Dynatrace, Inc.

call out that all references to growth rates will be in constant currency unless otherwise noted. Also, please note that with our global presence and European R&D footprint, we look at our business as generally hedged from a P&L perspective. Over the last 12 months, we have seen two points of negative impact from currency and on top line. We expect the mix of the business to drive an FX tailwind in the second half which will essentially neutralize currency impact on revenue for the year. Our guidance continues to reflect these changes and should pose minimal risk to our outlook. I'd also like to give a brief update on how COVID-19 is impacting our business. The highly affected industries we outlined in previous quarters, which represent about 20% of our business and include areas such as transportation, hospitality, retail and energy, continue to hold up well in Q2 as renewals of existing customers remain strong. Now, more than ever, customers in all industries recognize the importance of digital transformation and the automation and intelligence that Dynatrace can deliver. One of the great things about our business model is that it is resilient and predictable. With these attributes and our visibility into the pipeline, we feel confident about executing our plans. As a result, we are raising guidance for fiscal 21. We are raising our ARR guidance to $721 to $727 million, representing 25 to 26 percent growth. We are raising our total revenue to $668 million to $675 million, representing year-over-year growth of 22 to 24 percent. and we are raising our subscription revenue to $624 to $630 million, representing year-over-year growth of 28 to 29%. For the full year, we expect non-GAAP operating income to be in a range of $186 to $191 million, and our non-GAAP EPS of 55 to 57 cents per share. As discussed on prior calls and at our investor day, We are a growth company with a lot of runway ahead of us. We believe we are well positioned to deliver against our goal of building a multi-billion dollar category leader. As such, we plan to continue to accelerate investments to support ongoing platform innovation and commercial expansion efforts. Operating margins are expected to be very healthy in the second half of the fiscal year, but lower than Q2, which ran well ahead of our expectations primarily due to the strength of our revenue. I would also note that we anticipate tax expense to be in the range of $6 to $8 million in the back half. Our full-year guidance includes an annual effective cash tax rate of approximately 8% compared to our previous guidance of 11%. And to reiterate, we continue to expect unlevered free cash flow margins to be approximately 29% to 30%. resulting in $192 to $200 million of unlevered free cash flow. Turning to the third quarter, we expect total revenue to be in a range of $171 to $173 million, representing year-over-year growth of 18 to 20 percent. We expect Q3 subscription revenue to be in a range of $160.5 to $162 million representing year-over-year growth of 24% to 25%. From a profit standpoint in Q3, we expect non-GAAP operating income to be in a range of $43 to $45 million, 25% to 26% of revenue, and non-GAAP EPS of $0.12 to $0.13 per share. In summary, we are very pleased with our second quarter performance and are committed to operating the business as a Rule 50 company. We believe Dynatrace's financial profile is highly unique, including meaningful scale, strong growth, healthy profitability, and cash flow. With a large TAM in front of us and a market-leading position, we believe the company continues to be very well positioned to achieve our goal of becoming a multibillion-dollar category leader. With that, we'll take your questions. Operator?

Thank you. At this time, I would like to remind everyone, if you would like to ask a question, simply press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from with William Blair.

Thanks for taking my question, and congrats. That was a really solid set of numbers there. I guess I wanted to touch really quickly on two pieces, one a little more strategic about the TAM. So you obviously talked about the TAM, John, at the analyst day. But I guess, you know, as you look at the complexity of what every company is going through and the digital transformation that even mid-sized companies are going through, why not go below that sort of Fortune 15,000? Why not sort of maybe move not to small businesses, but to mid-sized businesses that may have a service desk that may have, a website and more than a website, multiple applications, multiple products. How should we think about the idea of expanding down market to sort of even further increase the TAM that you serve?

I appreciate the question. So our focus has been and will remain for some time that global 15,000 We believe we build products extremely well for that enterprise customer base. It's a more complex environment. Digital transformation matters to their business survival. And it's also where, you know, the profitability, you know, is as well. So we're pretty happy with a $32 billion TAM, you know, at this point. I should also say that nothing precludes us from going down market. There's no product issue. There's no pricing issue. There's nothing, you know, in that range. It's more of a focus of the business. And usually when you focus, you accelerate faster, in my experience. And that's what I think you're seeing in our numbers.

No, it's helpful, and I appreciate that. And then I just want to touch a little bit on something you brought up a couple times, So the digital experience piece, you talked about 70% of customers being attached to it. You talked about strength in the log piece. Just some sense on sort of as the initial customers or the newer customers are landing, are you seeing them land with multiple products? And what is the attach rate? Is there a pattern in the attach rate for some of the newer products for the new customers?

Thank you.

Another good question. And yes, we are seeing the attach rate of multiple modules with new customers increasing. So I think at Analyst Today, we talked about about 30% of new logo customers are landing with three or more modules. And I think what we're seeing, and it's starting to come through in our sales cycles and sales data, is that we're starting to see a gradual shift now. It's still early days. It's still small, but a gradual shift from sort of the APM landing zone we've talked about for the past year to an observability landing zone. And that observability landing zone is almost by definition a platform kind of thinking where the customers are looking for a wider footprint of value day one. And we're very well positioned for it. We've been anticipating it, and we're starting to see it happen. Again, like I said, it's early days, but it's beginning.

No, that's great information. Thanks for the color, and thanks, Jen. Thanks for your question. Appreciate it, Yvonne.

And your next question comes from the line of Raymond Linshaw with Barclays.

Hey, congrats from me as well. John, can you talk a little bit about, you mentioned about the increasing uptake for the infrastructure module. In terms of like, where do you see customer understanding in terms of that module being kind of crucial and being a potential starting point for you going forward? And I had a follow up for Kevin.

uh yes sure the um well the infrastructure module as as you know we've been you know working on it for the last you know 18 months to really mature it and it's come into its own now uh and that's allowed us to be much more aggressive you know in uh the expansion you know uh side of it as well as landing with that module alongside the apm module and the dim module from a wide infrastructure module and log analytics from Dynatrace versus someone else, usually there is some kind of incumbent in place, a series of tools in place to cover what that module covers. But when you start to consider that all of the data gathering across all those infrastructure services is automatic, It's all given context into our topology map SmartScape, which maintains that map continually in real time. And then an AI engine that applies knowledge and algorithms across it to understand where anomalies are happening that impact the business. and immediately surface those to folks to take immediate action to proactively handle things before users are impacted. You realize that the value of that platform, that inherent automation and AI assistance, you know, is hugely valuable as you consider most of these, you know, enterprise IT teams are pretty much resource strapped these days and time and giving them back time, giving them back resource for more meaningful things like innovation and driving better business outcomes, you know, is huge. So that's what's driving, you know, sort of that expansion of that infrastructure module. And we're still early in it.

you know i would say from a driving arr standpoint but the uh but the adoption you know is increasing rapidly within our customer base okay okay thank you yeah that's very clear and uh kevin for you just if you if you think about the investments you guys are doing and and john talked about the increase in sealed capacity how do you think about this going forward because in a way you're kind of moving from like a 20 percent core into a 30 percent grower um so in theory there should be like you know an increase in in needed hiring as well to kind of drive that further growth but then also you have obviously productivity gains coming out of that so you mentioned already like a little bit of the investments but how do you think about that in the kind of medium to long term here thank you

Sure. So I think if you take a look at our business model historically and you go back to fiscal 20, really what we're trying to work on in the next two quarters is to get back to those types of margins and investment levels. So if you look at our operating levels, our operating incomes, we're in sort of the low 20% range, 23%, 24% range. And we had to step up in Q1 and Q2 as a result of COVID and some pauses in investments and travel and things like that. But what I will say is in September, we made significant progress in terms of hiring, both from an innovation standpoint in the R&D area, as well as in sales organization as well, which we never took our foot off on again. So we're going to get margins down to that level. We've talked about that at Analyst Day. And when we think about over the longer term, what we are trying to do is maintain, as we communicated at analyst day, AR growth north of 25%, and continue to grow that top line. We want to balance that with investments, though, as we've said. So we're going to step on the gas a little bit here in Q3 and Q4, because we think the market is there, and the product's there, and there's a lot of opportunity.

OK, perfect. Thank you. Congratulations. Thank you.

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

Oh, hey, guys. Good morning, and I'll offer my congrats again. This is certainly not an easy environment. You guys are doing well. John, on the call, you noted cloud system integrators are becoming more important, which is really good to hear and similar to what we've picked up in our checks. Can you remind us what percentage of deals are either partner-influenced or maybe even partner-led? and perhaps where that mix might go in several years?

Sure. So partner-influenced is still the lion's share, which means your direct sales organization is doing sort of the finding and the development and then running to the partners that help us sort of move deals along and that sort of thing. And what we're working on is, you know, more partner source, you know, opportunities, which are starting to happen. We've had a partner program, as we said, at Analyst Day for years. But it's this move from sort of boutique resellers of APM over to cloud system integrators who think of a wider platform that really sort of driving these digital transformations for customers that is sort of the new opportunity for us. We're still in the 10% of opportunities sort of sourced through partners, I would say. Cloud opportunities sourced through partners. But we see that capable of growing considerably. We see it up year on year consistently right now. And when it becomes sort of the big push as it is for some other billion-plus companies, we'll start sharing more percentages and sort of what the pace is of that. What I wanted to share, you know, today is that we are starting to see the movement. We are leaning into it. We are getting more aggressive with it. And it will become a more meaningful sort of adjunct and augmentation to our go-to-market.

That's great. And then, you know, I wanted to – it didn't come up today, but it came up at analyst day, but I wanted to circle back on your intent to enter the application security market. It makes a lot of sense, I think, especially given SmartScape and your Davis technology. Can you talk a bit more about this opportunity? I assume customers are asking for this from you. And maybe remind us again about the timing of the launch here.

Sure, Matt. So I figure I probably ought to stick with the modules that we have today rather than sort of pre-announce anything. But as we did talk about on Investor Day, we've spent the last 18 to 24 months looking at that security market. We know we have a phenomenal data platform. for that environment, especially for the dynamic multi-cloud environments that are out there, security where you can't ring fence it. You have to build it into the applications themselves. And so as we get ready to add that capability, that module into our portfolio, we'll make sure that we keep everybody abreast as we go. It's not far away, but it's not ready to be announced. Got it. Thanks, guys.

And your next question comes from the line of Jennifer Lowe. And Ms. Lowe, please state your company name.

Thank you. This is Jen Lowe from UBS. Great. So I wanted to ask a little bit about the demand environment, and in particular, you know, John, at the outset you talked about this growing consensus that digital transformation is necessary and only more so in the current environment. But sometimes in our field work, we pick up that companies are conceptually on board, but maybe a little reluctant to commit to very big transformational projects in an uncertain time. So it's on their roadmap, but maybe not actually happening today. It's more, you know, next year. I'm just curious, you know, in that commentary, what nuances you're hearing in terms of those projects starting today? versus being on the roadmap but maybe more 2021 business for when things get a little clearer on the macro outlook?

Sure, Jen. Well, from our standpoint, we're not what I would consider a massive digital transformation project. Someone's already committed to digital transformation, and they're trying to figure out, how can I speed it up? How can I reduce risk? in the project, and how can I create greater efficiency, lower costs while I'm doing it? And it's that combination of gaining speed, reducing risk, and driving efficiency that makes it a very practical kind of choice and pay for itself within a 12-month window. So these aren't projects over three, four years, and maybe I'll get my payback over 10 years. They're much more practical than that. And I think that's a secret to our success, actually. That rapid return on investment is quite clear, and a number of customers experience it, and they talk about it with their peers.

Maybe one more for me. You know, we've seen some of the other players around the observability space, you know, adjust their pricing or announce new pricing plans or focus on plans that are really designed to make it easier to bring in data at a low price point and get away from kind of a host-based model. I'm curious if that's something that you're hearing from customers that they're asking for, anything you think might be on your roadmap at some point.

No, what we hear is customers want, at the enterprise level, they want predictability and they want transparency. They don't want surprises of consumption-based models where they're getting hit with overages month after month after month. They don't like the idea of, hey, come in cheap and then all of a sudden I'm being surprised. So our pricing model is built around use cases, the modules. You get pretty much everything you need within those modules. And the value that they look at is not just in collecting data. They're actually, with Dynatrace, getting the understanding of the data. They're getting the predictability of where bottlenecks and issues are arising so they can take action. And they're getting a system with precision enough for them to actually build auto-remediations off of. So it's a different kind of value proposition than the, hey, I'm just gathering data kind of value propositions. And I think that our pricing model, which we adjust all the time, by the way, you know, as the market moves here and moves there, is working extremely well for our enterprise customers. And I don't see really any reason to sort of change it at this point in time. Great.

Thank you so much.

And your next question comes from the line of Sterling Otte with J.P. Morgan.

Yeah, thanks. Hi, guys. John, in your prepared remarks, you kind of touched upon automation, some of those advanced capabilities, which brings to mind AIOps, at least from my thought. I'm just kind of curious, what is the penetration of those advanced automation AIOps capabilities at the moment inside the customer base? And what kind of revenue run rate or spending uplift do you get when customers go to that level?

It's a good question, Sterling. Built into the platform is the AIOps, you know, capability. So every Dynatrace customer, you know, enjoys it at some level. But how many actually take that from the Dynatrace platform and extend it beyond it is probably, I think, as we've been looking at, you know, sort of different environments, we're somewhere in the, you know, 10 to 20% range. of customers extending beyond. Some of them are pretty obvious ones, like connecting with a ServiceNow environment. Other ones are much broader, where they work on dozens and dozens of additional data sources pulled into the Davis AI for a much wider AIOS footprint. The way we monetize That is we charge for ingestion of third-party data, data that doesn't automatically come in via the one agent. It's not a large amount of our revenue stream, but it's becoming more meaningful over time. But I think as we go, you'll see us do more and more work in a broader AIOps footprint. You saw that we were the number one choice in the ISG observability quadrant that was recently put together. And you're going to see a few other things, you know, come up where, you know, focus specifically on AIOps, where you'll see us ranked, you know, quite high and sort of anticipate, you know, some of the moves we're going to make, you know, going forward here to be more aggressive, you know, in that growing market segment.

And your next question comes from the line of Keith Backman with Bank of Montreal.

Hi, thank you. I wanted to try to ask to first I want to talk about or ask about the competitive landscape. And the small and medium business category in observability has been disrupted over the last probably two years, in particular New Relic with Datadog providing some disruption. I think one of the larger overhangs for your stock is concern around disruption. And so my question is, if the S&B category within observability has been or faced increased competition, what can you say to investors about Your space is the, I think, the rock solid leader in enterprise. Why won't that get disrupted over the next couple years? And then I have a follow-up.

It's already being disrupted. It's just that we're the disruptor in that space. We're the ones that have been bringing modern observability to that enterprise segment for the last four years. We're the ones with the full stack platform We thought about it thoroughly, that it was more than just the data, that it was the understanding of the data, the predictability, the predictive analytics, the ability to take action immediately, quickly, precisely. We're the disruptor in that space. And what works in the S&B space, which is sort of a simpler, fewer applications, less change kind of environment, gets very complicated when you get to the enterprise. So that's my feeling there, and that as folks try to move from S&B up to enterprise, it's a pretty different world, and we're already there.

Yeah. OK. OK. The second question I had is on AR growth. So you're guiding AR growth and constant currency for the year of 25 to 26, which is up from your previous guide or increasing, I should say, from your previous guides. Your longer-term guidance is, as you say, north of 25%. Normally you see a decel over time, but what you're suggesting is as you reach a level at the end of this year, it holds that. But why – You know, it's just unusual to not see a decel, so to speak. So if you could just speak to or address, you know, why you think you hold at those levels rather than see some perhaps tailing off below 25% longer term.

Sure. So a couple things there. So the first thing I would say is, as we discussed again at Investor Day, we will be facing and we are currently facing some headwinds on our ARR growth due to the perpetual runoff of licenses. And those, as we discussed, over the next four to six quarters will be a headwind to ARR growth. So that's sort of on the negative side. And as we come out of fiscal 22, those headwinds to ARR growth will disappear However, if you think about the investments that we're making today, that's what makes us very optimistic about the future AR and sustainable growth. Our goal this year is to grow sales and sales capacity by 25%. We're on track to do that. Things are going very well from a sales standpoint there. We're also seeing a nice shift in our sales rep organization as well. We have a lot more mature reps than we did 12, 24 months ago, so that's That should provide a tailwind as well. And I say the third thing is we talked about before is we are no longer working on converting our base from classic to the Dynatrace platform. So that frees up additional capacity. We talked about that probably around the 20% of free capacity that over time should help productivity. So you think about those three things combined, sustainable, growing sales capacity and maturing of the sales organization, as well as no longer working on conversion programs, those should all be a tailwind to AR growth over time.

Perfect.

Many thanks.

And your next question comes from the line of Walter Pritchard with Citi.

Hi, thanks. Can you hear me? Hi, Walter. Hey, so I guess starting out, just on the 133 customers you added in the pipeline you're building for the second half, can you talk about the trial activity? How much of those are coming in through free trial or most coming in through the traditional sales motion where trials are not a big part of it?

Most everything involves a free trial, whether we stimulate the customer and suggest that they investigate that way or whether they've already investigated, done their homework and come in that way from their own investigation before we even touch them. The free trial accelerates the sales cycle no matter which way. the customer comes in or the prospect comes in. In fact, it also accelerates expansion. because it's an easy way for customers to pass on to their colleagues in other departments or other application stacks, you know, here's something you ought to look at and it accelerates that early investigation stage. So that's why we call it sort of a frictionless enterprise, you know, kind of program because that free trial is involved in almost every, you know, engagement.

Got it. And then as we think about the 300 that you talked about for the second half, can you help us understand? You talked in the past, I think last quarter and two quarters ago, about there is some headwind from the macro and so forth. How much headwind do you think you still face in adding somewhere around 300 customers? And do you think you've already converted or converted all your sales capacity to be able to add new customers? Do you think that 300 is still kind of work in progress and you could actually see improvements as you look into next year?

Yes, so a couple things. So there is no question that trying to build relationships with enterprise customers where it's a more complex sale, usually multiple people involved in making decisions, you know, it's harder over Zoom. than it is face-to-face. At the same time, we're getting better at it, and customers are getting used to it. So they know they have to advance, so they have to figure out a way to make that work. And having a free trial and then being able to do proof of concepts remotely, 100% remotely, is a big advantage for us. A number of our competitors still can't do that. So we've learned a lot. Customers have learned a lot. And we are starting to see the sales cycles move back to a normal cycle range. And that's what gives us confidence in the second half of the year. As we go into the future and things sort of normalize back again, I believe our muscle in driving new opportunity will continue to increase. Our productivity will increase per sales rep. You know, if you want to think about it that way. And then we should continue to see increases year over year and keep a steady sort of percent of ARR, you know, as we go in that new account, new logo, you know, segment.

Got it. Thanks. That's good to hear, John.

Thank you. Our last question comes from the line of TJ Hines with Conaccord.

Hey, thanks, guys. Congrats on the results. John, just one from me. So one of the questions I get from investors as they try and make sense of the competitive landscape is whether it's easier to expand from APM to infrastructure or from infrastructure to APM, right? And given your model, I know how you'll answer the question, but maybe you could just talk about why you think that's the case.

Well, so first of all, we continue to believe that the application layer is the strategic layer of value. It's where IT meets the business. A CEO doesn't want to talk about infrastructure. They want to talk about business outcomes that are driven by business applications. So that's sort of the first thing. The second thing is very few people have figured out how to do automatic application observability at scale. And in the cloud environment, that means you have to actually observe everything at once because it's all virtualized software. That's a very difficult challenge. There's hundreds and hundreds of compatibility idiosyncrasies with all the frameworks, all the layers, all the languages, et cetera. So that's always been sort of that difficult barrier. Otherwise, everybody would be doing it. And you'd see dozens of people in the upper right quadrant of the Gartner APM magic quadrant. So that said, you know, our view is, you know, infrastructure has its own, you know, peculiarities and uniquenesses. And it's taken us, as I said, you know, 18 months and we still have more work to do to get our infrastructure module to a mature level, you know, in that segment. So no segment is easy. But we view the infrastructure segment as a logical extension that we're fully capable of addressing and one that goes hand in glove with the application layer when you get to enterprise observability and the use cases and extensions thereof.

Yeah.

Yeah.

OK. That's helpful, Collin. Thanks, guys.

Thanks, TJ. I think we're sort of out of time. That was the last question. So let me just say thank you. We believe we have a fantastic opportunity in front of us with a massive market and a well-differentiated product. We have a great, balanced business that you can see. We're going to continue to invest, as Kevin said, in commercial expansion and continuous innovation, which has served us well. And we look forward to catching up again in late January, early February to cover our Q3 results. Thank you again. Enjoy your mornings.

And thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.