Dynatrace, Inc.

Good afternoon. My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dynatrace, Inc. Fiscal First Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Michael Bowen, Investor Relations, you may begin your conference.

Thank you, Operator. Good afternoon, and thank you for joining us today to review Dynatrace's first quarter fiscal 2020 financial results. With me on the call today are John Van Sicklen, Chief Executive Officer, and Kevin Burns, Chief Financial Officer. After prepared remarks, we will open up the call for a question and answer session. Before we start... I'd like to draw your attention to the safe harbor statement included in today's press release. During this call, we'll make statements related to our business that may be considered forward-looking within the meaning of Section 27A of the Securities Act of 1933 as amended and a Section 21E of the Securities Exchange Act of 1934 as amended. All statements other than statements of historical fact are forward-looking statements, including statements regarding management's expectations of future financial and operational performance and operational expenditures, expected growth, and business outlook, including our financial guidance for the second fiscal quarter and full year 2020. Forward-looking statements reflect our views only as of today, and except as required by law, we undertake no obligation to update or revise these forward-looking statements. Please refer to cautionary language in today's press release and to our final IPO prospectus. which was filed with the SEC on July 31st, 2019, and our other SEC filings for discussion of the risks and uncertainties that could cause actual results to differ materially from expectations. During the course of today's call, we'll refer to certain non-GAAP financial measures as defined by Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed in a reconciliation of the differences between each non-GAAP financial measure and comparable GAAP financial measure can be found with our first fiscal quarter 2020 earnings press release in the investor relations section of our website at dynatrace.com. With that, I'd like to turn the call over to our Chief Executive Officer, John Van Sicklen. John?

Thanks, Michael. And I'd like to start by thanking all of you for joining us today on our first conference call as a public company. We're excited to have completed our successful IPO on August 1st, This represented an important milestone for Dynatrace and one that further enhances our brand awareness and ability to execute the company's long-term growth strategy. We are also very pleased with the first quarter financial results, where we achieved 43% ARR growth to $438 million and strong total revenue growth driven by subscription and services revenue, which increased 36% year over year. We continue to focus on building a balanced business with strong growth and cash flow for greater durability over time. As this is our first quarter as a public company, I wanted to provide a brief overview of Dynatrace's transformation, our value proposition, and our market opportunity, in addition to providing details on key drivers behind our recent performance. Benetrace is a market-leading software intelligence company, purpose-built for the enterprise cloud. Every company and every industry is transforming into a software business. How they interact with their customers, assure quality experiences, optimize existing revenue streams, and create new ones, success or failure comes down to the software supporting these efforts. Benetrace software intelligence sits at the core of these digital transformations, to assure that this run the business software always works perfectly for every interaction, every transaction, and every user journey. Let's step back a moment and talk about how we got here. Dynatrace is now 14 years old. We spent the first nine years building a category leader in APM, Application Performance Monitoring. In 2014, After sending a dozen of our top product minds off to determine how monitoring would work in the future, we made a bold decision to reinvent our platform from the ground up, and in so doing, refresh our entire business model. This team realized that the cloud would disrupt the entire ITOM world. Everything would change. And if we seized the opportunity, we could redefine the market. Although we were already widely recognized as the APM leader, we decided to disrupt ourselves, and in so doing, disrupt the market. The result was a 2016 launch of Dynatrace, an all-in-one full-stack cloud monitoring platform with a powerful AI engine at the core. With the complexity, scope, and frequency of change these modern cloud ecosystems would experience, we chose to put answers first. versus simply pumping more data on glass and hoping IT teams could keep up. This answers-first approach brings highly differentiated value to our platform use cases of APM, cloud infrastructure monitoring, digital experience management, and AIOps. This new platform has been driving the company's growth ever since. At the end of our June quarter, the new Dynatrace platform comprised 75% of our total ARR, up from 70% at the end of our March quarter, and up from 39% a year ago. The remaining 25% of ARR relates to our classic product set, which continues to actively transition to our Dynatrace platform. We are now five quarters into what we believe is a 10 to 12 quarter transition, and our classic customer to Dynatrace conversion program continues to run ahead of expectations. After launching the new platform, our go-to-market motion has also evolved. We believe our customer acquisition process has become much more efficient, with most customers now discovering and exploring Dynatrace through a frictionless free trial. We then further nurture our land and expand sales process through a growing number of direct enterprise sales resources, value-added resellers, and system integrators. With a platform that instruments and baselines the entire cloud stack automatically, implementation is dramatically streamlined, and we're seeing a growing number of customers expanding beyond the traditional 5% barrier that continues to hinder outdated Gen 2 approaches. At the end of our fiscal Q1, we had 1,578 Dynatrace platform customers, an increase from 1,364 at the end of the prior quarter. Consistent with prior quarters, the majority of these new customers to Dynatrace were net new logos to the business, with the balance converting to Dynatrace from our classic base. And once again, our net expansion rate across all Dynatrace customers was over 120%, consistent now for the past five quarters on increasingly larger customer cohorts. Given our innovative AI-powered platform and streamlined go-to-market strategy, We believe we can capture a meaningful share of the $18 billion in growing TAM we estimate is in front of us. With about 10% of our target 15,000 global enterprise accounts having adopted the Dynatrace platform, Edward Gardner estimates to be only 5% of applications instrumented from an industry perspective versus what we believe is a longer-term target that ranges between 30% and 50%. There's plenty of growth potential to build a very large company over time. And when you add to this both ongoing cloud and application expansion and our ability to add additional platform use cases, we believe there's significant opportunity to further expand our TAM as time goes on. Now let me provide some insights into several new and expansion customers to illustrate our value differentiation along with the power of our land and expand approach. First, one of our new logos in Q1 was a large U.S. government agency that is moving to a hybrid multi-cloud environment as part of an overall IT modernization program to improve access to benefits and services for hundreds of thousands of policyholders. As with many Dynatrace customers, the move to the cloud brings with it an exponential rise in complexity resource-strapped IT organizations. The advanced automation of Dynatrace and the answers-first approach leveraging Davis, our AI engine, has allowed this agency to dramatically reduce performance issues, improve operational efficiency, and accelerate their cloud migration and modernization efforts. As a side note, the U.S. federal market is a relatively new market for us, for which we see tremendous opportunity over time. The next example I'd like to share is an expansion customer, a major European auto manufacturer that has been moving to a hybrid multi-cloud environment spanning across their own data centers, plus AWS, Azure, and Google Cloud Platform. They had been using a competitor's Gen2 APM product and found it inadequate for their new stack environment. It was proving too cumbersome, too manual, and with limited cloud-native observability. Although this customer started with a small taste of Dynatrace for an initial set of workloads several months ago, after experiencing the advanced automation of Dynatrace, their IT team was able to roll out an additional 2,000 hosts and dozens of applications in just a few weeks after acquiring additional licenses. With the continuous intelligent monitoring of Davis, their development and operations teams now focus on building value for their company versus wasting time gazing at dashboards, pouring through logs, or searching for answers to problems that may or may not be impacting users. Bottom line, this auto manufacturers gain greater efficiency, which translates into greater speed for innovation in their digital transformation. The final example I'd like to share is a customer who converted from our classic products to the new Dynatrace platform. This is a company in the business of managing and running a large car auction marketplace. With our Dynatrace offering, they saw an opportunity to modernize their own application and infrastructure environment and shift to Azure. As we did a proof of concept with Dynatrace as part of our conversion process, a number of application teams that we had never been able to access previously became interested. Before the cloud, these teams were separate. But with their new enterprise cloud, these teams were sharing cloud resources and software services. As a result, with the conversion came an upsell to expand coverage to more than two times the workloads, and there's potential for more. This conversion from classic to Dynatrace took only six weeks from start to finish, and that includes the planning and change management process time. This is very common. The time and effort to convert is short, while the value realized from doing so is very compelling. Switching to the product front for a minute, we continue to innovate organically. In Q1, we announced expanded support for Kubernetes, a dynamic container orchestration environment we've automatically instrumented and monitored for some time now. In the quarter, we extended our automatic analysis of Kubernetes performance, now delivering full-stack analysis Kubernetes clusters, their containers, and the application workloads within in a single solution, fully leveraging our AI engine data. In addition, we introduced first-day support for Red Hat OpenShift 4 environments, adding to our Google, AWS, and Azure coverage for Kubernetes, making it easier than ever to continuously observe and manage an enterprise multi-cloud environment. In addition, We extended our observability coverage for hybrid clouds with the announcement of one-agent support for KICS and IMS workloads on IBM mainframes, along with their associated integration and middleware frameworks. Now, Dynatrace customers can maintain their end-to-end visibility from mobile or IoT device through mainframe regions and back. This unique deep application and infrastructure observability allows our mainframe customers to understand the impact of cloud application workloads on expensive mainframe resources and optimize their behavior to better leverage these critical compute resources. With 25 major releases per year and hundreds of minor releases to assure cloud ecosystem currency and compatibility, we continue to increase the capabilities and scope of our market-leading software intelligence platform for our enterprise customers. As we look forward, fiscal 2020 is shaping up to be a very exciting year, and we couldn't be more excited about our future. We have reinvented our business on a fresh new technology stack, ideally suited for today's dynamic multi-clouds. Our shift to subscription is essentially complete. The conversion of our classic customer base is approaching the halfway mark, and the efficiency of our new platform affords us is evident in our strong profitability profile. There is a massive opportunity ahead of us. We plan to capture it with continued commercial investments in sales and marketing and ongoing innovation in R&D. We're excited to now be operating as a public company as we focus on building long-term success for our customers, long-term value for our shareholders, and a great place to work for our employees. With that, let me turn the call over to Kevin Burns, our CFO. Kevin.

Thanks, John. It is great to connect with both existing and prospective shareholders in our first call as a public company. I'm pleased that we have strong financial results to share, which were even better than the ranges we shared in our S-1. Before discussing our results in detail, as well as our guidance for the second quarter and fiscal 20, I want to first review the important aspects of our business and revenue model considering that some of you may be new to the Dynatrace story. As outlined in our S-1, as we discussed during our roadshow, our focus and the long-term future of the company is the Dynatrace platform. All revenue associated with the Dynatrace platform is recognized on a ratable basis and reported as subscription revenue. With respect to our classic offering, Maintenance and SAS revenues are recognized radically and run through the subscription revenue. Perpetual and term licenses for our classic offering are recognized on delivery and reported as one-time license revenue on the P&L. Classic license has declined significantly and is now down to an insignificant percent of our revenue. Overall, we believe our transition to a subscription model is substantially complete and this is becoming apparent in total revenue growth. Now, let me turn to our first quarter fiscal 20 results. Our key financial metric as an organization is annual recurring revenue. For the quarter, ARR was $437.6 million, an increase of 43% year over year. The Dynatrace platform continues to increase as a percent of total ARR, and was $326.3 million at the end of June, which, as John said, was 75% of our total ARR. The remaining 25% of our ARR relates to our classic offering, and we expect the majority of classic customer base to convert to Dynatrace over the next two years, with most of the remaining conversion activity to occur in the next four to six quarters. As a reminder, the ARR growth opportunity is not a conversion. It is getting customers onto the Dynatrace platform because from there, we can expand our footprint in ways that simply were not possible before. In addition, for investors new to Dynatrace, we do not charge a conversion or upgrade fee to move to the new Dynatrace platform. And as a result, all of our ARR expansion is either footprint expansion or new logos to the business. If we quickly break down these two ARR growth drivers, during the quarter, we added 214 net new Dynatrace customers, ending the quarter with 1,578 Dynatrace customers. Consistent with recent quarters, net new customers were a healthy balance of adding new logos to the franchise, as well as classic customers moving to the Dynatrace platform. In addition to a steady flow of net new customers, our dollar-based net expansion rate remained above the 120% threshold that we have experienced over the last five quarters since we ramped our efforts on the Dynatrace offering with existing customers. We will continue to confirm this net expansion level on a quarterly basis, and at the end of the fiscal year, we plan to share the specific net expansion rate for the year. Importantly, Please keep in mind that our net expansion rate excludes the upfront expansion that occurs when classic customers convert to the Dynatrace platform. So, our reported net expansion rate only takes into account expansion with customers after they are on the Dynatrace platform. Turning to revenue, total revenue was $122.6 million. This was an increase of 25% on a year-over-year basis. The acceleration in total revenue growth is being driven by the strong growth in subscription revenue, which was $108.1 million, an increase of 39% year-over-year. For the quarter, classic license revenue was down to $3.8 million and represented only 3% of our quarterly revenue. Please keep in mind that this will be going to zero over the next four to From a growth standpoint, we believe the best way to think about our revenue growth is the combination of subscription and services revenue, which was $118.8 million in the quarter, representing 97% of total revenue and an increase of 36% on a year-over-year basis. Before moving to our profit metrics, I would like to point out that I will be discussing non-GAAP results going forward, unless otherwise stated, and that our non-GAAP measures exclude stock-based compensation, amortization of acquired intangibles, and other items as outlined in the press release. Our non-GAAP gross margin was 82.3% for the first quarter, an improvement compared to 80.7% in the first quarter of fiscal 19. Gross margins are benefiting from increasing subscription margins due to the efficiency of the Dynatrace platform which has one code base and over 90% of our customers are on a version released in the last 30 days. Our non-GAAP operating income for the first quarter was $27.1 million, resulting in a non-GAAP operating margin of 22%, up from 13% in Q1 of 19. The increase in operating margin is largely driven by the fact that we are in the final stages of completing our transition to a subscription model. as historical revenue was negatively impacted when we moved from an upfront perpetual to a subscription model. In addition, we had some margin overachievement in the first quarter of 20 that was driven by a combination of revenue and the shifting of certain expenses from the first quarter to the balance of the year. Finally, please keep in mind that our first quarter expenses do not include the cost of being a public company, which will show up in G&A going forward. Non-GAAP net income was $9.3 million, and net income per share was 4 cents, based on 238.6 million shares outstanding. Turning to our balance sheet, as of June 30th, we had cash and cash equivalents of $57.5 million. When looking at our leverage at the end of the first quarter, our net debt was $945 million. On a pro forma basis, taking into account the $590 million of net proceeds from the IPO, our net debt as of June 30th would have been $355 million. This represents a leverage ratio of 3.3 times our trailing 12-month adjusted EBITDA of $106.4 million. Since the end of the first quarter, we have paid down $436 million of debt million dollars going forward the business will naturally do ever due to our healthy cash margins and we will steadily pay down debt over time which we believe will create value for equity holders the last balance sheet metric that I want to share was our RPO which was six hundred and fourteen million dollars up eighty three percent over q1 of last year the current portion of RPO is which we expect to recognize as revenue over the next 12 months, was $354 million at the end of Q1, an increase of 62% year-over-year. Looking at cash for Q1, our unlevered free cash flow was $45.8 million, and it was $172 million on a trailing 12-month basis. To be clear, we have seasonality, and we'll also have quarterly fluctuations in our unlevered free cash flow as we convert our customers from classic to Dynatrace, as this may impact the timing of how and when we invoice our customers. Before moving to guidance, I'd like to review a few items that will impact our GAAP results we incurred cash fees of approximately $14 million related to the IPO and structuring that will hit the P&L or APIC in the second quarter. These are in addition to the IPO commissions that were netted against the IPO proceeds discussed previously. Second, as a result of the spin of the CompuWare mainframe business, we will also be recording a cash tax charge in the second quarter of $273 million. Please keep in mind that we received $273 million from the mainframe business pre-IPO, and that these funds will be used to pay the federal and state taxes, a majority of which will be paid in the second quarter of fiscal 20, and the balance in early calendar year 20. Overall, this is a neutral cash item to Dynatrace. Finally, as disclosed in our S-1 and based on our IPO value, We're recording a one-time mark-the-market stock comp charge in the second quarter of $145 million. Now, let me turn to guidance. For the second quarter of fiscal 20, we expect total revenue to be in a range of $123 to $124 million, representing year-over-year growth of 21% to 22%. We expect our non-GAAP operating income to be in the range of $24 to $25 million and non-GAAP net income of $0.04 per share. This assumes approximately 270 million shares outstanding. For the full fiscal year, we expect ARR to be in a range of $545 to $550 million, representing year-over-year growth of 35 to 36%. Total revenue is expected to be in the range of $521 to $524 million, representing year-over-year growth of 21% to 22%. We expect our non-GAAP operating income to be in the range of $112 to $115 million, and our non-GAAP net income in the range of $0.20 to $0.22 per share. This assumes approximately 278 million shares outstanding for the fiscal year. In summary, we are very pleased with our performance in the first quarter and look forward to building a track record of success as we operate as a public company. We believe Dynatrace's financial profile is unique, including solid scale, growth, and cash flow. With a large team in front of us and a market-leading position, we believe the company is very well positioned for the long term. With that, we will open the call for questions. Operator?

To ask a question, please press star 1 on your telephone keypad. Please limit yourselves to one question and one follow-up. The first question is from Sterling Audie of J.P. Morgan. Please go ahead. Your line is open.

Yeah, thanks. Hi, guys. I wonder if you can peel back the onion a little bit and just update us on where you are or where you finished the quarter in terms of the legacy conversions, what's left in front of us and what kind of experience you're seeing in terms of, you know, the pace of those conversions?

Yes, Sterling, how are you? So, as we said, the conversions are, you know, nearly halfway through at this point. 75% of ARR is now on Dynatrace, but the conversion process is about halfway through now after five quarters. We believe, as we've talked about, that it's a two and a half to three year conversion process. Majority of those converting over the first two years or so. And we're very pleased with where we are right now. We're a little ahead of our internal plans and goals.

All right, great. And then the one follow up is, as you think about the three areas of monitoring, APM, infrastructure, logging, Can you give just even some kind of qualitative color in terms of the momentum that you're seeing in each one of those buckets on the new platform?

Well, as you know, and maybe some of those who are listening in, so our platform since day one has always assumed, you know, complete full stack observability. So whether if you're in the APM platform, an APM full stack customer, you get cloud infrastructure with it and the AI ops pieces as well. Log comes with it, you know, et cetera. So from that standpoint, and most of our opportunities we enter through APM, since that's our sort of been our legacy and that's what customers know us for and the market knows us for best, you know, that's, That has plenty of momentum, as you can see in the numbers. As far as cloud infrastructure-only environments, that's an expansion for us, and we're seeing good traction in that expansion. One of the unique characteristics of our platform is that our AI engine is at the core, and therefore, when someone adds a component, a new module, like infrastructure-only to extend the view, they also get the AI engine that stitches everything together along with their full stack hosts. And that's the same with digital experience management as well. You add that to the portfolio or to the platform, and the AI engine also absorbs that view into the full stack AI-powered answers first view. So from that standpoint, we're seeing good traction on all those additional modules, but we do think about it and the way we present ourselves to the market is much more of a platform than a set of piece parts.

That makes sense. Thank you.

Your next question comes from Matt Heidberg of RBC Capital Markets. Please go ahead. Your line is open.

Thanks. This is actually Matt Swanson on for Matt. You know, you guys have had a very well-established international presence. Could you just talk a little about what you're seeing from a demand environment and just from some of the, you know, recent earnings? We've heard some uneasiness in certain regions. So just what you're seeing out there.

So I appreciate the question, and you're right. We do have a pretty mature market. footprint, 40 to 45% of our business comes from outside North America. We haven't seen a real shift in demand, sort of negatively, in any region. Part of that may be that we focus exclusively on the more modern cloud environments, the dynamic multi-cloud environments. And those are sort of central to everyone's digital transformation around the world. So that may be part of the difference of what's keeping us, at least at this point, more resilient.

Thanks. That's really helpful. And that's really interesting hearing you talk about the U.S. federal opportunity. Could you just expand a little bit more? I know you said it's early days, but maybe how you look at that vertical and maybe what investments or in technology or go-to-market you think you might need to make to capitalize on that in the future?

Sure. The U.S. federal market is a very different market than the commercial market, those who have ever been close to it or watched those or talked to others about it. It requires a longer-term investment horizon, and so we hesitated to put that longer-term investment in place until we had you know, a quality team and a quality sales leader who really, you know, understood, you know, that market space. And so the last couple of years, we started the investment. We're starting to see the payoff, you know, begin. But as I said and you reiterated, it's early days, but promising. One of the things that is important, you know, in this environment is make sure you get FedRAMP certification, which we're in the process of. And, you know, that's also an important component to help build momentum, you know, long-term momentum in the federal space.

Thank you.

Your next question is from Heather Bellini of Goldman Sachs. Please go ahead. Your line is open.

Great. Thank you. I just had two questions. Was one wondering if you could share with us any information trends that you're seeing in the AIOps marketplace and the AIOps integration that you're offering. And then secondly, I wanted to ask a little bit about the competitive environment. There was a competitor of yours who, you know, I think it was early August, talked about kind of changing landscape from a competitive standpoint. We're just wondering if you could kind of walk us through what you've been seeing. Thank you.

So from an AIOps standpoint, we're seeing, and I sort of reiterated some stories there just a moment ago about customers, both new and existing, and even converting customers. Having AI at the core of our platform and really shifting from data on glass to an answers first approach where the answers come automatically in a very precise fashion so that that it's extremely actionable and the answers come within seconds of degradations and anomalies ranked by user impact. That's serving us extremely well from a differentiation standpoint and more and more customers, our CIOs and CTOs have it on their short list of additional automation for their IT organizations because they know they're resource strapped. So that's going extremely well. And as far as folks actually utilizing some of our new open APIs to bring new data sources into the Dynatrace AI environment, that's been going well also. It's fairly early days. It's been six months since we've had those APIs available. But we're with With some of the use cases around ServiceNow integration, F5, you know, low-balance kind of integrations, a number of things that are, you know, more out of the box now, it's accelerating. So we're very pleased there. As far as the competitive landscape in general, you know, definitely the observability space is getting a lot of interest. These days, you know, we view observability as obviously a really important component for modern cloud environments, but we also see it as just the first step, that the real value comes in the advanced automation and advanced analytics that come on top of the observability. And that's where we see the AIOps investment that we made when we reinvented the platform, you know, really paying off.

Great, thank you. Your next question is from Jennifer Lowe of UBS. Please go ahead. Your line is open.

Hi, thanks. This is Rakesh Kumar sitting in for Jennifer Lowe. So you just reported 40% ARR growth, plus ARR growth, which is certainly impressive. I was wondering if you could talk about how you think of levers of ARR growth as it relates to net new logos versus conversions and expansion on conversions.

This is Kevin. So yes, as I'm sure you can see, over the last couple of quarters, our AR growth has been over 40%. And as we discussed during our roadshow and in our S1, it really is a great combination of new logos to the business. As John mentioned earlier, majority of the additions in the quarter were new logos to the Dynatrace franchise. And then the other nice thing we're seeing is a really healthy net expansion rate. So not disclosing the the total number at this point, but it was north of 120%. For the last three quarters, when we talked about that on our roadshow, you know, it was in the high 130% range. So it really is a combination of getting new logos to the franchise, and then once they're on the 9Trace platform, they're expanding very nicely.

All right, and then I have a follow-up. I was wondering if you could talk about sales productivity trends and how long is it taking for reps to ramp and hiring plans that you have for the year.

So we're not disclosing sort of all the hiring pieces and sales and et cetera, et cetera. But what I will say is that we're in a better position than we've been in for two or three years now from a hiring standpoint. Part of it is the momentum in the business, of course, attracts talent. But also, I think some of the positive online You know, job site reviews relative to the company is also helping. So from our standpoint, we're doing extremely well, you know, meeting our hiring goals, attracting talent, and retaining talent.

Thank you.

Your next question is from Bhavan Suri of William Blair. Please go ahead. Your line is open.

Hey, gentlemen. Thanks, and congratulations there. Nice job out of the quarter, out of the gate there. I guess maybe I just want to touch first on the DM attach rate. Obviously, you sell that as a separate SKU there. I'd love to understand a little bit more about what you've seen there in terms of adoption and the attach rate and how that's trended in the recent quarters. Thank you.

So the digital experience management area, which is sort of the user experience components, has been, we've had that module in our classic product set for a while. It was just detached, sort of a separate product set. In the Dynatrace platform, it's an integrated module where the AI engine pulls everything together into a single stitch together view from every tap, click, swipe all the way through all the infrastructure components to the back end in a full stack view. So we are seeing continued momentum in the attach rate. It's interesting that the cloud, as we moved to the cloud, a lot of interest went to just building the foundation. But what we're starting to see now is an acceleration of you know, back to the numbers that we had, you know, three, four years ago in our classic world from an attach rate standpoint. I don't have the exact stats of the attach rate. You know, we're talking about how we want to, you know, bring that forward and present, you know, to the market and investor community. But it's been healthy. And any place where there's, you know, users attached, e-commerce, home banking, you know, go down the list. You know, those are perfect opportunities for, you know, solid attach rate for the DEM module.

Yeah, John, that's helpful. I guess maybe a more strategic question, and maybe I should have asked this one first. But as you think about sort of the automatic instrumentation, the automation features of the new Dynatrace platform, it feels like it should make it easier for you to achieve greater penetration within customers because it's much easier to deploy and manage. I guess, is that the right way to think about it? Because if you think about historically, maybe talk about it a little bit, the average percentage of applications monitored by classic customers, and what's that look like historically? And sort of, does that become meaningfully higher with Dynastrace platform because of the automatic instrumentation detection, the way the platform lights up? I'd love just to understand sort of the trends you've seen as customers switch, sort of what that, and you're seeing an expansion rate, obviously, but I'd love to know sort of numbers of applications or sort of, and is that the right way to think about sort of that shift?

Yeah, sorry if I misunderstood the first question. I thought you meant the digital experience, you know, management piece. I did.

This is more strategic. I actually did.

You answered it. Fair enough. But you're spot on that the automatic nature, and I mentioned it in the expansion, you know, customer that I was talking about just a few minutes ago, that, you know, people start with a taste. Try a few modules. Does this really work as advertised? Do my people really wield the weapon, you know, in other words? And the minute they get the hang of how easy it is, the expansion is quite rapid. It's been much more rapid than our classic product set and continues to show up, you know, in the net expansion rate. So, yes, the bulk of the net expansion today is additional applications. Going forward, we believe it will be a nice, consistent mix between additional applications and additional cross-selling of modules.

Got it. Got it. Helpful. Thank you, guys. Appreciate you taking my questions.

Thank you. Your next question is from Richard Davis of Canaccord. Please go ahead. Your line is open.

Hey, thanks very much. You know, one of the areas that we've seen some of our companies try to pivot into is kind of, you know, government and things like that. Have you, to what extent do you feel that that's an opportunity? And, you know, some companies, I can't recall if you have FedRAMP or not, but that's one of the, you know, check marks and things like that. To what extent do you see that as an opportunity over the long run? Thanks.

Yes, I was saying it's a huge opportunity. I mean, it I don't know where the U.S. government, you know, falls as far as a consumer of technology these days. It used to be like, you know, one of the top number six or five or six countries, you know, worth of spend. So it's a good, it's definitely a good size market space. But we're early days in it, mainly because it requires, you know, an ongoing investment for a while before you see the uptake. which we're now just starting to see, you know, beginning with. From a standpoint of FedRAMP, you know, that's something that's in process, important piece of the project. But I think that, you know, just we're excited about that opportunity going forward. I thought the example, customer example was pertinent. And I look forward to a lot more stories and success in that part of the market.

Thank you very much.

Your next question comes from Don DeFucci of Jefferies. Please go ahead. Your line is open.

Thank you. My question goes back to the ARR question. So, Kevin, as you point out, grew 43% this quarter last That's three consecutive quarters of ARR growth in the 40s, which accelerated from the low 30s prior to that. And we all know that ARR is a prelude to future revenue. I guess my question is, how sustainable is that accelerated growth? And it doesn't have to stay in the 40s, but those are pretty impressive numbers. And I'm just trying to understand, because we get the question a lot from clients, like, okay, when the classic ARR goes away, because you pointed out, I think, Kevin, that, hey, listen, when we convert, we see much broader adoption with the new Dynatrace platform. But you're also seeing the net retention that's really high, too. So just trying to understand, like, has something changed out there in the market, too? Maybe that's a second question, but it related. How should we be thinking about that ARR growth going forward?

Yes, I think so. I'll jump in, and then maybe John can add to this as well. But I think there's a couple things that are behind us right now, are working in our favor. First of all, we've been ramping our sales organization over the last 12 to 24 months, and we expect to continue to do that. So, you know, that will increase some bookings. So that's one growth driver. The second growth driver John mentioned is the ease of use and implementation, the ability to scale out the Dynatrace platform. and that expansion rate. So I think the combination of those two, and then as we're adding new logos, it's been a core focus for the company over the last 12 months as well. You know, that has tremendous opportunity. Our average ARR on the Dynatrace platform per customer today is north of $200,000. You know, we think each one of those customers can be a million-dollar ARR opportunity for us over time. So a lot of opportunity to continue to expand ARR in both new logos

Okay. Has there anything, and maybe, John, is there something else in the market, too? Because, you know, APM, as you guys know, especially from your experience back with the Classic, it's always made a lot of sense, right? And there was a lot of promise, even in the early 2000s, and a lot of companies went after the opportunity. CompuWare, Dynatrace, Gomez... and then all the others. But it never really became or never really fulfilled its promise. But we're seeing something today in Dynatrace and also in others. And there is a lot of questions. Competition is something that wasn't asked a lot about right now and on your call, but it will be, right, because there's other companies doing well too. I'm just trying to get a sense of is there enough room for others to continue to do well. There's something changed in the market that's also helping you.

I think there's a big disruptive shift that's going on around cloud. You know, we've talked about it before. This isn't just applications going to the cloud and everything else, status quo. This is the shift of the data centers to hybrid multi-clouds. And that's requiring an entirely new set of tooling. So think about the 20, 30 years worth of, you know, tooling that's been out there all having to change over the next, you know, 5 to 10 years. That's accelerating a shift to a modern, you know, set of platforms. And I say platforms because in the cloud, you can't go after it in the old way. with a bag of tools. You have to think about it in a much more holistic way because the entire stack is software. So with that disruptive shift and that collapse of what were traditional ITOM use cases, you really have a dramatic shifting moment. We saw that five years ago, we came to market four years ago with an initial sort of offering to you know, get our feet wet. We took it enterprise three years ago, starting in 2016. And, you know, we haven't looked back. So we're really pleased with the competitive position. I mean, you know, the foresight we had is paying off. And, you know, this disruptive moment is only beginning. It's in the early innings, for sure. And I think that's what we're seeing. That's why the TAM expansion... you know, is so great and so rapid.

Great. Great. Thanks, John. Thanks, Kevin.

Your next question comes from Remo Lenchow of Barclays. Please go ahead. Your line is open.

Hey, guys. This is Mohit Gogion for Remo. Thanks for taking my question, and congrats again on the first quarter out of the gate. So my question is on the product roadmap. So if you can shed more light on across, if you look at, obviously, it's a unified platform, but if you look at the different use cases, I guess, across APM logs and infrastructure monitoring, along with AIOps, I'm just wondering if you can give us a sense of the product priorities that you have. Like, are those more focused in some of those areas, or is it more consistent across the board? And I have a follow-up question to that.

No, it's a good question, and thank you for your for kind words. Our investment is consistent across all of them, really. They're all monetizable modules, and when you have something that's monetizable, then you're going to put some effort into it, so we have teams on every one of those, what we think of as key use cases. We're We're extremely strong in APM, as you would expect. That we believe is a high ground. It's very difficult to do well at scale. And at the same time, it's essential for the way CIOs and CTOs and even CEOs now think about their digital transformations. But we do have significant investments in cloud infrastructure monitoring in the AI office space and in the digital experience space, which we also feel is a very strategic high ground for us as well. So in order to cover the cloud, we've had to do all of these pieces because we do think of it as a full stack. And so what we're doing now is sort of breaking out different pieces of the puzzle in the standalone sort of components, you know, for extensibility, you know, and reach beyond just the full stack, you know, view that we started with, if that makes sense to you.

Yeah, that's helpful, Karagas. The follow-up to that is the other part of the equation is the pricing model. So, I mean, I'm just wondering if you can – give us more color on what you're seeing in the pricing environment, because some of your competitors are sort of like talking about some new pricing models, or maybe from your customer conversations, you were hearing the same. Just wondering if you can give us more color on the pricing environment you're seeing. Thank you.

From a pricing standpoint, we have been, I would say, We listen to customers. I mean, I really do believe that you need to make sure that your customers are happy, that you're easy to do business with and the rest. And I think we're being smart with how we manage our pricing and our licensing models. We have a fair amount of flexibility. We have a direct sales organization. 90% of our sellers are outbound in the market. We sell to enterprise customers who expect some flexibility. And we're pretty good at adapting, you know, license strategies that fit customers and help them expand our product set, you know, widely within their organizations. And I think you see that with the net expansion rates. I mean, if we're really difficult and challenging, you just wouldn't see that. So So I'm happy with how we're pricing. I'm happy with our flexibility and our licensing models. And, you know, I can only speak for ourselves, but that's, you know, that's where we sit today. No need to change.

Thanks, guys.

Your next question comes from Eric Suppager of JMP Securities. Please go ahead. Your line is open.

Hi, this is Joe Goodwin on for Eric. Thank you for taking our question. I was hoping you guys can give us some color on what portion of customers are using Dynatrace for applications running on containers, and then anything around how fast the containers business is actually growing.

So I don't have the exact numbers on Dynatrace customers running on containers, but what I can tell you is that nearly 100% of the Dynatrace customers are cloud-based customers. And the container world has been around for a little while now, whether they started with Docker, what have you. But what we've seen in the last 18 months of the rapid shift toward Kubernetes has really been interesting to watch as people look for a portability platform across sort of a multi-cloud strategy. And whether that's, you know, 15 to 20% of our customers or whether it's, you know, more than that today, I'm not sure. But what we do hear from customers and surveys and so on we've done is that, you know, cloud native, you know, workloads and container orchestrated environments are going to sweep through our enterprise customers to the tune of 80 to 90% over the next couple of years. I should probably add on that that it's actually a great situation for us because we purposely built for dynamic containerized environments. So it's great from our standpoint to see the rapid rise of this kind of dynamic orchestrated environments.

Understood. And then just a quick follow-up. Can you provide any insight into how much of a drag on gross margins was the cost of supporting the classic product during the quarter?

So this is Kevin. So we, as you know, we have a super-efficient dietary stack, one code base. All of our customers are tethered in when their data is in the cloud or behind a firewall, so super-efficient there. The classic product is winding down and we will see some margin expansion over time from a gross margin standpoint. But we're not really breaking down how many dollars are going to be pulled out of that business. But we will continue to see as we've seen gross margin expansion going forward.

Yeah, I think the point is that the classic product set is not as efficient as Dynatrace. And you can sort of expect that from a a totally new stack, you know, four or five years old versus, you know, some of the classic products that go back, you know, 12 to 15 years in their technology stack.

Great. Thank you.

There are no further questions at this time. I will turn the call over to John Van Sicklen for closing remarks.

Yeah, thank you. And I'd like to thank all of the investors and analysts for your time today, as well as I'd like to thank the many customers we have, partners and employees who've helped us build a very strong company. We're excited about the path we're on. We're excited about the opportunity ahead, and we look forward to updating all of you in what's about 60 days from now. Thank you very much. Good evening. Thank you.

This concludes today's conference call. You may now disconnect.