Dynatrace, Inc. Q2 FY2026 Earnings Call

Greetings. Welcome to Dynatrace's Fiscal Second Quarter 2026 Earnings Call. Please note, this conference is being recorded. At this time, I'll 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 Second Quarter Fiscal 2026 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 and annual report on Form 10-K. The forward-looking statements contained in this call represent the company's views on November 5, 2025. 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 year-over-year and non-GAAP, reflecting constant currency growth and per share amounts are on a diluted basis. We will also be discussing 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 today's call. Dynatrace delivered very strong second quarter fiscal 2026 results, exceeding our guidance across every metric. ARR grew 16%. Subscription revenue grew 17% and pretax free cash flow was 32% of revenue on a trailing 12-month basis. This overachievement in performance was due to successful execution of our strategy to capture the growing demand for end-to-end observability and large-scale multi-cloud tool consolidations, including ongoing growth in our logs business. Dynatrace's consistent execution gives us the confidence to raise our ARR, revenue and operating income outlook for the full year. Jim will share more details about our Q2 financial performance and guidance in a moment. In the meantime, I'd like to devote my remarks to why we believe AI-powered observability is mission-critical to software reliability and performance, especially in an evolving agentic world. And I will also provide an update on our key growth drivers. To start, the Dynatrace platform has evolved through multiple phases from reactive operations to automated root cause to now preventive operations. Our vision has been consistent over the past years to enable a world in which software works perfectly. By definition, that means that software must always be available. And when issues do occur, the software must self-heal. Preventive operations is about anticipating and taking action on issues before they become end user impacting. Customers are increasingly seeking not just answers followed by manual resolution, but rather answer-driven automation to deliver and operate software that works optimally. The Dynatrace third-generation platform was built from the ground up to handle precisely the level of complexity and scale of modern cloud and AI native environments, including the following core elements. Grail, our massively parallel processing data lake house, is capable of analyzing billions of interconnected data points in near real time to deliver comprehensive situational awareness. Smartscape provides deep contextual insights of topology and metadata through a directed knowledge graph. Davis delivers reliable, causal and predictive AI insights to produce deterministic answers. Davis Copilot automatically generates remediation proposals. and automation engine helps orchestrate and manage intelligent automated responses across the digital ecosystem. These technologies by being part of a fully unified platform rather than a series of point products with fragmented data stores enable true end-to-end observability, which is crucial to delivering accurate analytics and recommendations. In this way, our AI-powered platform is enabling the next phase of observability for Dynatrace, which is autonomous operations. In this business transformational phase, we take preventive operations to the next level by leveraging an ecosystem of agents, both from Dynatrace and third parties to take action to maintain software reliability, security and performance. It's about deploying intelligence that enables self-healing systems to keep software operational and performant with less human intervention. Moreover, worldwide spending on AI is forecast to be nearly $1.5 trillion in 2025 according to Gartner. As organizations broadly adopt agentic AI themselves, complexity will grow further, driving even greater need for a more scalable autonomous approach. We see Dynatrace and the evolution of observability becoming a bridge to the agentic world for enterprises. As stated perhaps most succinctly, we see Dynatrace as the AI-powered observability platform for autonomous operations. With this evolution, Dynatrace will be able to orchestrate and supervise both internal and external AI agents to auto prevent, auto remediate and auto optimize. We believe that Dynatrace is unique in our ability to deliver such an observability environment. One of our superpowers lies in our ability to pinpoint the so-called needle in the haystack in understanding software availability and performance. This has always been Dynatrace's biggest differentiator. And organizations will only allow autonomous action if it's based on precise, reliable answers, not loosely correlated data points. We like to think of this as answers, not guesses. Based on this deterministic knowledge, we can then confidently conduct agentic platform-based orchestration through both Dynatrace and third-party agents to take action. In order for an autonomous approach to be effective, it has to be built on a foundation of genuine end-to-end observability that provides deep analytics and insights, ultimately enabling an automated response. Our ability to analyze all observability data types, logs, traces, metrics, real user data, topology and even business events in context is essential for generating the most accurate and trustworthy answers. Additionally, the ability to oversee all domains, including infrastructure, apps, log management, user experience, application security and business observability provides the most comprehensive perspective of an organization's IT ecosystem. Whereas metrics and logs are often the data types of choice for infrastructure management, faces a long-time strength of Dynatrace become increasingly important for end-to-end inspection of agentic systems. Combination of full stack visibility and domain breadth allows customers to operate more efficiently, reduce overall costs and increase productivity as well as the pace of innovation. Perhaps most importantly, though, we believe these elements together yield superior outcomes. And customers are rapidly extending these outcomes beyond technical analytics of software performance into true business observability. There's also a vastly growing demand for organizations needing to observe AI native workloads. Customers adopting agentic AI will need to understand the complex interactions among agents and know exactly what to do when something unpredictable happens, including the avoidance of hallucinations. In order to have that level of visibility, all telemetry, especially traces and logs, must be captured, enriched with context and analyzed in real time at massive scale to prevent or instantly remediate issues. We are enabling AI to observe AI workloads through deep end-to-end observability. In sum, Dynatrace is rapidly progressing toward a future where our AI-powered platform doesn't just observe, but empowers organizations through knowledge, reason and action. This is why organizations that are leading the evolution of AI are partnering with Dynatrace as a foundation for smarter, faster and more reliable IT operations. So let me now highlight some recent developments with third parties to help bring autonomous operations to reality. Last Monday, Dynatrace and ServiceNow co-announced a multiyear strategic collaboration to advance autonomous IT operations and scale intelligent automation for joint enterprise customers. We are bringing together Dynatrace's AI-powered observability platform with ServiceNow's AI platform for business transformation to provide proactive self-healing IT environments. This partnership enables IT management and operations with real-time trustworthy autonomous actions across the software delivery life cycle. We also announced our integration with Atlassian to help customers fully understand issues and act quickly by embedding real-time production insights directly into incident management processes. Automatically tying incidents to root cause empowers organizations to operate more efficiently and proactively in managing complex digital ecosystems. And finally, we joined GitHub's Model Context Protocol Registry. This integration helps speed up debugging efforts during development and leverages Dynatrace observed production insights to increase agentic software improvements. This also further enables us to extend left to reach cloud and AI native development and platform engineering teams. I'd like to turn next to an update on 4 key growth drivers for our business, all of which continue to trend positively. First is the massive opportunity that we continue to see in log management. We believe the logs market remains ripe for disruption given the rising cost of legacy solutions that offer little to no expansion in business value. As we have stated in the past, we have taken a very different approach to logs. Traditionally, logs were separated from other observability data types. Instead, Dynatrace provides a unified data model inclusive of logs, allowing for cross-data analytics without manual stitching, resulting in faster root cause analysis and more accurate observability insights. Log management is our fastest-growing product category and is rapidly approaching $100 million in annualized consumption, continuing to grow more than 100% year-over-year. In addition, as more customers look to migrate their existing logs to Dynatrace, we're investing to increase the speed of those migrations. Last month, we announced a partnership with Crest Data Systems to deliver a seamless automated migration experience for customers moving to the Dynatrace platform. This enabled us, for example, to meet an aggressive timeline for a global financial services company by automating 70% of their dashboard migrations. Second, the investments we made last year to align our sales coverage around strategic accounts pipeline and partners continue to pay off. Our 4-quarter pipeline for strategic accounts is up 45% versus last year. Bookings through strategic GSI partners doubled year-over-year. And we saw a 53% increase in Q2 ACV from 7-figure deals compared to last year. Here are just a few examples of large wins in the quarter. An AI native revenue intelligence company and a new logo selected Dynatrace to be their end-to-end business solution for mission-critical workloads, displacing multiple tools. Our biggest new logo deal in APAC is one of Japan's largest banks. Fragmented tools and the complexity of their architecture were making it difficult for them to reduce mean time to resolution. With Dynatrace, they will now have an end-to-end view of their ecosystem to resolve issues more quickly. A major U.S. airline expanded its existing relationship with us 18 months after adopting Dynatrace to further consolidate tools, including logs after seeing significant improvement in incident resolution and the benefits of end-to-end observability. A third growth driver is the Dynatrace Platform Subscription licensing model, or DPS. We reached a major milestone in the second quarter with 50% of our customers and 70% of our ARR now utilizing DPS. When we launched DPS over 2 years ago, our expectation was that customers with full access to the platform would leverage more capabilities and extend Dynatrace more broadly into their IT environment. This thesis has played out with DPS customers adopting 2x the number of capabilities and at nearly double the consumption growth rates of those on a SKU-based model. And finally, overall platform consumption is a strong indicator of future expansions and is the primary compensation metric for our customer success team. Total Q2 consumption growth was more than 20% and continues to outpace subscription revenue growth. To wrap up, we are pleased to have delivered a strong first half of the fiscal year. The observability market opportunity is more critical than ever given the rapid evolution of cloud and AI native workloads. We have a differentiated AI-powered platform that is enabling autonomous operations in an evolving agentic AI world. We deliver significant customer value driving accelerating platform consumption. We continue to see momentum in our core growth drivers. And we have a compelling business model, which has enabled us to deliver a sustained balance of growth and profitability. Jim, over to you.

Thank you, Rick, and good morning, everyone. Q2 was an excellent quarter across the board. We surpassed the high end of our top line growth and profitability guidance metrics once again. As Rick mentioned, this strong performance was driven primarily by our ability to capture the growing demand from enterprise customers for end-to-end observability and large-scale tool consolidations. Among many highlights, we continue to demonstrate traction in key growth areas. This includes momentum in large deal activity and pipeline, accelerating consumption and adoption across the platform, notable strength in logs, continued adoption of DPS and a growing number of early expansions, including several 7-figure deals in the second quarter. Additionally, our partner ecosystem is maturing with growing traction across GSIs, hyperscalers and strategic partnerships. Let's review the second quarter results in more detail. Annual recurring revenue, or ARR, ended the quarter at $1.9 billion, representing 16% growth, consistent with Q1. Q2 net new ARR on a constant currency basis was $70 million, up 16% from a year ago, driven by both strong expansion and new logo bookings across the geographies. Execution was particularly strong in North America and Asia Pacific, with many deals influenced and driven by our GSI partners. For the first half of the year, net new ARR was up 14% from a strong first half last year. In Q2, we added 139 new logos to the Dynatrace platform with an average ARR per new logo of over $140,000 on a trailing 12-month basis. We continue to target landing with high-quality new logos that have a higher propensity to expand. The average land size in Q2 was particularly robust with new logo ARR growing well over 30% year-over-year. We continue to see accelerating consumption and adoption of the platform with our average ARR per customer over $450,000, highlighting the criticality and business value we provide to customers. The strategic relevance of the Dynatrace platform is further reflected in our gross retention rate, which remained in the mid-90s. Net retention rate, or NRR, was 111% in the second quarter, in line with the prior quarter. As Rick mentioned, our DPS licensing model continues to gain traction, achieving a major milestone with 50% of our customer base and 70% of our ARR now on this vehicle at the end of Q2. DPS has become our de facto contracting model. With access to the full platform, customers are adopting Dynatrace more broadly across their IT environments, resulting in increased consumption. Turning quickly to usage volumes on the platform. Q2 was another quarter of robust consumption of the platform with the annualized consumption dollar growth rate accelerating and continues to track north of 20%. Further, DPS customers continue to consume at nearly 2x the growth rate and leverage 2x the number of capabilities compared to SKU-based customers. Contributing to that consumption rate, logs remains the fastest-growing product category, growing well over 100% year-over-year and rapidly approaching our $100 million milestone. We believe there is plenty of momentum and runway into the second half and beyond. Increased consumption on the Dynatrace platform can sometimes accelerate usage above a customer's original DPS annual commitment, resulting in either ODC revenue or an early expansion opportunity. The decision to consume on demand or renew early is customer dependent and will vary based on that quarter's customer cohort behavior and influenced by the remaining duration of their contract. In Q2, we saw more DPS customers expand early versus going on demand and contributing to our strong net new ARR result. ODC revenue came in at $7 million for the quarter, just shy of our expectation. The key takeaway, however, is that the company's emphasis on driving platform adoption and consumption serves as the foundational growth engine, whether it's fueling ODC revenue or supporting early expansion of net new ARR. Both contribute to subscription revenue with ODC reflected immediately in ARR over time. Moving on to revenue. Total revenue for Q2 was $494 million, and subscription revenue was $473 million, both up 17% and exceeding the high end of guidance by nearly 100 basis points, driven by strong net new ARR bookings. Turning to profitability. Non-GAAP operating margin was 31%, exceeding the top end of guidance by 150 basis points, driven mostly by revenue upside flowing through to the bottom line. Non-GAAP net income was $133 million or $0.44 per diluted share, $0.03 above the high end of our guidance. We generated $28 million of free cash flow in the second quarter. Due to seasonality and variability in billings quarter-to-quarter, we believe it is best to view free cash flow over a trailing 12-month period. On a trailing 12-month basis, free cash flow was $473 million or 26% of revenue. As a reminder, this includes a nearly 700 basis point impact related to cash taxes. Pretax free cash flow on a trailing 12-month basis was 32% of revenue. Finally, a brief update on our $500 million opportunistic share repurchase program. In Q2, we repurchased 994,000 shares for $50 million at an average share price of just over $50. Since the inception of the program in May 2024 through September 30, 2025, we have repurchased 5.3 million shares for $268 million at an average share price of just over $50. Moving now to guidance. Our conviction in growth drivers continues to strengthen, fueled by secular tailwinds of vendor consolidation, cloud modernization and AI workload proliferation. Our go-to-market momentum and funnel of large anchor deals continues to grow with the pipeline of strategic enterprise ACV up 45% year-over-year. Consumption growth continues to significantly outpace ARR growth, driven by customer adoption of DTS, leading to broader upsell and cross-sell penetration. Log management continues to be a significant source of growth, both in our installed base and with new logos. We are balancing these leading growth indicators and our strength in the first half of the year with a prudent approach for the second half with 2 primary factors in mind. First, the weighting of the pipeline towards larger, more strategic tool consolidation opportunities often creates increased timing variability and longer duration to close. Second, while observability demand remains resilient, the macro and geopolitical environment, particularly in EMEA, remains dynamic. And with that as context, let me summarize our updated full-year outlook. The underlying strength in consumption growth, coupled with the strong first-half performance gives us the confidence to raise our full-year ARR growth guidance by 100 basis points at the midpoint to 14% to 15% growth in constant currency. Seasonally, we expect net new ARR to be weighted more towards Q4 than last fiscal year due to the mix and timing variability of large deals in the funnel. Moving now to revenue. We are raising our total revenue and subscription revenue growth guidance by 75 basis points at the midpoint to a range of 15% to 15.5% growth in constant currency. Given the half 1 mix shift towards early expansions and ARR, we now expect ODC revenue to be in the low 30s. Turning to our bottom line. We are raising our full-year non-GAAP operating income guidance by $8 million, translating to a non-GAAP operating margin of 29%. We expect free cash flow margin of 26%. While we do not guide to free cash flow on a quarterly basis, we anticipate free cash flow to be more weighted to Q4 than historical levels. Finally, we are raising non-GAAP EPS guidance to a range of $1.62 to $1.64 per diluted share, representing an increase of $0.04 at the midpoint of the range. This non-GAAP EPS is based on an expected diluted share count of 307 million to 308 million shares. Looking to Q3, we expect total revenue to be between $503 million and $508 million. Subscription revenue is expected to be between $481 million and $486 million. As a reminder, we saw a notable increase in ODC revenue in Q3 and Q4 of last year. And with the revision to estimated ratable revenue recognition treatment this year, this will result in a headwind to revenue growth rates in our third and fourth quarters this year. From a profit standpoint, non-GAAP income from operations is expected to be between $143 million and $148 million or 28.5% to 29% of revenue. Lastly, non-GAAP EPS is expected to be $0.40 to $0.42 per diluted share. In summary, we are very pleased with our Q2 performance and strong momentum in the first half of the year. The strategic adjustments and investments we made last year in our go-to-market strategy are taking hold and evidenced in the latest results. We're starting to see momentum in large deal activity and pipeline, accelerating consumption growth across the platform, ongoing traction in logs, broader DPS adoption and a maturing of our strategic partner ecosystem. We have a proven track record of consistent execution and delivering a balance of strong top-line growth and profitability. While we're maintaining a prudent approach to our near-term outlook, we're confident in the foundational elements driving growth in fiscal 2026 and remain committed to investing in initiatives that we believe will generate long-term value. And with that, we will open the line for questions.

And our first question comes from Fatima Boolani with Citi.

Jim, I was hoping we could spend a little bit of time on the net retention rate metric. And if you could help peel back the onion, so to speak, on some of the puts and takes there. And really, the spirit of the question is, why is the metric lagging in contrast to otherwise very favorable momentum that you have shared in your prepared remarks on renewals, on expansions, on accelerating customer growth as well as signs that you're seeing that customers are now expanding earlier. So I just wanted to get maybe more granular understanding on why net retention rate looks like it's stuck in the mud when all other factors in the business are pointing to more favorable momentum.

I'm happy to take that, Fatima. I'd start with we had a really strong net new ARR quarter. It grew 16% for the quarter, and it grew 14% for the half. So the business momentum is quite healthy in growing net new ARR. I think you know NRR is a kind of a trailing 12-month metric. And so it's going to take multiple quarters to significantly move NRR as a metric. So NRR stabilized from Q1 to Q2. So we feel really good. I mean one of the things we talked about in the prepared remarks is we're getting really good traction with the go-to-market changes that we made a year ago. It's showing up in the results. It's showing up in growing pipeline. We are poised to benefit from continued end-to-end observability tool consolidation opportunities. Consumption continues to grow at a rapid clip. So we're very optimistic about the underpinnings of the business. So these metrics, NRR, if we continue to see the performance that we are seeing in consumption in these other areas, you will start to see movement in NRR, but it will happen over time.

Our next question comes from the line of Matt Hedberg with RBC Capital Markets.

Congrats on the strong quarter and increased guidance. I had a question. You guys have spent a lot of time focused on go-to-market improvements really over the last several years, and it really feels like it's paying dividends right now in terms of large deals. I'm curious, when you think about sort of some of the capacity adds that you've added historically, could you talk to the level of productivity you're seeing there? And secondarily, with a strong Q2, I'm curious to see if the 6-month quotas are doing what was intended, sort of improving linearity for the year?

Happy to take that, Matt. You've raised two excellent questions. We've been implementing our go-to-market changes since the first quarter of fiscal '25. As mentioned, we focused on investing in the upper tier of our customer base, where each representative managed about 8 to 10 large accounts. Our goal was to reduce that to 4 to 5 accounts per rep. We're noticing positive trends in close rates and pipeline, which indicates our investments are leading to increased productivity. Regarding the two 6-month quotas, we introduced them to achieve two objectives. First, they allow for midyear adjustments in strategy or compensation plans. Second, they help improve the seasonality of bookings. We observed some effects last year, and this is our second year of implementing them. It's clear that the adjustments are enhancing the linearity of our business. It's not merely about pull-ins from Q3; rather, it incentivizes our sales team to be productive twice a year, and we're pleased to see that reflected in the results. Both factors are unfolding as we anticipated.

The next question is from the line of Brad Reback with Stifel.

Rick, you alluded to the over 20% consumption growth in the base. So either for you or Jim, how should we think about the convergence of net new ARR and subscription revenue growth towards that 20%? What are the puts and takes as we look out over the next year or 2?

So Brad, the factors to consider are that we operate a ratable revenue recognition business. When we book something, the subscription revenue is amortized over time. We don't recognize revenue based on consumption. If we did, the growth rates we're discussing would be in the 20s. It takes time for us to see these growth rates materialize, particularly due to contract terms and the process of meeting commitments and expansions. This won't happen overnight; it will take time. There will be a convergence. It’s important for investors to keep an eye on our updates regarding consumption tracking. Consumption, aside from acquiring new clients, is crucial for sales to upsell existing customers. We're witnessing this with early expansions. For example, we had a significant global airline client that expanded their contract after trying a product category that was not originally part of their setup. This led to a substantial upsell just two years into a five-year deal. As we concentrate on consumption and align our teams—like the customer success management teams and others—that will be the foundation for our growth. Over time, you will see convergence in growth rates from consumption with subscription and ARR growth.

I might just add, Brad, that while we don't recognize revenue based on consumption, it absolutely is a key leading indicator. The thought process is quite simply that we want consumption to be growing faster than ARR because it is an opportunity then to utilize fully DPS contracts as we use those contracts, then renewals and expansions occur thereafter. So it is the metric of choice for our customer success organization and is where we are pressing the organization to essentially affirm our performance for customers.

Next question is from the line of Eric Heath with KeyBanc Capital Markets.

Maybe just a clarification, Rick and Jim. Just given the focus on consumption and that's accelerating, I mean, should consumption be the key metric that we focus on over ARR and subscription revenue as an indicator for future acceleration looking into fiscal '27? And then just curious on logs and how that contributed to the $1 million ACV deals you did in the quarter.

I’ll address that. We have several metrics to consider. While I wouldn't single out one as the most important, Annual Recurring Revenue is certainly a key figure. However, the key is to effectively implement our go-to-market strategy to attract customers to our platform. Once they are onboard, our customer success and strike teams work to increase adoption. Ultimately, the foundation for growth is consumption. This is something we will continue to discuss because it doesn’t appear as a typical metric in our financial results. It’s not part of subscription revenue or Annual Recurring Revenue, but it plays a crucial role in driving expansion. While it’s important, it’s not the only metric we pay attention to, and there are others we report on. Regarding your question about logs, we are quickly approaching $100 million, making it the fastest-growing product category. We’ve seen a doubling of customers compared to last year who now spend over $1 million with us. Additionally, there has been nearly a fourfold increase in customers spending over $500,000 annually. We still have many customers spending under $100,000, representing a significant opportunity for growth. We are very pleased with our progress in logs.

Yes. Just to add on to the logs piece, growing more than well over 100% year-over-year on now what is getting to be a much larger number, as Jim said, approaching $100 million in consumption. And it is really key to emphasize what we said in the earlier remarks that not only are we saving customers a fair bit of money from legacy solutions and what they're doing today, but by incorporating logs into the overall observability mix and framework, we are delivering markedly better outcomes because you have logs, traces metrics, real user data, all in the same data lake house, it results in better outcomes. And that's what we're seeing across the board for the customers that have deployed at scale.

Our next question is from the line of Mark Murphy with JPMorgan.

This is Noah Herman on for Mark Murphy from JPMorgan. The constant currency net new ARR results really stood out positively this quarter. Based on the guidance framework, it seems like seasonality between first half and second half of the year is more equally weighted, whereas in prior years, it seems more like a 40-60 split. So can you just maybe unpack that a little bit, the seasonality dynamics we should expect going forward?

That's a good question. You're correct that we've typically observed something like a 40-60 or 42-58 split. Regarding our two six-month plan designs, I believe these plans will help us get closer to a balanced distribution between the first half and the second half of the year, thanks to the sales team's incentive to improve linearity. We're actually seeing some positive movement in that regard. Additionally, as I mentioned earlier, we are not facing any demand constraints; our pipeline is extremely robust. This marks the fifth consecutive quarter of an increase in our rolling four-quarter pipeline. The trends in pipeline and demand are quite strong. For the second half of the year, we've included some caution because our focus has shifted to larger customers with a high likelihood of spending. While this has substantially improved our pipeline, it also means we're dealing with larger deals that may introduce timing variability. Therefore, we’ve adopted a conservative approach for the latter half of the year, acknowledging that some deals might shift from the second half into the first half of fiscal '27. This mirrors what we discussed roughly a year ago. However, I can say that our pipeline is more weighted toward large deals than before, and we’re pleased with how it's shaping up. We simply exercised some caution, and we’ll need to see how effectively we execute. Overall, I'm very optimistic about the enhancements we've made to our go-to-market strategy and the pipeline across the business.

Our next question is from the line of Patrick Colville with Scotiabank.

When I consider the major macro trends in IT at the moment, such as accelerated public cloud migrations, a stronger move towards multi-cloud, and AI, I believe these trends should positively influence the Dynatrace narrative. Looking at this year's results, our net new ARR in constant currency has significantly improved compared to the latter half of last year. So regarding these macro trends, are we at a turning point for Dynatrace to effectively leverage these trends, or should we be cautious about the fluctuations in net new ARR we’ve experienced over the past two quarters?

I would say that the demand environment is very healthy. In terms of macro trends, we are experiencing a significant increase in our overall pipeline and its health. We had a very strong second quarter and a strong first half of the year. However, I want to clarify that this does not imply we expect the second half to be worse. We have incorporated some prudence regarding the timing of larger deals. We will monitor our progress in the second half, but I believe the demand environment remains strong, and we are well-positioned to take advantage of it. We have just added some caution to the execution of these large deals.

Yes, Patrick, I would say a very strong first half, a solid increase in the guide. We provided some of the metrics that are leading indicators for us, elements like strategic account pipeline up 45% year-over-year, large deals from the first half, up 53% year-over-year. I think these are all good indicators that are corroborating the evidence that we're seeing in what's happening in the hyperscaler results and the ongoing demand for cloud and AI native workloads.

Our next question is from the line of Jake Roberge with William Blair.

Congrats on the solid results. You talked about building some prudence in the back half just related to those large deals that you have in the pipeline. Can you talk about what some of the learnings have been from the past 2 years on these larger platform deals and whether you're starting to see an improvement in win rates and close rates as you've been able to kind of tweak and adjust the model?

That’s a great question. Each year brings its own unique dynamics. I believe we began noticing significant deals related to vendor consolidation around the fourth quarter of fiscal '24. While we didn't initially label it as a trend, we did experience exceptional performance during that quarter with strong deal closures. What started as an emerging trend has now continued to gain momentum, and it has become our main sales strategy. This approach resonates with customers who want to streamline their diverse toolsets. We recognize that this trend is legitimate, and our sales team is well-equipped to take advantage of it. Our win rates are quite favorable, thanks to our compelling offering. We're in a positive position, but we must acknowledge that timing can be unpredictable due to the size of these deals, which often require additional levels of approval. While I remain optimistic about our opportunities and win rates, we are being cautious regarding timing.

Jake, I would say at a very tactical level, the interest that we see from CXOs of major organizations around the globe is increasing at a very rapid rate. I have literally done dozens and dozens of CXO meetings around the globe over the prior 3 months. The interest and mission criticality of observability has never been higher in my observation. So that continues to drive things. And what I would say is they're all interested in 1 or more of 3 things. They're interested in end-to-end observability, which is driving tool consolidation, opportunity for more efficiency, better outcomes, lower cost. Secondly, they're interested in AI observability and deploying observability for AI workloads. And thirdly, they're interested in business observability, extending observability overall to include business events that give them a better handle on the business well beyond what's just happening technically in their software stacks. And these are core themes that really have evolved, I think, over the prior year.

Our next question is from the line of Matthew Martino with Goldman Sachs.

Great to see the momentum in the business. Rick, you highlighted an AI native win in your prepared remarks. Can you share a bit more on what attracted this customer to the Dynatrace platform? And are you starting to see more potential opportunities within the AI space, if you could contextualize that for us?

Yes, it's a great question. So let me sort of parse it into a couple of components. First, you have the companies that are our typical customers that are deploying AI workloads. Those customers we have in the hundreds already. They're deploying AI workloads using Dynatrace to provide observability. What you're getting at a little bit are the AI native companies that have developed against AI workloads. And that is where that is evolving rapidly. We are now deeply embedding with AWS services like Bedrock, Azure services like OpenAI and Foundry, Google services like Vertex, NVIDIA's AI infrastructure, et cetera. We are targeting more with our third-gen platform developer capabilities, and this is expanding interest in Dynatrace. And overall, what they're most interested in is getting deterministic answers that enable agentic action. And this is what I talked about earlier in the prepared remarks, but you cannot take action in an agentic world if you don't trust the underlying answers. And so this is where we say answers, not guesses. You have to know what the answers are in order to be able to take action. And I think this is what is increasingly attracting AI native companies to Dynatrace because that is foundational in how they need to operate the businesses autonomously as they look forward.

Our next question is from the line of Ittai Kidron with Oppenheimer.

Nice results, everyone. I have a couple of small questions. First, Rick, could you share your thoughts on the progress with DPS adoption, which is currently at 50% of customers and 70% of ARR? Do you have an updated perspective on where those metrics might peak? Secondly, when examining the growth in capabilities and the expansion among non-DPS customers, is there any decline in that area? This isn't because customers are engaging less, but perhaps due to the remaining groups being less attracted to your value proposition for various reasons.

Yes, I’ll address that. We’ve mentioned before our expectations for DPS penetration. Some industries, particularly government sectors, face challenges with DPS as they must purchase specific SKUs. We are exploring solutions to these issues. We believe we can get 80% to 85% of our business onto a DPS contract, and if we can eliminate some of the barriers I mentioned, that number could increase. For now, think of it as 80% to 85% of our business. There shouldn’t be barriers for customers transitioning from SKU to DPS. We have focused on acquiring new customers, with over 80% of them opting for DPS. For renewals, we initially transitioned customers to DPS only when they were expanding. We didn’t want to complicate the process for like-for-like renewals. However, we have changed our approach this half and will now assist customers even during like-for-like renewals in moving to DPS. I believe we will continue to see progress. There might be a slower transition from the current 70% to the 80% to 85% range. However, all the evidence we’ve shared indicates that once customers are on DPS, they can trial any platform offerings. Our data shows they experience double the growth in consumption, have twice the number of capabilities, and exhibit significantly higher Net Revenue Retention (NRR). This presents a strong value proposition for transitioning customers, and we are concentrating on the right initiatives.

Our next question comes from the line of Ryan MacWilliams with Wells Fargo.

I believe you mentioned more early DPS customer renewals in your remarks. I'd love to hear more color if early renewals of DPS customers are impacting the 3Q subscription revenue guide and the OTC guide as well. We'll just hear about those dynamics.

Yes, that's correct. You observed that Q2 was a quarter with strong net new ARR performance. A significant factor in that was the early renewal of contracts by customers on a DPS agreement, including a large global airline among others. It comes down to consumption; once customers are on the platform, we work with them to drive adoption and usage, which ultimately leads to positive outcomes. You’re also right that there’s a dynamic between whether a customer opts for an early expansion or chooses on-demand services, which we can't control. However, we have implemented some changes in compensation for our sales team in fiscal '26, incentivizing them to focus more on ARR-generating expansions rather than on over-the-counter sales. I believe this will continue to positively influence our approach. We’re proactively engaging with customers who have high consumption and looking to provide them with attractive pricing for increased volumes, and I expect this trend will persist.

The next question is from the line of Sanjit Singh with Morgan Stanley.

On the 16% constant currency net new ARR growth. I had a 2-parter, I apologize for it, but sort of around the same topic. But I was wondering if you could sort of unpack the strategic collaboration with ServiceNow and what's your hopes for that relationship over the next year from a commercial perspective? And then secondly, more broadly, when we think about making that evolution to that more proactive self-healing type system, when you think about capabilities around ITSM, which you're partnering with the leaders there. But also when you think of like, okay, if we need to drive some code fixes, how do you think about sort of the DevOps platform? Is that another area for partnership or a potential further organic expansion of the Dynatrace platform?

Thank you, Sanjit. I will address those points. Firstly, regarding the ServiceNow partnership, we are excited about the strategic collaboration we announced a couple of weeks ago. You can see it as ServiceNow facilitating and automating workflows, while Dynatrace provides the accurate insights needed to enhance those workflows. This presents a fantastic opportunity. In recent weeks, I have met with several customers, and each one highlighted the relationship between ServiceNow and Dynatrace, expressing interest in leveraging it to integrate our solutions more effectively. Currently, we have loosely connected systems, but this partnership with ServiceNow allows us to engage more thoroughly on the product side to improve the experience for our shared customers, especially since there is significant overlap between our customer base and that of ServiceNow. That's the first point. Additionally, as part of our announcement, ServiceNow is implementing Dynatrace for its digital operations, making us essentially the first customer for these integrations on both sides. We believe this will serve as an excellent proof point for customers on how to effectively use our technologies together in a complementary manner. On the ServiceNow aspect, as we consider more proactive integrations with tools like GitHub and Atlassian, we believe we have the reliable and accurate answers that can be made accessible through a series of APIs, whether through an MCP server or otherwise, for Dynatrace agents or third-party agents within the ecosystem, including Atlassian, GitHub, hyperscalers, and ServiceNow, to take appropriate actions for delivering autonomous operations. This reflects the evolution we are witnessing in observability, moving from reactive to proactive, then predictive, and now to autonomous. This is our vision and the future direction of observability, where we can truly deliver software that aligns perfectly with our goals for customers.

Our final question comes from the line of Howard Ma with Guggenheim Securities.

I want to extend my congratulations on a strong quarter as well. My question is, do you think the sales comp change to incent ARR over on-demand consumption? Is that the primary reason for customers opting to early renew? And is it the primary reason for the lowered ODC expectations in the back half? And on a related note, are the expansions tied to the early renewals above your expectations?

It's difficult to determine if compensation is the sole factor influencing behavior. While it certainly plays a role, ultimately, customer willingness is crucial. Now that we've been at this for a year, we are much more engaged with customers, comprehending their consumption needs. It's encouraging that our sales team is closely aligned with customers to see how their usage can foster mutual benefits, potentially leading to better pricing for them. Indeed, while compensation may influence some actions, our relationship with customers throughout their journey in observability is far more proactive. We're identifying new areas and use cases, especially regarding logs, and our early expansion initiatives are contributing positively. Regarding whether these efforts surpassed our expectations, the answer is yes—we have exceeded our expectations significantly.

And this does conclude today's teleconference. You may now disconnect your lines and have a wonderful day.