van Siclen -- Chief Executive Officer

Yes. I think that's well said, Kevin. And 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. And we're seeing more and more evidence that the difference that we bring to the market with advanced automation and intelligence being -- becoming requirements for the highly complex and high-scale environments that these large companies have is really starting to resonate and pay off.

And so that's another factor that I'd add but -- and I would say, yes, we're feeling optimistic about the business. Strong Q3 sets us up well for -- going forward.

Jennifer Lowe -- UBS -- Analyst

Great. And maybe just one more for me. You commented that 40% of customers were using the infrastructure-only module. And I'm curious, when you get in the door with that offering, how broad do customers typically go on the infrastructure side or are they -- I mean in theory, 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 work -- environments sort of related to where they're using APM. Could you just add some more context on how broad that can go at this point?

John Van Siclen -- Chief Executive Officer

Sure. Yes. So first, just to clarify, all of the sort of APM module customers, which is still the majority, that includes the infrastructure capabilities. But there are extensions that don't require those are 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 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 source of truth across a much wider footprint in the automation and intelligence leverage that gives their digital teams. So again, not only are more customers using that capability and exploring that capability, but they're also rolling it out in a broader way as we go, which is also evidenced in our net expansion rate continuing to stay above 120%.

Jennifer Lowe -- UBS -- Analyst

Great. Thanks, guys.

John Van Siclen -- Chief Executive Officer

Thanks, Jen.

Operator

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

Sterling Auty -- JPMorgan Chase -- Analyst

Yes. Thanks, guys. Just one question from my side. Just back on the partnerships, I think from the outsider's view, from the investors' view, it's kind of hard to delineate and differentiate some of the announcements that we've seen coming out of the Datadog and yourselves.

So, 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 that in the market?

John Van Siclen -- Chief Executive Officer

That's -- 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.

The Dynatrace has really 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 that aggregate enterprise spend. These are things that Dynatrace is at the front of and our customers expect us to be.

And the value that they receive from them is greater efficiency and confidence that we're there with the most advanced services that these hyperscalers offer at the time they offer them too. And I think that's really the key takeaway is that we have the same relationships or better than anybody else in our marketplace.

Sterling Auty -- JPMorgan Chase -- Analyst

Thank you.

Operator

Our next question today is coming from Bhavan Suri from William Blair. Your line is now live.

Bhavan Suri -- William Blair -- Analyst

Hey, guys. Thanks for taking my question. Let me echo my congrats on 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 I guess let me follow up on Sterling's question around partnerships, but not the web-scale partnerships but you've got a lot of other partnerships around ServiceNow. You've got system 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 -- 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 or 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?

John Van Siclen -- Chief Executive Officer

Great, 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 in its characteristics, like the Dynatrace platform is. It's not just in observability, it includes the automation and AI to provide understandability, predictability and actionability, all in one.

We believe that a sales organization is required to do that. But at the same time, we definitely to 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 revving up the partnerships, 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 now to 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 very enterprise level, sets us apart and will help accelerate, as Kevin and I've talked about, our ARR growth and continued momentum in the business.

Bhavan Suri -- William Blair -- Analyst

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. Certainly, oil and gas coming back a little bit 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, etc.?

John Van Siclen -- Chief Executive Officer

It's really not any specific area, Bhavan. It's -- it really is across the board. It's just that digital transformation around the globe continues to accelerate. Everybody is turning into a software company.

Everybody needs to make sure they manage that software extremely well, flawlessly if they really 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. On this -- let me add maybe a couple of 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 just 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.

Bhavan Suri -- William Blair -- Analyst

Got it. Got it. Super helpful. Thanks, guys.

Appreciate it -- you taking the questions.

Operator

Our next question is coming from Mohit Gogia from Barclays. Your line is now live.

Mohit Gogia -- Barclays -- Analyst

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 this ARR per customer from $0.25 million right now to $1 million that you have mentioned, right? Obviously, that's the long term. But as you go on the trajectory, do you think that the -- it's going to be more about, obviously, your penetration within APM? So you've talked about application monitoring coverage doubling -- and you expect that to double over the next few years at the Analyst Day 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, like are they going to mature enough and be a driver of land-and-expand motion as much, that, that will be an even bigger contributor of that ARR per customer growth? So I'm just wondering if you can help us give more color there.

John Van Siclen -- Chief Executive Officer

Sure, love to. So first of all, it's important to know that the three-plus module ASP or average ARR per customer is substantially higher than the average. Average is around $250,000, and our three-plus module cohort is well over $400,000. And 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, where you have a consumption-based model. And that means expansion on that application front alone is also 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 really think that 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 these new capabilities, new modules to the platform and gives us a lot of confidence and running room to continue to drive solid, sustainable growth for the long term.

Mohit Gogia -- Barclays -- Analyst

Great. Thanks for the color. My follow-up question is for Kevin. So great to see that you guys are feeling confident enough to raise the expectations around how much the sales capacity is going to grow too.

But Kevin, if I go back to sort of the mid- to long-term ARR growth sort of like framework you gave us, right, of 25%, I'm wondering if you can talk qualitatively as to if that moves as well, given that the sales capacity is sort of like -- higher sales capacity adds, right? I mean we -- most companies love 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, do you -- are are you sort of like baking in some expectations around that ARR growth in the mid to long term? That's it from my side, guys. Thank you.

Kevin Burns -- Chief Financial Officer

Yes -- no, if you think about the business and the building blocks of the business over time, 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 now also the fact that 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 we talked about the building blocks to ARR growth, right? And those are two.

It's pretty straightforward here, 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's going to -- that growth rate will accelerate. And we've also talked about a 15% to 20% new logo growth as we move the business forward.

You now couple that with 120% net expansion rate, you do the math, and that ARR number is above that 25% long-term target that we talked about. So -- but 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 have to move forward in the fourth quarter. I'm not -- 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 '22 then.

Mohit Gogia -- Barclays -- Analyst

Thanks, guys.

Kevin Burns -- Chief Financial Officer

Thanks.

Operator

Our next question is coming from Andrew Nowinski from D.A. Davidson. Your line is now live.

Andrew Nowinski -- D.A. Davidson & Co. -- Analyst

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?

John Van Siclen -- Chief Executive Officer

Great questions. So what we found when we were doing our sort of due diligence before we even brought that product to market, it's just playing out as we talk to more and more customers now and additional proof of concepts that are under way. There's a -- first of all, the folks with the pain are the same cloud application folks that we talk to today. They're the ones that are being throttled by the security teams and probably rightly so, because the security teams need to make sure everything is locked down, secure, that runs and sprawls across these clouds.

And now here the common way of doing this is to try to do code scan after code scan, the preproduction, 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 innovation, and it's not really what the -- I guess development teams want to do.

They want to innovate. And so we sort of -- we solved that friction between the security requirements and the speed of DevOps by providing not only preproduction scanning but continuous production scanning for vulnerabilities. And we have the intelligence in our platform that we have -- eliminates the false positives, I mean, reduces the noise dramatically, making the development teams much more efficient and, obviously, the speed of innovation and deployment much greater, and so that's what's playing out. We think it's a -- we have a great opportunity.

The feedback has been super positive. But like anything that's enterprise grade, especially if it's 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 around the first 90 days here -- or 60 days, and we'll be talking more about it, of course, as we go into the future.

Andrew Nowinski -- D.A. Davidson & Co. -- Analyst

That's great. Thank you. And then maybe just a follow-up to that as well. You had an integration with, I believe, Snyk along the same DevOps line, which Snyk just caught a very high valuation on their last round.

So I'm curious as to your views on where you think that partnership can go and how that helps you in that DevOps market.

John Van Siclen -- Chief Executive Officer

Yes. With Snyk in the DevSecOps space?

Andrew Nowinski -- D.A. Davidson & Co. -- Analyst

Yes.

John Van Siclen -- Chief Executive Officer

Yes. Well, they have a phenomenal vulnerability database. They also happen to have very good information for the developers as to exactly how to remediate an issue. So the combination of our continuous intelligent sort of vulnerability detection, combined with their database, which is what we now 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. We're excited to be -- have our systems sort of to be integrated together. We give them run time sort of view and value, and they give us some fantastic behind-the-scenes data for leverage.

Andrew Nowinski -- D.A. Davidson & Co. -- Analyst

Thank you.

Operator

Our next question today is coming from David Hynes from Canaccord. Your line is now live.

David Hynes -- Canaccord Genuity -- Analyst

Hey, thanks, guys. 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 now $250,000 with you, is it a 10% uplift, 20%, like more? Like just any frame of reference there would be helpful as we think about the opportunity.

John Van Siclen -- Chief Executive Officer

Well, so we have -- our plans include multiple different kind of capabilities in the dev for this module. This first capability, the vulnerability detection, we think, is a 10% to 20% uplift. But there's really 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 dollar to dollar with the APM module. I mean the value is significant, obviously, and it's the kind of solution that gets rolled out in a very broad way, not in any 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 great disruptive moment, but it's also that something we think we can continue to build on and really have a significant ARR impact over time.

David Hynes -- Canaccord Genuity -- Analyst

Yes, yes, 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 just this last couple of years, like 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 database, 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 maybe -- speak to that maybe in the context of sustainability of that 120-plus percent net dollar expansion?

John Van Siclen -- Chief Executive Officer

Sure. Well, so really is the couple of different motions. The first one, 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 wall, where the dynamic complexity at the new application level gets so great and that blind spots are vast and sort of massive gaps in observability when it comes to sort of multi-app portfolios and large-scale environments.

And there's nothing like Dynatrace in those environments. And more and more companies are finding that their alternative solutions, whether they were a gen two APM solution, whether they now think 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. And on the expansion front, like I said, everybody is 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, understood, troubleshot, optimized, etc. And then the cross-sell is just natural for our customers once they just 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. And so I think it's really the combination of all three of those that are driving the momentum. And that's what -- and this is why we're stepping things up, whether it's on the partner front or the sales front.

David Hynes -- Canaccord Genuity -- Analyst

Yes. Makes sense. Thanks and congrats.

John Van Siclen -- Chief Executive Officer

Thank you.

Operator

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

Walter Pritchard -- Citi -- Analyst

Hi, thanks. Just a follow-up on the last -- 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 your sales force sort of to enable you to sort of keep up this pace of growth and these new initiatives that you've articulated?

John Van Siclen -- Chief Executive Officer

Yes. 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 this a little bit around some vertical focuses. We're doubling down in state and federal in North America, a couple of things like that, that are obvious and smart expansions, I think. We are expanding our partner team, both on the tech alliance side and on the cloud system integrators.

So that also continues under the hood. We talked about that a little bit before. Then we've really stepped up our marketing efforts. We don't talk about that quite as much, but the entire organizational structure there and sort of program and program management there toward digital as opposed to physical has been a big shift for us over the last 12 months.

And so all these pieces are in place, and we're really just stepping up on what's in place and expanding across a number of areas. But nothing sort of really dramatic that we have to do, that we have to prove out. It's just more a step on the gas and build on what we have going right now. It's lot easier [Inaudible] from.

Walter Pritchard -- Citi -- Analyst

Great. And then just in terms of where you're getting salespeople, as you look toward that acceleration, is there any sort of band you're making in types of people you're hiring as you look at the future versus the last couple of years?

John Van Siclen -- Chief Executive Officer

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 or -- performance or infrastructure monitoring kinds of in the backgrounds. We find there are some bad habits there. So we like to train folks new.

And 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 our 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, and who to find and how to articulate our value advantage.

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 our market is moving, how our go-to-market is paying off, the innovation engine alive and well. And we're looking forward to giving you guys a good update in May as to Q4 results and into year as well as FY '22 guidance. So with that, we're back to execution. So, thank you very much, and have a great day.

Cheers.

Operator

[Operator signoff]

Duration: 63 minutes

Call participants:

Noelle Faris -- Vice President of Investor Relations

John Van Siclen -- Chief Executive Officer

Kevin Burns -- Chief Financial Officer

Matt Hedberg -- RBC Capital Markets -- Analyst

Jennifer Lowe -- UBS -- Analyst

Sterling Auty -- JPMorgan Chase -- Analyst

Bhavan Suri -- William Blair -- Analyst

Mohit Gogia -- Barclays -- Analyst

Andrew Nowinski -- D.A. Davidson & Co. -- Analyst

David Hynes -- Canaccord Genuity -- Analyst

Walter Pritchard -- Citi -- Analyst

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