Dynatrace, Inc. (DT) Q4 2022 Earnings Report, Transcript and Summary

Greetings. Welcome to Dynatrace's Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that today's conference is being recorded. At this time, I'll turn the conference over to Noelle Faris, Vice President of Investor Relations. Noelle, you may begin.

Thanks, operator. Good morning, everyone, and thank you for joining Dynatrace's fourth quarter and fiscal year 2023 earnings conference call. With me on the call today 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 filings 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 May 8, 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 Q4 financial presentation under the Events 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. I'd like to begin by thanking the 3,600-plus people of Dynatrace for their immense contributions in helping us to achieve several notable milestones in fiscal 2022. In particular, we continue to deliver very strong growth in adjusted ARR of 35% for the fourth quarter and the full fiscal year, marking the second straight year of mid-30s growth for Dynatrace. Additionally, in the fourth quarter, we surpassed the $1 billion threshold in annualized revenue. This is a significant achievement while operating at a rule of 60 when combining adjusted ARR growth and free cash flow margin. It is a testament to the strength of our market, our platform, and the durability of our business model, which, in combination, enable us to run a business that delivers high growth with strong profitability and free cash flow. Let me share a few financial highlights from the fourth quarter. ARR ended the fiscal year at $995 million. Subscription revenue was $235 million, an increase of 31% year-over-year. Non-GAAP operating income was $58 million or 23% of revenue. These strong results were driven by the combination of solid new logo additions to the Dynatrace platform in addition to the expansion of existing customers. We grew our new logo additions by 18% year-over-year for Q4 and 21% for the full year, above the high end of 15% to 20% annual growth. And our net expansion rate was at or above 120% for the 16th straight quarter. I'd like to devote the rest of my remarks to how we drive our continued success in fiscal 2023 and beyond, specifically covering market opportunity, product leadership and go-to-market leverage. Let me start with the market. We have sized our market opportunity at $50 billion in growing. Digital transformation has become ubiquitous and our market for observability and application security solutions has become an essential element of successful transformations. According to IDC's 2022 Worldwide CEO Survey, driving digital transformation is the number one business priority for CEOs in 2022. To execute these digital transformation initiatives, organizations are accelerating their movement to the cloud. But what many companies are realizing is that as they scale the dynamic nature of modern files introduces incredible complexity, the larger the business, the more complex their cloud ecosystem. Global 15,000 companies are running multi-cloud and hybrid cloud environments with thousands of applications, many of which leverage microservices and containers. This frequently yields a complicated ecosystem, often generating petabytes of data and tens of millions of interdependencies. Companies are often overwhelmed and ill-equipped to handle this level of complexity. The majority of observability solutions deployed have been assembled internally, pulling in multiple disparate tools to gain visibility into their ecosystems. But the end result is even more non-cohesive data for teams to process. And when there is an issue, these tools don't provide sufficient clarity to enable rapid resolution. Companies are looking to simplify this complexity with comprehensive observability, incorporating all forms of data across multiple aspects of their technology stack. They want more than just dashboards. They want answers and intelligent automation from their data along with remediation capabilities to enable them to operate more efficiently. This brings me to my second topic, the strength and differentiation of the Dynatrace platform and why enterprise customers choose Dynatrace. Overall, we are investing significantly in R&D to ensure that we expand customer value and deliver significant differentiation. Nearly 1/3 of our workforce is driving our innovation engine to extend the depth and breadth of our platform. What the Dynatrace platform delivers uniquely is end-to-end observability, leveraging our AIOps engine to invoke situational awareness and true causation versus just correlation across complex ecosystems. We deliver our platform across multiple modules. First is our industry-leading solution for apps and microservices, which delivers best-in-class observability across the full stack, including infrastructure and applications. Closely aligned to our full stack module is our digital experience management or DEM module, which optimizes user experience across channels and extends our platform value to digital business owners. Next is infrastructure monitor, which provides server, log, network and container observability. It is our fastest-growing module now in excess of $100 million in ARR and deployed by more than 50% of our customers. Our application security module has sparked significant interest in the market by helping companies manage vulnerabilities such as Log4Shell. In fourth quarter, the number of customers using our AppSec module more than doubled. Our Cloud Automation module enables customers to perform automated quality and security validation for safer deployments. Also during Q4, we announced the ability of customers to shift left by accessing a huge array of the answers delivered by our platform as code and easily incorporate software intelligence capabilities into their applications. And there is so much more to come with our platform. One in particular that we expect to release in the second half of this year is dramatically enhanced logging capabilities. Our vision is to provide a fully automated, highly performance and cost-effective log monitoring solution that scales with the largest businesses. We believe this market is ripe for disruption. Unlike current logging tools, we do not view logs as siloed, but rather a key data source to analyzing the full context of observability and security, leveraging intelligent automation capabilities of a full Dynatrace block. Our customers expand their usage in two dimensions, both with the number of modules deployed as well as the number and scale of the workloads run. Both dimensions provide visibility to immense volumes of data, and more data leads to more complexity, making manual a learning and response nearly antenna. But to Dynatrace, more data facilitates more sophisticated and improved AI analytics by processing all data sources while reducing the time it takes to get precise answers that ensure well-functioning software. The average ARR for customers using three or more modules is nearly $500,000 and that level continues to increase. Today, nearly half of our customers are multi-module. A British multinational telecommunication company had over 60 disparate systems deployed for observability, including those from our competitors. In Q4, they agreed to expand their existing relationship with an eight-figure transaction covering the entire breadth of the Dynatrace platform, an enormous deal and testament to the power of Dynatrace. Another example of the value of Dynatrace is a multinational consumer electronics retailer that consolidated a wide array of technologies by leveraging our software intelligence platform. They had over 30 disparate tools, collecting data across their ecosystem. The need for one solution that could expand the entire ecosystem, unify the data and provide intelligence was evident when an issue arose causing end user disruptions that were undetectable by any of their existing tools. Dynatrace was selected to provide visibility and precise answers. In Application Security, a large U.K. gaming company has started a POC just days before Log4Shell came to light and quickly converted just three weeks later due to the value of the platform in detecting all instances of the vulnerability, understanding the transaction patterns and prioritizing application updates. This brings me to our go-to-market strategy. Given the powerful trends and market opportunity I touched on earlier, commercial expansion continues to be a top priority for us. We've made great progress across three strategic go-to-market areas, including the expansion of our direct sales force, amplifying our partnerships and bolstering our brand. With our direct sales force, we successfully increased our quota-carrying sales reps by nearly 30% over the last 12 months, providing us with increased coverage for the Global 15,000 market that we target. And our goal is to drive the same level of growth in reps in fiscal '23. In late April, we had our annual sales kickoff with the entire global sales team. This was our first in-person kickoff since 2019, so you can imagine how energizing and engaging the event was for all of us. These events are to foster relationships, educate our sales force, and build upon our already successful and efficient go-to-market momentum. Adding to this momentum, we are heavily focused on the expansion of our partner ecosystem. To start, the three hyperscalers, AWS, Azure and GCP, offer greater leverage through deeper integrations, sales force engagement, and offerings in their respective marketplaces. New ARR transacted through hyperscalers, again, more than tripled during the quarter versus last year. The general availability of our platform last quarter running natively as SaaS with Azure and GCP, with AWS already available, represents another significant catalyst for us this year. I'm especially excited about our developing relationships with global system integrators. Today, Deloitte announced that they have chosen Dynatrace as their solution for their cloud observability practice. Their deep industry-specific knowledge and modern delivery expertise, coupled with our multi-cloud observability and advanced AIOps capabilities, is a powerful combination for Global 15,000 companies. The combined offering will focus on optimizing cloud ecosystems. I'll wrap up our go-to-market strategy with brand. Market and brand awareness continue to be important components of our go-to-market efforts. As you may have seen, we have begun to build out our branding and marketing efforts with an awareness campaign combined with increased targeting in search engine optimization. We want companies beginning or in the midst of digital transformation efforts to think of Dynatrace as cloud ecosystems done right. When they are ready to increase cloud workloads, we want to be part of the initial deployment decision, thereby shrinking the gap between cloud ecosystem migration and deployment of world-class observability. Finally, as most of you have seen, Kevin has decided to depart Dynatrace as of the end of this calendar year. During this period, we will be searching for an equally strong successor CFO for the Company. Kevin's contribution to Dynatrace over the past six years has been immense from overseeing one of the fastest moves to a high-growth recurring revenue business to our successful IPO in 2019. I'd like to thank Kevin for his strong dedication to Dynatrace, and I appreciate his commitment to a seamless transition. To close, we believe that our observability platform is highly differentiated and well positioned in a large and rapidly growing market. We are innovating at a rapid rate and we are building up go-to-market leverage through increased sales capacity as well as partners. Fiscal 2022 was an extraordinary year for the Company as we drove record levels of ARR and revenue with excellent operating margins and cash flow. We remain committed to ongoing strong financial performance and are deeply passionate about the opportunity ahead. With that, I will turn it over to Kevin to cover the financials and detailed guidance. Kevin?

Good morning, everyone, and thank you, Rick. I appreciate the kind words. Before I get into the financials, I want to thank the entire Dynatrace team for giving me this incredible opportunity to be CFO of this amazing company. Together, we have built a world-class team and organization that is still early in its growth trajectory. I look forward to working with Rick to onboard a new CFO, ensuring a successful transition and then taking a break to enjoy time with my family. As Rick mentioned, Q4 was a fantastic quarter, capping off a strong finish to fiscal '22. ARR is a key performance metric of the overall strength of the business, and we delivered 35% adjusted ARR growth for the second year in a row, exceeding the high end of our guidance range by one percentage point, highlighting the resiliency and predictability of our business model. Please keep in mind, adjusted ARR growth normalizes for currency and the wind down of perpetual license ARR, a reconciliation can be found on our IR website. Total ARR was up $221 million year-over-year, ending the fiscal year at $995 million. Reported ARR would have been $10 million higher and well above the high end of our guidance range when you take into account two items. First, we suspended business in Russia, resulting in a nearly $6 million reduction in ARR. And secondly, we had another $4 million of incremental currency headwinds as the U.S. dollar strengthened yet again in recent months. As we have communicated for the last few years, the building blocks for ARR growth continue to be the combination of our net expansion rate and the addition of new logos. Our net expansion rate for the fourth quarter was above 120% which is now four years in a row. We continue to see momentum in new logo additions. We added 205 new logos in the fourth quarter. That's up 18% over last year. In total, we added 706 new logos this year, that's 21% growth and above our previously communicated expectations of 15% to 20%. Our average ARR per customer with three or more modules continues to increase. This cohort represented nearly half of our customers in the fourth quarter. These customers have an average ARR of nearly $500,000. Given the significant cross-sell and expansion opportunities in our customer base, we continue to believe that the average ARR per customer could be $1 million or more. Moving on to revenue, total revenue for the fourth quarter was $253 million, $6 million above the high end of our guidance. Total revenue and subscription revenue both grew 31% over last year. With respect to margins, total non-GAAP gross margin for the fourth quarter was 84%, down one percentage point, driven by a slight change in revenue mix and increased investments in customer success. We expect gross margins to remain roughly consistent in fiscal '23. Our non-GAAP operating income for the fourth quarter was $58 million, $4 million above the high end of our guidance range, driven by the revenue upside in the quarter. This resulted in a non-GAAP operating margin of 23%, exceeding our guidance range by roughly 100 basis points. Non-GAAP net income was $48 million or $0.17 per share, $0.01 above the high end of our guidance. Turning to a quick summary of the financial results for the full year. Total revenue was $929 million and subscription revenue was $870 million, both of which grew 32% year-over-year. Non-GAAP operating income for the year was $234 million, resulting in a non-GAAP operating margin of 25%. Non-GAAP net income for the year was $198 million or $0.68 per share. 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 the top line and bottom line. This approach proves to be even more important as we navigate the rapidly evolving macro environment, where the resiliency and predictability of our business model is the parent. Turning to the balance sheet, as of March 31, we had $463 million of cash, and our net cash position was $189 million. Our unlevered free cash flow for Q4 was very solid at $82 million. For the full year, our unlevered free cash flow was $234 million or 25% of revenue. This came in below our guidance range due to a tax refund that was due in fiscal '22, but not received until the start of fiscal '23. Given the strength of our cash flow and the declining interest expense as we've reduced our long-term debt consistently, this quarter will be the last quarter we provide unlevered free cash flow and are moving to free cash flow as a metric. The last financial measure that I would like to discuss this morning is our remaining performance obligation, which at the end of the quarter was approximately $1.6 billion, an increase of 33% over Q4 of last year. The current portion of RPO, which we expect to recognize as revenue over the next four quarters, was approximately $900 million, an increase of 34% year-over-year. Now let me turn to guidance. We are very pleased with how the business has performed in recent years, and we anticipate delivering another strong performance in fiscal '23. We believe we have the right foundation in place to sustain 15% to 20% growth in new logos and a net expansion rate of 120% or higher for fiscal '23. There are a few things to keep in mind with respect to our guidance. First, we are mindful of the evolving macro environment. To be clear, we have not seen any material impact to our business, and we are confident in the durability and predictability of our growth. However, we believe it makes sense to be prudent with guidance. Second, with almost half of our business conducted in foreign currency, the continued strength of the U.S. dollar creates a sizable currency headwind. Based on FX rates as of April 30, we expect the FX headwind to ARR and revenue to be roughly $20 million for fiscal '23. And with respect to Q1, we anticipate the FX headwind to be roughly $15 million to ARR. As you think about your models over the course of the year, keep in mind that every 1% movement in non-USD currency equates to roughly $6 million of movement in ARR. Third, we announced that we suspended business in Russia, which results in a headwind of approximately $6 million on ARR and revenue for fiscal '23. And finally, fiscal '23 will be the final year where the perpetual license wind down will have a significant impact on ARR growth rates. The overall annual impact in fiscal '23 is approximately $8 million or 80 basis points. The impact will be most notable in Q1 with a three percentage point headwind and then tapering off throughout the year. Starting with our guidance for the full year, again, with growth rates in constant currency, we expect ARR to be between $1.25 billion and $1.265 billion representing an adjusted ARR growth of 29% to 30%. This assumes net new ARR growth of $290 million at the high end of guidance, offset by the $20 million headwind that I just mentioned. Given the FX impact in Q1, we wanted to provide you with a little bit more color on Q1 seasonality. Historically, roughly 18% of our annual net new ARR is closed in Q1, which would imply $52 million of net new ARR in constant currency in Q1. As I just said, there is also a $15 million currency headwind on our fiscal '22 year number that needs to be taken into account in Q1. Total revenue for the full year is expected to be $1.142 billion to $1.158 billion. Underlying that, subscription revenue is expected to be between $1.071 billion and $1.086 billion, both up 27% to 28% year-over-year. We expect non-GAAP operating income to be between $257 million and $266 million, resulting in a non-GAAP operating margin of 22.5% to 23% for the year. We expect non-GAAP EPS of $0.74 to $0.77 per share based on 292 million to 294 million diluted shares outstanding and a non-GAAP cash tax rate of 13%. We expect free cash flow margin to be approximately 29% to 30% of revenue, which equates to $330 million to $345 million. This is 45% growth year-over-year at the midpoint and incorporates the impact from the timing of the tax refund I mentioned earlier. Looking at Q1, we expect total revenue to be between $261 million and $263.5 million or 29% to 31% growth. Subscription revenue is expected to be between $244 million and $246.5 million, up 29% to 30% year-over-year. From a profit standpoint, non-GAAP operating income is expected to be between $60 million and $62 million, 23% to 23.5% of revenue and non-GAAP EPS of $0.17 to $0.18 per share based on the share count of 291 million to 292 million diluted shares. In summary, we are very pleased with our fourth quarter and fiscal '22 performance where we saw strong ARR and top line growth combined with healthy cash margins. We have achieved the important milestone of $1 billion in annualized revenue and continue to operate at Rule of 60. Dynatrace's breadth of product offerings and our geographic reach provides us with multiple growth opportunities in the future. Overall, we believe we are well positioned for resilient and predictable growth profitability and cash flow in fiscal '23 and beyond. And with that, we'll open the line for questions. Operator?

Thank you. At this time, we will now be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Fatima Boolani with Citi. Please proceed with your question.

Rick, I wanted to start with you just with respect to some of your comments in the prepared remarks around the broader secular opportunity and still what is a vastly underpenetrated state for observability solutions given those broader trends. But I know there's been a lot of hanging in the investor community around these, business and pricing, models rather than are consumption and usage based. So I'm curious if you can just sort of give us a quick overview on how your model with one agent is differentiated; and cloud usage and consumption trends that are perhaps impacting some of -- might not necessarily sort of come your way? And I have a quick follow-up for Kevin, please.

Thanks very much for the question. So first of all, completely agree with you in terms of the secular trends and the opportunity and insurability. We believe, as I mentioned in my remarks, that it's quite substantial. In terms of consumption, I do think that we'll see more consumption-based pricing over time. And I do think that there is accretion opportunity in pricing as we look ahead just amidst the overall market environment. We do have built-in price increases in our typical support contracts at the time of renewal. So, we see accretion opportunity as we look at it.

And Kevin, just for you, with respect to the new logo performance in the quarter, I know Rick talked about sort of elevating or expanding the sales capacity by 30% in the trailing 12-month period. But I'm wondering when and where we're going to see a more meaningful or visible acceleration on the new logo front? And that's it for me.

So when we think about the building blocks for next year, the base model that we have right now is 15% to 20% new logo growth, which is what we've been doing consistent the last couple of years. I do agree with you how we're giving some of the investments that we're making and accelerating in terms of the direct sales force, the investments that we're making in the hyperscalers and partners in SI. There could be some further tailwinds. Will that materialize in fiscal '23 or starting into fiscal '24, I think it's in that time zone or in that timeline where, yes, we can probably start to see a little bit of a further acceleration on the new logo side. But today, we're super happy with the 50% to 20% new logo growth and the 120-plus percent net expansion rate. That gives us a sustainable 30-plus percent ARR growth.

Our next question is from the line of Mike Cikos with Needham & Company. Please proceed with your question.

First question was more about the guidance. And I want to come back to maybe some of the comments on guidance during the call. But we're in this macro environment currently, and I know that you guys are, I think the comment was that you're being prudent with guidance. Can you help us think about puts and takes to how you guys thought about guidance coming into this year? Is there -- how did you weigh some of those external factors as headwinds or tailwinds to your business over the course of the next 12 months?

Mike, it's Kevin. So, there's some headwinds and some tailwinds that we obviously evaluate. We're certainly aware of the macro environment and the uncertainty that is out there today. So that's one thing that we've considered. The other thing that we were considering are the investments that we're making and when we think those are going to begin to pay off, as I just mentioned to Fatima. They're growing the direct sales organization, the hyperscalers the Deloitte partnership that we announced this morning, which is very exciting. And I think all those can be some tailwinds, but there is some uncertainty in the actual world. I think that uncertainty though, when Rick and I think about the guidance, I think that's offset by the trend in digital transformation. Companies need to transform and the value that our software delivers help companies operate more efficiently and drive higher ROI. So, those are sort of the things that we consider. We certainly do appreciate we're operating in a different environment than we were 90 days ago, six months ago, and those are things that we put together [indiscernible].

Maybe just building on that for the follow-up. And I did -- I'm trying to put it in comparison to where we were last year when we first got our guidance for the year that we just finished, right? There were still some puts and takes last year when we were thinking about a normalizing environment post-COVID. And we've all seen how that's kind of played out to a certain extent. But is it fair to think that maybe with the current macro environment, there is maybe a bit more conservatism when thinking through, again, the kind of demand environment that we're in today and how these organizations respond accordingly?

I think that's fair, Mike. I think there's a lot of uncertainty out in the world today. And I think that certainly, as we said in the prepared remarks, helped us establish sort of a prudent guide where we are. But we also don't want to get over our speed in terms of the top track here and set expectations too high. We're very bullish on the year. The Company is moving in the right direction, things are in motion and we're excited about it. But given that macro uncertainty, we think the guidance is prudent.

Our next question is coming from the line of Adam Tindle with Raymond James. Please proceed with your question.

Kevin, I just wanted to start on the net new ARR ex-PERP in constant currency, and that's a mouthful it bounces around a little bit, but 7% growth in Q4. I think Russia accounts for a little bit of that. But if you want to maybe unpack a little bit of color on that 7% number in Q4, what the real number would be. And you made some comments on Q1 net new. I just wanted to clarify if you could maybe expand a little bit more on how you're thinking about Q1 net new ARR.

Sure, and for those of you who are interested in our -- on our Investor Relations website, we do have the net new ARR broken out in the Reconciliation. But to answer your question, Mike, in Q4, you're absolutely right. The net new ARR was $71.5 million, actually 7%, and that was impacted by $6 million because of Russia. So normalizing that for Russia, that growth rate was 16%. For the year, as I'm sure you appreciate, the total net new ARR do grow to $267 million, $268 million. That was up 33% on a year-over-year basis. So, that -- we're pleased with that. There was a change in seasonality that we've been talking about in fiscal '21 due to COVID, which made those year-over-year comps a little bit different in fiscal '22. We do believe year-over-year comps in fiscal '23 will normalize a little bit more, meaning, historically, we've always got about 40% of our net new business in the first half and 60% in the back half. That's fairly consistent with what we did in '22, and we think that will continue into '23. So I hope that helps Adam.

And maybe just as a follow-up for Rick, obviously, big shoes to fill. But if you can maybe talk about some key characteristics that you and the Board will be seeking in Kevin's successor. I know you mentioned previously that you might be a little bit more open to M&A, for example. I'm not sure if that was maybe like a core competency that you'd be looking for? Just any kind of general characteristics that will be important to you.

Thanks, Adam. It's big shoes to fill for sure with Kevin. So that's true and great to have them through the end of the year to make sure that we get exactly the right person on board. Dynatrace is a great company in a very exciting market space, obviously, impeccable financial results as we saw this quarter and has seen over the course of the last couple of years and beyond. So, we believe that we will attract a very, very strong candidate into the role. The characteristics, obviously, you want global experience, you want multibillion-dollar scale ideally in terms of capabilities in the person's background and above and beyond all else. Perhaps, I want an exceptional business leader and partner to join our leadership team as we look at it. So, those are some of the elements. You mentioned M&A, Adam. Obviously, M&A tuck in, as we talked about last quarter, is certainly on the docket. We're not looking at transformational M&A, but tuck in M&A is something that we'll look at. So if the person has that kind of experience as well, obviously that's a plus.

Our next question comes from the line of Matt Hedberg with RBC Capital Markets. Please proceed with your question.

This is Anushka for Matt Hedberg. So you're continuing to hire at a strong pace, and you're again expecting a similar growth in the quota-carrying reps in fiscal '23 or fiscal '22. Could you expand on how you think about hiring and attracting the right people in this competitive environment with labor shortages and wage inflation?

We are adding very, very strong people. It's been amazing to watch over the last one, two, three quarters. I do introductory meetings with new hires, especially in our sales team, but really more broadly in on a very frequent basis. And the engagement passion, enthusiasm that we're getting the quality of the candidates we're seeing by way of resumes is very, very high. So it gives us very strong confidence as we look to FY '23 as to both the numbers of our ability to recruit to the levels that we described in our prepared remarks, but also to the very high quality threshold that we have set for ourselves as we look to the future. So far, end of the year, very, very strong. And I think Dynatrace is a brand is becoming more and more visible. And that brand awareness and recognition is assisting us in making sure we recruit the best talent as well. So, very optimistic on the recruiting front as we look at FY '23.

Next question comes from the line of Koji Ikeda with Bank of America. Please proceed with your question.

Kevin, congrats on the well-deserved upcoming break. I guess maybe the first one for Kevin or for Rick, thinking about the fiscal '23 operating margin guide, looks like it's about 22.5% there kind of at the midpoint. I wanted to ask how you're thinking about the margin guidance framework here, thinking about typical conservatism. Have you thought about it in the past, any sort of return to work or in-person expenses this year? And then I guess kind of following up on the last question, too, any sort of wage inflation or talent retention that's embedded in the guide this year?

Yes, so from a wage inflation standpoint, the market is moving, as I think we all appreciate, and we have looked at that as an organization and made some nice adjustments in terms of cash compensation, also some long-term incentives and equity. So, we use the tools in our tool bag to make sure that we're meeting the requirements and demands of where the market is today. From a margin standpoint, I think the way we think about these investments, these are targeted investments that we're making in the business in fiscal '23. They will happen during the course of the year. It's not going to happen all in one quarter. But then what we will see as we go into fiscal '24 is the margin we appreciate, right? So, getting back to a 25% operating margin in fiscal '24, and frankly, going forward after that, there should be additional leverage in the model. So, the targeted investments this year, bringing margins down from 25% down to about 23%, and then we will see that re-accretion happening shortly thereafter.

And then just one quick follow-up, if I may, pretty simple question. Just kind of thinking about the guidance here for the full year, both from a revenue and a margin standpoint, thinking about the macro-related headwinds out there. I mean, I guess, does it assume the guidance with the macro out there? Does it assume things get better, same or maybe even worse for the rest of the year?

Thanks, Koji. I would say that it's a balanced view in evaluating the macro environment. We believe it's a prudent guide amidst macro constraints and considerations. But we're not making any prediction about the macro environment improving in any material way, either geopolitically or in terms of the macroeconomic environment with respect to inflation or other factors in the market.

I would just add to that just add to that as well, so we're highly instrumented that we brought a very efficient business here for the last six years. We're super well instrumented in terms of visibility and we're making those investments. And if we do see a change in circumstance in the environment, I think you will see us react pretty promptly as well.

Our next question comes from the line of Joel Fishbein with Truist. Please proceed with your question.

Kevin, congrats to you as well and good luck. Rick, on the last call, you talked about doubling down on the Fed. I'd love to get your input on where we are in Fed and observability? And any color you could share there would be really helpful.

Yes. So, the federal government opportunity, I think, is really significant for us. I've been engaged personally in that over the course of the last few months. And it is growing faster than the baseline growth of the Company in terms of overall ARR growth at a very nice fit. I believe it's a significant opportunity for us to place additional bets and investments. So, that's precisely what we're doing as we look to FY '23. So, I'd corroborate all the comments from last quarter in terms of ongoing trends around federal government. And for that matter, also the slight environment we see as well.

Our next question comes from the line of DJ Hynes with Canaccord. Please proceed with your question.

Rick, a two-parter for you on the Deloitte partnership, and then a quick follow-up for Kevin. Just on Deloitte, curious what kind of RFP process went into that? I mean I know they're a customer, so maybe that was enough for them, but talk a little bit about why they landed on Dynatrace? And then part two of the question is just in your experience, does this get more or less likely that other SIs will kind of consolidate and build practices around Dynatrace? I don't know if there are fast followers in that industry or if they'd actually prefer to have some sort of differentiated offering? Any thoughts along those lines would be helpful.

To start, I would say, we are very enthusiastic about the Deloitte partnership. I've spent personal time on this is the senior leadership team of Deloitte, and we believe that there is substantial opportunity in working numbers to look at. And it really does come back to our view of the overall environment for observability because as companies do digital transformative work and go through cloud migrations, we believe that Dynatrace can deliver a cloud done right. And it is that notion of reducing the gap between a digital transformation workload effort and moving to an observability solution with Dynatrace that really is our principal objective. So if we can pull those things together and that's a substantial opportunity, Deloitte can do this for us. We're very excited with the partnership. You asked about how we got this point, they are a customer, but I assure you they did a thorough review based on their input to us of solutions in the market, and they believe that Dynatrace is the best solution for their target customer base, which aligns very nicely to ours and Global 15,000. So that's, I think, why they picked us. I think that this is just an on-ramp to additional opportunities with further global system integrators as we look ahead, because there's ongoing overlap with others as well. I think that there are additional opportunities to come in the future.

And then, Kevin, the follow-up for you. Can you quantify the tax refund, and then confirm has that already been received in fiscal '23?

Yes, DJ, it has. It was a little over $30 million that we received actually in April.

Next question is from the line of Raimo Lenshow from Barclays. Please proceed with your question.

It's Vinod on for Raimo. First, I just want to touch on adoption patterns for some of your newer modules. Can you just talk about how infrastructure growth trended this quarter? And then how have adoption patterns for other solutions like app security, trying to have dynamic infrastructure or are there any differences worth pointing out?

It's Kevin. Yes, the infrastructure module continues to be at last quarter, I think we communicated it about a 70% growth rate on infrastructure module. The growth rate this quarter is fairly consistent with that. So, we're seeing continued adoption of over half of our customers have the infrastructure module. It's also still very early in terms of penetration there. As we've communicated in the past, we believe for every dollar our customer spends in apps on micro services, they should be spending another $1 on the infrastructure side. And right now, they're spending about $0.15 to $0.20 on the dollar. So a big opportunity to continue to expand our customer base there, but also the opportunity -- additional opportunity to expand in our customer base in terms of further penetration. So, that's on the infrastructure side. App Security, given some of the things that happened in the world Log4j, the demand there is very good. We've converted a lot of customers as well. Not a meaningful mover to the ARR line at this point. So, we do think that's going to be a mover as we continue through fiscal '23.

And then just one more for me. You mentioned you've hired about 30% of sales reps this year and you plan on doing that again this year. Can you just remind us how long does it take to get a rep fully productive? And kind of what have you learned over the last year or so, just as an organization in terms of kind of expediting that process?

So, it's in that -- it's in the four- to five-quarter time frame. It is a very big priority for our organization. So, we've made big investments in terms of our sales enablement organization our training ongoing education. We just had our big sales kickoff that Rick mentioned on the call as well, where we've got the whole team together for further education. So, we are making investments and we do believe over the next couple of years, we can make a meaningful improvement in time to productivity.

Next question is from the line of Kamil Mielczarek with William Blair. Please proceed with your question.

One more follow-up on the macro. So, we've heard from several other software companies this earnings season that while demand was generally strong. Some companies did see one or two deals slip in Europe. Can you talk about what you're seeing in that market? And more generally, have you seen any changes in customer conversations and their willingness to adopt the observability tools?

Kamil, it isn't our view that we've seen any slippage in deals at least at the moment, inclusive of Europe. So, we are not seeing that as an impact to our business at the current time. It's certainly possible that, that changes in the future. But at least so far, our pipeline and deal flow has continued to remain in roughly the same rate as expected.

And Rick, you spoke about the lag between cloud transitions and adoption of observability. And we talked about this in the past where often the Company first tries an open source product or attempts to build something internally, which, as you mentioned, is very difficult to do today. So, two questions on that. First, can you provide more detail on what you're doing to cut down that lag in purchasing decisions? And second, we've seen strong rates of cloud transitions over the past two years and likely acceleration in '21. Do you think Dynatrace is seeing the benefits of these accelerated cloud transitions today? Or given the lag, is there potential for this to be a driver of higher levels of net new customer wins later this year or maybe in fiscal '24?

I think, yes, in terms of seeing the benefit of cloud transition, the movement of customers and Global 15,000 companies, in particular, to the cloud is absolutely fueling demand for Dynatrace and fueling the increased interest in the Dynatrace platform. So, I'd say, absolutely is the answer to that question. In terms of the lag, that really is the opportunity that we're driving against, how do we shorten that gap between the time of the cloud migration and an observability decision? And so too many customers or companies are deploying home build solutions, simple dashboard and space on open source tools, and it is those companies that deploy Dynatrace out to show at the time of cloud migration that we believe get the best performance. In terms of their overall cloud platform and get the best results, in terms of precise answers rather than dashboards and data to glass. So that's really what we're pushing. How are we doing that? Partners as well as our direct efforts in terms of new logo generation, where we've been talking about partnerships like the Deloitte partnership should help in that regard. So, that's where we're focused.

Our next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed with your question.

Congrats on a fantastic finish to fiscal year. Rick, I'm curious to get your perspective on customer conversations given that your customers presumably have labor shortage, supply chain shortage, inflationary pressures, how are they prioritizing Dynatrace? And what do those ROI conversations look like, especially since you've had 1.5 months or so after the quarter ended? Are there -- is there any change in the tone of how Dynatrace is being prioritized? And I have a follow-up question for Kevin.

Cash, I would say that if anything, the ROI for Dynatrace is as strong as ever, especially amidst IT shortages of personnel, as well as wage inflation in that market. It's very difficult, as you all know, to retain IT people at the current time. And that's resulting in a need for greater automation, automation of tools, automation of processes et cetera. Dynatrace can bring that to companies. And so if anything, we should be able to deliver improved results to companies that are experiencing those kinds of shortages. We actually do see it as well in terms of ongoing strength of our services bookings in that more companies are asking us to do more work for them in terms of deployments to ensure that we get seeded as quickly and effectively as possible inside the infrastructures.

Kevin, congratulations on your retirement. I was wondering, if I could get your perspective on the quality of the customer base kind of exposure to unprofitable tech companies, if you will, that is somewhat material or not your company for certain other companies. And the risk factors associated with collectability, ongoing business conditions for certain aspects of your customer base that may be impacted by the recession. Maybe we're starting to see some negative effect, but maybe you're more insulated. But any statistics you get thrown with respect to the diversification of your customer base or industry verticals and the quality of their own financials that can give you more conviction that those pressures are not an issue for you guys?

Thanks, Kash, appreciate it. Look, we're very excited about customer base that we have, right? We target, as you know, the Global 15,000 largest enterprises in the world. We had best-in-class retention rates. And so, we're enterprise-first, we had very high-quality revenue, and we think that's going to be very durable for the long term. So, it's low churn, sticky products, high ROI. And when CIOs, CTOs, they're looking to make investments we believe observability is going to be one of those areas because we're just talking about the value that we deliver, especially in an environment where there's IT shortages. We're going to help these companies become more efficient. So, we've thought about that as well, given the environment that we operate in. We think that's a big asset to the Company.

Kash, I'd like to just add a quick point on the notion that you raised around profitable software companies. It is really important to, I think, to pick and understand that Dynatrace is operating at a very high level of growth, mid-30s adjusted ARR as we discussed, but also a very strong level of profitability and free cash. This is -- as you saw in the guide at 29% to 30% guide for FY '23 in terms of free cash flow at very strong and good operating margins that we expect to actually re-accrete in the early portion of FY '24 into the mid-20% range. And on top of that, a very strong and solid growth, for a company that's been delivering, I guess, a Rule of 60 over the course of the past couple of years. So we intend to continue to operate the Company in a very balanced way and maintaining that profitability and strong cash flow through the future of the Company.

That it's absolutely well appreciated. I was more curious about your customers and their profitability and they're going to renew contracts. But I think Kevin covered that. Thank you so much. Good to see the conviction.

Next question is from the line of Keith Bachman with BMO. Please proceed with your question.

I have two as well. First on the broader side, I wanted to think about how Rick and Kevin, you're thinking about portfolio expansion over the next two years. I think there's a perception in the marketplace that perhaps one your primary competitors is innovating faster and perhaps populating their portfolio more rapidly than you are. And I just wanted to kind of get your take over the next two years, how should investors be thinking about the expansion of portfolio, if you're at X now, what does it look like in two years X plus something? If you could just speak to the investment dollars you're making surrounding R&D and how that might expand your portfolio? And then I have a follow-up, please.

I am very, very pleased with the rate of growth of our innovation engine and how we're investing here. We have, as I mentioned, about 1/3 of the people of Dynatrace in R&D or R&D-related activities. So, this is a very sizable investment for the Company that we're driving forth. We are making investments, as we've discussed in the infrastructure area in the logging area with which we, of course, are very excited and then on into application security, cloud automation and other modules, as I described at the outset. So, we are innovating, innovating aggressively. I do think that there is a difference in perception just based upon overall R&D spend, just relative to where we conduct our R&D primarily across the globe. But that doesn't change the commitment of us to driving the R&D engine as we have been in the past.

And my follow-up, Kevin, probably is more directed to you. And again, sort of preliminary congratulations on your pending transition. What's the behavior been of the perpetual customers? And what I mean by that, have the perpetual customers been leaving that license or that contract in place and just paying the maintenance? Or have there been some conversion of the perpetual either in terms of add-ons or even transitioning away from perpetual? I'm just trying to understand how the underlying economics have flowed and as we think about FY '23, how that may flow.

Yes. If you go back, Keith, a couple of years, and then think about where those customers are today, I would say probably half of those customers have converted to subscription model to a pure model. And the reason they've done that is, when we started to add additional offerings, whether it's AppSec or them or infrastructure, those were only available on a subscription basis. So, over the last couple of years, we've been moving our customers in that direction. And as you also know, in the last six, seven quarters, we haven't sold any new perpetual licenses. So, that underneath the covers, that will lead to preparing.

So, they're converting the perpetual and then moving away from maintenance and converting that to subscription.

At times of expansion, that's when we see doing it. They want to cover more apps, more micro services. They want to add them or infrastructure. Those are the points where we're having those conversations in moving them.

At this time, we're nearing the end of our question-and-answer session. There is time for one final question, which is coming from the line of Gray Powell with BTIG.

Okay. Great. Congratulations on the good results. So, yes, maybe on the new product side, how are you thinking about pricing on the log monitoring product in the second half of the year? How disruptive could you be there to that space? And then, how additive could log monitoring be to your typical customers' build?

Well, the first element on log monitoring is that it is, we believe, a significant opportunity for disruption in the market. We do not look at log monitoring in isolation. That is to say that that we don't look to sell log monitoring in a unique independent way. We really do believe that it is part and parcel to the value of the entire Dynatrace portfolio to have logging capabilities essentially built in to evaluate that along with apps and micro services, infrastructure, AppSec and the other modules that we offer. So that's sort of point number one is we really do believe that it is the value of the portfolio as a whole that log monitoring will get added to. That said, log monitoring in and of itself in terms of the solution that we offer, we believe, there will be a leapfrog solution and will add an opportunity for significant ARR growth into the future as we end up FY '24 and beyond.

And then I guess just a follow-up would be -- I mean, how do you think the traction -- and I know it's really early, -- but how can the traction there compare with what you've seen in the last couple of years with your infrastructure monitoring side? Should it be like as good, better? Any thought there

Logging is really quite consistent with the way that we look at infrastructure in terms of this opportunity for growth. It will be a consumption-based model with the way that logging typically would occur from a pricing standpoint. So, it will be essentially a pricing model that is oriented to consumption around logging. But yes, I think it's safe to think of it as infrastructure like in terms of this opportunity for substantial growth as we look at it.

Yes, very helpful. Thank you very much.

So that brings us to a close. Thank you, all, for joining today. We really do appreciate your support and your engagement with Dynatrace. FY '22 was really an extraordinary year for us. We drove record levels of ARR and revenue growth, very strong operating margins, excellent cash flow. We remain committed to that ongoing strong financial performance for the future. And I can assure you that we've got 3,600 plus or so people who are extremely passionate about the opportunity that Dynatrace has ahead. Thanks very much for joining our call today. We look forward to speaking with all of you in the ongoing events.

This will conclude today's conference. You may disconnect your lines at this time. We thank you for your participation.