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Greetings, and welcome to the Dynatrace Fiscal Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded. I’ll now turn the conference over to Noelle Faris, Vice President of Investor Relations. Ms. Faris, you may begin.

Good morning and thank you for joining Dynatrace’s second 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 November 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. 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. We had an outstanding quarter, exceeding the high end of our guidance across all metrics. ARR grew 24% year-over-year in constant currency. Subscription revenue increased 26% year-over-year in constant currency. Non-GAAP operating income increased to $106 million, or 30% of revenue, and we delivered a 25% free cash flow margin on a trailing 12-month basis, including a four-point impact for cash taxes. These results continue to highlight the increasing criticality of observability and application security and the significant value our platform provides to our customers. They also demonstrate the strength and resilience of our business model, resulting in a balanced combination of top-line growth and profitability, as well as our ability to execute consistently in a challenging macro environment. Jim will share more details about our Q2 performance and increased fiscal 2024 guidance in a moment. In the meantime, I'd like to review my perspective of the observability market, areas of strategic go-to-market investment, and our ongoing focus on innovation. Let me start with what I'm hearing from customers. We've just wrapped up our annual Dynatrace Innovate series. We welcomed over 1,200 customers, prospects, and partners in person to our events in Sao Paulo, Sydney, and Barcelona. These events add tremendous value in terms of exchanging ideas, highlighting the value of our latest innovations, and building long-term relationships. They also provide me with the opportunity to have one-on-one conversations with key decision-makers about the topics that are critical to their businesses. A few themes stood out across these events. First, observability and application security are critical not only to customers' digital transformation journeys, but also a key element to business transformation and how they win in their respective markets. The CIO of a major Asia-Pacific Bank told me that they expect to differentiate on the quality of their software and user experience, and further, that Dynatrace is a core part of their strategy to achieve this business outcome. Second, large enterprises continue to outgrow their DIY open-source and competitive dashboard and monitoring tools, seeking instead a much more dynamic, fully unified observability platform. They want a solution that leverages all data types, traces, metrics, logs, really user data, et cetera, with the analytics and context that come from a unified data store rather than a common user interface that requires a lot of extra effort to leverage. They come to Dynatrace to gain efficiencies through AI and automation capabilities to proactively resolve issues before they result in costly outages. The CIO of a large Canadian financial customer told me that he wants to leverage Dynatrace to move to the next level of software liability and performance. He believes that Dynatrace will enable better prediction of user impacting issues, and in so doing improve business results. And perhaps an even more clear articulation of the value that Dynatrace provides our customers when it comes to identifying and resolving issues proactively is from the CTO of a major bank in India. What he told me was, “we sleep because you don't”. And third, vendor consolidation and standardization across their organizations are key priorities. Observability decisions that have previously been made at the department or even application level, especially in large complex enterprises, are increasingly centralizing. Dynatrace helps eliminate siloed tools, radically improve software availability and performance, reduce cost, and increase organizational productivity. This enables our customers' teams to focus on innovation and growth rather than break fix and maintenance. I had a customer from a global 50 technology company tell me based on a very broad deployment of Dynatrace that our platform is magic, providing insights into their software performance that they couldn't reproduce otherwise with multiple alternative tools. As a result of these market dynamics and the accelerated merging of business and technology objectives and strategies, customers are prioritizing observability spent. And our unified platform, AI leadership and automation are the three principal differentiators enabling them to derive maximum value from these investments with Dynatrace. This leads me to three strategic areas of increased go-to-market investment for the second half of our fiscal year to promote future top-line growth. First, we continue to evolve and expand our partner focus, especially with the world's most preeminent global system integrators and hyperscalers. To start, our customer base aligns directly with that of the GSIs. Given the complexity of cloud deployment submits broad-based digital transformation projects, observability has moved from optional to mandatory. And our GSI partners have broadly selected Dynatrace as their observability platform of choice for such initiatives. In addition to our existing relationships with Deloitte and DXC, yesterday Kyndryl and Dynatrace together announced a global strategic alliance, which has already resulted in numerous six and seven-figure wins. This agreement leverages Kyndryl's experience as the world's largest IT infrastructure services provider. And given our shared focus on AI ops, we'll enhance our joint cloud and application modernization offerings. We are additionally pleased to announce the evolution of our partnership with Accenture. This expanded engagement brings together the value of the Dynatrace platform with Accenture's global professional services capabilities and cloud modernization delivery experience. Together, we can enable customers to accelerate their digital transformation and modernization journeys with end-to-end observability and application security. With respect to hyperscalers, this past quarter, we extended our footprint with new cloud regions in Sao Paulo, Sydney, and

Thank you, Rick and good morning everyone. Q2 was another quarter of consistent execution by the Dynatrace team. We delivered strong results in a dynamic environment meeting the high end of our guidance across all of our top line and profitability metrics. These strong results were driven by the combination of high value new logo lands on the Dynatrace platform, the ongoing expansion of existing customers and an inherently efficient business model, allowing us to deliver a continued balance of growth and profitability. Our ability to successfully navigate in a tight budgetary environment is a testament to the resilience of our value proposition, our commitment to customer success and our incredible team. Now let's dive into the second quarter results in more detail. And please note that 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 second quarter was $1.34 billion, an increase of $279 million year-over-year, representing 24% year-over-year growth. Net new ARR on a constant currency basis was $59 million in the quarter and exceeded our expectations in what is normally one of our seasonally lightest bookings quarters of the year. This outperformance were driven by several notable seven figure competitive wins and ongoing expansions in the customer base. We added 160 new logos to the Dynatrace platform in Q2, roughly consistent with the year ago quarter. As we have shared in the past, we have very focused on the quality of new logo lands that have a greater propensity to expand. The average ARR per new logo land size continues to grow and was roughly $140,000 on a trailing 12 month basis up 18% year-over-year. As Rick outlined, we continue to attract enterprise customers that are outgrowing their existing DIY or commercial tooling solutions 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 114% in the second quarter in line with our expectations. Observability remains a priority for our customers and we continue to see them expand with us, albeit at a moderate pace as they move more cautiously in an uncertain economy. Customer platform adoption remains strong with 64% of our customers using three or more modules up from 55% of customers in the year ago quarter and with an average ARR of over $500,000. As Rick mentioned, we see growing customer interests in newer product offerings, including logs on Grail and application security. Our track record of groundbreaking innovation will support expansion opportunities in our installed base with more meaningful ARR contribution from our latest product introductions expected in fiscal 2025. We also believe the new DPS pricing model is another area that will drive future expansion opportunities. We're seeing traction with both new customers joining the platform and existing customers like Duke Energy and an Australian government agency who prefer the flexibility and predictability of our DPS licensing model. We have closed over 100 DPS deals globally since it became generally available in April of this year, bringing total DPS customers to over 250. And while the rollout is still in the early stages, we believe DPS has the potential to drive meaningful accretion and net retention rate across most of our installed base in the future. Moving on to revenue, total revenue for the second quarter was $352 million, up 24% year-over-year, and subscription revenue for the second quarter was $334 million, up 26% year-over-year. Both exceeded the high end of our guidance by $6 million, driven by strong bookings linearity in the quarter. With respect to margins, non-GAAP gross margin for the second quarter was 85%, up a point from the prior quarter and up two points from Q2 of last year. Our non-GAAP operating income for the second quarter was $106 million. This is $13 million above the high end of our guidance range. Roughly half of the overachievement was driven by the revenue upside in the quarter. The other half was driven by gross margin improvements from ongoing cloud hosting efficiency efforts, prudent half one hiring, and the timing of the workout acquisition closing. This resulted in a non-GAAP operating margin of 30%, exceeding the top end of the guidance range by 300 basis points. Non-GAAP net income was $93 million, or $0.31 per diluted share. This was $0.4 above the high end of our guidance range, driven by the items I just highlighted. Our free cash flow was $34 million in the second quarter. As we've mentioned in the past, we believe it is best to view free cash flow over a trailing 12 month period due to the seasonality and variability in billings quarter-to-quarter. On a trailing 12 month basis, free cash flow was $330 million, or 25% of revenue. As a reminder, this includes 400 basis points of impact related to cash taxes. Pre-tax free cash flow on a trailing 12 month basis was 29% of revenue and up 32% year-over-year. Finally, we ended the second quarter with a robust balance sheet, including $702 million of cash and zero debt. Moving on to guidance, we are raising our full year guidance across all top line and profitability metrics to reflect the strength of our second quarter performance, the health of our pipeline, and our visibility into the back half of the fiscal year. This increasing guidance includes incremental FX headwinds from a strengthening U.S. dollar. Before I jump into the details, there are a few items to keep in mind with respect to our guidance. First, the building blocks of growth for business -- for the business continue to be new logos and net retention rate. This guidance assumes new logo growth in the low single digits and a net retention rate of 112% to 113% for the second half of fiscal 2024. Second, our guidance assumes the net new ARR contribution from new logos will approach 40% with roughly 60% of net new ARR from expansion activity. This mix differs from our historical mix of roughly one third of ARR growth from new logos in two-thirds from expansion. But given the robust new logo pipeline health and growing deal sizes, we believe the net new ARR mix will be more weighted to new logos than in the past. Third, the strengthening of the U.S. dollar since our last call creates a headwind relative to our prior full year guidance. Incrementally, the foreign exchange headwind is roughly $16 million to ARR and approximately $8 million to revenue for the full year. And with that, let's start with our updated guidance for the full year with growth rates and constant currency. We are raising our ARR guidance by roughly $3 million at the midpoint to $1.48 to $1.49 billion, representing 19% to 20% growth year-over-year, up 100 basis points from our prior guidance. This guidance raise represents an increase of approximately $19 million on a constant currency basis. Given the strength of ARR in the second quarter, we now expect the seasonality of net new ARR to be similar to prior years with roughly 40% in the first half and 60% in the back half of fiscal 2024. Also similar to last year, we expect Q4 net new ARR to be slightly higher than Q3 on a constant currency basis. We are raising our revenue guidance by approximately $7 million at the midpoint to $1.409 and $1.419 billion, representing 21% to 22% growth year-over-year, up 100 basis points from our prior guidance. This guidance raise represents an increase of roughly $15 million on a constant currency basis. We are raising our subscription revenue guidance by approximately $6 million at the midpoint to $1.334 to $1.344 billion, representing 22% to 23% growth year-over-year, up 100 basis points from our prior guidance. This guidance raise represents an increase of roughly $14 million on a constant currency basis. Turning to our bottom line, the strength and resilience of our financial model is evident in our ongoing margin performance. We are committed to maintaining a balanced approach that optimizes costs to drive profitability, while also investing in future growth opportunities that we believe will drive long-term value. We will continue to invest heavily in R&D innovation. And as Rick mentioned, we plan to step up go-to-market investments in several areas, GSI partnerships, sales capacity, and demand generation activities. With this in mind, we are still raising our full year non-GAAP operating margin guidance by 125 basis points to 27%, an increase of $20 million at the midpoint. We are raising non-GAAP EPS guidance, $1.09 to $1.12 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 300 million to 301 million shares, and a non-GAAP effective cash tax rate of 19%, consistent with prior guidance. And finally, we are raising our free cash flow guidance to $313 million to $320 million, representing an increase of $9 million at the midpoint, and a free cash flow margin of 22% to 23% of revenue. As a reminder, 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. Looking at Q3, we expect total revenue to be between $356 and $359 million, or 19% to 20% growth. Subscription revenue is expected to be between $337 and $340 million, up 20% to 21% year-over-year. From a profit standpoint, non-GAAP operating income is expected to be between $94 million and $97 million, or 26.5% to 27% of revenue. And non-GAAP EPS is expected to be $0.27 to $0.28 for our diluted share. In summary, we are very pleased with our second quarter fiscal 2024 performance, and we have a strong pipeline and good visibility into the remainder of the fiscal year. We continue to take a prudent approach to our outlook, given the ongoing volatility of the macro environment, but we remain optimistic about our long-term growth opportunities and our ability to deliver balanced growth and profitability. And with that, we will open the line for questions. Operator?

Thank you. At this time, we'll be conducting a question and answer session. [Operator Instructions] Thank you. And our first question is from the line of Matt Hedberg with RBC Capital Markets. Please proceed with your questions.

Great. Thanks, thanks, thanks team. Great quarter and Rick, you’ve done a good job outlining all the product advancements, certainly, a lot to look forward to there. You know, what struck me in your comments, you mentioned stepping up hiring in the second half. That sounded bullish to us, given sort of like what you guys talked about on the call. With unchanged macros out there, I guess maybe to double click on what gave you the confidence to reinvest in the business now?

Thanks Matt, appreciate the comment. What we're seeing is very good visibility and pipeline into the second half, which obviously has increased invisibility for the second half relative to where we were last quarter. So that's point number one. And point number two is that at some stage, macro is going to improve. And obviously in putting in place salespeople, it takes some time to really get them ramped to value. So we wanted to start at this stage to be prepared for FY 2025.

That sounds good. Maybe just one other quick one. In the spirit of unchanged macros, you know, I’m curious, you guys aren't necessarily tied to consumption as much as others, but curious what you saw on kind of the cloud optimization trends within your customer base. I know it's been an ongoing debate with hyperscalers, but curious what your customers are saying on kind of the optimization side?

Our view is that the optimization cycle continues. The good news is with a subscription as opposed to directly consumption-oriented business model, we have an opportunity to really prevent the same degree of impact that others see in the optimization cycles. So that's good. I'd say that's point one. Point two, from our perspective, as we've maintained matter over the last couple of calls, is that we really see observability as in many ways an antidote to cloud optimization cycles by making your cloud deployments actually more efficient. So we continue to see that in our new logo lands, which were very strong last quarter.

Thanks a lot.

Our next question is from the line of Pinjalim Bora with JPMorgan. Please proceed with your questions.

Hey, thank you so much. I just wanted to double click on this trend in ARR performance this quarter. Maybe talk about what drove that. Was there any pushouts from Q1 that helped anything to call out in terms of federal budget plus studies? So anything that'll helped?

Thank you, Pinjalim. I'll take that. So we had a really strong Q2. And really, we continue to see, and we've actually, this has been probably three or four quarters now in a row, where we continue to see growing interest in Dynatrace on the new logo front with really high quality lands. And so that trend has continued. Our pipeline, as I mentioned in our prepared remarks for new logos in the back half is also quite strong. So we had a really strong second quarter for new logo lands, which I think is a testament to the value proposition of the Dynatrace platform. Customers are outgrowing either DIY solutions or in several cases, outgrowing competitive solutions that just couldn't scale. And so, that was largely the driver, Pinjalim. And as I mentioned before, we're still seeing healthy expansions. We're just seeing expansions at a more moderated pace as customers are more cautious, given the macro environment.

Understood. One for Rick, that on logs and Grail, cost has been an issue in general in the industry around log analytics for customers. What has been the customer feedback on pricing for log analytics on Grail? And maybe touch on the pipeline for logs on Grail from the second half. And if you're seeing any kind of impact from the recent acquisitions in the industry, kind of starting to help at least in the conversations, if not in deal closures?

Thanks, Pinjalim. On the pipeline, perhaps I'll cover that one first. Last quarter we reported on the order of about 300 PUCs in logs on Grail. And as we sit here, this quarter, we've got a few hundred or so paying logs on Grail customers in the PUC pipeline as increased by about 20% over where we were last year. So we're seeing, I would say, very good penetration of logs on Grail overall. On the pricing piece, our expectation is that while we do price more heavily in the analytics area, then say in the ingest or storage area of logs that on average, we're going to still provide a discount to current market pricing from most other vendors. So we should be a good solution in the market from a pricing and cost standpoint as well.

Understood, I'll leave the floor. Thank you.

Our next question's from the line of Will Power with Baird. Please proceed with your question.

Okay, great, thanks. Rick, maybe starting with you, just interested in some of your comments on your innovate meetings, and in particular, kind of what you're hearing with respect to customer demand around some of the hypermodal AI capabilities that you're working on, expect to go GA next year. Just love to kind of hear your perspective as to what customers are looking for there? What demand indicators look like on that front? And then how you're thinking about the monetization there?

Thanks, Will. The short form is that as customers understand our story, they fully appreciate the notion that we deliver causal and predictive AI today, and we have for over a decade, and that these are highly deterministic AI techniques. So they provide very precise answers and intelligent automation from data already. The generative piece through Davis CoPilot then is incremental to essentially provide not only a natural language interface into causal and predictive AI, but to do so in an iterative way to make the whole greater than some of the parts. So from the feedback that I got from Sao Paulo, Sydney, Barcelona, the innovate sessions we did, there is a lot of talk around how to leverage Dynatrace for all three AI techniques as we look to the future.

Okay. Any thoughts just with respect to kind of the monetization piece of that, how that kind of folds into the equation?

We haven't finalized the monetization piece well, but we will do so over the coming quarter or so to sort out how we're going to monetize gendered of AI and Davis CoPilot in particular, but nothing to report yet on that at this point.

Okay. And if I could just sneak in one, maybe for Jim, I'm just thinking about net retention rates, I know down a bit, although I expected. I just would kind of love to try to get a little additional cover as to what's driving that. Is it fewer new product expansions? Is it lighter usage, weaker renewals? Is anything else you could, any other color there?

Well, I'll start with, I mean, our renewals remain really strong. I mean, we've talked about that that our gross retention rate remains in the mid 90s. So the product is very, very sticky. So it's certainly not a retention rate. As I outlined kind of in the prepared remarks that there are customers that continue to prioritize observability, but I would say customers continue to remain cautious and they're doing expansions. And not every customer is the same. Some customers are prioritizing, hey, I'm seeing growth in new workloads and I'm going to moderate maybe newer workloads that have observability until I have better line of sight into my own kind of business. And then there are cases where customers are adding new workloads. So it kind of varies, it varies by customer, it varies by industry. But I would say customers continue to prioritize observability. And, you know, until they get better visibility into their own environments, I think that kind of what we're seeing is probably going to remain consistent. I will say, as I said earlier, that we are quite optimistic that we continue to see growing pipeline, not just with new logos, also expansions, but new logos in particular, I think suggests that customers are starting to make observability architecture decisions. And I think that's a net positive for Dynatrace, but I think we're well-positioned in that space.

Thank you, nice job on the results.

Thanks, Will.

Our next question comes from the line of Raimo Lenschow with Barclays. Please proceed with your question.

Thank you. Actually, can I stay on that topic and maybe we kind of up level it a little bit? I mean, like look in tough times, usually it's you're leading in on the installed base and the new logos are coming in a bit slower and it's tougher to sign them there. But with you, it seems almost the other way. How much of that is driven on the new logo side in terms of people understanding your broader message? There's a lot of competitors that got taken out, so there's a lot of disruption in the market. So what's driving that? And you obviously did a lot more work on kind of getting new logos started to work with partners better, et cetera. Like can you speak to that a little bit because that's kind of different than what you hear from anyone else?

Yes, I'll take that. So I want to be clear, we're continuing to see healthy growth with installed base customers. So I just want to make sure we're clear that we continue to see good growth with the installed base customers. And in particular, we see customers that where our value proposition is really, really strong, which is large, complex environments, those customers, their expansion rates are growing at an even more increased pace than kind of the average for the company. And on the new logo front, it's more -- customers are seeing pain points. They're seeing pain points with either their existing solutions, which could be competitor solutions, or existing tooling. And it's cumbersome when they're seeing outages. It's difficult to ascertain where it is, and there's people chasing alerts that, so I would say, observability, customers are making more and more architectural decisions. And when they're making architectural decisions and they're evaluating vendors, especially in large, complex environments, we score very well. And so I think we're seeing a pipeline relative to that with customers that are starting to make, I would say platform decisions. They're making platform decisions in different areas, and they're making decisions on observability as kind of a platform, observability and application security. So I think we're well-positioned. And I think the sales organization is appropriately going after that opportunity. And as I said for the last few quarters, we're focusing on the quality of the land more so than the number of new logos, because we find that the quality of land results in better expansion, longer term.

Yes, that's perfect, yes, that's very clear. And I know it's tough with DPS to kind of go into different parts, but what are you seeing in terms of, we talked a little bit about logs on Grail, et cetera, but in terms of you kind of being able to be broader than just APM in terms of getting infrastructure more logs into the deals, like when you talk about the big architecture decisions, is that people kind of understanding the full observability package that you guys are offering and kind of going that way, or is it still, what are you seeing there on the more than newer areas where you like infrastructure logs? Thank you, and congrats from me as well.

Thanks, Raimo. What I would say on the DPS front, then in particular on the penetration of multi-modules is that a year or so ago, we were around 50% or so, customer lands were at three plus modules, that's now two-thirds. So we continue to see the broad platform play. We certainly expect DPS to be a key component of that by facilitating expansion across the portfolio of modules that we have for customers to utilize a broader array of the Dynatrace platform. So DPS really does facilitate this multi-module deployment in use.

Okay, perfect. Makes sense. Thank you, congrats.

Thanks, Remo.

Our next question is from the line of Kash Rangan with Goldman Sachs. Please proceed with your questions.

Thank you very much, congrats. Rick, I applaud you on stepping up to go to market investments really, really well timed. I've got one for you, one more financial question. When you look at the different initiatives to drive growth, you've got the product initiatives, Grail, you've got app security, and you've got the partnerships with the hyperscalers, SI. Are the growth through the companies very solid in whatever you printed, which means that the underlying core APM business is probably a little bit slower. Maybe that will pick up in the macro clear. So any thoughts on how the company's exposure to growth opportunities looks like as you come out of this malaise? Could we see the underlying X growth acceleration initiatives really start to come back to the forefront? And a financial question is, how do you measure return on investment, whether it's investing a dollar and go to market or research and development? What are the ways in which you quantify the return you're looking for? That's it for me. Thank you so much.