Dynatrace, Inc.

Hello, and welcome to the Dynatrace second quarter fiscal 2022 earnings call and webcast. At this time, all participants are in listen-only mode. A question and answer session will follow a formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Noelle Farris, Vice President, Investor Relations. Please go ahead.

Thanks, Operator. Good morning, everyone, and thank you for joining Dynatrace's second quarter fiscal 22 earnings conference call. With me on the call today are John Van Sickland, Chief Executive Officer, and Kevin Burns, 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. These forward-looking statements are subject to risks and uncertainties, depending on a number of factors, that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these uncertainties and risk factors is contained in Dynatrace's filing with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking statements included in this call represent the company's views on October 27, 2021. Dynatrace disclaims any obligation to update these statements to reflect future events or circumstances. As a reminder, we will be referring to some non-GAAP financial measures during today's call. A detailed reconciliation of GAAP and non-GAAP measures can be found on the Investor Relations section of our website. And with that, let me turn the call over to our Chief Executive Officer, John Van Sickland. John?

Thanks, Noelle. Good morning, everyone, and thank you for joining us today. First, let me start by sharing how extremely proud I am with the team's performance this quarter, once again beating guidance across all our key operating metrics. ARR was $864 million, up 35% year-over-year, and subscription revenue was $213 million, also up 35% year-over-year. Once again, we balanced these strong top-line metrics with solid bottom-line performance as well, which Kevin will elaborate on in a few minutes. we continue to believe that a smart balance between growth and profitability makes for a more durable business. Underpinning our consistent year-over-year top-line ARR growth above 30% are two key building blocks, net new logos to the Dynatrace platform and the ongoing expansion of existing customers. I'm pleased to report that we added 160 new logo customers to the Dynatrace platform in Q2, up 20% from a year ago. and that our net expansion rate, fueled by growth across all modules, was once again at or above 120%. The consistent execution against these two building blocks, we believe, will sustain a 30 plus percent growth business at scale for some years to come. With the strength of our Q2 results and positive outlook ahead, we are increasing our guidance for fiscal 2022, which Kevin will provide more detail on shortly. This morning, I'd like to provide an update on the three topics that I believe will continue to drive Dynatrace's momentum and success. First, the ongoing market dynamics that continue to drive new logo growth and rapid expansion within our growing customer base. Second, the progress we are making in commercial expansion to accelerate go-to-market success. And third, the progress we are making in expanding our platform and module strength to address the full $50 billion TAM we see ahead of us. Let me start with the market dynamics. We sit in a rapidly growing market that's being driven by digital transformation across every geography and vertical. IDC predicts digital transformation investments will exceed $7 trillion by 2023. And the pandemic, whether protracted or short-lived, has little effect on this movement. At the core of digital transformation are three mega trends that are interrelated. The first is that applications are eating the world as businesses look for innovative ways to transform. The second is that these applications and the platforms they run on are cloud first. In fact, multi-cloud first. And the third is the rise of automation and AI to simplify the complexity, increase the speed, and mitigate the risk of these transformations. Dynatrace's unique combination of multi-cloud observability and application security, unified with powerful AIOps capabilities, position us to benefit nicely from all three of these megatrends. Digital transformation is not an event. It's a journey. And we are in the early innings of digital transformation and these three megatrends. Take one of our brick and mortar retail customers who are shifting more business online, increasing customer loyalty, and optimizing supply chains, all while reducing their real estate footprint dramatically. Leveraging digital channels at scale will be a long-term imperative for increasing profitability while reducing business risk for years to come. Another example, one of our media entertainment customers who is digitizing their entire library of video assets, extending their online licensing capabilities, and leveraging public clouds for scale and flexibility. New digital partnerships new revenue streams, and powerful new branding opportunities will fuel their business well into the future. For one of our US federal customers who is on a multi-year journey to migrate hundreds of applications from legacy data centers to a modern multi-cloud platform for greater agility, efficiency, and security, application effectiveness and responsiveness needs to be maintained while scale increases, functionality advances, and mobile access becomes the primary channel of engagement. These are just a few of the thousands of customers Dynatrace is helping to modernize and transform. Modern cloud native application stacks, multi-cloud platforms, AIOps enabled for ease and efficiency. Our numbers are proof of our superior fit for these digital transformers. As I mentioned earlier, we added 160 new logos to our franchise in Q2, up from 135 last quarter and up 20% year over year. Great companies and agencies such as HCA, Victoria Secrets, PG&E, and the FAA, all digitally transforming in one way or another, all with observability requirements that include hyperscaler platforms, Kubernetes container orchestration, cloud-native applications, and modern DevOps practices. Some of these accounts are transforming off outdated monitoring tools, while others have been trying to cobble together their own modern cloud observability solutions, and all considered multiple alternatives before selecting Dynatrace as their digital transformation partner. On the expansion front, once customers experience the value of the Dynatrace platform, they are eager to expand module usage and increase coverage. This quarter, global leaders such as Hertz, MasterCard, Bell Canada, American Airlines, and the U.S. Department of Veteran Affairs expanded their use of Dynatrace and all now use three plus modules of Dynatrace to cover their multi-cloud observability needs. As digital transformations expand, as applications drive more and more value for the business, as scale and complexity accelerate faster than human expertise, the Dynatrace value advantage gets stronger and stronger. As you've heard us say in the past, we believe the market is moving toward us. The macro trends of applications eating the world digital transformations as cloud first and the need for automation and AI ops capabilities on the rise put us in a very strong position for continued new logo and net expansion success going forward. This brings me to my second topic this morning, increasing investment in commercial expansion to capture the powerful market opportunity in front of us. We continue to invest aggressively to grow our sales force, expand our partner relationships, and increase awareness of the Dynatrace brand in the market. Our ability to attract talent to Dynatrace has never been stronger. We grew our quota carriers by over 30% this past quarter and expect to continue growing this team at or above 30% for the foreseeable future. Our market is strong. Our products are well differentiated. Our customers are happy and there's plenty of room for expansion. A great combination if you're an experienced seller. One of the most exciting market expansion opportunities we have underway is our doubling down in the U.S. federal market. This is a huge market with the U.S. government projected to spend over $7 billion this year alone on cloud platforms. Over the past 12 months, our U.S. federal ARR has more than doubled as we win new agencies and expand across our growing number of U.S. federal customers. Though still early in our penetration of this massive market, our investments are paying off. Hoping to accelerate our success with both government agencies and commercial accounts is our growing portfolio of partners. We continue to invest in cloud system integrators and strategic tech partner alliances, and the results are strong. Our partner community is now influencing nearly 50% of our transactions globally, and the leverage we are seeing through the hyperscale of marketplaces continues to grow even more rapidly. In fact, the growth in ARR through hyperscale of marketplaces has more than doubled year over year. Our reputation for reducing risk and accelerating project success, especially for projects of scale, continues to catch the eye of more and more partners and their community members, an exciting opportunity for us as we scale beyond a billion-dollar business. Market and brand awareness continues to be an important component of our sales and partner go-to-market efforts. We often leverage the voice of the customer or third-party experts to tell our story. Keeping with this approach, in Q2, ISG named Dynatrace the leader in cloud native observability. GigaOM named Dynatrace leader and outperformer for AIOps solutions. And Gartner rated Dynatrace highest for application performance monitoring in their 2021 Peer Insights Review. The recognition by these experts for leadership across various dimensions of modern cloud observability is gratifying. and helps clarify our value advantage for the market. The third and final topic I'd like to cover today is a continuous investment in innovation in both the Dynatrace platform and its growing number of monetizable modules. As observability becomes a primary market requirement, our three plus module customer account continues to climb, now over 40% of our growing base. We are landing and expanding with full stack for apps and microservices, plus infrastructure for hyperscaler platform metrics and logs, plus digital experience for mobile more and more often. Our landing ARR is gradually increasing, and our average ARR for three-plus module customers is nearly $500,000. With AppSec and cloud automation modules kicking in over the next few quarters, we see a great opportunity to both increase the value of our landing zone as well as expand ARR per customer materially. Behind these advances is an extremely strong organic innovation engine. This team anticipated the massive disruption modern dynamic clouds would have on the IT ops, software development, and digital business landscapes. And they continue to lead in the cloud automation, causal AI, and data analytics the global 15,000 need for continued digital transformation success. To augment this team and accelerate our innovation roadmap, we may do technology tuck-in acquisitions from time to time. Our recent acquisition of SPECTx, which closed in September, is a great example of strong technology fit and team fit to accelerate our value and differentiation across both platform and modules. A high-performance parsing and analytics engine, SPECTx will continue to accelerate the convergence of observability and security use cases as the cloud continues to disrupt classic approaches. Going forward, where the fit is strong and roadmaps could be meaningfully accelerated, we continue to augment our organic innovation engine in a smart way. With that, let me summarize as I've covered several important topics this morning. It's an exciting time for Dynatrace as we fire on all cylinders. We have an incredible long-term market opportunity and we are investing aggressively to seize the advantage. Commercial expansion is strong and our product differentiation is increasing. We're gaining new digital transformer logos at a steadily increasing rate, and the net expansion of our base across multiple modules continues to be robust. We are building a long-term category leader with the building blocks to sustain a 30% plus growth business well into the future. Now, let me turn it over to Kevin to take us into our financial results and guidance. Kevin.

Thank you, John, and good morning, everyone. As John mentioned, we delivered another great quarter on both the top and bottom line, setting us up for a stronger fiscal 22. The investments we have made in sales productivity and commercial expansion are evident across all of our top line metrics with ARR above our internal expectations and revenue and subscription revenue exceeding our guidance. ARR for the second quarter was $864 million. That's up $226 million a year over year, representing 35% growth or 34% in constant currency. Excluding the perpetual license headwind, which was roughly $25 million, our adjusted ARR growth rate was 39% on an as-reported basis and 38% on a constant currency basis. That's up 200 basis points sequentially from Q1. Please keep in mind our ARR, as reported, was impacted by currency movements, and I will cover that component when I review the full year ARR guide. The building blocks for sustained ARR growth remain the same. The addition of new logos to the Dynatrace platform combined with the ability to expand existing customer relationships as measured by our net expansion rate. As John discussed, new logo growth continues to be strong. and it was up 33% for the first half to 295 new logos. We continue to see positive traction across all of our regions with notable strength in EMEA and North America. We ended the quarter with more than 3,100 Dynatrace customers. At the same time, existing customers continue to see the value of the Dynatrace platform, adopting new modules and expanding coverage. This is evident in our net expansion rate, which for the 14th consecutive quarter was at or above 120%. As a result, our ARR per Dynatrace customer continues to increase, and in Q2, it was $277,000, an increase of 19% year over year. In addition, we continue to see strong momentum in the number of customers that are leveraging the Dynatrace platform for full-scale observability, defined as customers using three or more modules. At the end of Q2, more than 40% of our customers were using three or more modules with an average ARR of nearly $500,000. We now have over 1,300 customers using three modules, and this cohort has increased by well over 400 customers over the past year. Moving on to revenue, total revenue for the second quarter was $226 million, $5 million above the high end of our guidance and representing an increase of 34% on a year-over-year basis or 33% in constant currency. Subscription revenue for the second quarter was $213 million, $5 million above the high end of our guidance, representing an increase of 35% on a year-over-year basis or 33% in constant currency. With respected margins, total non-GAAP gross margin for the second quarter was 85%, in line with last quarter and Q2 of last year. As we have said before, a very healthy margin reflecting the value and efficiency of the Dynatrace platform. Overall, we are extremely pleased with the strength of both our ARR growth and revenue performance. We believe this further validates that our strategy to continue to increase investments to grow our top line is the right path and you will continue to see us lean in to both commercial expansion and technology innovation to capture the large and growing market opportunity ahead of us. As a result, we invested $32 million in R&D this quarter. That's up over 33% from last year and approaching our targeted R&D investment level of 15% of revenue. On the commercial side, we invested $76 million in sales and marketing this quarter, up 52% over last year, and within our target investment zone for sales and marketing of 34 to 36% of revenue. Even with these levels of increased investments, we continue to run a balanced business. Our non-GAAP operating income for the second quarter was $61 million, $6 million above the high end of our guidance range due primarily to the revenue upside that flowed through to the bottom line. This resulted in a non-GAAP operating margin of 27%. compared to 32% in the second quarter of last year. Again, keep in mind, we saw significant savings in the first half of last year related to the COVID shutdown, and we continue to invest for growth and innovation. On the bottom line, non-GAAP net income was $52 million or 18 cents per share. Turning to the balance sheet, As of September 30th, we had $370 million of cash, an increase of $122 million compared to the same period last year. We are pleased with our continued healthy cash generation and believe it puts us in a strong position to consider strategic business investments where there's an opportunity to accelerate our growth in select areas, as we did with Specdex this past quarter. Year-to-date, our unlevered free cash flow was $93 million, up 20% compared to the same period last year. As a reminder, due to seasonal variability, we believe it's best to view unlevered free cash flow on a full year basis. On a trailing 12-month basis, our unlevered free cash flow was $252 million, or 31% of revenue. The last financial measure that I would like to mention is our remaining performance obligation, which at the end of the quarter was approximately $1.3 billion, an increase of 42% over Q2 of last year. The current portion of RPO, which we expect to recognize as revenue over the next four quarters, was $719 million, an increase of 38% year-over-year. Though RPO may become a more meaningful metric for us in the future, we continue to believe ARR is the best metric to understand the performance of the business as it removes variability associated with billings and contracts. Moving on to guidance. As I outlined last quarter, we believe the investments we are making in commercial expansion and product innovation will enable us to maintain 120% net expansion and at least 15 to 20% new logo growth over the midterm. These are the core building blocks that support ARR growth of 30% plus. With respect to fiscal 22, ARR as reported is expected to be between $986 and $996 million, up 27% to 29% year-over-year. As I mentioned at the beginning of the call, our as-reported ARR guidance was impacted by currency movement. To be specific, there was about $15 million, or roughly 200 basis points of headwind, to our as-reported ARR guidance when comparing to previous guidance. To eliminate the FX impacts, I think investors should focus on our constant currency guide, which we are increasing to 29 to 30% year over year. This is an increase of 250 basis points at the midpoint of the range. Also, keep in mind our ARR guidance assumes roughly 300 basis points of headwind to ARR growth rate in fiscal 22 due to the perpetual license wind down. We expect the third quarter to be roughly 450 basis points of headwind, and then it will decline to about 300 basis points in Q4 and continue to decline thereafter. Excluding the perpetual license headwind, our full year adjusted ARR growth rate is expected to be between 32 to 33% year over year on a constant currency basis. This is also an increase of 250 basis points compared to what we communicated last quarter. Moving on to revenue, similar to ARR but not quite as pronounced, currency had a $7 million negative impact to our previous as reported revenue and subscription revenue guidance. Despite that headwind and based on the strength of ARR, we are raising our revenue guidance for the full year. We expect total revenue to be between $913 to $919 million up 30 to 31% year-over-year, or 29 to 30% in constant currency. We're raising our subscription revenue guidance, now expected to be between 857.5 and 862.5 million dollars, up 31 to 32% year-over-year, or 30 to 31% in constant currency. That's also an increase of 250 basis points at the midpoint of the guidance range for both metrics when compared to our previous guidance. We continue to expect subscription revenue to be 94% of total revenue, driven by the size and strength of ARR and associated subscription revenue growth. Moving down the P&L, we expect full year non-GAAP operating income to be between $219 and $226 million. As we have been communicating, we are investing for durable growth of the business. We believe the proper levels of investment for sales and marketing to be in a range of 34 to 36% of revenue, and R&D to be around 15% of revenue. The result of which is a non-GAAP operating margin of 24 to 24.5% of revenue for the year, up roughly one point when compared to our prior guidance, and up from a dollar standpoint due to the higher revenue guidance. For the full year, we expect non-GAAP EPS of 63 to 65 cents per share, up two cents on the high end of our previous guidance, due to our revenue over performance. Our non-GAAP net income and non-GAAP EPS calculations assume a non-GAAP effective cash tax rate of 12%, consistent with prior guidance. At these investment levels, we are able to continue delivering strong unlevered free cash flow margins. For the year, we are raising our unlevered free cash flow slightly to be between $263 to $275 million, or approximately 29 to 30% of revenue. To summarize our full year guidance, it is a continuation of our durable balance of growth and profitability, guiding to a rule of 50 plus business when combining ARR growth and another free cash flow margin. Quickly looking at Q3, we expect total revenue to be between $233 and $235 million, up 27% to 28% year over year, or 28% to 29% in constant currency. Subscription revenue is expected to be between $219.5 and $221 million, up 29 to 30% year over year, or 30 to 31% in constant currency. From a profit standpoint, non-GAAP operating income is expected to be between $54 and $56 million, resulting in an operating margin of 23 to 24% of revenue as we continue to execute on our investment strategy. Finally, we expect non-GAAP EPS to be $0.16 per share. In summary, we are very pleased with the overall momentum of our second quarter performance with strong ARR and top-line growth combined with healthy margins. As John mentioned, we have an incredible long-term market opportunity ahead of us, and we are investing aggressively in commercial expansion to accelerate go-to-market success and in our platform to further strengthen our already robust module offerings. Overall, we are well positioned for sustained and durable growth in fiscal 22 and beyond. And with that, we will open the line for questions. Operator?

Thank you. We'll now be conducting a question and answer session. In the interest of time, we ask that you please limit yourselves to one question and one follow-up, then return to the queue. If you'd like to be placed in the question queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star one. And as a reminder, please limit yourselves to one question and one follow-up in the interest of time. Our first question today is coming from Matt Hedberg from RBC Capital Markets. Your line is now live.

Great. Thanks, guys, for taking my questions. Congrats on the quarter. The adjusted currency ARR acceleration on a sequential basis here is super impressive. You know, John, I guess, you know, as you alluded to in your script, one of the biggest drivers seems to be the growth in just cloud applications and workload. And I wonder if you could talk about that dynamic a bit more, really in the scope of the hyper scale, sort of size and scale, all of this is net new workload. I guess the question also is, what does this mean for the percentage of deals that are really greenfield today in what I think a lot of people see as a more competitive market for observability solutions?

Yeah, well, thank you, Matt. And good question. You're right in that we're seeing the greenfield space increase for us as this market expands and shifts from sort of a tool-layered market into an observability market. The dynamic cloud environments that our customers find themselves in now, they realize that old tooling isn't you know, something that they can live with that actually fails, they actually fail. And so there's a scramble for, for new tooling. Um, many of the customers start with just trying to cobble things together themselves. And when, uh, when we show up, it's a pretty, you know, open opportunity for us to provide, you know, a platform approach that accelerates their ability to regain control over their environment. which gives them the kind of visibility they need to scale faster and at lower risk. So we're seeing that green field actually open up for us from what we saw when we first IPO-ed a couple years ago. And it is accelerating growth in a number of areas.

That's super helpful. And then maybe as a follow-up, you continue to add new sales rep at a rapid pace. I guess I'm wondering, what is the plan for sales reps getting back on the road, face-to-face meetings? And if they do so to a greater extent, do you think that could start to have a positive sort of incremental benefit to pipeline generation?

Well, we're already back on the road, actually, around the world. And the sales organization has been you know, pretty, pretty, um, sort of thoughtful and, but aggressive at, uh, you know, re-engaging both customers as well as prospect opportunities. And I do believe with our direct approach, you know, to the global 15,000, uh, especially since we call on sort of director level and above in organizations that, that the, the direct face to face will help accelerate pipelines, especially in the new logo area.

Thank you. Our next question is coming from Remo Linschow from Barclays. Your line is now live.

Hey, thank you. Congrats from me as well. Can I stay on that topic a little bit, John? If you think about the sales expansion and the new functionalities you're getting there, like how do you think about that motion around sales expansion in terms of overly kind of specialized of the new modules versus kind of guys that kind of sell the whole portfolio? And then a follow-up for Kevin there is like, you're expanding to sales by 30%. What's the notion or what's the situation on sales productivity? How is that tracking for you? Thank you.

Sure. Well, so most of our sellers, in fact, all the direct sellers, you know, handle the entire portfolio. So there's no confusion over, you know, who's calling on what account or how we manage, you There's no friction at the point of customer. And we think that that's very important. Most products are actually very similar in that they complement various dimensions of observability. The only outlier is the AppSec module, which does have a separate overlay team to help with some of the specialized selling skills around security, especially with the CISOs. So that's the only one, but we're getting great cross-sell now. A year and a half ago, we talked about, hey, when we're done with our conversion program, we'll lean into cross-sell. And we built quite strong muscle there. And you can see those in the numbers. The fact that three plus modules continue to climb every quarter at a steady pace. And that's without really sort of AppSec and the new cloud automation module kicking in yet. So we just see that our motion is strong. The sales organization and partner organizations have embraced it. And we're executing well to that multi-module strategy that we talked about two years ago and are now executing against today.

Hi Ramos, Kevin, just to follow up on your question around productivity. So first of all, it's been great over the last couple of years, as you know, we've been stepping on the gas in terms of the sales acceleration, growing that organization 20, 25% in this past quarter, growing 30 plus percent. So super excited there. I'd also say, you know, that's noteworthy is we're doing a great job, you know, giving the company's brand visibility, awareness of attracting great talent across the organization and we've invested a lot in onboarding and bringing those people up to speed as well. So that whole commercial engine is working extremely well. We obviously keep an eye on productivity. I think generally our view on productivity is if we start to see it creeping up too much, then what we want to do is probably go out and lay around a few more sales reps to keep productivity relatively flat. Our goal is not to lean on a certain part of the organization too heavily. We want everybody to be productive, and when we sort of hit productivity levels, we step on the gas a little bit more.

Okay, perfect.

Thank you. Well done.

Thank you. Next question today is coming from DJ Hines from Canon Corp Genuity. Your line is now live.

Hey, thanks, guys, and congrats also on the quarter. John, as the partner-influenced deals continue to increase as a part of the mix, right, be it through the SIs or the hyperscalers, Is there any notable difference in the typical profile of those deals versus what you're attracting and closing directly?

DJ, no, not really. We've had this partner operation for quite a while now, and it does take a little while to get them up to speed and gain momentum, but they've really become quite a strong augmentation to our direct sales engine. And so the type of deals are relatively similar. What is a little bit different is that the global SIs, you know, think of, so they're more general contractors. So their deals will include, you know, five, six, ten different piece parts of an entire cloud transformation project and ecosystem and will be a piece of it. So from that standpoint, you might say, oh, well, that's different in how they move and what their motion is in the market. But the kind of deal and use cases and so on that they bring Dynatrace in for, very similar to the kinds of deals we do directly.

Yeah. Okay. That's helpful. And then, Kevin, as a follow-up, is there any way to get a bit more granular on the trends you're seeing in dollar-based net retention? Is it improving? Is it staying the same? I know kind of north of 120 is kind of the default comment. And maybe it's part of that, like there are multiple levers to expansion. So maybe just unpack maybe what's having the most impact there.

Sure. So I think some of the visibility, we put this out actually in our investor deck, but we break out the expansion between two components, DJ. So we break out AR growth between what's coming from new logos and what's coming from expansion in the base. And if I just sort of mentioned the last couple of quarters, when we've been growing 30 plus percent, 24% growth has been coming from expanding in the base. That was in the fourth quarter. And over the last couple of quarters, that stepped up. So in Q2, I'm sorry, in Q1, that went to 25%. And then in Q2, that went to 27%. So that's sort of an indicator of that net expansion rate. As you know, we don't specifically give you the net expansion rate, but expansion from the base has been growing, which is contributing to the overall AR growth.

Yeah, perfect. Thank you, guys.

Thank you. Our next question today is coming from Sterling from JP Morgan. Your line is now live.

Yeah, thanks. Hi, guys. That's perfect timing. So maybe a segue on that question is when you look at that net expansion, how much of that is more modules versus more applications?

It's actually the module expansion beyond applications is growing a little bit faster than the applications. But I won't say that it's materially faster because application expansion is, as I've said before, it's sort of an evergreen environment. Everybody's adding more applications. Every application is scaling further than it was a quarter or two ago. And so it's because we're consumption-based, you know, it's a continued, you know, growth environment for us just in the application side alone. And we really only have, I mean, we still believe we're still early innings where at most, you know, 15 to 20%, you know, penetrated in the, you know, application areas where we believe that most customers would like to have 50 to 60% of their applications, you know, monitored by a, you know, sort of a deep wide technology like a Dynatrace. So, you know, lots of room to grow there and no question that we have even more room to grow on the module side. So, you know, I think we're just in a, we're doing a good job of executing, but there's so much more room to go. You know, it's a, it's a wonderful market.

That makes sense. And maybe one quick follow up. When you look at the new business in the quarter, How would you characterize the mix of that business that's for observability on Azure versus AWS versus GCP versus private cloud versus something else?

Well, you know, the 80% or so of our customer base, and this includes new logos, at least 80%, probably closer to 90, are coming to us because of our expertise in modern cloud environments. whether they're public cloud, Kubernetes orchestrated, cloud-native application environments. It's a combination of all those that really drives our business. The fact that we are extremely strong in the hybrid extension side is just another reason for why the global 15,000, the digital transformers out there, favor Dynatrace. so they can get a real end-to-end view as they're migrating from the old to the new. But what drives our business is where companies are headed. And that is, you know, modern cloud, modern workload, you know, everywhere.

Thank you. Our next question is coming from Jonathan Reutgeber from Baird. Your line is now live.

Yeah, good morning, guys, and congrats on the performance. So, John, we're starting to see some of these DevOps platform vendors, notably GitLab, talk about their ability to provide value across the entire DevOps lifecycle, including observability. And I'm just kind of curious, how do you view that position from a DevOps perspective and the focus on that buying center? Do you view it as a potential competitive impact over time?

Well, the short answer is we don't view it as a competitive impact over time because what we do sort of sits up above the CICD tool chain kind of approach out there. And having intelligent automated observability along the path and the same sort of tooling between deployment to production to sunsetting of legacy or outdated, you know, code, you know, at scale, it requires a little bit different kind of platform and different kind of approach than sort of that, you know, multi-tool approach that, you know, pretty much everybody has included GitLab. So it's a compliment for sure, but not a competitive, you know, kind of situation the way we view it.

Okay, that's helpful. The second question I have, it might be more for Kevin, but you've talked about potentially turning off a few hundred lower value accounts. I'm wondering if you could just talk about how that has progressed, including, are you seeing success maybe turning those accounts into more meaningful platform customers? And then on the other hand, if you are seeing some churn on those customers, any way to quantify what kind of impact that might be to ARR?

Yeah, so we mentioned that there are a few hundred customers that were single module customers, and a lot of these customers have been running one of our synthetic monitoring products. And we have sort of seen some churn over the last couple of quarters on that. We also do land some new logos, not a lot at this point, but some new logos with single modules. But we've been very successful in terms of growing those customers to multi-module, more observability players over time. So yes, we're seeing the churn as we communicated, I think, in our fourth quarter call. Nothing sort of out of line there. Keep in mind that customer segment, when you look at it from an AR standpoint, it's sort of mid single million dollar AR number. So not meaningful from an AR standpoint and not meaningful from a customer account standpoint.

Thank you. Our next question is coming from Jack Andrews from Needham & Company. Your line is now live.

Good morning. Thanks for taking my question. I want to ask maybe a two-part question. And the first part is, could you speak to what types of metrics your enterprise customers are focused on deriving from their observability solutions these days? meaning that is it still just about number of critical incidents and things like meantime to resolution, or are they increasingly looking to tie observability to tangible business outcomes like measuring net promoter score, for example?

More and more of these customers are trying to tie together sort of the business impact of that IT platform and tool chain. In other words, measuring results around user experience against different kind of indexes and so on, or relative to conversion rates or abandoned carts, and that kind of direct connect to business outcomes. And it's one of the unique and powerful aspects of Dynatrace is that we actually connect the dots between all the rest of the plumbing, all the applications and services with the actual outcomes themselves to give operators a very good, well-focused approach to how they should optimize, where they should troubleshoot, and how they should manage their innovation investments to improve their business results. So it is a growing trend and one that we're excited about and well-positioned for.

Thanks for the color on that. Just as a quick follow-up, could you maybe expand on your comments in terms of how you're thinking about M&A and other particular aspects of your platform that you think might make sense to perhaps acquire capabilities rather than building organically?

Yeah, no, great question. Our approach has always been platform first because we believe that's easier for customers to manage, to operate, and we can apply greater degrees of automation and AI against use cases if we sort of manage all the components of that platform. And so technology tuck-ins, therefore, you know, fit extremely well in that strategy. And we've started to do, we announced our spec deck acquisition. And as we find additional similar kinds of talented teams that can accelerate roadmaps materially, you know, we'll be acquisitive. And it just makes sense, you know, where we have a large enough portfolio. Kevin talked about sort of the cash generation of the business, and we want to put that to work in whatever way we can to continue to extend our differentiation and drive top-line growth.

Thank you. Our next question today is coming from Koji Ikeda from Bank of America. Your line is now live.

Hey, John and Kevin. Very nice quarter, and thank you for taking my questions. I guess just as a follow up, or just to dig in on that M&A strategy, you know, thinking about the SPECT-X acquisition. It's been about six weeks now since the acquisition closed. So a couple of questions here. First, around the technology, you know, that was acquired. I guess, how much did it accelerate the roadmap for high-speed parsing and analytics for Dynatrace? And is SPECT-X a good way to think about the inorganic roadmap acceleration strategy? And then I guess second, you know, it's still early, but how has the initial reaction been with the partners and customers out there?

Yeah, no, good, good, good question. So, so first of all, you know, I'd say that from a roadmap standpoint, it's a 18 to 24 month kind of bump forward, which is, you know, which is significant. Second of all, you know, we believe the first, you know, parts of their, you know, technology will, will, be infused into our platform in somewhere between six and nine months from closing the acquisition, which is about the right kind of timeframe that we think about when we think tuck-ins. And the feedback that we've gotten from customers and partners have been two thumbs up, what's next and what else do you have up your sleeve kind of thing. So we've done these before. We did one a couple years ago. We found it to be highly successful. And, you know, Kevin and I, you know, see more in our future where they make sense. You know, they'll be smart. They'll be tuck-ins. But we'll be, you know, aggressive in, as I said, extending our differentiation and, you know, driving top-line growth.

Thanks, John. And maybe a follow-up for Kevin, if I may. I was hoping we could dig into the FX impact a bit more. Can you help us understand a bit more granularly around what regions are driving the FX impacts we're seeing right now?

Yes. So for the year, as I mentioned in the call, our as-reported guidance was reduced by about $15 million, or sort of two percentage points of growth related to FX A majority of that came as a result of the dollar strengthening, primarily against the euro and the pound and also the Australian dollar. So those are sort of the three major currencies that we're operating in where we saw the currency movement towards the end of the second quarter. So that resulted in that as reported impact. But as we said in the call and what we'd like investors to focus on is certainly the constant currency AR growth, which we increased by about 250 basis points at the midpoint for the year. So trying to normalize out that any of that FX headwind there.

Thank you. Next question today is coming from Gray Powell from BTIG. Your line is now live.

Great. Thanks for taking the questions. Um, just a couple on my side. Uh, so last quarter you highlighted that I think 45% of customers use infrastructure monitoring outside of full stack. Um, any update there? And then for customers that are taking infrastructure monitoring outside of full-stack APM, how much are they spending on the product? Like, if they're spending $100 per year on APM, what does infrastructure add today, and where could it go?

Yeah, so, you know, we just dropped some of the side, you know, data, but Think of it as about a 5% increase in the customer base on a quarter-over-quarter basis. I mean, we're doing extremely well cross-selling that module in with the full-stack customers. And when you think about how many cents on the dollar versus the full-stack application microservices module, You know, think about it as probably today, maybe we're in the 15 to 20 cents, you know, on the dollar kind of range. And it can clearly be a dollar for dollar. There's a lot of infrastructure, you know, kind of workloads. In that, by the way, is log analytics for us because we package that together in our infrastructure module. So there's a lot of dimensions of expansion, you know, for that module with every customer, you know, we have. So, like I said, we're excited about its maturity. It can go toe-to-toe with anyone, and, you know, cross-sell is going very well with that module in particular. And it's a key driver of the three-plus module, you know, growth as well.

Got it. Okay, that's really helpful. Thank you.

Thank you. Next question today is coming from Camille Miserec from William Blair. Your line is now live.

Thank you. Congrats on the thought quarter. John, you said in the past that a third of customers land with the three or more module platform approach. And you've attributed this, I think, to last quarter to the move toward observability as a landing zone away from applications as a landing zone. So in that context, I'd like to better understand how you expect the size of new lands to trend long term. How do you expect that landing zone to evolve? And is there a point where you choose to limit the growth in new lands in favor of maybe a faster pace of new logo wins and then faster expansion rates? Or should we expect a size of new logo ASPs to trend up for the foreseeable future?

You know, that's definitely, you know, a key, you know, question that we continue to ask ourselves. because the speed of new logo acquisitions, you know, is a really important, you know, long-term growth driver for us. So that's why you've seen that landing zone stay pretty constant. But I will say when we, you know, IPO'd a couple years ago, it was more in the, you know, 90 to 95K, and now it's in the 105 to, you know, 110K. So it has been creeping up, and that creep has been, you know, more modules on day one. So the shift to observability definitely has some impact to it. No question about that. And I do believe that it will continue to creep up. Okay, it won't jump up, but it will creep up as, you know, more and more landing zones are observability, a broader platform approach. which is today, as you pointed out, about a third, you know, as that approach is 50%, you know, obviously that will impact, you know, that landing zone number. I think we'll always try to keep it, you know, pretty close, you know, to the 100K, maybe it gets to 120, 125, but, you know, even there, it's still, you know, it's still not, it's not too high for a billion dollar business who's digitally transforming to try something new that just might work better than advertised, you know, fulfill the promises that many have had that have fallen short. So I still think it's in the right zone, but I do expect it to creep up over time.

That's helpful. Thank you. And a quick follow-up for Kevin. Current RPO is up in the high 30s. Billings on a trailing 12-month basis is up close to 40%, I think. ARR after adjustments, also high 30s. Why aren't we seeing that kind of growth rate in revenue yet? What's causing the divergence? And is it fair to expect ARR and revenue growth to converge sometime over the next few years?

So I think what we are seeing, so first of all, from an RPO standpoint, I think we're very pleased in the growth of that. We've implemented one contract, one price. We're also doing a lot of more rip and replace and accelerating growth with our customer base and extending the three-year deal. So that's sort of driving that RPO growth. But the more important metric, I think, as you appreciated, the AR growth. And that's been growing nicely. And subscription revenue, I think that's the metric that you need to think about. And I think those will start to converge. There's a little bit of a dynamic in the subscription revenue due to the perpetual license wind down. But as we get through that transition here over the next couple of quarters, you will start to see the AR growth rate and subscription growth rate essentially mirror each other. But I think that's probably four to six quarters away. So there'll be a slight discrepancy between those two metrics at this point. But again, they're both growing pretty nicely and they'll converge over time.

Thank you. Our next question today is coming from Keith Bachman from Bank of Montreal. Your line is now live.

Hi, thank you. I wanted to focus on security for my first question. Could you give us an update on where you are in terms of potential traction over the next 12 months and going back to the dollar-for-dollar opportunity set, how would you characterize it now that you've had a couple more quarters to at least observe it? and what the potential is. But if you could just give us an update on security, including how the recent M&A may impact your thoughts there, and then I have a follow-up if I could. Sure. Sure, Keith.

So things are still going extremely well with that module. We've introduced it now to about 20% of our customer base, trialed it in about 10%. Feedback is still the same that we've heard before. There's nothing like this. This is a greenfield opportunity for us, and it just needed a few pieces to be mature enough for a global 15,000 CISO to approve. We're at that point now in a combination of coverage as well as operational automation capabilities of how it fits in a DevSecOps environment. So those have been the two key technology elements to add. We see this quarter, or really the second half of this year, as a scale-up of customers and growth opportunities. But it's still off a super small number, so you won't see it really in any ARR impact until fiscal 23. But that's consistent with what we said about a year ago when we talked about it. It was either December or January that we introduced the AppSec module, and we're on track, maybe a little bit ahead of track actually. As far as acquisitions go and sort of impact over time, today with the functionality we have, we think we're probably able to capture maybe 20 cents on a full-stack dollar. But with the roadmap we have, you know, a year from now, we'll be capturing 50 cents on the full-stack dollar. And where we are two years from now, we think it's clearly should be a dollar-for-dollar, you know, with the observability suite. Perfect.

Okay. A lot of room to scale up.

A lot of room to scale up.

Yeah, yeah. Well, that relates to smoke. Oh. Sure, sure, sure. Three plus modules, and I think your total module offering is six. How would you think investors should consider what that looks like three years from now? In other words, does your module offering double over the next three to five years? Or how should we be thinking about the potential for portfolio expansion over the next three plus years?

so so first of all let me let me just start with the way we package modules is is different than others we package by use cases which you know includes you know multiple sort of features and and components things other people might call products you know we'll package them all around you know use cases so it's a it's a different kind of packaging strategy which which fits our global 15 000 customer you know a little bit a little bit better so we'll never have you know, a massive amount of modules, but we will continue to gradually increase the modules over time. I think with the way, you know, we'll end up talking about, and this is a little, you know, speculative, but, you know, I think, you know, you'll start talking a little bit about four-plus module, five-plus module customers, but the key, I think, is the movement of ARR per customer. Like, how do you, you know, go from a landing zone of 100,000 in ARR to, you know, a million dollar ARR, which we believe all of our customers can reach and exceed. And I think that that's really, right now we're talking about three plus modules because you can see it's close to 500,000 halfway there. You add a fourth and a fifth and you keep growing. And it's, you know, it really underpins our thesis of net expansion above 120%, you know, for a pretty long time to come. And, you know, that's a key part of our entire you know, growth strategy to stay above 30% over the long term.

Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management for any further or closing comments.

You know, I appreciate your attendance today, support for the business. Just leave you with a few thoughts. First of all, you know, we believe our business has never been stronger. You know, this was our first a very strong financial quarter for us, business results, and, um, uh, and one of our, you know, stronger guides actually, you know, when you take it in a constant currency. So we're thrilled about that, you know, teams extremely strong proven and our execution ability has never been better as well. So, you know, we're thrilled for the future and look forward to catching up, you know, at the, uh, at our next call in January, uh, or early February when we, uh, talk about Q3 results. Thank you very much.

Thank you. That does conclude today's teleconference and webcast. Let me just connect your line at this time and have a wonderful day. We thank you for your participation today.