Dynatrace, Inc. Q3 FY2024 Earnings Call

Greetings. Welcome to the Dynatrace Fiscal Third Quarter 2024 Earnings Call. At this time, all participants will be in listen-only mode. A question-and-answer session will follow the formal presentation. I will now turn the conference over to Noelle Faris, Vice President of Investor Relations. Noelle, you may now begin.

Good morning, and thank you for joining Dynatrace's third quarter 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, 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 was filed earlier today. The forward-looking statements contained in this call represent the company's views on February 8, 2024. 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 rates and per-share amounts are on a diluted basis. We will also discuss other non-GAAP financial measures on today's call. To see reconciliations between non-GAAP and GAAP measures, please refer to today's earnings press release and supplemental presentation, which are both posted in the Financial Results section of our IR website. And with that, let me turn the call over to our Chief Executive Officer, Rick McConnell.

Thanks, Noelle, and good morning, everyone. Thank you for joining us for today's call. Our Q3 results of balanced growth, profitability, and free cash flow reflect our continued ability to execute successfully in a dynamic market. ARR grew 21% year-over-year. Subscription revenue increased 23% year-over-year. Non-GAAP operating income increased to $105 million or 29% of revenue. And we delivered a 25% free cash flow margin on a trailing 12-month basis or 30% on a pre-tax basis. These results are a testament to our market leadership, the strategic importance of our differentiated platform, and the durability of our business model. Jim will share more details about our Q3 performance and fiscal 2024 guidance in a moment. In the meantime, I would like to discuss the trends we're seeing in the market, highlights from our Perform Customer Conference last week, and our continued rapid pace of innovation. I'd like to begin with three transformative megatrends that are driving the market. Last week, at Perform, we called them Waves. First, cloud modernization continues to drive workloads to the cloud. Second, the AI revolution is sweeping across industries with the opportunity for enormous advancements in innovation and productivity. And third, the escalating threat landscape is increasing the need for more sophisticated cybersecurity protection. These megatrends are occurring amidst an increasing focus by organizations to leverage digital transformation to drive business transformation, but they also bring sizable challenges such as an explosion of data, a massive increase in its complexity, disconnected tools, and a need for better analytics. And it is these challenges, especially with the exponential increase in AI workloads, that have moved observability and application security from optional to mandatory, but not all observability and application security tools are created equal. In this world of containers, microservices, hybrid and multi-cloud environments, as well as limited resources, it is no longer feasible to use dashboards, alerts, and manual triage to manage these workloads. Given this landscape, our approach is radically different in three critical respects. First, the Dynatrace platform enables contextual analytics. We will store all data types, logs, traces, metrics, real user data, business events, others in Grail, an integrated, highly performing and massively scalable data store. By keeping all of these data types together in context, we are able to analyze billions of interdependencies across applications, networks, and infrastructure throughout the enterprise. These dependencies are continuously captured providing virtually instant end-to-end awareness that is not possible to replicate without a unified data store. Our second key differentiator is our hypermodal AI. For over a decade, Dynatrace customers have relied on the predictive and causal AI techniques of our AI engine Davis. We expect to make our generative AI capabilities available on the platform through Davis co-pilot beginning this quarter, thereby bringing the Dynatrace platform to a much wider array of end users. These three AI techniques together deliver a game-changing solution, with each making the other iteratively more intelligent. Our third key differentiator is automation. Organizations want broad-based situational awareness in analytics that can lead to an auto-remediation of issues. Dynatrace ONE agent automatically discovers an entire cloud environment, dynamically instruments applications, and consistently learns and updates without human scripting or user configuration. The result is a trusted foundation that supports workflows to automate resource optimization and progressive delivery, eliminating the need for manual troubleshooting. This is especially critical during business-impacting incidents and textual analytics, hypermodal AI, and automation are three key reasons why Dynatrace is considered a visionary leader in the market. Our customers view these elements as essential in enabling them to navigate the challenges brought on by digital transformation, an explosion of generative AI, and the growing threat landscape. These differentiators enable us to deliver actionable answers, rapid resolution, and incident prevention. They also drive purchasing behavior for customers across a variety of use cases, including enterprise-wide tool consolidation, cloud-native application performance, faster software delivery, cost-effective log management at scale, and secure cloud applications. These trends, differentiators, and advantages were certainly top of mind last week at our Perform Conference in Las Vegas. It was a tremendously exhilarating event where we hosted over 2,000 people in-person, including customers, prospects, and partners, plus thousands more virtually. If you weren't able to participate, I encourage you to watch the replay of our main stage presentations and breakout sessions. We along with several customers and partners, share insights on how these trends and challenges can present business transformation opportunities for customers, especially in the areas of driving innovation, optimizing cost, and mitigating risk. One example of how Dynatrace is helping innovation was from TD Bank. They survived to deliver legendary experiences for their customers requiring consistently high application availability and performance. They found that by reducing a myriad of tool sets down to one, the team can now focus on driving innovation rather than maintaining complex relationships among tools. Lloyds Banking Group shared their story of optimizing cost. They have teamed up with Dynatrace to measure and reduce proactively the carbon footprint of their IT ecosystem. Lloyds Bank is a thought leader in their approach to sustainability, looking to reduce the direct carbon emissions in their operational sectors by at least 75%. Dynatrace has helped Lloyds assess its IT carbon emissions, see where their sustainable efforts are most impactful, and identify meaningful opportunities to optimize their digital infrastructure. A standout example showcasing our ability to mitigate risk comes from the largest application security win in our history, which we closed in Q3. A leading global payment technology company chose Dynatrace because of our ability to immediately identify impactful common vulnerabilities, provide contextual understanding of criticality, and pinpoint the exact location of their vulnerabilities, something their existing security tooling was not able to do. It is a fantastic mode of confidence in our security product from a very large organization. As customers look for ways to drive innovation, optimize costs, and mitigate risk, they know that consolidating their existing observability tools and standardizing on a unified platform is the optimal way to do it. As such, another great story from Perform last week came from the VP of Engineering at PicPay, Brazil's financial ecosystem app. He shared his experience using Dynatrace to help them achieve platform observability at massive scale. This encompasses 35 million users and hundreds of Kubernetes clusters with thousands of nodes. PicPay is a newer customer for Dynatrace. They realized that using multiple tools is costly and inefficient. With Dynatrace, they gain the benefits of visibility and automation through a single unified platform. PicPay is not alone. We are seeing increased demand in large strategic deals, where customers are looking to make broader observability architecture decisions. We believe Dynatrace is in a great position to benefit from this trend given our proven track record of helping customers eliminate siloed tools, significantly improve software availability and performance, reduce cost, and drive organizational innovation and productivity. While these deals are a positive sign of future growth potential, near term, these larger deals add a degree of variability as customers require more time to make these strategic decisions. We view this increasing trend to consolidate existing observability tools and standardize them on a unified platform as a significant opportunity for us. As such, we are continuing to invest in strategic go-to-market areas such as GSI partnerships, demand generation, and targeted sales capacity, while also continuing to prioritize investments in R&D. In addition to the frictionless sales motion that we're driving with hyperscaler partners, we are seeing early positive signs of traction with the investments we've made with GSI partners such as Accenture, Deloitte, DXC, and Kyndryl. It was through one such GSI that we closed a seven-figure Q3 win with a major social media platform. The customer was looking to gain end-to-end visibility into their incredibly complex environment. Our ability to demonstrate the power of AI and automation to greatly reduce outages while saving costs drove the opportunity. We plan to continue to invest in these partnerships to generate pipeline and gain efficiency as we maintain our focus on scaling the business. We also plan to continue our investment in targeted sales capacity in the fourth quarter, weighting our resources toward the higher end of our target global 15,000 market where the propensity to spend is far more significant. We are confident that with the evolution of our go-to-market leadership team, we have the right skills and proven track record to scale the team and build the brand to seize this market opportunity. I'd also like to call out the exciting addition in January of Laura Heisman, the former CMO at VMware, as our new Chief Marketing Officer. In addition to our targeted go-to-market investments, we plan to continue investing in our R&D engine to extend our technology leadership position. The team's relentless focus on market-leading innovation was evident last week with a plethora of announcements in new solutions we unveiled to enhance our platform. First, we announced the availability of Dynatrace AI Observability, which enables customers to embrace AI confidently by providing insights into all layers of AI-powered applications, including large language models and generative AI to manage cost, experience, reliability, and security. Second, we announced Dynatrace OpenPipeline to empower customers with full control of data at the point of ingest, helping customers boost security, ease management, and maximize the value of data. And third, we announced Dynatrace Data Observability to help ensure that data collected through external sources outside of our OneAgent such as OpenTelemetry, business systems, and through Dynatrace APIs is reliable and accurate for business analytics, SmartCloud orchestration, and reliable automation. We believe these platform enhancements provide further monetization opportunities as customers drive more usage, more ingest, more storage, and most notably more queries in business analytics. Before I turn the call over to Jim, I wanted to comment on our plans to acquire Runecast. Adding Runecast to the platform will extend Dynatrace contextual security protection in analytics with Runecast security posture management. This will enable customers to address the risk of misconfigurations and compliance violations in hybrid and multi-cloud ecosystems based on AI-driven and automated real-time vulnerability assessments. Additionally, it will allow customers to perform threat detection and incident response with full context detailing their security vulnerabilities, affected applications, and attack factors. We are thrilled to welcome this talented team to our R&D organization. In closing, our Q3 results reflect the ongoing demand for automated observability and application security solutions. The durability of our business model and our ability to execute successfully in an evolving marketplace. Our unified platform with contextual analytics, hypermodal AI, and automation differentiates us in the market and positions us well relative to competitive alternatives. We believe the market is moving toward us with a desire for fewer solutions, better insights, and actionable answers leading to rapid incident resolution and prevention. And we plan to continue to invest strategically in go-to-market areas, as well as R&D innovation to capture market opportunity and drive ongoing leadership while maintaining our commitment to balance growth, profitability, and free cash flow. Jim, over to you.

Thank you, Rick, and good morning, everyone. As Rick mentioned, Q3 marks another quarter of solid execution by the Dynatrace team as we once again surpass the high end of our top-line growth and profitability guidance metrics. Our continued ability to execute successfully in this dynamic environment is a testament to the growing criticality of observability and application security in the market, our platform differentiation, the value proposition we provide to customers, and the ongoing durability of our business model. Now let me review the third quarter results in more detail. Please note the growth rates mentioned will be year-over-year and in constant currency unless otherwise stated. Starting with annual recurring revenue or ARR, total ARR for the third quarter was $1.43 billion, an increase of $263 million compared to the same period last year, representing 21% growth year-over-year. Net new ARR on a constant currency basis was $70 million in the quarter. In Q3, we added 209 new logos to the Dynatrace platform, roughly consistent with the year-ago quarter. As I have shared in the past, we are focused on the quality of new logo lands that have a greater propensity to expand. In Q3, average ARR per new logo came in at roughly $140,000 on a trailing 12-month basis, consistent with Q2, and up 17% year-over-year. We continue to attract enterprise customers that are outgrowing their existing DIY or commercial tooling solutions, seeking business value in tool consolidation and coming to Dynatrace for the depth, breadth, and automation of our unified observability platform. Our gross retention rate remained best-in-class in our industry in the mid-90s and contributed to a net retention rate of 113% in the third quarter, coming in at the high end of our expectations. When we think about our net retention rate, there are three areas that drive customer expansion: One, growth of existing observability workloads; Two, adding new observability workloads; And three, cross-selling new solutions like log management, analytics or application security. We estimate that our customers are observing only 20% to 30% of their workloads today. We believe these three growth vectors provide us with significant opportunity to expand further within our installed customer base. And as we have highlighted last week at Perform, our innovation engine continues to deliver enhanced platform solutions to increase our upsell and cross-sell opportunities. In addition, we believe our DPS licensing model will further contribute to growth in the net retention rate over time as customers gain greater access to newer solutions and encounter less friction in the buying process. We continue to see strong momentum and interest in this type of contracting model. In Q3, we closed over 150 DPS deals globally, bringing total DPS customers to roughly 400, representing more than 10% of our customer base. Moving on to revenue, total revenue for the third quarter was $365 million, up 21% year-over-year, and $6 million above the high end of guidance. Subscription revenue for the third quarter was $348 million, up 23% year-over-year, and $8 million above the high end of guidance. With respect to margins, non-GAAP gross margin for the third quarter was 85%, consistent with the prior quarter and up 100 basis points from Q3 of last year, driven by ongoing cloud-hosting efficiency efforts. Our non-GAAP operating income for the third quarter was $105 million, $8 million above the high end of our guidance, driven by the combination of revenue upside and disciplined expense management. This resulted in a non-GAAP operating margin of 29%, exceeding the top end of guidance by 200 basis points. Non-GAAP net income was $96 million, or $0.32 per diluted share. This was $0.04 above the high end of our guidance range, driven by the items I just highlighted and a slightly lower tax rate driven by several discrete items related to additional foreign tax credits and incentives. Our free cash flow was $67 million in the third quarter. As we've discussed in the past, we 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 $340 million or 25% of revenue. As a reminder, this includes 500 basis points of impact related to cash taxes. Pre-tax free cash flow on a trailing 12-month basis was 30% of revenue and up 43% year-over-year. Finally, we ended the third quarter with a robust balance sheet, including $783 million of cash and zero debt. Before I move to the guidance details, I want to give you a brief update on the demand environment and trends we are seeing. The observability market opportunity is growing, the demand environment remains healthy and our pipeline continues to grow at a faster pace than our reported ARR growth rate. More specifically, within the sales funnel, we are seeing a growing number of larger and more strategic deals related to observability architecture and vendor consolidation initiatives, and we expect this directional heading to continue. To give you a sense of the magnitude of this trend, the number of deals in the pipeline greater than $1 million of ACV, both new logo and installed base, has increased 39% compared to the same quarter last year. We view the growing number of these deals as a sign that the increasing complexity of managing fragmented tools is becoming unmanageable, and customers are looking for a partner to help them drive business value and tool consolidation. We believe our highly differentiated unified platform with contextual analytics, AI leadership, and data-driven automation positions us well to capture these opportunities. At the same time, given the larger values of these strategic deals and the C-level approvals that they require, they introduce increased variability in terms of timing required to close. As such, we believe it is best to be incrementally more prudent in our near-term guidance. With that in mind, let's start with our updated guidance for the full-year, with growth rates in constant currency. We are lowering our ARR guidance by 100 basis points from our prior guidance to account for the incremental level of prudence related to the timing of the large strategic deals I just mentioned. We now expect ARR to be $1.485 billion to $1.495 billion or 18% to 19% growth year-over-year. As a reminder, we have $13 million of ARR expansions associated with early renewals in the fourth quarter last year. It was the first time in our history as a public company where we saw a sequential increase over our seasonally strongest third quarter, making for a difficult year-over-year compare this Q4. Given our strong Q3 finish for revenue, we are raising our revenue guidance by approximately $11 million at the midpoint to $1.422 billion and $1.427 billion, up 50 basis points from our prior guidance and representing 22% growth year-over-year. We are raising our subscription revenue guidance by approximately $16 million at the midpoint to $1.352 billion to $1.357 billion or 24% growth year-over-year. This represents an increase of 150 basis points from our prior guidance. Turning to our bottom line, the strength and resilience of our financial model is evident in our ongoing margin performance. We are committed to investing in future growth opportunities that we expect will drive long-term value, while also optimizing costs to drive profitability. We continue to rebalance our cost profile to prioritize our investments in R&D innovation, CSM coverage, and strategic go-to-market areas such as GSI partnership, demand generation activities, and targeted sales capacity. With this in mind, we are raising our full-year non-GAAP operating income guidance by $9 million. This translates to non-GAAP operating margin guidance of 27.25% to 27.5%, representing an increase of 25 basis points at the low end of the range and 50 basis points at the high end of the range. We are raising non-GAAP EPS guidance to $1.16 to $1.18 per diluted share, representing an increase of $0.06 at the midpoint of the range. This non-GAAP EPS is based on a diluted share count of 299 million to 300 million shares. We are raising our free cash flow guidance to $330 million to $335 million, an increase of $16 million at the midpoint, representing a free cash flow margin of 23% of revenue, up 50 basis points at the midpoint. Finally, this guidance assumes the acquisition of Runecast, which we expect will close by March 31. This technology tuck-in transaction will not have a material impact on our financial results. Looking at Q4, we expect total revenue to be between $372 million and $377 million or 18% to 19% growth. Subscription revenue is expected to be between $353 million and $358 million, up 20% to 21% year-over-year. From a profit standpoint, non-GAAP operating income is expected to be between $85 million and $90 million or 23% to 24% of revenue. Keep in mind, we have some seasonal expenses taking place in the fourth quarter, including incremental spend for our Perform customer conference, as well as a structural reset of payroll taxes. Non-GAAP EPS is expected to be $0.26 to $0.28 per diluted share. In summary, we are pleased with our third quarter fiscal '24 performance. We have a proven track record of disciplined execution, balancing top-line growth with profitability and free cash flow. We are building incremental prudence in our near-term outlook, while we remain optimistic about our intermediate-term growth opportunities and our growing differentiation in the market.

At this time we will be conducting a question-and-answer session. Our first question comes from the line of Jake Roberge with William Blair. Please proceed with your question.

Hey, thanks for taking the questions. Rick, you've talked in the past two quarters about the incremental go-to-market investments you're making. Can you talk about what you're seeing in the top of funnel and pipeline activity that continues to give you confidence to make those investments?

Sure, Jake. Thanks for the question. The short form is we continue to see pipeline growth in advance or higher than our ARR growth. So that's one element. As Jim indicated in his remarks, we see increasing deal sizes across the board. These are strategic deals. They take a little bit longer to close, but we feel very positive about the pipeline growth that we're seeing.

Thank you. Our next question is from the line of Brad Reback with Stifel. Please proceed with your question.

Great, thank you very much. Rick, net ARR growth has been the best it's been for the last five or six quarters. What needs to improve, execution, the economy, or both to return to a more consistent growth rate? Thanks.

Well, I would say that the pipeline coverage continues to grow. So that's a positive. We see, as I mentioned in the answer to the prior question, pipeline growth exceeding ARR growth, so that's good. We need to be able to convert that pipeline at a higher rate, and that's going to come with macro improvement that occurs over time. And also, obviously, with sales execution against these larger deals and larger transactions that we mentioned.

Thank you. Our next question is from the line of Patrick Colville with Scotiabank. Please proceed with your question.

All right. Thank you so much for having me on the call. I mean one of the juicy metrics you gave this quarter was the 150 DPS deals. I think you called out that 10% of customers are now in DPS. I mean, I guess, what impact is DPS having on NRR, if at all already? And if it's not having any impact right now, can you just give us a framework as to like when we think DPS might impact NRR? Thank you.

Thank you, Patrick. This is Jim. Regarding DPS, we've discussed this previously. The DPS contracting vehicle provides full access to the platform with a unified rate card for all our capabilities instead of purchasing on a SKU basis. You commit a dollar amount for a term and draw down based on consumption against this rate card, allowing you to utilize all platform capabilities. This creates a much more seamless buying experience. As for the timing of expansion, it occurs when customers are on the platform. We’ve demonstrated that customers using DPS contracts consume faster, leading to higher expansion rates. We are still in the early stages of this, as it has been generally available since April. Expect to start seeing results within about a 12-month period. We monitor this closely and have observed that customers with a DPS contract consume at a faster rate than those without. Therefore, we anticipate this trend will continue, likely impacting fiscal '25.

Thank you. Our next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed with your question.

Hi, thank you for the opportunity to ask a question and congratulations on an excellent performance. It's great to see you making an impact on stage. My question pertains to the timing of the large deals and the closing process. With the pipeline for new annual recurring revenue up by 39% and the potential for DPS to kick in next year, I'm wondering if you believe that the next fiscal year, starting in a few months, could experience higher growth rates than this fiscal year. This obviously reflects the investments you've made in new products, which have performed very well, alongside the expansion of go-to-market capacity and the focus on large deals and DPS. Thank you.

Yes. This is Jim. I'll take that. Obviously, we're not going to provide fiscal '25 guidance on this call. I would say the thesis of the various areas that you talked about are certainly growth drivers. I'm not going to comment on whether that leads to an acceleration in fiscal '25. But what I will say, just to make sure that I was clear in the prepared remarks that when you step back and say, what has fundamentally changed in the last 90-days relative to the pipeline? The pipeline remains strong. We have a growing number of very large vendor consolidation opportunities that I mentioned. So I'd say it's a net positive for Dynatrace because what we're seeing in the market is a trend towards customers doing or considering more tool consolidation, vendor consolidation because of the complexity of the environment of having a bunch of disparate tools. So this is a net positive we believe for Dynatrace. The only thing that has changed is that we are building an incremental level of prudence knowing that these deal sizes are very large. They're strategic and the timing for closing them can be a bit variable to pick within a three-month window. So all we've done is we tried to build a level of incremental prudence into the guide. There is no change in the demand environment. The demand environment remains healthy.

Kash, let me just add to that. First of all, thanks very much for attending Perform; that's exceptional. What I would say simply is that the market fundamentals here remain, in our view, very strong. And we like our position based on contextual analytics, hypermodal AI, and automation to take advantage of a market that really requires this degree of automation to evolve, because the number of IT resources that are available to do manual processing of IT workloads is constrained and observability, in particular, sophisticated observability and application security solutions like Dynatrace's are going to become more and more critical, in fact, mission-critical in this market as we look at.

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

Hi, thank you very much. It was great to attend Perform last week. I have a question regarding the recent trends. If we analyze the ARR growth and consider different scenarios for logs and analytics and security, there seems to be a notable decline in what we can refer to as the residual business. I'm curious to know if this perspective is accurate and why you believe this decline is occurring, especially in light of the growth of your new offerings. Also, Jim, could you clarify for us regarding cash taxes? Will there be an impact due to incremental cash taxes in FY '25, or is it more of a one-time situation? This would help us establish a framework for our cash flow for next year. Thank you.

Yes, I'll start with that. The cash tax we've experienced, which is about 500 basis points, will continue. Fiscal '25 is not a one-time occurrence. We are a full cash taxpayer because we are GAAP profitable, and we do not have net operating losses or tax loss carryforwards. Therefore, you should anticipate that the cash tax we have in fiscal '25 will persist going forward. There are ongoing strategic tax planning efforts, but generally, you should expect that to continue. Regarding the ARR, we do not provide detailed breakdowns of all our product categories. I want to remind you that we are still in the early stages of our journey in application security and logs. We mentioned that both areas are expected to reach $100 million in ARR by the end of fiscal '25. We've been involved in AppSec for a bit longer than in logs. To highlight, with logs, we start with the proof of concept, then move to smaller workloads in production, followed by newer workloads. The final stage involves leveraging existing workloads. Therefore, we are still in the very early phases of this journey. Currently, logs and AppSec do not significantly contribute to our ARR, while our strengths remain in full-stack infrastructure, which continues to drive the majority of our ARR. We expect to see acceleration in application security and logs, with significant growth occurring in fiscal '25. That is our expectation.

Keith, I might add that quarter-over-quarter, we saw a 50% increase in paying logs customers, log management customers, and an additional 30% increase in POCs on log management. So we do continue to see traction in this new offering.

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

Great, guys. Thanks for taking my question. I guess for either of you, regarding the ARR commentary, and I think the uncertainty of large deal timing, did any abnormal large deals push out of the quarter? And I guess are there things that either your sales force or partners are focused on to accelerate the closing of with some like a growing pipeline of these large deals that could ultimately start to have a positive impact on growth?

Yes, I guess I will take that. Relative to these deals that we're seeing and whether they had kind of some of them that pushed out of Q3, I'd say you always have deals that push out of a quarter that you pull into a quarter. But I would say nothing, Matt, that's like notable. These are deals that, as you can imagine, they've been in the funnel. They don't happen overnight. And as they progress, you get a better assessment of kind of the deal size and the deal timing. The good news is these deals, many of them have been growing as we've been working through the sales process. So we're actually in a good position relative to the health of the funnel. The only thing that has fundamentally changed is, as I mentioned, the timing. And the challenge with deals like these is there's not always a compelling event for a specific date for them to close because if you're doing a vendor consolidation decision. There may be the timing of maybe a competitor solution that may have a contract up for renewal. So that may be one element of a compelling event. But in general, these are very strategic decisions for customers and so there is a serious and significant evaluation when they go through that. You have to anticipate that as you're trying to determine a close date.

I would just add, Matt, that with GSIs in particular, since you mentioned the partner front, we continue to be very enthusiastic about the evolution of the GSI partner opportunities, especially with some of the core GSIs I mentioned, like Accenture, Deloitte, DXC, and Kyndryl. And those deals are inherently going to be bigger and take a bit longer to close as well. But we feel very good about our posture and position associated with the GSI evolution.

Thank you. Our next question comes from the line of Mike Cikos with Needham & Company. Please proceed with your question.

Thank you for taking my question. There's been a lot of discussion about the ARR guide, and I want to clarify it. Jim, you've mentioned adding some caution regarding these larger, strategic deals. Could you explain the extent of that caution? This would help set expectations as we consider the changes to the guidance approach. Additionally, it would be helpful for investors to know whether, excluding these larger deals that are taking longer to finalize, management would still be raising the fiscal '24 constant currency ARR guide.

Well, you can imagine the pipeline is just a basket of opportunities. There's large opportunities, small opportunities. So I think what we are seeing though is the funnel is becoming a bit more weighted to these large opportunities. And I will tell you that the guide that I provided last time, which was 19% to 20% growth, in the guide now, 18% to 19%, the way you should think about that is the difference in that of 100 basis points is literally just incremental improvements. Nothing else has fundamentally changed.

Thank you. Our next question comes from the line of Fatima Boolani with Citi. Please proceed with your question.

Good morning. Thank you for taking my question. Jim, just along these lines, historically, it's been very helpful for us to internalize your growth algorithm between new logo acquisition and the installed base expansion. So just bearing in mind some of your commentary on some of the expansionary behavior, the DPS uptake, and what you're seeing in the pipeline, I was hoping you could help us flesh out for us what your expectations are as it relates to a new logo business versus a potential recovery on the installed base expansion side?

Yes. I mentioned previously that we expected expansion rates to be in the range of 112% to 113% in the near term, and I anticipate this to continue for the rest of this year. We have also indicated that new logo growth will likely be in the low single digits, but with larger land sizes. Currently, our land sizes are approximately $140,000 on a trailing 12-month basis. These factors remain fundamental to our strategy. On the new logo side, our focus on acquiring a larger set of customers has shown that they tend to expand more when we start with a larger contract. These key elements are unlikely to change. When I provide guidance for fiscal '25, I will offer more details on this. Additionally, we maintain a best-in-class retention rate, demonstrating that our product is quite sticky, with minimal churn or downsell expected.

Thank you. Our next question is from the line of Ray McDonough with Guggenheim. Please proceed with your question.

Great, thanks. Rick, when we talk to some of your partners, it does seem like tool consolidation is accelerating, and you've hit on that throughout the call. But is that acceleration due to a change in control at a couple of your competitors? And if so, can you help us understand where those opportunities are coming from specifically? Is it some of your traditional APM competitors? Or are you seeing displacement opportunities in log management and other areas at this point? Obviously, you mentioned it's still early on for logs, but any color would be helpful.

Thanks, Ray. I would say a bit of all of the above by way of tool consolidation. AppDynamics continues to be a source of new logos for us in a material way. New Relic going private certainly has created some disruption, as has the acquisition of Splunk by Cisco, which creates certainly some degree of market confusion and apprehension that leads to opportunity for us. Having said that, it's all still relatively early stage in terms of some of these transaction announcements, and we'll have to see how they evolve over the course of time.

Thank you. Our next question comes from the line of Gray Powell with BTIG. Please proceed with your question.

Thank you for allowing me to ask a question. I appreciate the insights on net new ARR trends, particularly regarding the $1 million ACV deals. Could you help us understand what the typical sales cycle looks like for larger deals and how it has been extending in recent quarters as customers are increasingly opting for multiproduct deals? Thank you.

Our typical sales cycle ranges from six to nine months. This can vary based on whether we are acquiring a new customer or expanding an existing relationship. New customers generally take longer as they conduct thorough evaluations, including proofs of concept. However, we're seeing an increase in larger deals with both new logos and existing customers. Even our current customers are starting to consolidate their toolsets, making decisions about DIY tools and other commercial solutions. The sales funnel shows a 39% increase compared to the same period last year, which indicates a positive trend. However, this does introduce some variability in our timelines. It's challenging to pinpoint a specific time frame, as it can range from a month to a quarter, depending on the deal size and the impact on customer organizations and processes. Customers must carefully assess these changes, making it harder to provide an average close date.

Thank you. Our next question comes from the line of Joel Fishbein with Truist Securities. Please proceed with your question.

Thank you for the question. I have a follow-up regarding the observability consolidation we're witnessing in the market. Could you discuss the vendors you believe are positioned to compete with you in these observability deals? We’ve heard ServiceNow making some moves, along with a few others. I would like to understand the competitive landscape in this area. You elaborated on your competitive advantages last week, so I would appreciate hearing from you, Rick, about what you are observing in the market.

Well, I talked about some of the competitors already to some extent, I think, that are providing some opportunity based on the disruption in those areas. To extend that further, I would say, again, that I very much like our position recently these trends towards larger strategic deals based upon our core differentiation, especially at the higher end of the market. You had asked about ServiceNow; we actually still see them mostly as a partner as opposed to a competitor in the market. They just don't have the capabilities yet in observability and application security that we do. So it's more times than not, customers are asking us to integrate with ServiceNow instead of competing with them.

Thank you. Our next question comes from the line of Adam Tindle with Raymond James. Please proceed with your question.

Okay, thank you, Rick. Good morning, I wanted to ask a strategic question related to Runecast. To start with, the motivation for that was posture management something that customers were asking before adopting AppSec or would you characterize this as maybe the start of a broader push into security? And then secondly, into that, just zooming out your kind of strategic view on cloud security, broadly speaking. There's been a lot of investment and a lot of growth in that space, a combination of agent and agentless technologies going on. I wonder where you think Dynatrace plays in that market? Do you see a holistic platform like a Wiz type of player over time or attractive areas that you're going to pick and choose your spots? Thanks.

Thanks, Adam. Regarding posture management, our goal is to enhance security and utilize cloud security posture management to improve our vulnerability analytics capabilities. We really appreciate the Runecast team and their technology, which incorporates AI and contextual security protection analytics, fitting well into our portfolio. This addition helps us tackle the risks associated with misconfigurations and compliance violations alongside our existing vulnerability analytics. It's an excellent enhancement. On the broader topic, we have consistently pointed out that observability and application security are merging. The features we offer in our platform, such as contextual analytics and hypermodal AI, provide strong capabilities in application security as well. In the market, we have been focused on using our observability platform's core elements to enhance application security more effectively than our competitors. We are very excited about Runecast and continue to invest in application security overall.

Thank you. Our final question comes from the line of Will Power with Robert W. Baird. Please proceed with your question.

Okay, great. Thanks for fitting me in. I guess, Rick, it would be great to get your perspective on kind of the tone of customer conversations that Perform being fresh here. Just how customers that you're talking to are thinking about, I guess, both budgets and priorities as we kind of head into 2024 here? And then any perspective with respect to how any of that might have changed versus those conversations a year ago?

I would say that Perform customers are typically existing Dynatrace users or potential prospects, which gives us insights into the market. The feedback from customers at Perform was outstanding, and their engagement was remarkable. They are very committed to Dynatrace and the investments in the platform. They understand that observability is increasingly important in a landscape where digital transformation is crucial for business transformation. Additionally, they recognize that relying on manual methods like dashboards and alerts isn't sufficient. They need a platform that provides analytics, AI, and automation to enhance their capabilities. Overall, the feedback was extremely positive, and the event was exceptional. That brings us to the close. I want to thank you all for your engaged questions and your ongoing support. As we have mentioned throughout this call, we remain very optimistic about the opportunities ahead. We look forward to connecting with you at upcoming investor relations events in the coming weeks, and we wish you a great day. Thank you.

This will conclude today's conference. You may now disconnect your lines at this time, log off your webcast, and thank you for your participation. Have a wonderful day.