Dynatrace, Inc. Q1 FY2024 Earnings Call

Greetings, and welcome to the Dynatrace Fiscal First Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Noelle Faris, Vice President of Investor Relations. Thank you. Noelle, you may begin.

Good morning and thank you for joining Dynatrace’s first quarter and fiscal 2024 earnings conference call. Joining me today are Rick McConnell, Chief Executive Officer; and Jim Benson, Chief Financial Officer. Before we get started, please note that today’s comments include forward-looking statements such as statements regarding revenue and earnings guidance and economic conditions. Actual results may differ materially from our expectations due to a number of risks and uncertainties discussed in Dynatrace’s SEC filings, including our most recent quarterly report on Form 10-Q that we filed earlier today. The forward-looking statements included in this call represent the company's views on August 2, 2023. We assume no obligation to update these statements as a result of new information, future events or circumstances. Unless otherwise noted, the growth rates we discuss today are non-GAAP reflecting constant currency growth and per share amounts are on a diluted basis. We will also discuss other non-GAAP financial measures on today's call. We provide reconciliations between non-GAAP and GAAP measures in today's earnings press release and in the financial presentation slides posted in the Investor Relations section of our website. And with that, let me turn the call over to our Chief Executive Officer, Rick McConnell. Rick?

Thanks, Noelle, and good morning, everyone. Thank you for joining us for today's call. We had a solid start to our fiscal year, exceeding the high end of our guidance across all metrics. ARR grew 25% year-over-year, subscription revenue increased 27% year-over-year in constant currency, and non-GAAP operating income was $92 million, or 28% of revenue. These results continue to demonstrate our ability to deliver a powerful combination of top-line growth and profitability. They are a testament to the criticality of observability and application security in the market and the significant value our platform provides to our customers, even as the economic environment continues to impact behavior. Jim will share more details about our Q1 performance in a moment. In the meantime, I'd like to share an update on the broader market outlook, customer wins, and recent announcements. Let's start with our market opportunity, which we continue to view as massive and growing. As organizations increasingly rely on multi-cloud and cloud-native computing for a successful execution of their digital transformation strategies, simplification through observability has become essential. The scale and dynamic nature of modern cloud ecosystems have made them too complex to manage with dashboards, alerts, and manual troubleshooting. Organizations are frustrated with fragmented tools, negative customer experiences, and limited analytics. Dynatrace makes order out of this chaos by enabling customers to have better control of their IT ecosystems and to help combat these pain points. Last quarter, I mentioned several use cases that have become key drivers of customers' purchasing behavior. Among them, organizations purchase Dynatrace because they are looking to deliver highly performant cloud-native infrastructure and applications. They are seeking cost-effective and more insightful log management at scale. They are investing substantial sums to secure their cloud applications. They want to dramatically reduce incidents and downtime. And they are seeking a fully unified observability platform to help drive material cost savings and improved oversight by consolidating the myriad of disconnected tools they're using today. These use cases helped drive new logo growth of 15% in the first quarter on a year-over-year basis and led to dollar-based net retention of 116%. Some notable customer wins from this quarter include the following. A leading financial software company signed a seven-figure deal through the Azure Portal. This customer is in the process of modernizing their environment from legacy virtual machines to Kubernetes. The time and cost associated with triaging incidents and manual troubleshooting in a modern complex environment was a major pain point for them. Now, with full stack observability and logs on Grail with Dynatrace, this customer estimates they will save $1.5 million in the first three months of deployment due to greater efficiency, productivity, and higher collaboration across teams. Another seven-figure win in the quarter was with one of the largest satellite television providers. This customer was overwhelmed with the number of alerts and manual troubleshooting their existing monitoring tool provided. They were looking to simplify and reduce inefficiencies, as well as get visibility into every aspect of their cloud environment with no blind spots. They have now chosen to standardize on Dynatrace. And a major U.S. oil and gas company signed a significant expansion to add application security to their deployment. After the log for Shell software vulnerability was identified, they realized they didn't have visibility into what vulnerabilities were either unresolved or reintroduced into their environment. With Dynatrace AppSec, they now have better visibility into their applications and were able to integrate DevOps with DevSecOps. These are just a few examples of the strength of our product offering and the business value that the Dynatrace platform provides. As we have often said in the past, we strive to enable our customers to deliver flawless and secure digital interactions. The analytics and automation embedded in our unified observability and security platform are what differentiate us in the market and frequently drive customers to choose Dynatrace over alternative approaches. Last month, after evaluating 19 vendors, Gartner named Dynatrace a leader in the 2023 Magic Quadrant for Application Performance Monitoring and Observability, positioning Dynatrace furthest for completeness of vision and highest for ability to execute. This was the 13th straight time that Dynatrace has been in the leader quadrant. We were also ranked number one across all six use cases in the Gartner 2023 Critical Capabilities for APM and Observability Report. We believe Dynatrace's position, longevity, and criticality in both reports reflect our ability to execute and anticipate change in this constantly evolving market. I'd like to turn next to two key announcements we made over the past couple of weeks in the areas of hypermodal AI and developer observability, both of which are great examples of our core focus on innovation. First, let's start with hypermodal AI, evolving from a radically different approach to artificial intelligence. Dynatrace Davis is our AI engine that has long been a primary differentiator for us. Dynatrace customers have used Davis AI for years to tie server-side observability with user impact, deterministically reduce hundreds of alerts to single problems, and automate the root cause analysis process in large-scale and complex cloud-native environments. We've extended our causal AI to security use cases, such as automating risk analysis of vulnerabilities and accelerating investigations and remediation. And we've made our predictive AI more powerful by leveraging machine learning to identify anomalies and forecast future patterns with great precision based on historical behavior. Last year, we extended our predictive AI and causal AI capabilities with even richer context, leveraging our Grail data lakehouse, extracting precise answers and driving automation from data in real-time at massive scale. Last week, we announced the planned addition of a third critical element to our AI architecture and solution set, generative AI, to deliver the industry's first hypermodal artificial intelligence observability offering. Hypermodal AI is the combination of three different AI techniques delivered by Dynatrace, each having a unique value but with a whole much greater than the sum of the parts. Predictive AI uses models to recommend future actions based on data from the past. Causal AI analyzes dependencies across massive datasets while retaining an accurate context to deliver fact-based precise answers and automation. And generative AI provides recommendations on how to solve specific tasks through prompts enriched with automated context of a customer's environment uniquely provided by Dynatrace. Our generative AI capability is named Davis CoPilot. Davis CoPilot will work with Dynatrace causal and predictive AI to automatically provide recommendations for issue remediation and optimization, create actions, and allow people to use natural language to explore, solve, or complete tasks. Many organizations have announced strategies around generative AI. Our approach, however, goes far beyond simply adding a natural language interface that relies on human intelligence to steer generative AI solutions. Our predictive and causal AI will be designed to feed comprehensive and specific prompts to Davis CoPilot to help avoid outages or degradations before they happen and help remediate and resolve active incidents when they arise. We view hypermodal AI as a significant catalyst for customer expansion, increasing both the breadth of end users who can leverage the platform and the creation of workloads. We believe this will lead to higher dollar-based net retention resulting from more customer cross-sell and upsell as well as an increase in the stickiness of the Dynatrace platform. We are also very excited about the ongoing evolution of our platform in the area of developer observability. As we have indicated in the past, we believe that the role of development teams will continue to expand in the observability and application security decision process. In particular, we believe these capabilities will continue to shift left into software development lifecycles to enable more productive handling of observability insights and answers directly in software. And that, in turn, will lead development teams to shift right to take on greater responsibility for successful software operations, including availability and end-user experience. This week, we signed a definitive agreement to acquire Rookout, a Tel Aviv-based developer-first observability platform to further expand our capabilities and investment in this area. In particular, code debugging in production environments has been a major pain point for developers. Traditionally, debugging tools have only addressed issues in pre-production environments, leaving developers without an efficient or secure way to troubleshoot production applications. Rookout's highly differentiated technology allows developers to address issues in live code, with privacy controls in place without restarting, redeploying, or adding even more code. We believe the combination of Rookout's debugging technology, seamlessly integrated into the Dynatrace platform, will be very powerful for our customers. We expect it to create a new standard for how engineers improve code quality and deliver better business outcomes by enabling developers to troubleshoot and debug without disruption. In addition to these exciting announcements on product innovation and platform evolution, we've also had some noteworthy announcements on the go-to-market side of the business. Two weeks ago, we announced the expansion of our relationship with Microsoft. We are stepping up our committed spend over a multiyear horizon in anticipation of even more growth through the Azure platform. Together, it will be increasing our joint sales enablement and marketing to accelerate cloud migration and optimization initiatives. Earlier in the quarter, we announced the expansion of our collaboration with Red Hat with new integration capabilities between Dynatrace and Red Hat Event-Driven Ansible. This is a great example of how Dynatrace turns data into answers that can then be turned into actions. This integration enables customers to automate DevSecOps use cases, such as closed-loop remediation and application healing, to drive greater operational efficiencies and boost the performance, reliability, and security of their workloads. And we continue to build momentum with leading strategic global system integrators, or GSIs. We have more than 10 strategic GSIs partnering with us today, and a few, including Deloitte and DXC, have built Dynatrace into their reference architectures. By way of example, sales pipeline contribution from one of our largest ESI partners has more than doubled when compared to last year and continues to show strong momentum. Before I turn the call over to Jim, I'd like to take a moment to discuss our CRO transition. In June, we announced the appointment of Dan Zugelder as our new CRO. Dan is four weeks into his role at Dynatrace and we are extremely pleased to have him on board. Dan brings deep industry knowledge, having spent his career working at ADP, Dell EMC, and most recently, VMware. He has a strong background in building multibillion-dollar sales organizations, which will be instrumental as Dynatrace plans to scale in our next phase of growth. On behalf of the entire Dynatrace team, I'd like to thank Steve Pace for his dedication and execution as our CRO over the past seven years. His contributions to building a world-class sales organization have positioned Dynatrace for sustainable long-term growth. Steve will be retiring from Dynatrace in early October, and he is actively involved in ensuring a smooth transition. In closing, we had a solid start to a fiscal year even as ongoing macro headwinds persist. We remain highly confident in our market opportunity, our platform leadership, and the powerful combination of top-line growth and profitability. We are humbled by the third-party validation from Gartner of our product leadership, and we are committed to continuing our delivery of significant innovations and customer value consistent with that leadership. Financially, we will continue to manage our business prudently and invest thoughtfully in those strategic opportunities that we believe put us in a position of strength for the future. We are purposeful and driven by our vision of enabling our customers to deliver a world in which their software works perfectly. We have made great progress. But in the context of an increasingly cloud-based software world in which we can materially improve software performance and end-user engagement, we have really only just begun. With that, let me turn the call over to Jim.

Thank you, Rick, and good morning, everyone. As Rick mentioned, we are off to a solid start to our fiscal year, beating the high end of our guidance across all of our key operating metrics. Our continued ability to successfully execute in this dynamic macro environment is a testament to the growing criticality of observability and application security in the market, our product differentiation, the value proposition we provide to our customers, and the ongoing durability of our business model. Now let's dive into the first quarter results in more detail. Please note that the growth rates mentioned will be year-over-year and in constant currency, unless otherwise stated. Starting with annual recurring revenue. As a reminder, the headwind associated with the wind down of the perpetual license is now less than 100 basis points. As I mentioned last quarter, we will no longer be referring to adjusted ARR growth in our prepared remarks. For comparison purposes, we will continue to share the impact of perpetual license in our quarterly presentation, and in the financial data trends file available on our website. Total ARR for the first quarter was $1.29 billion, an increase of $263 million year-over-year and $47 million sequentially. Foreign exchange was a $3 million tailwind year-over-year and a $10 million tailwind sequentially, resulting in 25% year-over-year ARR growth on a constant currency basis. Net new ARR on a constant currency basis was $37 million in our seasonally lightest bookings quarter of the year. And as we shared in our last call, we had a tremendous close to Q4 fiscal '23, which included $13 million of incremental expansions from early renewals that we originally expected to close in the first quarter. New logos grew 15% in the first quarter, adding a total of 155 new logos to the Dynatrace platform. The average ARR per new logo land was consistent with the prior quarter at roughly $130,000 on a trailing 12-month basis. Our gross retention rates continue to be best-in-class in the mid-90s and contributed to a solid dollar-based net retention rate of 116% in the first quarter, in line with our mid-teens expectation for fiscal 2024. With nearly two-thirds of our customers using three or more modules, it's clear that customers are standardizing on Dynatrace as their full stack observability and security platform. Our innovation engine continues to hone, creating additional cross-sell and upsell opportunities in our customer base. As Rick mentioned, hypermodal AI and developer observability are great examples of building incremental capabilities to extend our reach to a wider range of users and accelerate the pace and volume of new workloads, which we believe will ultimately contribute to an incremental expansion in the future. In addition, we're seeing strong customer interest for the Dynatrace platform subscription, or DPS, having made it generally available to customers in April. With DPS, we're making our solutions broadly and easily accessible through a simplified cross-platform licensing model. This model allows customers to trial and deploy any aspect of our solution, such as logs or AppSec, while leveraging a single commitment. We expect DPS will drive enhanced net expansion and accelerate ARR in future periods. Moving on to revenue. Total revenue for the first quarter was $333 million, up 25% and exceeding the high end of guidance by $5 million. And subscription revenue for the first quarter was $316 million, up 27% and exceeding the high end of our guidance range by $7 million. With respect to margins, we continue to have a very healthy margin profile, reflecting the value and efficiency of the Dynatrace platform. Non-GAAP gross margin for the first quarter was 84%, consistent with both last year and Q4 levels. Our non-GAAP operating income for the first quarter was $92 million, $14 million above the high end of our guidance range due to the revenue upside in the quarter and a staggered pace of hiring in anticipation of the Rookout acquisition. This resulted in a non-GAAP operating margin of 28%, exceeding the top end of the guidance range by roughly 400 basis points. Non-GAAP net income was $79 million or $0.27 per share. This was $0.05 above the high end of our guidance range driven by the items I just mentioned. Turning now to the balance sheet. As of June 30, we had $701 million of cash and zero debt. This represents a sequential increase in our cash balance of $145 million compared to March 31. Our free cash flow was a very healthy $124 million in the first quarter. We continue to believe it is best to view free cash flow over a trailing 12-month period due to seasonality and variability in billings quarter-to-quarter. On a trailing 12-month basis, free cash flow was $321 million, or 26% of revenue. The last financial measure that I would like to discuss is our remaining performance obligation. RPO was approximately $1.9 billion at the end of the quarter, an increase of 20% over Q1 of last year. The current portion of RPO, which we expect to recognize revenue over the next four quarters, was $1.97 billion, an increase of 24%. It is important to remember that seasonality associated with bookings and contract upselling will cause variability in the RPO growth rates. As such, we continue to believe ARR is the best metric to understand the health and durability of the business as it removes noise associated with the timing of billings. Now, let me turn to guidance. As Rick mentioned, we are confident in the long-term growth opportunity for Dynatrace. The addressable market is large and growing. Observability and application security are becoming even more critical to successful cloud and multi-cloud deployments. Our offerings are highly differentiated. We are well positioned as the industry leader, and we have a financial model that is both balanced and durable. Near term, we are mindful of the current macro uncertainty. And while we have seen signs of resiliency in the observability and application security market, we believe it is prudent to continue to factor the dynamic macro landscape into our guidance. Enterprises remain cautious in their spending. And our approach to guidance assumes that tighter budget scrutiny and elongation of sales cycles will persist. We had a solid start to the year, but it is still early in our fiscal year. And we do not want to get ahead of ourselves. There are a few things to keep in mind with respect to our guidance. This guidance continues to assume new logo growth in the low single digits and a dollar-based net retention rate in the mid-teens for fiscal 2024. We expect the full-year foreign exchange tailwind to as reported ARR to be approximately $11 million and approximately $15 million on revenue, roughly consistent with our prior guidance. The Rookout acquisition is expected to close within the second quarter and is embedded in our guidance. As this is a technology tuck-in acquisition, there is insignificant revenue as part of this transaction. However, we believe the combination of Rookout's code debugging technology seamlessly integrated into the unified Dynatrace platform will be very powerful and address a major developer pain point. And with that as an opener, let's start with our guidance for the full year with growth rates in constant currency. We are maintaining our ARR guidance of $1.475 billion to $1.49 billion or 18% to 19% constant currency growth. Consistent with what I shared last quarter, the seasonality of net new ARR is expected to be more backend loaded this year compared to prior years, with roughly 35% expected to land in the first half of fiscal 2024 and approximately 65% in the back half. Turning now to revenue. We are raising our revenue guidance at the midpoint by $11 million for the year. Driven by our overachievement in subscription revenue in the first quarter, we expect total revenue to be between $1.4 billion and $1.415 billion, or 20% to 21% growth, up 100 basis points from our prior guidance. We are raising our subscription revenue guidance at the midpoint by $15 million for the year, as we expect a slightly higher mix of subscription services versus services revenue. Total subscription revenue is expected to be between $1.326 billion to $1.341 billion, representing 21% to 22% growth, up 100 basis points from our prior guidance. From a profit standpoint, given the revenue increases and ongoing disciplined management of spend, we are raising our non-GAAP operating margin guidance by 50 basis points to a range of 25.5% to 26%. We are raising non-GAAP EPS guidance to $1.03 to $1.06 per share, representing an increase of $0.05 at the midpoint of the range. This non-GAAP EPS is based on a diluted share count of 300 million to 301 million shares and a non-GAAP effective cash tax rate of 19%, consistent with prior guidance. And finally, we are maintaining our free cash flow guidance of $303 million to $312 million, representing a free cash flow margin of approximately 22% of revenue. And while we do not guide free cash flow quarterly, due to the seasonality and variability in billings as well as the timing of cash tax payments, we expect free cash flow to be higher in our first and fourth quarters and significantly lower in our second and third quarters. And given our expected backend loaded bookings linearity this year, free cash flow will be even more skewed to Q4 than in prior years. Looking at Q2, we expect total revenue to be between $343 million and $346 million, or 21% to 22% growth. Subscription revenue is expected to be between $325 million and $328 million, up 22% to 23% year-over-year. From a profit standpoint, non-GAAP operating income is expected to be between $90 million and $93 million, or 26% to 27% of revenue and non-GAAP EPS of $0.26 to $0.27 per share. In summary, we are pleased with our first quarter fiscal 2024 performance. We have a proven track record of consistent execution. As we have consistently demonstrated, we are committed to maintaining a balanced approach to optimize cost to drive profitability while continuing to invest in future growth opportunities that we expect will drive long-term value. And with that, we will open up the line for questions.

Thank you. We will now start the question-and-answer session. Our first question is from Pinjalim Bora with JPMorgan. Please go ahead with your question.

Great. Thank you for taking the questions and congrats on the quarter. I want to ask you on DPS since you're leaning on DPS this year. What have you seen so far from customer feedback on DPS? Are people kind of able to map their existing spend on DPS? Is there a period of learning and anyway to understand the expansion characteristics month-over-month? I think you talked about the point about accelerating ARR because of DPS. I think you said that last quarter as well. I'm just trying to understand any indications that might corroborate that point here.

Hi, Pinjalim. It's Rick. Very early still in the DPS rollout. We just went GA in late April, but very good momentum, already many dozens of closures of new customers on it. Pipeline continues to grow. And already for new logos, the vast majority of our dollar-based pipeline is coming in, in DPS. So I would say early, but very solid positive performance on DPS evolution so far.

And I'd just add something, Pinjalim, that you mentioned on the expansion side. We've certainly seen for DPS customers that DPS customers have actually shown better expansion rates than non-DPS customers. Now admittedly, some of that is some of our largest customers. So the sample size is a bit skewed. But we're optimistic that DPS is going to be a great contract vehicle to actually drive more expansion.

Thank you, and I have a follow-up question for you, Jim, regarding ARR. I am trying to understand the implied guidance for net new ARR in Q2. You have maintained the 35% figure, which I appreciate given that it is still early in the year. However, this suggests a potential decrease in net new ARR for Q2 compared to Q1 in terms of growth. Can you clarify if there are any indications in the business that might lead to a dip in net new growth next quarter? Was there a possibility that some deals were pulled into Q1 from Q2? Or is there a more cautious approach being taken due to the recent changes in leadership?

It's a great question. In fairness, we’ve maintained our guidance for the year because we believe the seasonality will be more backend loaded this year than usual, roughly 35% in the first half and 65% in the second half. We had a solid start to the year, but it's still early, so we want to remain cautious. The demand environment remains solid, but we observed that the timing of deal closures can be unpredictable, especially for larger deals. These often close a month or even a quarter later than anticipated, so we want to recognize that given the broader landscape. Demand trends look good, and we are being prudent. As we mentioned, more of our business is expected to be backend loaded, which aligns with the majority of our renewal activity occurring in the latter half of the year, where we usually see more expansions. This is what is influencing our broader guidance.

Got it. Thank you very much.

Thank you. Our next question is from Mike Cikos with Needham & Company. Please proceed with your question.

Hi, guys. Thanks for getting me on here. And I appreciate all the disclosures for the guidance. I think my question is going to be more along the lines of that guidance construction though. And I just wanted to get a sense for the dollar-based net retention in the 116 that we're looking at in Q1, is there a thought that we'd see further erosion of that metric through this year? And then the follow up, if I could just tack it on now, but I guess in your view, what helps that net retention climb back from current levels? If we're looking for improvement, what in your view needs to happen to drive that improvement? Thank you.

Yes, so it's a very good question. So we had shared in our guide last quarter that we thought dollar-based net retention would be in the mid-teens. And so I still expect that. So Q1 came in roughly in line with what we had thought. Very, very strong new logo quarter for Q1. I think you saw that we had a 15% growth in new logos which was actually a pretty good land size of roughly $130,000. So really strong on the new logo front. And dollar-based net retention in line with our expectations. We do expect that to hover at the mid-teens level, call it 114 to 116 through the year. And what's going to cause an acceleration, I think, one, we're being a bit cautious, given we have seen longer buying cycles and we've seen expansions as they've gone through the funnel, shrink in size as customers may be split expansions over multiple periods, whereas they used to give us large expansions at once. So some of the budgetary environment has caused maybe less expansions in the near term. I'll tell you on the positive side, there's a lot more to sell with logs on Grail and other opportunities that we have in the business from a product perspective. So I think near-term, we're dealing with some budgetary headwinds. I do think that the portfolio continues to grow. I think the market opportunity continues to grow. So we're quite optimistic that you're going to see a reacceleration dollar-based net retention. I think we're just being cautious here over the next year.

Great. Thank you. I'll turn it over to my colleagues. Thank you, Jim.

Thank you. Our next question is from Sterling Auty with MoffettNathanson. Please proceed with your question.

Yes. Thanks. Hi, guys. I just want to continue on with one question around the macro just specific, if you can give us a little bit of color in terms of what you experienced at the end of the quarter and now in the beginning of this quarter, and has that changed in any degree versus what you have been experiencing? Because I think a lot of the commentary you're using matches what's been said through the calendar year. So just wondering if anything's different? And then specifically, the one question we all ask is cloud optimizations and what your sense is about nearing the bottom and kind of getting past that? Thank you.

I'll begin, and then Rick might add something regarding the cloud optimization. We haven't observed any significant changes in the macro environment. I would describe it as very stable over the last three quarters. It's neither improved nor worsened; it's simply consistent. However, this consistency means that approval cycles for deals are taking longer, and deal sizes, particularly for expansions, are decreasing. While the demand environment remains healthy, we have noticed an increase in the length of the sales cycle. The situation is neither getting worse nor better. We have adjusted our guidance to reflect this stable yet uncertain macro environment, and we believe it’s wise to maintain a cautious outlook until we see any changes. Rick, would you like to share your thoughts on the cloud optimization trends?

Right. On cloud optimizations, a couple of quick points. First, as we've said in the past, Sterling, our view is that cloud optimizations really do in many ways speak to Dynatrace’s value add in the market. So we continue to believe and see that. We are a solution in many ways to cloud optimizations. We're also less impacted just based on our business model and our approach to pricing. So that's sort of the Dynatrace perspective. Overall, my view is that cloud optimizations are beginning to reduce in overall impact to the market. Not sure we're at the bottom, but we seem to be making progress toward that end.

Makes sense. Thank you, guys.

Thank you. Our next question is from Adam Tindle with Raymond James. Please proceed with your question.

Okay. Thanks. Good morning. Rick, I just wanted to start with kind of a general question on AI broadly. And just would be curious, your observations from bleeding edge customers or maybe your relationships with hyperscalers. The question would be how did the needs of the observability stack change with those types of deployments? Wondering if the attach rate of monitoring software is similar or different than a traditional deployment? And then secondly, how does the competitive landscape differ and bake-offs with those use cases?

Thanks, Adam. First on the market in general, I would just say before even getting to generative AI and hypermodal AI and our solution to that, the market continues to show very, very strong evolution. Observability overall continues to be of higher demand, of higher need for our customers due to an increased complexity and volume of data and workloads. So that's my overall comment on the market. How does that relate to the AI commentary? The way it relates is that AI and in particular generative AI is going to contribute notably to enabling customers to be more efficient, more productive in their management observability systems. So the combination of generative AI along with causal and predictive AI, which collectively we call hypermodal AI, we believe to be a mission-critical solution that will catalyze demand over the course of the future by opening up observability to more end users, to more people within companies bringing natural language capabilities into the observability framework, but also using the combination of productivity from generative AI with the deterministic capabilities of causal and predictive AI. And collectively, these elements provide substantial value to catalyzing we think future demand.

Got it. That's helpful. Maybe as a follow up, I wanted to ask about the Microsoft partnership. And Rick, we hear a lot of competitors talk about working with Microsoft, but this sounds a little bit different and much more strategic. So maybe you could start with just what went into forging that partnership? And Jim, if you could talk about what this means for margin? It sounds like there's some committed costs associated with this. Just curious what it means from a margin perspective, the costs, how variable they are, anything that you can give us around the financial aspect of this partnership? Thank you.

Sure. Very important relationship with Microsoft, as you point out, Adam, material extension of our commit to them and their commit back to us on the go-to-market side. So obviously, we just signed it, but very optimistic about the evolution of it. Jim?

Yes. And what I'd say on the financial side is, as you can imagine, as Rick said, we're expanding our relationship with them, which means we're expanding our Azure commitment with them from a dollar perspective. So what it's telling you is the signal of strong customer interest of having Dynatrace business on the Azure platform. And so with that and with an increased commitment, we get much, much more favorable pricing. And so the pricing that we get is very consistent with pricing that we get with say, an AWS. And so customers are now in a situation and we're in a situation where your pricing is very similar on an Azure platform as well as an AWS platform. So this is something that is going to be, I'd say, enable us to continue to scale on gross margins as we move more and more of the business to SaaS. And so the way you should expect it is it will allow us to continue to maintain this very, very healthy gross margin profile kind of in the mid-80s.

Very helpful. Thank you.

Thank you. Our next question is from Andrew Nowinski with Wells Fargo. Please proceed with your question.

Thank you. Good morning, everyone. I want to ask about your GSI partners. I believe you mentioned you now have 10 partners signed up, and one of them has a pipeline that has more than doubled year-over-year. Is there anything unique about that partner's pipeline? How does it compare to the pipelines of the other nine partners?

Thanks, Andrew. I appreciate the question. GSI has continued to grow quite notably for us in terms of pipeline, even in terms of conversion. So we feel very good about the evolution. The primary takeaway on GSI is we're playing this for the long game. We do believe that GSI has become an increasingly material segment of our channel distribution over the course of time. But these deals tend to be quite large in many cases that are coming through digital transformation initiatives, hyper-cloud migrations, and other types of solutions of that nature. So they're going to take a little bit longer to close. So pipeline is a great leading indicator, which is why we provided that. The statistic we provided on the doubling of one of our largest strategic GSIs was just an indicator of that leading indication of that pipeline.

Okay. Thank you. And then I wanted to ask about the new Chief Revenue Officer. Dan's only been in the seat for less than a month, but any early observations about maybe changes to go-to-market that he plans to implement?

Yes. At four weeks in, we're not planning on any notable or material changes in our go-to-market strategy. What I would say is that, obviously, we are increasing our focus and intensity around partners. For example, the hyper-cloud is also the GSIs. So we're going to continue to lean in, in those particular areas to grow our partner focus. And that's going to be evident in our go-to-market strategy as we evolve.

Thank you. Our next question is from Matt Hedberg with RBC Capital Markets. Please proceed with your question.

Great, guys. Thanks for taking my questions. Rick, I wanted to go back to Grail. It's starting to show up a lot more in partner conversations. And these tend to be somewhat larger deals too on the logging side. Can you give us a bit more color on how you're thinking about cross-selling that, what does the pipeline look like for that? And in terms of like areas to maybe reaccelerate NRR, how do you think about Grail in the context of that?

Well, let me sort of separate out Grail from logs on Grail to start, which I tried to do in last quarter's call as well. So the first thing is Grail is an underlying core technology in the platform that is used as a massively parallel processing data lakehouse, if you will. That data store expands, traces logs, metrics, all of the components of data store that we would have. It is initially focused at AWS for SaaS deployments, and virtually every one of our AWS SaaS customers is already on Grail as a core technology. They are already using and operating on Grail as a core technology. Now it's a seamless migration, happened in the background, customers didn’t have to do anything. So they are already benefitting from Grail and the Grail deployment. Now the question that is the next question is what about logs on Grail? The good news is very strong evolution, already seeing customers using it at material scale. Customers like global retailers doing 30 terabytes of logs per day, for example, so good evolution there. Logs on Grail requires a selling process through POCs. Now on the POC front we saw an increase in active POCs of about 20% quarter-over-quarter, so we continue to see the evolution of our POCs again as a leading indicator for logs on Grail. So hopefully that clarifies the distinction between Grail as an underlying core technology and logs on Grail as an incremental sale.

Yes, got it. Thank you for that. And then going back to AI, there’s been a lot of talk in the industry about vector databases or vector search. I don’t know that we’ve talked about that in terms of the Dynatrace platform. Can you give sort of your perspective on vector and if it plays a role in the tech stack?

Yes, I don’t want to spend too much time on that other than to say that our view is that our hypermodal AI approach we do believe to be radically different from other solution announcements in the market in the sense that it brings together multiple different AI techniques, and those techniques include what we’ve been doing for more than a decade with causal and predictive AI linked in to what we expect to GA by the end of the year or the end of the calendar year which is the generative AI piece. Putting those together we believe gives us a very, very strong platform for AI being an enormous ongoing differentiator for Dynatrace as it has been really throughout our history.

Got it. Thanks, Rick.

Thank you. Our next question is from Koji Ikeda with Bank of America. Please proceed with your question.

Yes. Hi, guys. Thanks for taking the question. Just one for me. I wanted to ask a question on new logo growth and actually how to think about new logo growth for the rest of the year. In the quarter, very nice new logo growth of 15%, definitely above that low single-digit target for the rest of the year. But when we look at the new logo compares for the rest of the year, they get harder and harder. So how can we be thinking about the new logo growth cadence from here and what are you seeing in the pipeline that is giving you confidence for the remainder of the year on the new logo front?

It's a good question, Koji, and you're right. We had a strong new logo quarter this time around, just like we did in the fourth quarter. Looking at our guidance, we're still maintaining it in the low to mid single digits. The pipeline appears robust, and we have good visibility into it for the upcoming quarter and possibly the second half of the year. The new logo pipeline is solid. As I've mentioned in previous calls, we're focused on acquiring the right new logos that we believe will lead to incremental growth after we secure them. We're not just bringing in new logos for the sake of increasing our customer base; we are selective, which is why our average land size remains around $130,000 over the past 12 months, which is strong. Our emphasis is on the quality of these acquisitions. I think our visibility regarding new logos is good. While we may not see 15% growth every quarter, I am confident we can achieve growth in the low to mid single digits.

Got it. Thanks, Jim. Thanks for taking the question.

Thank you. Our next question is from Kash Rangan with Goldman Sachs. Please proceed with your question.

Hello. Thank you so much. Good morning. I have a question for you on GSI. Rick, your forward indicators look quite good considering the macro environment. You got this GSI that is 2x to the pipeline, you got this expanding partnership with Azure. You also discussed why it’s taking longer, but why would you not consider ramping up your sales capacity? It does look like next year we do not have a recession and the ones that actually have the go-to-market, gain share or end up being very successful. So in that regard, as CEO of the company, how do you look to up the ante and gain share versus competition because it does look like the product value proposition is coming in by the end of this year all look to really position the company well. But one way you could counter the slow growth is to increase sales capacity, this conversion multiplied by as you know you’re a veteran in the industry, we could still achieve better growth by deploying extra sales capacity when forward-looking indicators are looking good. So maybe what’s your thoughts out there on that front? And also, Jim, one for you. If you ex out the early renewals in Q4, what would be the net new ARR growth look like? Thank you so much once again.

I’ll address both points. Regarding sales capacity, we're quite optimistic. As I mentioned in the last call, the number of our experienced representatives, those with over two years of service, has increased compared to previous years. These seasoned reps tend to be more productive than new hires. Therefore, I don't believe we're limiting our sales capacity. We're committed to adjusting our sales force as necessary. I don't see any constraints; instead, we aim to align our capacity with demand. If we experience an uptick in demand, we will respond by increasing our sales capacity. We believe there's potential to enhance our current model, and we'll make adjustments based on changes in demand signals. Overall, we feel positive about this aspect. In terms of early renewals, you're correct that we recorded around $13 million in expansions during the fourth quarter that were initially scheduled for the first quarter. While the first quarter typically includes minor fluctuations, there weren't any significant early renewals to note. Historically, the first quarter tends to be the slowest for the company as I mentioned earlier. We feel good about how we've started the year, although we may see more activity later in the year due to the reasons I've previously outlined. Overall, I'm confident about our current position.

Jim, the change in CRO leadership did not have any effect on pulling the business into Q4 at the expense of Q1?

No.

Thank you. Our next question is from Keith Bachman with BMO Capital Markets. Please proceed with your question.

Hi. Good morning. Thank you. I wanted to ask about targets for both logs and analytics on security. I understand Grail was the platform that enables logs and analytics. You’ve sort of talked about ideas or direction of maybe kind of 100 million ARR in '25 for both. Is that still the case and where do you think you’re relative to those goals? And then last quarter you gave us some numbers for where you are in EPS in terms of the number of customers. My understanding is that to adopt Grail and thereby have log and analytic, you need to be on the DPS contract. Could you give us some update on specifics as it relates to the number of customers on the new contract platform? Thank you.

So I’ll take maybe both of those. And if Rick wants to comment additionally, he can. So we feel pretty good about both the areas you mentioned, both applications of security and logs on Grail that we’re on track to deliver the numbers that we talked about, a $100 million for each. Obviously, Grail is being a little bit sooner, we said over a couple of years versus AppSec which is going to be over three years. So we feel pretty good about that. I’d say as you can imagine, we’re further along on AppSec because AppSec has been out in the market longer. But to Rick’s earlier points, we feel very good about the interest in Grail. And so I would expect to see an uptick in logs on Grail in particular over the course of the next year. We’re still kind of early days with that. So again, feel pretty confident in both $100 million targets. And relative to DPS, I just want to make sure we’re clear that you can buy logs on Grail. You don’t have to have a DPS contract to buy logs on Grail. You can buy logs on Grail through a skew-based model. Obviously, you have to be on the SaaS platform to benefit from logs on Grail. But you can buy logs on Grail outside of a DPS vehicle.

Okay. But any comments on the status of your conversion efforts?

I believe we are where we anticipated. As Rick mentioned, we have had DPS generally available only since the end of April. Given that buying cycles typically range from six to nine months, most of the deals we've been closing have been in the pipeline for some time and were not initially tied to DPS. Thus, a significant increase in DPS shouldn't be expected just yet. I do expect to see an increase in DPS, particularly with new clients and more activity in the latter half of the year. As Rick noted, we secured several dozen additional DPS contracts in the first quarter, and I anticipate more growth with new customers. Additionally, as existing customers renew their contracts, we should see them expanding their use of DPS. However, I expect more noticeable growth later this year and into fiscal '25.

Okay, great. Many thanks.

Thank you. Our next question is from Erik Suppiger with JMP Securities. Please proceed with your question.

Yes, thanks for fitting me in. I'm curious about the competitive landscape, if you have seen any change. And also, can you speak to what you see from the likes of New Relic? In light of some of the changes going on with New Relic, I'm curious if you have any comments about them going private, if that changes anything on the competitive front?

The competitive landscape has remained stable with no significant changes in pricing. DIY continues to be our biggest competitor, followed by a few other vendors. We didn't specifically mention it in our previous remarks, but we are effectively managing complex customer environments that involve additional tools, whether they are DIY or from competitors. We are seeing ongoing competitive takeouts, particularly against AppD and New Relic. Overall, we are doing well, especially when customers reach a point where DIY and competitor tools reach their limits. Regarding New Relic, they have focused on a different market segment than we do, and where we compete with them, we perform strongly. In fact, in our last call, we noted that many of our competitive takeouts involved New Relic. Although their transition to being a private company has caused some disruption, we continue to compete effectively against them.

And we've provided examples of that in prior calls of takeouts of competitors that have simply not scaled with the size, volume or complexity of their existing observability environments.

Very good. Thank you very much.

Thank you.

All right. Well, thank you all very much for your engaged questions. That brings us to the end of our formal call. We really do appreciate your ongoing support. We remain extremely bullish about the opportunity that lies ahead. Fundamentally, the software environment needs more and more observability, and the observability that they need needs to become more sophisticated in automating their solutions. We are fueled by and proud of the third-party validations such as that from Gartner, with us being highest in ability to execute, furthest out in terms of completeness of vision, and we believe that that provides even a further catalyst for Dynatrace as we look ahead. We very much look forward to connecting with you at upcoming IR events over the coming weeks, and we wish you all a very good day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.