Ladies and gentlemen, thank you for standing by. And welcome to the Dynatrace Fiscal Second Quarter 2021 Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today Noelle Faris.

Great. Thank you, Operator, and good morning, everyone. With me on the call today are John Van Siclen, Chief Executive Officer; and Kevin Burns, Chief Financial Officer. Before we get started, please note that today’s comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties, and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these factors is contained in Dynatrace’s filings with the SEC, including our annual report on Form 10-K and quarterly report on Form 10-Q. The forward-looking statements included in this call represent the company’s view on October 28, 2020. 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 lastly, references to growth rates will be in constant currency unless otherwise noted. And with that, let me turn the call over to our Chief Executive Officer, John Van Siclen. John?

Thanks, Noelle. Good morning, everyone. And thank you for joining us on our Q2 fiscal 2021 earnings call. First, let me start by sharing how extremely pleased I am with the team’s ability to continue to navigate the prolonged remote work environment. Productivity and attitude remained strong and we continue to add talent to the team at an accelerating rate. We had another strong quarter of balanced growth and profitability driven by a combination of new logo additions to the Dynatrace platform and the continued expansion of existing customers. ARR for the quarter was up 33% year-on-year and subscription revenue was up 35%, resulting in a non-GAAP earnings of $0.18 per share. Based on the strength of our Q2 results and visibility into the back half of our fiscal year, we are raising our top and bottomline guidance for fiscal 2021, which Kevin will provide more details on shortly. As discussed at our Investor Day last month, there are two macro trends driving our business. The first is the acceleration of digital transformation, and the second is the dynamic multiclouds are the platform of choice for these digital transformations, especially in the global 15,000 account base we target and serve. Digital transformation is taking place around the globe and across every industry. We recently commissioned a study of 700 CIOs primarily from $1 billion plus enterprise companies and almost 90% of them agreed digital transformation has accelerated in the last 12 months and nearly 60% felt it will continue to accelerate into the future. These are not just the well-known technology brand names you would typically consider when talking about digital transformation, these are retailers, financial service providers, manufacturing companies, public sector agencies and others who realize digital transformation is essential to the success of their businesses moving forward. As…

Thank you, John, and good morning, everyone. Today, I plan to review our strong Q2 results and then I will review our increased full year guidance and our outlook for the third quarter. As John mentioned, we delivered a great quarter on both the top and bottomline, delivering what we believe is a best-in-class combination of growth and profitability at scale. This is consistent with our goal to continue to deliver against the Rule 50. Annual recurring revenue was $638 million at the end of the quarter. That’s up 33% year-over-year, an increase of $158 million or $167 million on an as reported basis. The two drivers of ARR growth are new logo customers and our net expansion rate. As we expected, we accelerated new logo additions this quarter adding 133 new logo customers in Q2 to finish the second quarter with 2,594 Dynatrace customers. This puts us on track to achieve our previously shared plan of about 530 new logos by the end of this fiscal year. We continue to invest aggressively in expanding the functionality of our platform, broadening the use cases covered by our existing modules and expanding beyond the modules we offer today. This has led to a consistent net expansion rate, which remained over 120% for the 10th consecutive quarter. ARR per Dynatrace customer also increased to $234,000, up 14% year-over-year. Moving on to revenue, total revenue for the second quarter was $168.6 million, $7.6 million above the high end of our guidance and representing an increase of 30% on a year-over-year basis. The strength in total revenue growth is being driven by 35% growth in subscription revenue, partially offset by the expected decline in Classic license revenue. From a topline growth perspective, we are focused on driving subscription revenue, which makes up 94% of…

Thank you. [Operator Instructions] Your first question comes from Bhavan Suri with William Blair.

Thanks for taking my questions and congrats for the really solid set of numbers there. I guess, I wanted to touch really quickly on two pieces. One, a little more strategic about the TAM, so you obviously talked about the TAM, John, at the Analyst Day, but I guess as you look at the complexity what every company is going through in the digital transformation that even midsized companies going through, why not go below that sort of Fortune 15,000, why not sort of maybe move not to small businesses, but to midsize businesses that may have a service that may have a website and then -- more than a website, multiple applications, multiple products, how should we think about the idea of expanding down market to sort of even further increase the TAM that you serve?

Bhavan, appreciate the question. So our focus has been and will remain for some time that Global 15,000. We believe we build products extremely well for that enterprise customer base, it’s a more complex environment, digital transformation matters to their business survival and it’s also where the profitability is as well. So we are pretty happy with a $32 billion TAM at this point. I should also say that…

Understood.

…that that nothing precludes us from going down market. There is no product issue. There is no pricing issue. There is nothing in that range. It’s more of a focus of the business and usually when you focus you accelerate faster in my experience. And that’s what I think you are seeing in our numbers.

No. That’s helpful and I appreciate that. And then, I just want to touch a little bit on something you brought up a couple of times. So the digital experience piece you talked about 7% of customers being attached to it, you talked about strength in the log piece. Just some sense on sort of as these initial customers are -- the newer customers are landing, are you seeing them land with multiple products and what is the attach rate. Is there a pattern in the attach rate for some of the newer products with the new customers? Thank you.

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

No. That’s great. Thanks for the color and thanks, John, for answering my question.

Appreciate it, Bhavan.

And your next question comes from the line of Raimo Lenschow with Barclays.

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

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

Okay. Perfect. Okay. Thank you. That’s pretty clear. And Kevin, for you, if you think about the investments you guys are doing and John talked about the increase in the sales capacity. How do you think about this going forward, because in a way you are kind of moving from like a 20% grower into a 30% grower? So in theory there should be like an increase in needed hiring, as well as to kind of drive that further growth, but then also you have obviously productivity gains coming out of that. So, you mentioned already like a little bit of the investments, but how do you think about that in the medium-term to long-term here? Thank you.

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

Okay. Perfect. Thank you. Congratulations.

Thank you.

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

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

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

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

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

Got it. Thanks, guys.

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

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

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

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

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

Okay. Thank you so much.

And your next question comes from the line of Sterling Auty with JPMorgan.

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

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

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

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

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

Yeah. Okay. Okay. The second question I had is on ARR growth. So you are guiding a growth in constant currency for the year of 25% to 26%, which is up from your previous guide and increased, and I should say, from your previous guidance. Your longer term guidance is as you say north of 25%, normally you see a de-sell over time, but what you are suggesting is, as you reach a level at the end of this year, it holds that. But why it’s just unusual to not see a de-sell so to speak. So if you could just speak to or address why you think you hold at those levels rather than see some perhaps tailing off below 25% longer term?

Sure. So a couple things there. So the first thing I would say is, as we discussed again at Investor Day, we will be facing and we are currently facing some headwinds on our ARR growth due to the perpetual run-off of licenses and those as we discussed over the next four quarters to six quarters will be a headwind to ARR growth.

Yeah.

So, that sort of on the negative side and as we come out of fiscal ‘22, those headwinds to ARR growth will disappear. However, if you think about the investments that we are making today that was -- that’s what makes us very optimistic about the future ARR and sustainable growth. Our goal this year is to grow sales and sales capacity by 25%. We are on track to do that. Things are going very well from a sales standpoint there. We are also seeing a nice shift in our sales rep organization as well. We have a lot more mature reps than we did 12 months, 24 months ago. So that should provide a tailwind as well. And I’d say the third thing is, we talked about before is, we are no longer working on converting our base from classic to the Dynatrace platform. So that gives frees up additional capacity. We talked about that probably around the 20% of free capacity. That over time should help productivity. So you think about those three things combined sustainable growing sales capacity and maturing of the sales organization, as well as no longer working on conversion programs. Those should all be a tailwind to ARR growth over time.

Perfect. Many thanks.

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

Hi. Thanks. Can you hear me?

Hi, Walter.

Hey. So just starting out, just on the 133 customers you added in the pipeline your building for the second half. Can you talk about the trial activity? How much of those are coming in through free trial or most coming in through the traditional sales motion where trials are not big -- not a big part of it?

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

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

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

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

Thank you. And our last question comes from the line of T.J. Hynes [ph] with Canaccord.

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

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

Yeah. Yeah. Okay. That’s helpful color. Thanks guys.

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

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