Dynatrace, Inc.

Greetings. Welcome to Dynatrace Fiscal Second Quarter 2023 Earnings Call. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero from your telephone keypad. Please note, this conference is being recorded. At this time, I'll now turn the conference over to Noelle Farris, Vice President of Investor Relations. Ms. Farris, you may now begin.

Thanks, Operator. Good morning, everyone, and thank you for joining Dynatrace's second quarter fiscal 2023 earnings conference call. Joining me on today's call are Rick McConnell, 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 view on November 2, 2022. 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. Unless otherwise noted, the growth rates we discuss today are non-GAAP, reflecting constant currency growth To see the reconciliation between these non-GAAP and GAAP measures, please refer to today's earnings press release and financial presentation under the event section of our website. And with that, let me turn the call over to our Chief Executive Officer, Rick McConnell. Rick?

Thanks, Noelle, and good morning, everyone. Thank you for joining us on today's call. Dynatrace's Q2 results solidly beat expectations on the top and bottom line. In particular, adjusted ARR in the second quarter was 33% year over year. Subscription revenue came in at $261 million, an increase of 29% year over year in constant currency. Non-GAAP operating income was $73 million, or 26% of revenue. And on a trailing 12-month basis, free cash flow margin was 29%. These results once again highlight our ability to run a balanced business that delivers compelling top-line growth coupled with strong bottom-line performance. And they are a testament to the strength of our market, the significant value of our platform, and the ongoing durability of our business model. In addition, I am excited to highlight the launch and release last month of what we believe will prove to be a market-changing product innovation with the launch and release of Grail. Kevin will share more details about our Q2 performance and guidance in a moment. In the meantime, I'd like to share my view of the current market environment and long-term demand trends, our platform leadership, including further comments on Grail, and our intended operational approach for the remainder of the fiscal year. Beginning with market opportunity, digital transformation remains one of the most durable areas of investment for enterprises. This has driven a sustained need for more sophisticated observability and application security solutions to successfully navigate the resultant complexity and enormous scale of data. Our customers tell us that such solutions are mission critical and view them as increasingly mandatory to drive greater operational efficiency, improve customer satisfaction, and facilitate commerce. This market evolution has been a key catalyst to our growth in recent years. and we continue to see very healthy demand and resultant pipeline generation across our business. This is a great indicator of the value our customers place on our solutions and of the substantial market opportunity still to come. We added 164 new logos in Q2, and our net expansion rate was greater than 120% for the 18th straight quarter. We have, however, begun to see additional macro impact, particularly in Europe. Clearly, enterprises are working to navigate the rapidly changing economic environment that is leading to increased caution in spending and a resultant lengthening of our average close cycle. Consequently, we are bringing down our ARR guidance to reflect increased pressure on new logos and net expansion rates. As I mentioned, demand generation remains very healthy, and our competitive positioning plus win rates remain consistent and strong. Given our pipeline growth, market strength, and portfolio evolution, we are highly confident in our ability to re-accelerate ARR growth as economic conditions normalize. Moreover, our strong enterprise customer base coupled with our recurring subscription revenue model provide us with excellent P&L resiliency even in an uncertain economic environment. As I said last quarter, we are focused on executing well during this period to exit with greater competitive differentiation once the economy improves. Let me now turn to platform differentiation. Our approach to observability and application security is radically different. Dynatrace does not provide a single product or address a single data type. Rather, we deliver a comprehensive software intelligence platform that combines the industry's deepest and broadest multi and hybrid cloud end-to-end observability solution with continuous runtime application security. It is rapidly becoming impossible for even an army of people in network operation centers to oversee and triage an organization's entire software ecosystem. By leveraging our AI ops and automation expertise, our solution enables customers to successfully navigate this uncontainable, increase in complexity. This is the power of Dynatrace. Whereas other approaches deliver dashboards, we deliver precise answers and intelligent automation from data. It enables our customers to deliver flawless and secure digital interactions by providing broad-based situational awareness of their cloud ecosystems at all times. And it enables them to take action immediately to ensure maximum uptime and performance. Industry analysts corroborate our leadership position. Last quarter, we announced our position as a leader in the Gartner Magic Quadrant for application performance monitoring and observability for the 12th consecutive time. In October, ISG released their 2022 Provider Lens for Cloud Native Solutions, which named Dynatrace a leader with the top overall position in cloud native observability and a leader in cloud native security. This recognition reflects both our leading position in observability, as well as our strength in its convergence with application security. Our customers agree. Of the 164 new logo customers that we landed in Q2, well over half of them are leveraging 3D Plus modules. In addition, we saw an increase in the size of our new logos, with our trailing 12-month average land growing to $120,000. The reason customers typically choose Dynatrace is because of our platform strength, and I'd like to share just a few examples of Q2 wins. First, one of the world's largest multinational energy companies made a significant new investment in Dynatrace. With over 4,000 applications across multiple cloud providers, this customer recognized that the scale and complexity of their clouds created a need for a unified observability platform. They selected Dynatrace across the organization and deployed five of our modules. This is also a great example of the power of our partner channel, having leveraged the AWS marketplace with support from our strategic technology partner, DXC. Second, once customers experience the scale and efficiency of automation and AI, they are eager to expand their relationship with Dynatrace. One such customer is a large financial organization seeking to enhance customer experience, improve operational efficiency, and reduce cost by consolidating multiple disparate tools. As a result, the customer made an eight-figure commitment to standardize on Dynatrace. They also identified Dynatrace as a crucial player in their strategic initiative to accelerate cloud migration. A third example highlights the continued traction of our application security offering with one of the largest global cruise lines. They struggled with prioritizing the hundreds of vulnerabilities they see on any given day. Dynatrace AppSec gave this customer the ability to sift through the noise and help them focus on the vulnerabilities that really mattered, saving them time and resources by speeding up their development processes. These are just a few examples of the trends that are widespread throughout our customer base. We continue to maintain our aggressive focus on innovation as a core differentiator of Dynatrace. We deliver 24 major releases per year. Our innovation engine is constantly humming, adding functionality to accelerate product leadership. In fact, the vast majority of our R&D team is working on growth and strategic initiatives. AppSec and Grail are great examples of this investment in innovation. I'd like to take a moment to thank our founder and CTO, Bern Greifenader, along with our product and R&D teams, for their immense work over the past few years to bring these groundbreaking technologies to market. With respect to Grail, you should think of it not as a new module, but as an additional core technology in the Dynatrace platform, joining one agent, PurePath, SmartScape, and Davis. It becomes a key element of our comprehensive, end-to-end observability solution, and will enable us to capture our $50 billion TAM faster. RAIL is a purpose-built, massively parallel processing data lake house that changes the game for data ingest, management, and real-time analytics. We see it as a quantum leap forward for Dynatrace's competitive differentiation, and we are extremely excited about the plethora of opportunities it enables. While there are many salient GRAIL attributes, here are three areas that differentiate it in the market. First, GRAIL enables organizations to cost-effectively ingest and retain all of their data while preserving its context across a myriad of data types, including traces, metrics, logs, real user data, et cetera. Second, GRAIL leverages the new Dynatrace Query Language, or DQL, to easily build queries for even the most complex use cases that can be run in near real time. And third, Grail takes advantage of massive hyperscaler compute resources that can scale to thousands of processors operating in parallel on a single query. Our first use case for Grail is log management and analytics, which we continue to see as a market that is ripe for disruption. While we don't expect Grail to have a meaningful impact ARR in FY23, we are delighted to see strong early demand with nearly 100 customers lined up for POCs in less than a month of its availability. One early adopter of Grail is Toyota Financial Services. Before Grail, the team had to decide which log data to keep and store. With Grail, they can get cost-effective storage for logs while retaining context enabling them to deliver more value and better user experience. This brings me to my final topic, covering our operating approach over the second half of the fiscal year. I'd like to begin by providing a brief update on partners as a key investment area within our go-to-market strategy, most notably with global system integrators. In addition to our formal alliance agreement that we announced with Deloitte, last week we announced a significant expansion of our relationship with DXC, a leading technology services company. DXC has been a longtime partner of ours, and they now plan to embed the Dynatrace platform as the preferred observability solution within its DXC platform access solution, helping their customers optimize and automate their cloud and digital services. In addition, Dynatrace and DXC have agreed to launch a joint global strategic go-to-market program to bring the solution to customers worldwide. In addition to our commitment to thoughtful and strategic investment in innovation and partnership, we are equally committed to protecting margins. We have adjusted our planned headcount increases and OPEX through the balance of the year to yield an expected increase in our FY23 operating margin relative to prior guidance, and in alignment with our revised top-line model. Overall, we have proven our discipline in delivering growth in challenging environments while managing top-to-bottom line in a balanced way, and we plan to continue to execute in this way as we look ahead. Before I turn the car over to Kevin, I'd like to take a moment to share my thoughts on the CFO transition. I am thrilled to have Jim Benson join Dynatrace as our CFO. Jim is a tremendous financial leader with a proven track record of leading and scaling global finance organizations. Having worked with Jim previously at Akamai, I'm confident that he will be a strong partner to me and to the global leadership team. In addition, I'd like to thank Kevin for his excellent leadership over the past six years and for his dedication to Dynatrace. Having announced his intention back in May to leave Dynatrace by the end of this calendar year, I very much appreciate his commitment to the company through this rigorous search process and to ensuring a seamless transition to Jim. I want to thank the finance organization and the rest of the Dynatrace team for their engagement in supporting this transition. I continue to be extremely impressed with the strength of this team, and I look forward to its next phase of growth. In closing, Dynatrace is a business that delivers high growth with strong profitability and free cash flow. We delivered a strong second quarter even amidst macro uncertainty, and we remain highly confident in the strength of our market opportunity as well as our platform leadership. Moreover, we will continue to drive innovation to meet our customers' evolving needs and further differentiate ourselves in the market. We expect to manage prudently from a financial perspective, and we intend to invest thoughtfully in our strategic priorities near term to emerge from this period in a position of expanded strength. With that, let me turn the call over to Kevin.