Hello and welcome to Dynatrace Fourth Quarter Fiscal 2023 Earnings Call and Webcast. [Operator Instructions] A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Noelle Faris, Vice President of Investor Relations. Please go ahead, Noelle.

Good morning and thank you for joining Dynatrace’s fourth quarter and fiscal 2023 earnings conference call. 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-K 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. Unless otherwise noted, the growth rates we discussed 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 today's 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?

Thanks, Noelle and good morning, everyone. Thank you for joining us for today's call. Dynatrace delivered an exceptional finished FY 2023 with fourth 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. 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 FY ‘24 and beyond. Let's start with our market opportunity. We believe the estimated $50 billion 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, help customers navigate AI initiatives and are in early stages of actively…

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 were driven by the combination of solid new logo lands to the Dynatrace platform. The ongoing expansion of existing customers 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. Now let's dive into the fourth 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. Total ARR for the fourth quarter ended at $1.25 billion, an increase of $252 million year-over-year. Foreign exchange was a $29 million headwind year-over-year. Excluding the impact of currency and the perpetual license roll off, we added $84 million…

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Mike Cikos from Needham & Company. Your line is now live.

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? When I think about the $13 million that came in Q4 that was 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.

I'll take that, Mike, that's a good question. The $13 million 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 first quarter. And in some cases, they were going to be doing expansions anyways, 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 and had some pretty significant expansions associated with them.

Terrific. Thank you for the color on that. 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 adopted this at the earlier stages? And thank you again.

Hi, Mike, it's Rick. So we now are up from where we were last ordered about 100 customers on DPS, which were the really the largest customers to already about 130, that continues to grow and we expect to grow over the course of FY 2024. By many, many 100s. 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 at DPS customers, so that we've had on the platform using DPS for some time.

Thank you very much.

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

Great. Thanks for taking my questions guys. Congrats on a really strong quarter. Rick, maybe to start with you, you know, you spend a little bit of time in the prepared remarks talking about generative AI being a tailwind to the platform. I guess I'm wondering from sort of a more holistic perspective, can you talk about the long-term monetization strategy there? I mean what -- how would we see it show up perhaps in ARR growth in the future?

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 10 times multiplier in software development efficiency. So given that, that's going to drive a huge number of additional applications. 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 too quick, maybe additional points on this since I figured this would be a key question. First, generative AI and causal AI, which is the brand of AI that we deliver are highly, highly synergistic. 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 Chat DQL, 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 two 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.

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

No. Yes that's a great question, I'll start with we had a fantastic finish to the year and as we enter fiscal ‘24, we're actually in a really good position relative to the tenure of our sales organization. So a tenure of our reps that are two-plus years, it is very, very high. So we're in a good position. So we 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.

Thank you.

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

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 and starting to deploy it as it really does seem like a unique data storage to capture and analyze data for both observability and the security use cases? Thanks.

Sure, Vinod. Let me take that one. The Grail, remember, is simply an underlying core technology that we use in the platform as a data store that is a massively parallel processing data lake house. And what it does is it enables the aggregation of data, whether they be logs, traces, routes, metrics, our sSmartscape topology map, et cetera. That then enables us to monetize that through the sale of very separate modules, all of which use Grail as an underlying platform element, but 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 Grail, so that's the way to think about it.

Thanks. Appreciate that. And then I think Grail was initially available on AWS. When do you expect it to be available on all of the hyperscalers?

We continue to work to deliver that, and we expect that we'll deliver that on the next platform over FY ‘24.

Thanks.

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

Thank you very much. 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 becoming less APM-centric and more broadly diversified. Can you talk about the shift in the business and how the go to market and product organizations are allowing 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? Thank you so much, congratulations.

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 three 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 application security, digital experience management for real-time user feedback. So the net of that is we will expect to see an ongoing evolution toward accessing the platform through one or more of the use cases I described in the prepared remarks. But then ultimately, the destination for most of them is really to use the entire platform over the course of time.

Yes. And the added color on what have we seen? 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. 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.

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 DPS. 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.

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

Great, thank you. Congrats on another great quarter and a great close to the fiscal year. I just have two quick questions for you. I guess I wanted to ask about the Grail in the SaaS platform. How much of a revenue or an ARR uplift are you seeing from customers that move from on-prem to your Grail-based SaaS platform?

Let me 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 platform.

10%, okay. Thank you. And then I wanted to ask about your operating margin. So you mentioned, I think, Rick, you said you expect modest margin expansion in fiscal ‘24, but you guided margins flat at 25%, 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.

Yes. I mean, so we landed in fiscal ‘23 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 bp improvement in margins. As you can imagine, as a reminder, obviously, we are a rare breed of company that has balanced growth and profitability, having growth in the 20s, in 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. 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.

Super. Thank you, guys.

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

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 parallel processing like house. Thanks, guys.

Koji, we already have a customer doing 100 terabytes or more of storage in real time on Grail. So we think we've already proven that scale, and we are fusing 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 towards both reducing the log management costs, as well as increasing its effectiveness.

Got it. Thanks, Rick. And maybe just a follow-up. In the prepared remarks, the commentary on the potential AI tailwinds sounded pretty bullish, and I was just wondering, just to be super clear here on the FY ‘24 guide, is there any embedded tailwinds from AI in the guidance? Or -- and if there is, could you please quantify that magnitude? Thanks, guys. Thanks so much for taking the questions.

Right, Koji. No embedded tailwind in AI. This is new. It's exciting. 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 ‘24 guide for generative AI.

Thank you, Rick. Thanks so much for taking the questions.

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

Great. Rick, just want to circle back on generative AI. And 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?

Will, 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 of Perform around chat DQL. This is really exciting. Imagine if you're a user of the Dynatrace platform today, you have to write DQL queries. Now the good news is this is a very common language and our end users have this capability in spade, 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 and extending the Dynatrace platform to more end users. And then lastly, imagine if you were using one of the hyperscalers, AI -- generative AI platforms and that you can actually use that to query the Dynatrace data using causal AI, also a strong extension of the platform. So these are some of the areas in which we could imagine this evolving.

Okay, I appreciate that. And maybe just as a follow-up, kind of, sticking with the automation analytics theme coming out of your user conference, a big focus on automation engine, app engine. I wonder any other -- any early color you could provide in terms of customer interest and progress on those fronts?

The way that I would answer that, Will, is that we really do see FY ‘24 as the year of adoption. So we are really driving through our customer success team, our services teams, their SEs and other trials, POCs, deployment of these capabilities, because we think that it makes the 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. Too early to really say too much more about it, but excited with the early returns.

Thank you.

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

Oh, 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 becoming part of the reference architectures. Do you see Dynatrace 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? And as that evolves, does that kind of up levels the opportunity for Dynatrace?

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 and sanitations work better. And the result of that is that we expect that the clients of those GSIs will see the same, and the GSIs 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.

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? When do we see that over the next two, three years?

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 EPS 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 them and infrastructure, and I don't have to come contract for AppSec or log management, I can just extend those within my existing contract. It creates less friction.

Got it. Thank you.

Thank you. Next question today is coming from Keith Bachman from BMO. Your line is noe live.

Hui, 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 talk to a large customer. So it's inevitable, they will adopt Grail, because of the way the data set 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? And when you referenced 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.

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, we -- 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 million over a three-year span that gets us there by the end of FY ‘25. We continue to expect that outcome. And then lastly, with regard to Grail deployment, this is a very important question, because we expect rail, just to be very clear, again, is underlying core technology to be present in 100% of our installed base over the course of time. Log management using Grail won't necessarily be 100%, but Grail is simply an underlying data store. And that data store will be used across the entire platform.

Okay, yes. That’s exactly where I was getting to. Many thanks.

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

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 take security? And then on the $100 million target by the end of fiscal ‘25, just how should we think about the linearity to get there? Thank you.

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.

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

Okay. Well, thank you all very much. In closing, we are very, very pleased with the finish to fiscal ‘23. We're very bullish about the opportunity that lies ahead, as you can tell. 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.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.