Dynatrace Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 17, 2023

There are 12 speakers on the call.

Operator

Hello, and welcome to the Dynatrace 4th Quarter Fiscal 2023 Earnings Call and Webcast. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Noelle Ferris, Vice President, Investor Relations. Please go ahead, Noelle.

Speaker 1

Good morning, and thank you for joining Dynatrace's 4th quarter and fiscal 2023 earnings conference Joining me today are Rick McConnell, Chief Executive Officer and Jim Benson, Chief Financial Officer. Before we get started, please note that today's comments include forward looking statements, such as statements regarding revenue and earnings guidance and economic conditions. Actual results may differ materially from our expectations due to a number of risks and uncertainties discussed in Dynatrace's SEC filings, including our most recent quarterly report on Form 10 Q and our upcoming annual report on Form 10 ks that we plan to file later this month. The forward looking statements included in this call represent the company's views on May 17, 2023. We assume no obligation to update these statements as a result of new information, future events or circumstances.

Speaker 1

Unless otherwise noted, the growth rates we discuss today are non GAAP, Reflecting constant currency growth rates and per share amounts are on a diluted basis. We will also discuss other non GAAP financial measures on call. We provide reconciliations between non GAAP and GAAP measures in today's earnings press release and in the financial presentation slides posted in the Events section of our website. And with that, let me turn the call over to our Chief Executive Officer, Rick McConnell. Rick?

Speaker 2

Thanks, Noelle, and good morning, everyone. Thank you for joining us for today's call. Dynatrace delivered an exceptional finish to FY2023 with 4th quarter results that exceeded expectations across the board. For the full year, adjusted ARR growth, constant currency subscription revenue growth and free cash flow margin were all 29%. I'd like to thank the nearly 4,200 Dynatracers globally for their incredible commitment to excellence and tremendous execution this past year.

Speaker 2

These results continue to demonstrate our ability to run a balanced business that has been delivering high growth coupled with strong bottom line performance. They are a testament to the strength of our market, the significant customer value of our unified observability and security platform, our people and partners and the ongoing durability of our business model. Jim will share more details about our Q4 performance and fiscal 2024 guidance in a moment. In the meantime, I'd like to share my view of the broader market dynamics, primary use cases that are driving customer buying behavior and significant investment areas for FY24 and beyond. Let's start with our market opportunity.

Speaker 2

We believe the estimated $50,000,000,000 market for observability and application security is at an inflection point. The complexity of modern technology ecosystems is forcing companies to move from in house or open source dashboards to much more sophisticated observability solutions that deliver vastly improved insights and automation. Additionally, we expect that AI technologies such as generative AI and predictive analytics will contribute to this inflection point. In particular, we believe AI technology advancements will increase the volume and complexity of software delivery, further strengthening the need for observability and security with automation and AI at its core. We are fully equipped already today in our platform to help customers navigate AI initiatives and are in early stages of actively collaborating with the hyperscalers to create secure enterprise ready offerings that bring the power of generative AI and predictive analytics to market.

Speaker 2

This past quarter, AWS, Azure and GCP reported over $175,000,000,000 in combined annualized revenue. Yet Andy Jassy, Amazon's CEO estimated that 90% Global IT spend is still on premises and poised to move to the cloud. For these and other reasons, we believe the market opportunity for observability and security of cloud based workloads is enormous. Without question, the cloud yields undeniable benefits, including accelerated product development, increased supply chain efficiencies, improve customer satisfaction and more. At the same time though, the cloud has also brought some notable challenges.

Speaker 2

In particular, the scale and dynamic nature of modern cloud ecosystems have made them too complex to manage through legacy monitoring approaches and manual troubleshooting. Effective operations require more than dashboards and alerts. As such, We believe automated observability is rapidly moving from optional to mandatory. Dynatrace makes order out of this chaos. We leverage sophisticated causal AI capabilities and a comprehensive understanding of an organization's hybrid and multi cloud ecosystem to deliver rapid insights in real time along with actionable remediation.

Speaker 2

We enable delivery of more reliable infrastructure and applications, improved application security and more successful digital transformation initiatives. And we believe we are uniquely positioned to lead this market evolution by providing the only fully unified end to end platform for observability and application security with analytics and automation at its core. I'd next like to offer several specific use cases that have become key drivers of our customers' purchasing behavior. First, companies are looking to deliver highly performant cloud native infrastructure and applications. We as end users expect applications to work perfectly.

Speaker 2

Many organizations underestimate the complexity of the microservice processes required to manage their cloud workloads effectively. In Q4, one of the top 10 global financial services companies broadly expanded their deployment with a mid-seven figure Dynatrace platform subscription or DPS deal to ensure their growing footprint of infrastructure and applications continues to run smoothly. Speaking of DPS, we made it available to our entire customer base last month. With DPS, we are now making our solution set broadly and easily accessible through a simplified cross platform licensing model. This model allows customers to trial and deploy any aspect of our solution such as logs or AppSec while leveraging a single commit, we expect DPS will drive net expansion and become an accelerant to ARR in future periods.

Speaker 2

2nd, companies want to increase productivity and accelerate software delivery through cloud native technologies and processes. We believe the adoption of agile development, continuous deployment and DevOps will drive accelerated demand for automated observability solutions to ensure development teams deliver secure, high quality releases faster. In Q4, a Fortune 50 technology company embraced a shift left approach and delivered self-service observability and security to their development teams, resulting in increased innovation through automation. 3rd, organizations are seeking cost effective and more insightful log management at scale. They tell us that they are spending too much time and money on slow and limited analytics and forensics that add few insights to their business without substantial manual engagement.

Speaker 2

Companies are capturing logs, but a log without context of other data types fails to enable rapid reaction to changing business conditions. We now have a major retailer spending 7 figures with us to take advantage of the insights our log management solution provides with Braille. 4th, companies are spending substantial sums to ensure delivery of secure cloud applications, global data compliance requirements, an increase in software vulnerabilities, end user data breach concerns and brand impact are among the many contributors to this trend. We closed our largest application security deal to date, a 7 figure expansion with the same Fortune 50 company I mentioned earlier to help secure their cloud applications from vulnerabilities. We now have nearly 400 AppSec customers and remain on track toward our goal of reaching $100,000,000 in security ARR by the end of fiscal 2025.

Speaker 2

5th, companies are increasingly coming to Dynatrace for us to provide a fully unified observability solution at scale. This especially applies to the vast array of organizations often using dozens of district tools in an effort to manage their software ecosystem. They struggle with a fragmented set of capabilities that lack a single source of truth, making it difficult to develop meaningful insights. This need for unified observability at scale, including a consolidation of other third party solutions is what Brazil's financial ecosystem app Pickpay, in addition to a leading French SaaS marketing company to displace and consolidate their existing monitoring tools and sign 7 figure deals with Dynatrace in Q4. And finally, we discussed cloud optimization last quarter as a tailwind or Dynatrace, despite being a headwind for the cloud providers.

Speaker 2

One part of cloud optimization is about cost optimization, reducing or eliminating ancillary workloads. Critical workloads, however, generally cannot be eliminated. Organizations need these workloads to be optimized, to run more efficiently and with less manual oversight to ensure maximum return from their cloud environments. These are the areas in which cloud optimization plays directly into our mantra of cloud done right. And this is precisely the value that Dynatrace provides through process automation, faster deployment of software and dramatically improved analytics.

Speaker 2

Given that we are at the beginning of the new fiscal year and following directly on the pain points that are driving purchasing decisions, I'd like to wrap up with some of our primary investment areas as we look to the future. Keep in mind, our approach to investments remains unchanged. We take a targeted and prudent approach and we plan to balance our investments to grow the top line while also delivering modest margin expansion in First, we plan to leverage both in our R and D as well as go to market efforts the demand shift from point products and observability to a unified analytics and automation platform. As I noted, customers are looking for a single solution that cohesively solves a variety of use cases. Our platform processes all data types, logs, metrics, traces, open telemetry, real user data, behavioral analytics and more in a single contextual data store We believe our core technologies of Davis, Grail, OneAgent, PurePath and SmartScape combine to deliver a radically different approach to solve the observability challenge and provide enormous platform differentiation relative to the more siloed approach of our competitors.

Speaker 2

2nd, we continue to invest in security expansion. We see an ongoing convergence of observability and application security, in large part because the insights derived from observability enable a much more comprehensive and time critical security response. We recently conducted an independent global survey of 1300 CSOs in large organizations. The research revealed that 68% of CSOs found it increasingly difficult to keep their software secure given the growing complexity of their hybrid and multi cloud environments. We are expanding our efforts from vulnerability management where we participate today to adjacent areas in both agent driven and data driven security.

Speaker 2

3rd, we are accelerating investment in developer observability. Development teams are increasingly expected to incorporate observability into their solutions or shift left as well as assume greater ownership for availability and operational management or shift right. Biz DevSecOps will become more crucial in this environment. At minimum, we expect development teams to have growing influence over the observability, application security and automation environments, and thus we intend to expand both our R and D as well as our go to market initiatives to deliver best in class observability to this audience. 4th, we are executing against a broad based set of initiatives around optimizing and expanding our go to market.

Speaker 2

We remain focused on the Global 15000, where complexity and the value of automation and analytics at scale are greatest. In addition to our planned sales force expansion during FY 2024, we increasingly expect to leverage partners to drive a flywheel of opportunity. Partners today already influenced nearly 2 thirds of our new ARR, but they account for a much smaller percentage of deal origination. Hyperscalers play an important role in the frictionless onboarding of customers. In fact, new ARR transacted through our largest hyperscaler partner grew by more than 80% in FY2023 versus the prior year.

Speaker 2

We also saw strong traction from the investments we made in growing our relationships with global system integrators, driven both by direct overlap in our customer basis as well as the highly synergistic value they can deliver to clients in digital transformation projects. We ended the fiscal year with 10 GSI Partners and a few including Deloitte and DXC have built Dynatrace into their reference architectures. Final area of investment is in customer success. Fiscal 2023 was a year of incredible innovation with the delivery of critical and new functionality enabling improved log management, enhanced infrastructure monitoring and application security, improve user experience and access to insights, faster application development and broader automation tools. We are driving fiscal 'twenty four as a year of customer adoption and value realization.

Speaker 2

We want our customers to derive maximum value from our solution set and enable them to solve not one, but several of the use cases I described earlier. We expect this will also drive net expansion and contribute to future ARR growth. In Closing, we are proud to have delivered a tremendous finish to FY2023 despite ongoing macro headwinds that continue to create market uncertainty. We drove record levels of ARR and revenue with excellent operating margins and cash flow generation. Additionally, we are innovating at a very rapid pace with groundbreaking new customer solutions and platform enhancements.

Speaker 2

Our products uniquely address the challenges that our customers face with a high degree of differentiation around data driven automation and analytics, we are building upon and evolving our go to market initiatives, including increased leverage with formidable partners or expanding their digital transformation practices to include observability, and we remain passionate about delivering ever more value to our customers. With that, let me turn the call over to Jim.

Speaker 3

Thank you, Rick, and good morning, everyone. As Rick mentioned, Q4 was another quarter of great execution by the Dynatrace team. In a dynamic macroeconomic environment, We delivered strong results beating the high end of our guidance across all of our key operating metrics ARR, total revenue, subscription revenue, operating margin, free cash flow and EPS. These continued strong results and an inherently efficient business model, allowing us to deliver a sustained balance of growth and profitability. Our ability to successfully navigate through a tight budgetary environment is a testament to the resilience of our value proposition, our commitment to customer success and our incredible team.

Speaker 3

Now let's dive into the 4th quarter results in more detail. Please note that the growth rates mentioned will be on a year over year basis and in constant currency unless otherwise stated. As we have shared in the past, ARR is a key performance metric of the overall strength and health of the business And we delivered 29% adjusted ARR growth, exceeding the high end of our guidance range by 300 basis points. Please keep in mind, adjusted ARR growth normalizes for currency and the wind down of perpetual license ARR, a reconciliation of which can be found on our IR website. We saw broad based strength across most geographies and verticals with notable strength in North America and Latin America and within the government, insurance, banking and financial services verticals, despite the current volatility in the banking sector.

Speaker 3

Total ARR for the 4th quarter ended at $1,250,000,000 an increase of $252,000,000 year over year. Foreign exchange was a $29,000,000 headwind year over year. Excluding the impact of currency and the perpetual license roll off, we added $84,000,000 of net new ARR in the 4th quarter. That's $26,000,000 above the high end of our guidance, driven by some notable 7 figure competitive wins and consistent expansion across the customer base, including $13,000,000 of expansions associated with early renewals scheduled to closed in the Q1 of fiscal 2024. This is the first time in our history as a public company where we saw a sequential increase over our seasonally strongest Q3.

Speaker 3

We ended the year with more than 3,600 Dynatrace customers, representing an increase of 9% over last year. Our gross retention rates continue to be best in class in the mid-90s and contributed to a strong dollar based net retention rate of 119% in the 4th quarter. We added 179 new logos in the 4th quarter for a total of nearly 700 new logos this fiscal year. ARR per new logo was particularly strong, highlighting the market trend away from point solutions toward platform adoption. In the Q4, 65% of our new logos landed with 3 or more modules, up from approximately 50% a year ago, Driving our average new logo land up to more than $130,000 on a 12 month trailing basis.

Speaker 3

We were pleased with the uptick in the average sizes of the new logo lands, including several large competitive takeouts. This aligns well with our focus on the quality of lands that have a greater propensity to expand. As we've mentioned in the past, we believe that the average ARR for enterprise customer could be $1,000,000 or more Given the significant cross sell and expansion opportunities in our customer base, over 60% of our customers are using 3 or more modules with an average ARR of over $500,000 and customers with 4 or more modules have an average ARR of nearly $700,000 Moving on to revenue. Total revenue for the 4th quarter was $314,000,000 $7,000,000 above the high end of our guidance. Total revenue grew 27% compared to the Q4 last year.

Speaker 3

Subscription revenue for the Q4 was $293,000,000 $6,000,000 above the high end of our guidance. Subscription revenue grew 28% compared to the Q4 last year. With respect to margins, total non GAAP gross margin for the 4th quarter was 84%, consistent with both last year and Q3 levels. Our non GAAP operating income for the 4th quarter was $78,000,000 $4,000,000 above the high end of our guidance range due to the revenue upside in the quarter. This resulted in a non GAAP operating margin of 25%, exceeding our guidance by roughly 100 basis points.

Speaker 3

Non GAAP net income was $92,000,000 or $0.31 per share. This is 0 point 0 $8 above the high end of our guidance range, Our net income was $80,000,000 or $0.27 per share. We highlight this GAAP financial metric because following several years of profitability, We determined that we are now able to realize a substantial portion of our deferred tax assets in the U. S. The release of the valuation allowance against these assets resulted in a $40,000,000 GAAP P and L benefit in FY 'twenty three.

Speaker 3

Turning to a quick summary of the financial results for the full year. Total revenue was $1,160,000,000 and subscription revenue was $1,080,000,000 both of which grew 29% year over year. Before we move on to operating income, I wanted to provide a quick update on our methodology for allocating certain operating expenses across R and D, sales and marketing and G and A. In the past, depreciation expense was primarily allocated to G and A. As the company scales and invests across functions, we believe a better presentation is to have the cost aligned with the related use of the assets.

Speaker 3

In the Q4, we made the decision to revise our methodology to allocate depreciation expenses, which are mostly facilities related across R and D, sales and marketing and G and A. We also recast Q1 through Q3 accordingly. There is no impact to total operating expense, but you will see approximately 100 basis points of reduction in G and A and a corresponding total increase in sales and marketing and R and D to align to this new methodology. Non GAAP operating income for the year was $292,000,000 resulting in a non GAAP operating margin of 25%. Non GAAP net income for the year was $282,000,000 or $0.97 per share.

Speaker 3

Our non GAAP EPS includes an effective cash tax rate of 4.5%, below the 11% we guided as we were able to take advantage of a couple one time strategic cash tax planning opportunities in the quarter. As we've mentioned in the past, we believe in a balanced approach to operating the business, one that delivers strong and durable performance on both where the resiliency and predictability of our business model shines through. Turning to the balance sheet. As of March 31, we had $555,000,000 of cash and 0 debt. Our free cash flow was $115,000,000 in the 4th quarter $333,000,000 for the full year We're 29% of revenue, exceeding the high end of our guidance by $12,000,000 As a reminder, our full year free cash flow was positively impacted by a one time tax refund of approximately $35,000,000 in the Q1.

Speaker 3

Excluding the tax refund, normalized free cash flow would have been approximately 26%. The last financial measure that I would like to discuss is our remaining performance obligation, RPO. RPO was just under $2,000,000,000 at the end of the quarter, an increase 28% over Q4 of last year. The current portion of RPO, which we expect to recognize as revenue over the next four quarters, was approximately $1,100,000,000 an increase of 27% year over year. It is important to remember The seasonality associated with bookings and contract upselling will cause variability in the RPO growth rates.

Speaker 3

As such, we believe ARR is the best metric to understand the health and durability of the business as it removes noise associated with the timing of billings. Now let me turn to guidance. We are confident in the long term growth opportunity for Dyna We believe the addressable market is large and growing. The observability ecosystem is expanding. The demand environment remains healthy.

Speaker 3

Our product has proven to be highly differentiated and our financial model is balanced and durable. Near term, we are mindful of the current macro uncertainty. And while we've seen signs of resiliency in the observability market, we believe it's prudent to continue to factor the dynamic macro landscape into our guidance. Enterprises continue to be cautious in their spending and our approach to guidance assumes the tighter budget scrutiny and elongation of sales cycles we experienced in the back half of last fiscal year Will persist through fiscal 2024.

Speaker 1

There are

Speaker 3

a few things to keep in mind with respect to our guidance. 1st, new logos and net retention rate continue to be the building blocks for future growth in the business. We believe we have the right foundation in place to grow new logos in the low single digits and maintain a dollar based net retention rate in the mid teens for fiscal 2024. As I mentioned last quarter, we expect roughly a third of net new ARR for the full year to come from new logos and 2 thirds is going to come from expansion. 2nd, With more than 40% of our business denominated in foreign currency, the continued weakening of the U.

Speaker 3

S. Dollar Creates a modest tailwind on ARR and revenue. Based on foreign exchange rates as of April 30, 2023, we expect the FX tailwind to ARR and revenue to be roughly $10,000,000 $13,000,000 respectively for fiscal 2024. And with respect to Q1, we anticipate the tailwind to be roughly $7,000,000 to ARR and an immaterial impact on revenue. 3rd, as we mentioned in the past, the headwind associated with the wind down a perpetual license is now less than 100 basis point impact.

Speaker 3

To simplify our ARR reporting moving forward, we will no longer be referring to adjusted ARR growth in our prepared remarks. ARR guidance will be provided on an as reported dollar basis and growth rates will be in constant currency. For comparison purposes, we will continue to provide the perpetual headwind detail in our quarterly presentation and in the financial data trends file available on our website. And the final point I'd like to highlight relates to expected increases and cash income taxes and the impact on our fiscal 2024 free cash flow. Given the increasing strength of our profitability, We have fully utilized our NOLs and tax credit carry forwards and we will be a full cash taxpayer.

Speaker 3

As such, we expect a significant increase in our effective cash tax rate and related cash taxes in fiscal 2024. And with that as an opener, let's start with our guidance for the full year with growth rates in constant currency. We expect ARR to be between $1,475,000,000 $1,490,000,000 representing an ARR growth of 18% to 19%. And as I mentioned earlier, this growth rate no longer excludes the headwind associated with perpetual license wind down. At the high end of guidance, this assumes net new ARR $243,000,000 on an as reported basis.

Speaker 3

And while we don't guide to ARR on a quarterly basis, we did want to provide you with some color in terms of how we expect net new ARR to come in throughout the year. As I mentioned earlier, we had an exceptional close Q4 of fiscal 2023, which included roughly $13,000,000 of expansions from early renewals expected in the Q1. As such, the seasonality of net new ARR will be a bit more back end loaded this year compared to prior years With roughly 35% landing in the first half of fiscal twenty twenty four and 65% in the back half. Turning now to revenue. We expect total revenue for the full year to be 1.388 to $1,406,000,000 up 19% to 20% year over year.

Speaker 3

Underlying that, subscription revenue is expected to be $1,311,000,000 $1,327,000,000 of 20% to 21% year over year. We expect non GAAP operating income to be between 348 and $358,000,000 resulting in a non GAAP operating margin of 25% to 25.5% for the year. At the high end, this represents a 25 basis point margin improvement over fiscal 2023. We expect non GAAP EPS of $0.98 to $1.02 per share based on roughly 300,000,000 to 301,000,000 shares Our non GAAP net income and non GAAP EPS calculations assume a non GAAP effective cash tax rate of 19% due to the notable uptick in cash taxes that I mentioned earlier. We expect free cash flow to be between $303,000,000 to $312,000,000 or approximately 22 percent of revenue.

Speaker 3

This is roughly 400 basis points below our normalized fiscal 2023 levels, exclusively driven by the projected increase in our tax rate from 4.5% to 19% in fiscal 2024. The anticipated free cash flow impact from the tax rate increase is approximately $60,000,000 Pre tax free cash flow is expected to grow during fiscal 2024. As a reminder, due to seasonality and variability in billings, we expect higher free cash flow in the 1st and 4th quarters and significantly lower free cash flow in the second and third quarters. Looking now at Q1, we expect total revenue to be between $325,000,000 $328,000,000 or 22% to 23% growth. Subscription revenue is expected to be between $306,000,000 $309,000,000 up 23% to 24% year over year.

Speaker 3

From a profit standpoint, non GAAP operating income is expected to be between $76,500,000 $78,500,000 or 23.5% to 24% of revenue. From a seasonality perspective, we tend to see a dip in Q1 and Q4 operating margins due to our annual sales kickoff, payroll tax resets and our Perform customer conference. Lastly, non GAAP EPS is expected to be approximately $0.22 per based on a share count of approximately 296,000,000 to 297,000,000 shares. In summary, we are very pleased with our Q4 and fiscal 2023 performance. We have a strong track record of consistent execution.

Speaker 3

And as we have continued to demonstrate, we are committed to maintaining a disciplined and balanced approach to optimizing costs and improving efficiency and profitability, while continuing to invest in future growth opportunities that we expect will drive long term value. And with that, we will open the line for questions. Operator?

Operator

Thank you. We'll now be conducting a question and answer session. Our first question today is coming from Mike Scikos from Needham and Company. Your line is now live.

Speaker 4

Hi, team. Thanks for getting me on here. And I just wanted to circle up on a couple of items. Appreciate all the color on the guidance too. But on the ARR that you guys delivered and I know that you had cited the early renewals in Q4 here.

Speaker 4

When I think about the $13,000,000 that came in Q4 that earlier than expected expansion, those early renewals. Is that in any way tied to customers co terming licenses? And I guess where I'm going with that is, How much is that being influenced by potentially customers adopting DPS? Thank you.

Speaker 3

I'll take that, Mike. It's a good question. The $13,000,000 is more as you can imagine that we're in our Fiscal year end and sales is certainly incented to try to close as much business as possible. And you happen to have customers that are close to their renewals in the Q1. And in some cases, they were going to be doing expansions anyways.

Speaker 3

And what we found was we had situations where customers were ready to expand And we had already had the engagement with the customer and we were able to close it a little bit earlier. So it's nothing more than that. So it's not really a matter of more DPS or anything like that. It's just literally just some customers that renewed early

Speaker 4

And while we're on the subject, I guess I'll just use my follow-up on DPS, can you help us think about the number of customers that are currently non DPS or what are the early findings as far as how customers are using your platform more broadly once they're on, DPS, what are you guys seeing? Because I know that you had called out You envision this being an ARR accelerant over time. Is there any evidence of that with the customers that have at the earlier stages. And thank you again.

Speaker 2

Hi, Mike, it's Rick. So we now are up from where we were last quarter at about 100 customers on DPS, for the really the largest customers already about 130 that continues to grow and we expect to grow over the course of FY 2024 by many, many hundreds, the feedback from customers on DPS is very strong and we do see it as ARR accretionary as we look at. And by the way, we've seen good evidence of this in the existing installed base of DPS customers That we've had on the platform using DPS for some time.

Speaker 4

Thank you very much.

Operator

Thank you. Next question today is coming from Matt Hedberg from RBC Capital Markets. Your line is now live.

Speaker 5

Congrats on a really strong quarter. Rick, maybe to start with you, you spent a little bit of time in the prepared remarks talking about generative AI strategy there, I mean, what how would we see it show up perhaps in ARR growth in the future?

Speaker 2

Thanks, Matt. It is a fascinating time to be in technology is what I would say at the outset. Generative AI from our point of view is really all about productivity, whether writing text or developing code, whatever it might be. And we see it over the long haul as being upwards of a 10x multiplier in software development efficiency. So given that, that's going to drive a huge number of additional applications.

Speaker 2

It's going to drive more cloud migration, more workloads, more compute. And the result of that is we see it being a tailwind for observability solutions such as ours, especially those with deep automation analytics. Our platform as I mentioned in the prepared remarks is already available to handle these workloads and by handling these workloads today, it's going to be generated through additional compute cycles and additional elements to observe. The other thing I would say just 2 quick, maybe additional points on this Since I figured this would be a key question. 1st, generative AI and causal AI, which is the brand of AI that we deliver are highly, highly synergistic.

Speaker 2

So the causal AI from Dynatrace delivers precise answers and automation from data in real time at scale. And at our Perform conference, we announced a new capability called ChatPQL, which is for our Dynatrace query language. What this does is enable customers to use natural language to write DQL queries. So by doing that, we're really bridging the 2 capabilities together to make the Dynatrace platform more accessible to more users to get more insights out of the causal AI that we deliver. So hopefully that helps provide a bit of color.

Speaker 5

It does, great. Then maybe just a quick one for Jim. The guidance commentary was super helpful. I guess the one other thing I How are you thinking about sales capacity this year? I mean, normally, we've got a pretty programmatic view on how you think about adding capacity, but just any color there would be helpful.

Speaker 5

Thanks, guys.

Speaker 3

No. Yes, that's a great question. I'll start with we had a fantastic finish to the year. And as we enter fiscal 'twenty four, we're actually in a really good position relative to the tenure of our sales organization. So The tenure of our reps that are 2 plus years is very, very high.

Speaker 3

So we're in a good position. We've got tenured reps and you can expect that we will continue to add capacity probably in the mid to high teens this year and it will probably be a little bit more back end loaded Matt Because obviously we are living in kind of an uncertain macro environment. So we're going to be moderate in the way we increase capacity based on the demand that we see.

Operator

Thank you. Thank you. Our next question today is coming from Vinod Srinivasarathavan from Barclays. Your line is now live.

Speaker 6

Hi. Thanks for taking my question and congrats on the quarter. You spoke a bit about this, but can you talk a little bit more about the rollout of GRAIL, how customers are experimenting starting to deploy it as it really does seem like a unique data store to capture and analyze data for both the observability and the security use cases? Thanks.

Speaker 2

Sure, Vinod, let me take that one. The GRAIL remember is simply an underlying core technology that we use in the platform as Data store that is a massively parallel processing data lakehouse and what it does is it enables the aggregation of data whether they Logs, traces, routes, metrics, our smartscape, our topology map, etcetera. That then enables us to monetize that through the sale of various different modules, all of which use Braille as an underlying platform element, the first and foremost of those being log management. So the example that I used was a case where we've already got a customer doing mid-seven figures of ARR on log management, which of course uses underlying that Braille. So that's the way to think about it.

Speaker 6

Thanks. Appreciate that. And then, I think Braille was

Speaker 2

We'll deliver that on the next platform over FY24.

Speaker 6

Thanks.

Operator

Thank you. Next question today is coming from Kash Rangan from Goldman Sachs. Your line is now live.

Speaker 7

Congratulations on the results. I was wondering, Rick, if you could give us your perspective. The mix of business certainly maybe because of DPS is in the business and how the go to market and product organizations are aligning to increase the sources of revenue the company gets. And also One for Jim. On DPS, the early cohort of customers, what has been your analysis as to the increased revenue uptake, Although early it might be relative to the previous levels of consumption of the Dynatrace platform.

Speaker 7

Thank you so much. Congratulations.

Speaker 2

Thanks Kash. We see the evolution of the platform and our sales model as Being really quite notable in terms of the move from where we were a year ago landing around 50% of new logos on multiple modules which we consider to be 3 or more modules and that number is now up to 65%. So when we've got new customers that are coming in wanting more of the platform, we think it is strong evidence that they want not just APM from Dynatrace, but they want APM, they want infrastructure, they want back to see an ongoing evolution toward accessing the platform through 1 or more of the use cases I described in the prepared remarks, But that ultimately the destination for most of them is really to use the entire platform over the course of time.

Speaker 3

Yes. And the added color on what are we seeing, I would say it's early days. As Rick said, we have roughly 130 customers. They tend to be our largest customers. And we see very, very healthy expansion with those customers.

Speaker 3

And to Rick's point, as you more broadly roll it out, It's just a vehicle to make a much more frictionless purchase experience and leverage more of the Dynatrace platform. So In that regard, we just think it's a much better vehicle for customers to grow and expand on the platform.

Speaker 2

Maybe Kash, just to provide a little bit more color on DPS and also for those others on the call, the opportunity around DPS is really quite enormous because this is what customers are asking us for. They have wanted us to deploy a model where they have a single commit that spans the entire platform. And that's precisely what we've delivered with TPS. So single commit, you can use application security, you can deploy log management, you can do trials, you can deploy them, All of this with your single contract that is under DPS. So this is why it really is fueling very strong interest in customers to move to this model And why we've enabled it really across the customer base.

Operator

Thank you. Our next question is coming from Andrew Nowinski from Wells Fargo. Your line is now live.

Speaker 8

Great. Thank you. Congrats on another great quarter and a great close to the fiscal year. I just had two quick questions for you. I guess, I want to ask about the GRAIL and the SaaS platform.

Speaker 8

How much of a revenue or an AR uplift are you

Speaker 3

Want me to take that? I would say that it varies, but we see roughly a 10% uplift when customers go from kind of a managed to a SaaS

Speaker 8

10%. Okay. Thank you. And then I want to ask about Your operating margin. So you mentioned, I think Rick, you said you expect modest margin expansion in fiscal But you guided margins flat at 25%.

Speaker 8

So I'm wondering if you could just put some guardrails around what you consider modest expansion and also whether you have any long term targets for operating margin that we could think about? Thanks.

Speaker 3

Yes. I mean, so we landed in fiscal 2023 At around 25% and we guided 25% to 25.5%. So at the high end of the range, what I said is that that's probably about a 25 bps improvement In margins, as you can imagine, just a reminder, obviously, we are a rare breed of company that has balanced growth and profitability, Having growth in the 20s and margins in the low to mid-20s. So we think we're in a really, really good place. I think there's a significant opportunity for margin expansion long term for the company.

Speaker 3

We're going to be having an Investor Day here probably In the future, we haven't set a date yet, and we'll provide more insight on where we think maybe a long term model could be for op margins. But you should expect that we think there's significant room for accretion in the operating model. It's obviously about rate and pace, When do you do that and how do you balance it based on the opportunities that you see in front of you?

Speaker 8

Super. Thank you, guys.

Operator

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

Speaker 5

Thanks Rick and Jim for taking the questions. I wanted to ask another question on GRAIL. And we've been hearing from partners that initial testing and proof of concepts have been going Pretty well and really the next step is demonstrating the ability to scale to similar levels to the competition out there, specifically in enterprise log analytics. So I was wondering if you could share some of your thoughts on GRAIL, maybe its ability to scale to the largest workloads and what specifically from a technology perspective for GRAIL gives you that confidence. Maybe I'm just simply under appreciating the power of GRAIL's A parallel processing lighthouse.

Speaker 5

Thanks guys.

Speaker 2

Koji, we already have a customer doing 100 terabytes or more Storage in real time on Grail. So we think we've already proven that scale and we are POC ing it broadly. So we now have well over 300 POCs. That's more than double where we were last quarter this time. And customers are very interested as I said in the earlier remarks on testing GRAIL as a mechanism toward both reducing the log management cost as well as increasing its effectiveness.

Speaker 5

Got it. Thanks, Rick. And maybe just a follow-up. In the prepared remarks, the on the potential AI tailwinds sounded pretty bullish. And I was just wondering, just to be super clear here on the FY 'twenty four guide, Is there any embedded tailwinds from AI in the guidance or and if there is, could you please quantify that magnitude?

Speaker 2

No embedded tailwind in AI. This is new. It's citing, it's rapidly developing. We think it's going to result in added workloads as we discussed, but there's nothing embedded in the FY 'twenty four guide

Operator

Next question today is coming from Will Power from Baird. Your line is now live.

Speaker 9

Great. Yes. Rick, just want to circle back on I appreciate the comments and color earlier on some of the monetization opportunities. I wonder how you're also thinking about generative AI in terms of driving efficiencies in your own underlying businesses, what do the opportunities look like on that front?

Speaker 2

Well, it's a really good question. The short answer is that just as we expect our Customers to gain productivity as a result of large language models, LLMs as well as generative AI, we expect to do the same. In addition, I mentioned the announcement at Perform around chatDQL. This is really exciting. Imagine if you're a user of the Dynatrace platform today you have to write DQL queries.

Speaker 2

Now the good news is this is a very common language and users have this capability in spades, so that's great. But imagine that we can provide that to be even more accessible by using natural language to query the Dynatrace platform. Very, very exciting in extending the Dynatrace platform to more end users. And then lastly, imagine if you were using 1 of the hyperscalers AI, generative AI platforms and that you can actually use that to query the Dynatrace data using Causal AI, Also strong extension of platform. So these are some of the areas in which we could imagine this evolving.

Speaker 9

Okay. I appreciate that. And maybe just as a follow-up kind of sticking with the automation analytics any other any early color you could provide in terms of customer interest and progress on those fronts?

Speaker 2

The way that I would answer that Will is that we really do see FY24 as the year of adoption. So we are really driving through our Our services teams, our SCs and other trials, POCs, deployment of these capabilities because we think that it makes Dynatrace platform dramatically more valuable to customers. Obviously from our standpoint it creates more stickiness, more ARR generation, all of those elements as well. But the primary value is really to the customer and that's where we're focused on driving these kinds of POCs. On App Engine, Automation Engine and others, very good early returns in POCs.

Speaker 2

Too early to really say too much more about it, but excited with the early returns.

Speaker 5

Thank you.

Operator

Thank you. Next question today is coming from Pinjalambura from JPMorgan. Your line is now live.

Speaker 10

Great. Hey, congrats on the quarter. Rick, I want to ask you about the DXC and the Deloitte comment that you made. It seems like Dynatrace is part of the reference architectures. Do you see that data trace more and more becoming embedded for application development holistically impacting how applications are developed and how any changes to the application impacts the entire stack?

Speaker 10

And as that evolves, does that kind of up levels the opportunity for that increase?

Speaker 2

Two answers to the question. First of all, with respect to the GSIs, becoming part of the reference architecture is really core and a major first step toward making sure that when the GSIs do a digital transformation project, a cloud migration and so forth that they are thinking about Dynatrace because after all we really do see Dynatrace an opportunity to make cloud instantiations work better. And the result of that is that we expect that the clients of those GSIs will see the same and the GSI's engagement with us is very productive in that regard. So that is a key element of the GSI story. So let me leave it at that for now.

Speaker 10

Understood. I wanted to double click on the DPS accelerant to ARR comment. Can you explain that? Is that largely driven by kind of the higher expansion dynamics that you might be seeing? When do you see DPS start making an impact to ARR numbers.

Speaker 10

When do we see that over the next 2, 3 years?

Speaker 2

Well, we've already seen that in the existing DPS customers. They tend to have higher ARR accretion than non DPS customers. So we already do see that value to existing DPS customers today. The way that this works is that it creates just a more frictionless expansion opportunity by avoiding additional contracting for new modules. Like for example, if I've got APM, DIM and Infrastructure and I don't have to come contract for AppSec or Log Management, I can just Send those within my existing contract, it creates less friction.

Speaker 10

Got it. Thank you.

Operator

Your next question today is coming from Keith Bachman from BMO. Your line is now live.

Speaker 11

Hi, many thanks. The first question I want to revert back to GRAIL is, what do you think the penetration rate will be on GRAIL? So for instance, we talked to a large customer, said it's inevitable they will adopt GRAIL because of the way the dataset models work relative to the application usage. And so just wondering how you think the adoption trends will unfold. I know you said there's been a significant increase, I think 300 customers versus 150 last quarter, but where do you see this ending up?

Speaker 11

And when you reference POC, what did you mean by the customers have signed a POC in terms of what was the monetization impact? And I have a follow-up, please. Well, I'll just ask my follow-up now. If you could give some update on where security is in terms of adoption kind of run rate, That would be great. Many thanks.

Speaker 2

Well, Keith, on the question of POCs, this means that customers are deploying POCs, they're using it in trial environments headed to production environments and testing it out. So that's that piece. With respect to the security piece, as we said, we have 400 customers now on security, that's about 10% penetration to our installed base. We continue to expect that to grow and penetration to increase to the point where we said that we expected to do $100,000,000 over a 3 year span that gets us there by the end of FY 'twenty five. And then lastly with regard to rail deployment, this is a very important question Because we expect rail, just to be very clear, again, as underlying core technology to be present in 100% of our installed base over the course of time.

Speaker 2

Log management using RAIL won't necessarily be 100%, but RAIL is simply an underlying data store. And that data store will be used across the entire platform.

Speaker 11

Okay. Yes, that's exactly where I was getting to. Many thanks.

Operator

Thank you. We've reached the end of our question and actually our final question today is coming from Gray Powell from BTIG. Your line is now live.

Speaker 5

Great. Thank you for squeezing me in. I'll be quick. So yes, just following up on the security question. What's the typical ASP uplift you get for a customer that takes security?

Speaker 5

And then on the $100,000,000 target by the end of fiscal 'twenty five, just how should we

Speaker 6

think about the linearity to get Thank you.

Speaker 3

Yes. I think obviously the uplift on if you're talking about AppSec, the uplift on AppSec obviously varies based on the size of the customer. So it's hard to just give you a generic response because of the way we've kind of positioned it. So I can tell you that You can expect in general that at least based on customers that have a reasonable ARR, it's probably a 10% uplift.

Operator

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

Speaker 2

Okay. Well, thank you all very much. In closing, we are very, very pleased with the finish to fiscal 2023. We're very bullish about Thank you all for your engaged questions as well as for your ongoing support. We look forward to connecting with you at upcoming IR events over the coming weeks and we wish you all a very good day.

Operator

Thank you. That does conclude today's teleconference and webcast. You may disconnect your lines at this time and have a wonderful day.

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Key Takeaways

  • Exceptional finish to FY2023: Q4 results exceeded expectations with full-year adjusted ARR growth, constant-currency subscription revenue growth, and free cash flow margin all at 29%.
  • Large, accelerating market opportunity: Dynatrace sees a $50 billion observability and application security market at an inflection point driven by cloud complexity and AI, positioning its unified platform and causal AI as key differentiators.
  • New DPS licensing model: The simplified cross-platform Dynatrace Platform Subscription (DPS) launched in Q4 to make trials and module expansions frictionless, already adopted by ~130 customers and driving higher expansion rates.
  • Strong customer use-case momentum: Major wins in cloud-native performance, developer “shift-left,” large-scale log analytics, application security, and tool consolidation—including multiple mid-seven-figure deals—fueling net expansion.
  • FY24 guidance balances growth and profitability: ARR is guided to $1.475–1.49 billion (18–19% growth), revenue to $1.388–1.406 billion (19–20%), non-GAAP operating margin of ~25–25.5%, and free cash flow of ~22% of revenue.
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Earnings Conference Call
Dynatrace Q4 2023
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