Dynatrace Q4 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 15, 2024

There are 11 speakers on the call.

Operator

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Noelle Farris, Vice President of Investor Relations for Dynatrace.

Operator

Thank you. You may begin.

Speaker 1

Good morning, and thank you for joining Dynatrace's 4th quarter and full year fiscal 2024 earnings conference call. Joining me today are Rick McConnell, Chief Executive Officer and Jim Benton, Chief Financial Officer. Before we get started, please note that today's comments include forward looking statements such as statements regarding revenue, earnings guidance and economic conditions. Actual results may differ materially from our expectations due to a number of risks and uncertainties discussed in Dynatrace's SEC filings, including our most recent quarterly report on Form 10 Q and our upcoming annual report on Form 10 ks that we plan to file later this month. The forward looking statements contained in this call represent the company's views on May 15, 2024.

Speaker 1

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 discuss today are non GAAP, reflecting constant currency growth rate, and per share amounts are on a diluted basis. We will also discuss other non GAAP financial measures on today's call. To see reconciliations between non GAAP and GAAP measures, please refer to today's earnings press release and supplemental presentation, which are both posted in the Financial Results section of our IR website. And with that, let me turn the call over to our Chief Executive Officer, Rick McConnell.

Speaker 2

Thanks, Anuel, and good morning, everyone. Thank you for joining us for today's call. Dynatrace delivered a very strong finish to fiscal 2024 having achieved several noteworthy milestones and accomplishments. We surpassed $1,500,000,000 in ARR, representing 50% growth compared to the $1,000,000,000 level 2 years ago. We landed our first 9 figure TCV deal.

Speaker 2

We closed our largest new logo ever, a nearly 8 figure ACV deal. Top analyst firms named Dynatrace a leader 9 times in reports on observability and AI ops over the past year. And during fiscal 2024, we added approximately 300 basis points of non GAAP operating margin from fiscal 2023 plus grew pre tax free cash flow margins by 200 basis points. There are 3 key themes I'd like to highlight as we begin today's call. 1st, we are confident that our expanding observability market.

Speaker 2

2nd, we are benefiting from the evolution toward larger, more strategic observability architecture and vendor consolidation initiatives and we expect this trend to persist. And third, we continue to execute with a business model that is well balanced in growth and profitability. Jim will share more details about our Q4 and FY 'twenty four performance, fiscal 2025 guidance and the share repurchase program we announced earlier today in a moment. In the meantime, I would like to discuss some of the key wins in the quarter, the market opportunity, investments in ongoing platform innovation and our go to market evolution. Starting with some notable wins, last quarter, we shared that we were seeing increased demand for large strategic deals in which customers were looking to make broader observability architecture decisions.

Speaker 2

Our thesis was that Dynatrace is uniquely positioned to benefit from this trend given our proven track record of helping customers eliminate silo tools, significantly improve software performance and user experience, reduced cost and brought organizational innovation and productivity. Our Q4 results show that this thesis played out as we had expected. We successfully closed numerous platform consolidation deals, contributing to a record 18 7 figure ACB wins in the quarter. Among these were the following. We won a 9 figure multiyear TCV expansion with a top 20 global financial institution.

Speaker 2

In a POC, the customer found Dynatrace to have the most advanced offering for cloud and container environments resulting in dramatically reduced time and cost to prevent and resolve incidents. I'm also very pleased that this deal was closed in conjunction with Accenture. We won a mid-eight figure TCV expansion deal with a Fortune 50 corporation. This company is in the process of moving to the cloud and selected Dynatrace to displace their existing monitoring solutions. As part of their digital transformation efforts, they are aiming to have 70% of their applications and 75% of their data in public or private clouds by the end of the year.

Speaker 2

Dynatrace's end to end observability platform was selected to provide a view across their entire hybrid and multi cloud environment. We landed a nearly 8 figure ACV new logo with 1 of the world's largest airlines. It is yet another tool consolidation win, but what ultimately led to this selection was our focus on their business transformation initiatives and how Dynatrace could help them seamlessly transport more than half a 1000000 passengers every day. And we won a 7 figure expansion deal with a large healthcare company that is seeking to enable its developers to focus on innovation rather than performance issues or vulnerabilities. Dynatrace's real time vulnerability analytics and contextual awareness proved the perfect fit and made up nearly half of this expansion deal.

Speaker 2

We believe that these types of larger strategic deals will be a material contributor to our long term growth. And while we are extremely pleased with the number of these large strategic deals that closed in the quarter, they do come with an increased level of variability that will continue to necessitate a prudent approach to guidance. Interest for our newer offerings, including log monitoring and application security, also continues to grow, especially for those customers leveraging our Dynatrace platform subscription or DPS contract vehicle. The airline deal I just mentioned is our largest EPS transaction to date, and they are already leveraging log monitoring. In Q4, approximately 70% of our new logo deals were closed with DPS licensing.

Speaker 2

And we've increased the number of DPS customers from 100 over 700 since DPS became generally available just over a year ago. DPS is now our default offering for new logos and we are driving increased penetration in our significantly faster rate than our ARR growth. Also of note, partner momentum is building. 15 of these 18 7 figure deals were closed in collaboration with partners, especially GSIs and hyperscalers. Turning next to the market, we believe that our success in closing anchor deals provides evidence of the tailwind in what is already a large and GCP reported a combined annualized revenue of nearly $220,000,000,000 growing 24% year over year.

Speaker 2

Each of the hyperscalers mentioned the underlying growth drivers of workloads moving to the cloud as well as Gen AI. Andy Jassy from Amazon stated that 85% or more of the global IT spend remains on premises, and this is before we contemplate Gen AI impact. We believe that Gen AI will over time materially increase developer productivity. This in turn is expected to result in radically more data as well as complexity, both of which play to the strengths and differentiation of Dynatrace given our more than a decade of leadership in AI. On the innovation front, we see our R and D engine as driving an ongoing stream of technology advancements.

Speaker 2

Last year, we released a game changing platform evolution with Grail, an integrated, highly performant and massively scalable data store that keeps all data types, metrics, logs, traces, real user data, business events together in context, providing near real time end to end awareness. RAIL serves as the foundation for all of our solutions, including full stack, infrastructure, log monitoring and application security. Throughout fiscal 2024, the team's relentless focus on market leading innovation was evident with the plethora of platform enhancements that provide further monetization opportunities in core as well as adjacent areas. We believe the Dynatrace platform is highly differentiated and delivers unmatched business value in driving the business transformation initiatives that executives care most about. Our platform is integrated from the front end to the back end.

Speaker 2

We have a single underlying data store where each of the solutions access that data store through the same set of core technologies. We have the industry's leading causal and predictive AI technologies along with automation that provides precise answers in context. In contrast, our peers generally have a series of separate data stores that are aggregated only at the user interface level through manual error prone tagging. This may be effective for SMB Companies, but large complex enterprises recognize the value of Dynatrace's end to end platform with automation and AI enabling them to deliver much more performance software in a highly enriched end user experience. We continue to receive exceptional third party recognition of our platform and resultant market leadership.

Speaker 2

Most recently, we were named a leader in the 2024 Gigaohm Radar Report for Cloud Observability Solutions, positioned as the vendor closest to the center of the radar. Dynatrace was also recognized as a customer's choice in the 2024 Gartner Peer Insights Voice of the Customer for Digital Experience Monitoring Report, the only provider to receive this distinction. We are humbled by this ongoing third party validation of our strategic differentiation, and we remain committed to our ongoing investment to maintain this leadership position. Turning last to our go to market strategy. We recently hosted our annual kickoff in Orlando with our global sales team.

Speaker 2

The energy and excitement were at an all time high. Over the past 10 months, we have added several seasoned leaders with extensive experience scaling large go to market functions with the addition of our Chief Revenue Officer, Chief Marketing Officer and SVB and Partner and Alliances. Sales kickoff provided this new leadership team the opportunity to share their vision and specific plans to execute on our fiscal 2025 go to market strategy. We are enhancing and evolving our go to market approach in 3 focal areas to drive deeper penetration within our installed base and better capture and extend our leadership to maximize the opportunity in front of us. First is customer segmentation.

Speaker 2

We will be increasing the focus of our sales force on the Global 500 and strategic enterprise accounts to drive the highest productivity with the accounts that have the largest potential ARR. Territory and account coverage changes have already been communicated and we are executing accordingly. We are also expanding our international reach and sector specialization consistent with this segmentation approach. And we will be investing in customer success to align these resources to our segmentation mapping to ensure successful deployment, adoption and expansion. The second go to market area, which I mentioned earlier, is our focus on partners.

Speaker 2

Partners today influence more than 2 thirds of our ARR, but they account for only 30% of deal origination, highlighting the enormous white space of opportunity in this area. We are focusing our energy on our highest priority and most impactful partners. We are building a dedicated partner enablement engine to scale our priority partners. And we are simplifying our economic model with partner neutral compensation and a co sale approach with hyperscalers to remove friction and drive closer collaboration. The 3rd and final go to market focal area relates to harnessing our competitive differentiation to drive broader market adoption and deeper installed base penetration.

Speaker 2

We will increasingly focus on end to end observability opportunities as we have discussed. We will continue to drive application performance engagements, our traditional sales motion that enables us to land and expand across our customers' workloads. And finally, we will target cloud modernization efforts in which platform engineers and DevOps teams are responsible for how their organizations develop and release software and require complete visibility of data at scale. In closing, we delivered a fantastic finish to fiscal 2024. And I'd like to thank the approximately 4,700 Dynatracers globally for their incredible commitment to innovation and excellence this past year.

Speaker 2

As we look to fiscal 2025, I'm highly enthusiastic about our prospects. Finishing where I began, the market for observability and application security is growing rapidly. Our end to end platform differentiates us and puts us in a strong competitive position. And finally, we have a solid business model that continues to deliver a strong balance of growth and profitability. Jim, over to you.

Speaker 3

Thank you, Rick, and good morning, everyone. Q4 was indeed a very strong finish to fiscal 2024. Once again, we surpassed the high end of our top line growth and profitability guidance metrics. Our value proposition continues to resonate as enterprises look to consolidate their siloed monitoring tools into a unified observability platform specifically architected to address the growing complexity inherent in dynamic multi cloud enterprise environments. Our results reflect relentless execution by the Dynatrace team, the criticality of observability and application security in the market and our platform differentiation.

Speaker 3

Now let's dive into the Q4 and full year fiscal 2024 results in more detail. Please note, the growth rates mentioned will be on a year over year basis and in constant currency unless otherwise stated. Beginning with annual recurring revenue or ARR. In Q4, as Rick mentioned, we surpassed the $1,500,000,000 threshold for ARR representing 20% growth. This result was 100 basis points above the high end of guidance, driven primarily by our strong execution including many of the large strategic observability architecture vendor consolidation deals we outlined in our last earnings call.

Speaker 3

Our EMEA geo in particular had a tremendous finish to the year. We added $84,000,000 of constant currency net new ARR in the quarter, driven by a record number of 7 figure competitive wins, our largest nearly 8 figure ACV new logo land and our first ever 9 figure TCV expansion. These results clearly demonstrate enterprise customers are choosing Dynatrace for our highly differentiated unified platform with contextual analytics, AI leadership and data driven automation. We closed 168 new logos in the 4th quarter for a total of 692 new logos for the fiscal year, roughly consistent with a year ago. A number of the 7 figure deals added in the quarter were new logos and contributed to the average new logo land size of roughly $140,000 on a trailing 12 month basis.

Speaker 3

As we have shared in the past, we are focused on the quality of new logo lands that have a greater propensity to expand. Our value proposition continues to resonate with enterprise customers that are outgrowing their existing DIY or commercial tooling solutions, seeking business value in tool consolidation and coming to Dynatrace for the depth, breadth and automation of our unified observability platform. Once customers experience the benefits of the Dynatrace platform, they are quick to expand their usage. Our average ARR per customer continues to increase and is approaching $400,000 highlighting the business value we provide to customers. Our gross retention rate is in the mid-90s and continues to be best in class in our industry and net retention rate or NRR was over 111% in the 4th quarter.

Speaker 3

We ended the year with nearly 4,000 Dynatrace customers representing an increase of 10% over last year. Our DPS licensing model continues to see strong traction. As Rick noted, we now have over 700 DPS customers, representing more than 18% of our customer base and over a third of our ARR. We believe our simplified cross platform DPS licensing model will further contribute to growth in NRR over time as customers can more easily gain greater access to newer solutions, encounter less friction in the buying process and enjoy more flexible, predictable and transparent pricing, all of which should lead to more consumption of the capabilities in the platform and deliver more business value for our customers. And while it's still early days for our DPS customers, we're seeing very healthy usage across the platform.

Speaker 3

In fact, consumption of the platform for DPS customers is growing nearly 2 times faster than non DPS customers and an indication of increasing expansion opportunity in the future. Turning to our emerging solution areas of logs and application security traction, we now have roughly 600 customers leveraging each of these solutions and consumption for these offerings is growing very rapidly north of 100% exiting fiscal 20 24. As such, we remain confident in our ability to exceed the $100,000,000 annualized revenue thresholds we set for ourselves some time ago. However, based on current consumption trends, it's more likely we will surpass these thresholds during fiscal 2026 rather than the end of fiscal 2025. Nothing has changed relative to the market opportunity or our competitive differentiation.

Speaker 3

But the increasing market shift away from point solutions to broader end to end observability platform decisions is impacting the sequencing and ramping of deploying these new solutions. Moving on to revenue. Total revenue for the Q4 was $381,000,000 21% growth $4,000,000 above the high end of our guidance. Subscription revenue for the Q4 was $360,000,000 22% growth and $2,000,000 above the high end of our guidance. Shifting to margins, total non GAAP gross margin for the 4th quarter was 84%, consistent with last year.

Speaker 3

Our non GAAP operating income for the Q4 was $95,000,000 $5,000,000 above the high end of guidance due to the combination of revenue upside and disciplined expense management. This resulted in a non GAAP operating margin of 25%, exceeding the top end of guidance by nearly 100 basis points. Non GAAP net income was $89,000,000 or $0.30 per diluted share. This is $0.02 above the high end of guidance, primarily driven by the items I just highlighted. Turning to a quick summary of the financial results for the full year.

Speaker 3

Total revenue was $1,430,000,000 representing 22% growth. Subscription revenue was $1,360,000,000 representing 24% growth. Non GAAP operating income for the year was $398,000,000 resulting in a non GAAP operating margin of 28%. This result is 50 basis points above the high end of guidance and nearly 300 basis points above fiscal 2023 as we have consistently demonstrated our ability to drive further leverage in our business model. Non GAAP net income for the year was $358,000,000 or $1.20 per diluted share.

Speaker 3

Our non GAAP EPS includes an effective cash tax rate of 17.4%. Turning to the balance sheet. As of March 31, we had $883,000,000 of cash and investments and 0 debt. Our free cash flow was $121,000,000 in the 4th quarter and $346,000,000 for the full year or 24% of revenue, exceeding the high end of guidance by 100 basis points. As a reminder, this strong cash flow result includes absorbing nearly 600 basis points impact of cash taxes.

Speaker 3

Adjusted for cash taxes, fiscal 2024 pre tax cash flow was up 34%, representing 30% of revenue and up more than 200 basis points year over year. As our free cash flow profile evolves, our capital allocation strategy also evolves. Our top priority continues to be investing in the business both organically and through solution adjacency acquisitions to help drive sustainable long term growth. Even as we strategically invest, we are equally committed to driving increased free cash flow. Given our strong profitability, cash flow and balance sheet, we also believe the time is right to add a share repurchase program as another strategic use of capital.

Speaker 3

As we announced today, our Board has authorized a $500,000,000 share repurchase program, which we plan to utilize opportunistically based on market conditions. This program underscores our confidence in the business, our conviction in the significant long term opportunities ahead and our commitment to driving exceptional shareholder value. With that, let me turn to guidance. We are confident in the long term growth opportunity for Dynatrace. The addressable market is large and growing.

Speaker 3

The observability and security ecosystem is expanding. The demand environment remains healthy. Our pipeline continues to grow faster than our ARR growth. Financial model is both balanced and durable. Near term, we are mindful of the ongoing dynamic macro landscape.

Speaker 3

And while we've seen resiliency in the observability market, we believe it's appropriate to continue to assume a challenging macro climate in our guidance philosophy. Enterprises continue to be cautious in their spending and our approach to guidance assumes that ongoing budget scrutiny and elongation of sales cycles will persist through fiscal 2025. We also expect the growing trend of larger more strategic deals related to observability architecture and vendor consolidation initiatives will continue. We are well positioned to capitalize on this trend. At the same time, these deals come with increased timing variability and longer duration to close.

Speaker 3

Lastly, as Rick outlined, we are enhancing and evolving our go to market strategy in fiscal 2025. These changes are all designed to drive deeper penetration and customer intimacy within our installed base and better capture and extend our leadership, especially with Strategic Enterprise and Global Account segments. With more than 30% of our accounts now transitioned to new sales reps, our guidance incorporates the potential for some near term impact from these changes as they will take time to mature and begin positively impacting our sales performance. And with that as an opener, let's start with our guidance for the full year with growth rates in constant currency. We expect ARR to be between $1,720,000,000 $1,735,000,000 representing ARR growth of 15% to 16%.

Speaker 3

And while we don't guide to ARR on a quarterly basis, we expect the quarterly seasonality of net new ARR to be similar to fiscal 2024. We expect to provide an update on our full year ARR guidance on our fiscal Q2 earnings call when we have a better sense of our go to market traction. Turning now to revenue. We expect total revenue for the full year to be $1,644,000,000 to $1,658,000,000 up 16% to 17% year over year. Underlying that, subscription revenue is expected to be $1,571,000,000 $1,585,000,000 up 16% to 17%.

Speaker 3

Based on foreign exchange rates, as of April 30, 2024, we expect a $10,000,000 headwind to both ARR and revenue for fiscal year 2025. We expect non GAAP operating income to be between 4.59 dollars $467,000,000 resulting in a non GAAP operating margin of approximately 28% for the year. This represents an anticipated 25 basis point improvement over fiscal 2024. We plan to continue prioritizing investments in R and D, sales capacity, customer success and our partnership program, while realizing additional leverage in other areas. We expect non GAAP net income to be $383,000,000 to $392,000,000 resulting in a non GAAP EPS of $1.26 to $1.29 per diluted share based on roughly 303,000,000 to 305,000,000 shares outstanding.

Speaker 3

Given the strength of our profitability on a GAAP basis, we fully utilized our remaining tax credit carry forwards in fiscal 2024. Further, given our R and D is primarily outside the U. S, we are significantly impacted by internal revenue code Section 174, which requires a 15 year capitalization and amortization period for international R and D. As such, we expect an increase in our effective cash tax rate and related cash taxes in fiscal 2025. Our non GAAP net income and non GAAP EPS calculations assume a non GAAP effective cash tax rate of 22%, up from 17% in fiscal 2024.

Speaker 3

We expect the cash tax rate to stabilize in the low 20s going forward. With incremental cash taxes factored in, we expect free cash flow to be between $386,000,000 to $398,000,000 or 23.5 percent to 24 percent of revenue. The anticipated free cash flow impact from cash taxes is approximately $110,000,000 or 7 percent of revenue, up from $81,000,000 or 6% of revenue in fiscal 2024. Excluding cash taxes, pre tax free cash flow is expected to be between 30% 30.5%, up 50 basis points from fiscal 2024 at the high end of the range. As a helpful reminder for your modeling, due to seasonality and variability in billings, we expect significantly higher free cash flow in the 1st and 4th quarters and significantly lower free cash flow in the second and third quarters.

Speaker 3

Looking now at Q1, we expect total revenue to be between $391,000,000 $393,000,000 or 18% to 19% growth. Subscription revenue is expected to be between $374,000,000 $376,000,000 up 19% year over year. From a profit standpoint, non GAAP operating income is expected to be between $105,000,000 $108,000,000 or 27% to 27.5 percent of revenue. Lastly, non GAAP EPS is expected to be approximately $0.29 to $0.30 per diluted share based on a share count of approximately 301,000,000 to 302,000,000 shares. In summary, we are very pleased with our Q4 and fiscal 2024 performance.

Speaker 3

We are balancing conviction in our long term opportunity with near term prudence as we evolve our go to market to drive customer adoption and support our growing pipeline of large competitive displacement opportunities. We have a strong track record of consistent execution. We are committed to maintaining a disciplined and balanced approach to optimizing costs, improving efficiency and profitability. At the same time, we will continue to invest in future growth opportunities that we expect will drive long term value. And with that, we will open the line for questions.

Speaker 3

Operator?

Operator

Thank you. At this time, we'll be conducting a question and answer Thank you. Our first question comes from the line of Sanjit Singh with Morgan Stanley. Please proceed with your question.

Speaker 4

Thank you for taking the questions and congrats on the Q4. I wanted to talk a little bit about some of these large deals that you landed in Q4, a 9 figure TCV deal, an 8 figure land deal, sort of reaffirms what you guys have been telling us last couple quarters that there's a lot of these large strategic deals in the pipeline and it looks like you guys got close a healthy amount of them in Q2. Rick, I was wondering if you want to push the go to market changes that you have planned for the early part of the year and the context of the success you're seeing with these large enterprise deals. Should I take the go to market changes, meaning that you're trying to focus more down market and other customer segments or you just need more sort of sales capacity to close more volume of deals, Given the success that you've seen in landing in Q4, I would love to just better understand the rationale for some of these go to market changes that you have planned for the first half of the year? Thank you.

Speaker 2

Good morning, Sanjit. The short form answer is that we're seeing increased momentum, increased traction, increased centralization of the end to end observability and broad based observability architecture decisions. And the result of that is that's where you focus your sales energy. So in the go to market evolution, our focus on things like customer segmentation and partners really to address that end to end observability architecture approach is very consistent with what we're seeing in the market and that's the bet that we're making headed in FY 2025.

Speaker 3

The only other thing I'd add to that is it's Sanjit, it's actually providing more resource at the top of the pyramid. So if you think about the Global 500, the propensity for spend there is significantly higher than those customers that are below that. So we are waiting more resource at the higher end of the pyramid. So that's primarily what we're doing and it's in line with what Rick outlined, which is more end to end of durability decisions tend to occur with very large enterprise customers where our value proposition really thrives.

Speaker 2

Yes. It was great to see the validation of the thesis in 'eighteen anchor deals closed in Q4 greater than $1,000,000 So 7 figure ACV deals, very, very strong performance.

Speaker 4

Yes. No, it's very impressive. As a follow-up, just in terms of what sort of underpins the guidance, it's certainly not you're assuming any sort of improvement in outlook. If you look at some of the things that could drive upside to your guidance, What would be some of the swing factors, if you will, that could get the ARR north of the 15% to 15% guidance?

Speaker 3

Yes, Sanjay, I'll take that. That's a good question. That as we outlined kind of as a context for the guidance, we did suggest that, hey, we think the macro environment is not going to improve, it's not going to worsen. Customers are still leveraging observability as a priority. We did outline that we do expect this trend of architecture for observability decisions to continue.

Speaker 3

And as we outlined around some of these go to market enhancements, what we're doing is we're building in some prudence. I mentioned in my prepared remarks that roughly 30% of our accounts are going to have a new rep. It's already taken place. So this is not like it's going to change throughout the year, but we've changed accounts per rep. We know at times that can result in some near term disruption.

Speaker 3

We've tried to factor that in. So to answer your question directly, to the extent we can minimize that, to the extent some of these larger deals, the timing of them occurs faster. I think those would be 2 factors that would drive improvement to this guide.

Operator

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

Speaker 5

Hi, thank you very much. One question for Rick and one for Jim. So, Rick, clearly, the move up market is working. We are landing big deals, very strategic engagements, and that's great. But it does look like the net expansion rate on a trailing 12 month basis came down.

Speaker 5

So wondering if you could talk about the other side of the fence, the mid market business and what's happening there and what could happen there? And one for you, Jim, looks like net new ARR first phase, first of all, I got to tell you that you guys are one of the very few that disclose net new errors. So thanks for the transparency. The year was down, but the quarter was up. Trend is getting better, right?

Speaker 5

This trend holds, notwithstanding the changes to the field organization, what does that do to the guide? Thank you so much.

Speaker 2

Let me take the first one, Kash. So relative to the net new ARR, in particular, question around mid market, the strategy around mid market is really partners. We talk about that a lot. We are definitely leaned in relative to GSIs and hyperscalers. And that is really how we would expect to attack them in market space, which is through that avenue.

Speaker 2

Jim, on the second piece?

Speaker 3

Well, relative to the net new ARR, one of the things you are right that if you look at the guide, this guide would suggest a slight moderation in net new ARR for the year for fiscal 'twenty 25. As I mentioned to Sanjit, I think there are factors that could drive improvement to that. We actually felt that it was important to start with a guide that we thought reflected some prudence given some of the changes that we outlined. I would tell you, as you know, just from a seasonality perspective, the other thing we included in the prepared remarks is you should expect the net new ARR, Lenny calls seasonality to be similar to what it was in fiscal 2024, which is lighter in the first half and heavier in the second half. In Q1, in particular, because it's the Q1 of the year, Q1 is seasonally our lightest quarter.

Speaker 3

Yes.

Speaker 5

You went through that. That was crystal clear. Absolutely. Appreciate it. But Rick, on the mid market, what's happening in the mid market?

Speaker 5

So why couldn't net expansion rates be back to the 118, 119 that they were versus the 111? It looks like the swing factor is really mid market because the large enterprise is doing really, really well. Thank you so much. I appreciate your patience.

Speaker 2

Yes. I would say again that partners really are going to drive the mid market for us, especially hyperscalers. If you get more granular cash, we would expect GSIs to be headed up market if anything. You look at the 9 digit TCB Accenture deal with large global financial institution, that's the kind of thing that we're going to see out of GSIs. Hyperscaler engagements, we announced the go to market partnership with GCP in the past quarter as well.

Speaker 2

Those are the elements that will likely drive NRR in the mid market.

Operator

Thank you. Our next question comes from the line of Cody Ikeda with Bank of America. Please proceed with your question.

Speaker 6

Yes. Hey, guys. Thanks for taking the questions here. A couple from me. I wanted to ask or go back to the record 18, 7 figure deals and wanted to ask how often was GRAIL a part of those big deals?

Speaker 6

And speaking about consolidation, was it part of that logs on GRAIL replacing incumbent vendors?

Speaker 2

Yes and yes. GRAIL is part of essentially every SaaS deal that we do at this point. So GRAIL remember is not equal to logs. GRAIL is underlying massively parallel processing data store for enormous amounts of data that can be accessed to store all sorts of different data types, logs, traces, metrics, etcetera. Logs access grail and logs are a key element of this end to end observability architecture approach.

Speaker 2

What customers are finding is that the log element really should not be viewed as an independent data type or an independent avenue for things like root cause analysis. They instead want to incorporate all data types into one universal observability orientation. It drives better user experience. It drives lower cost, drives better outcomes. And so logs on Grails are very typically part of the Grails deployments.

Speaker 6

Got it. No, thank you for that. Maybe a follow-up for Jim here. In the past, you said that internally the company thinks of the business as a rule of 50 type business, 20% plus ARR growth with the remainder coming from pre tax free cash flow. And so looking at the guide today, a bit shy of the target, appreciate all the commentary on why the guidance is starting the way that it is.

Speaker 6

But it does sound like when you're looking at the Rule of 50 type business profile, it's mostly falling short from the ARR growth side of the equation. And so how do you view the shape of ARR growth over the next, call it, 12 to 24 months to achieve that target? Or are you thinking about that target a bit differently now? Thank you.

Speaker 3

It's a great question Koji. We still do view very much internally this rule of 50. You're absolutely right. We've done a fantastic job driving leverage in the model with 30% pretax free cash flow margins. So the guide would suggest we're going to be a bit below that for fiscal 2025.

Speaker 3

You can certainly imagine that we're driving the business to a better outcome on the top line. So that is certainly our ambition. And the changes that we're making on the go to market side that Rick outlined, we know those changes may take a little while to kind of mature, but those are the changes that we believe will lead to acceleration in ARR growth. And so that will be the driver of getting us back to rule of 50.

Speaker 6

Thank you. Thank you for taking the question.

Operator

Thank you. Our next question comes from the line of Keith Bachman with BMO Capital Markets. Please proceed with your question.

Speaker 4

Thank you

Speaker 7

for taking the question. I wanted to direct my first question on the why. And what I mean by that is, if we take the feedback that we get from channels, pretty universally that Dynatrace has leading technology, particularly with the advent of GRAIL. And yet if I look at the trends from 2022, 2023, 2024 and what you're guiding to for 2025, there's a steady erosion of growth, particularly if I focus on net new. And while I appreciate you've made some comments on there's some changes to go to market and whatnot, this has been an ongoing trend.

Speaker 7

And I'm just trying to maybe tease out the why a little bit more about the deceleration, particularly in light of if I superimpose our views of what security and logs are doing, it suggests the legacy or core, if you will, is having a more meaningful deceleration. And I'm just trying to understand why, because the elongation of deal cycles, you would think that that anniversaries at some point in time. So it's hard to reconcile that with the amount of deceleration that you're demonstrating. And is it because the underlying market of APM is slowing down? Or is it the fact that you guys are focused on the largest customers, so perhaps spend is tighter there?

Speaker 7

Just really trying to understand not just what this quarter is, which was an excellent quarter, but really what's the trend over the last couple of years? And why is there such significant slowdown and deceleration? Because it doesn't seem that go to market fully explains it.

Speaker 3

Well, I can start with that and Rick you can offer. So one, I remind you that the timeframe that you're talking about is a timeframe where the macro environment worsened materially. So a moderation in growth rates, look at anyone in the software sector that generally has affected all software companies. So that is not unique to Dynatrace. So I would say the growth moderation is not an anomaly.

Speaker 3

I would concur that this guide specifically for fiscal 2025 is prudent. I think we are building changes for the company for the long term. We've not abandoned the land and expand model at all. So that's still a predominant motion. But we do believe in order to get the penetration and growth that we need an adjustment to the go to market model was needed.

Speaker 3

We needed to get more weighting of resources to higher propensity to spend customers. And these customers are the customers that our offering is a sweet spot for them. Our value proposition is really oriented to very enterprise oriented complex environment companies, ensuring we had the right focus there is what we needed to adjust. That is largely the driver. So these changes that we're making, we think, are focusing on the right profile of customers for the value proposition that we provide.

Speaker 3

And that once we navigate through this, will lead to a reacceleration.

Speaker 2

Yes. Keith, I would simply add that we've gone through a platform transition really to GRAIL, number 1. Number 2, we've gone through a go to market transition. So there have been a couple of transitions amidst this macro environment that Jim described as well. And as we think about these trends toward end to end observability architecture decisions that play to our favor, combined with the strength of Braille, the strength of the platform underlying it, along with these go to market changes to take advantage of this market trend, we're very optimistic as we look to the future.

Speaker 7

Okay. Okay. Terrific. And Jim, maybe I'll just direct my follow on question which relate to that. You indicated that the $100,000,000 targets that you had previously anticipated for 2025 are pushing into 2026.

Speaker 7

Was that for both security and for logs? And what which in past conversations, I think you had some more optimism, if you will, around logs. But maybe you could just tease out a little bit why those are being pushed out? And did I hear you correctly that sort of both are pushing into 26?

Speaker 3

Yes. You did. So I'll start with we're making very good traction with both of those. So both areas, we have 600 plus customers leveraging either our application security solution and 600 on the log side. So we're getting good traction.

Speaker 3

I would say on the adoption side, I've always said on logs in particular that the adoption would take a while and that there would be a requirement for an uptick in the back half of fiscal twenty twenty five. Again, we still have confidence and so the market is still good for those offerings. I think our competitive differentiation is still compelling. So I think they will be $100,000,000 plus businesses. We just wanted to be open that we think that that might extend.

Speaker 3

And the reason is, as we see a growing trend of these end to end observability decisions from customers, what we have found and it's still early days is they sequence what they deploy. And when they sequence what they deploy, sometimes they're deploying application observability, infrastructure monitoring, things of that nature first. And logs and application security are like on their roadmap, but those are call it those are following. And so the adoption of those areas we believe are probably going to push a little bit. So we think these businesses will still be $100,000,000 plus businesses.

Speaker 3

We do think this trend of what we're seeing with platform consolidation will change the sequencing and adoption of some of these new emerging areas.

Speaker 7

Okay, terrific.

Speaker 2

Yes. I would also just add the increase in number of log customers to 600, which is up 30% quarter over quarter, increase with substantial growth in consumption.

Speaker 7

Okay, okay, terrific. Thank you.

Operator

Thank you. Our next question comes from the line of Raimo Lenschow with Barclays. Please proceed with your question.

Speaker 8

Thank you. As we as you guys kind of pursue these larger deals, obviously, there's only like a few like can you talk a little bit about like the changes in the vendor landscape that you're kind of dealing with then? Is that kind of consolidation of tools? Are you replacing things? And then on the replacement side, obviously, just then just one big one that comes to mind, but that kind of seem to have locked in a lot of their customers on kind of renewals.

Speaker 8

Can you talk a little bit about the timing then that we could see here in terms of like getting some and then kind of the building momentum on the larger deal side? Thank you.

Speaker 2

Raimo, the landscape is evolving, as I mentioned earlier, really toward an increased view towards centralization of the overall landscape and decisions associated with observability. What we saw, for example, in the large airline example that we provided in our prepared remarks was they felt they were spending too much money to get too little user experience and too many incidents. By consolidating multiple different vendors together, they felt they would improve user experience, reduce cost, and dramatically reduce the number of incidents. And this is the trend that we're seeing. And there are frankly just very few vendors in the space that can provide this solution to that landscape orientation.

Speaker 2

And Dynatrace is core among them.

Speaker 8

Yes. Okay, perfect. And then the for Jim, like in the previous quarters, you talked a little bit about the needs for investments, etcetera. And you were one of the first point out that I need to pre invest into sales capacity, etcetera. If I look at the guidance and the numbers now, it actually looks like you're kind of managing to kind of still show us good profitability levels and still seem to invest well.

Speaker 8

Can you talk a little bit about some of the initiatives you're doing there to achieve that? Thank you and congrats from me as well.

Speaker 3

You're right, Raimo, that one of the things you've always gotten with Dynatrace is a commitment to continue to try to drive leverage and drive balance, as evidenced by what is almost 300 basis points of operating margin expansion this year, 200 basis points of free cash flow. We're going to we are continuing to drive scale across the business. So if you saw leverage in G and A, you should expect to see more leverage in G and A. There's things we're doing around cloud hosting costs where potentially we can drive some modest leverage in gross margin. So I would say it's multiple and it's call it modest in areas, but it adds up.

Speaker 3

The areas that we are making very specific investments are we are making very specific investments in R and D. We expect R and D to actually as a percent of revenue to grow in fiscal 2025. We do think on the sales and marketing side, we will see a little bit of leverage. Some of that leverage will come from to Rick's opening point around partners and driving more through partners. But I do want to make it clear, we are also going to make incremental sales rep investments in fiscal 2025.

Speaker 3

So there will be investments in sales capacity in addition to kind of getting better partner leverage and productivity. So it's a bunch of different areas. And what we're committed to is to stabilize and or expand margins for the business.

Speaker 8

Great. Perfect. Thank you.

Operator

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

Speaker 9

Hey, it's Dan Bergstrom for Matt Hedberg. Thanks for taking our question. So on the partner side, it sounds again like great contribution for partners on those large 7 figure deals. You talked to some white space around new logos for partners in the prepared remarks. Just wondering what maybe can you do to help the origination side of the equation for partners?

Speaker 2

Well, the whole purpose of driving partners is really for that origination. We already have a very substantial percentage of partner influence deals. I mentioned in my prepared remarks over 2 thirds of deals are already partner influenced. So we are deeply engaged with the partner community already. The real thrust around our partner initiatives is to drive that 30% origination higher, which is precisely what we're doing with the GSIs and the hyperscalers.

Speaker 2

So that is the major thrust of our partner strategy.

Speaker 5

Thank you.

Operator

Thank you. Our next question comes from the line of Brent Thill with Jefferies. Please proceed with your question.

Speaker 9

Good morning. I know you mentioned that the changes in the sales force changing out 30% of your logos. I guess, have you done this in the past? And what have you seen? And effectively, what are you trying to achieve?

Speaker 9

It seems like a pretty big change in the go to market. So I'm just curious if you could double click and what you expect to achieve through this?

Speaker 3

Yes. So I'll take that. So every year there is some modest level of account movement. So that's call it not unique. I'd say it is what is unique is having 30% of your accounts now kind of move to a new rep.

Speaker 3

But just to be clear, again, one of the things that we're doing is the sweet spot for Dynatrace is in very large enterprise environments. And when we looked at the resource coverage that we had in the Global 500, we felt we needed to wait more investment there. We needed more sales capacity there that the number of accounts per rep and that part of the kind of coverage pyramid was not the density that we wanted. So we are making more investments. Some of that investment is just reallocating investments from call it the mid commercial to the strategic global accounts.

Speaker 3

Obviously, the whole point of this is those customers have a greater propensity to spend. The more we can do to get better coverage with them, the more I would say the more intimacy and the more penetration we can get for their spend. And so the whole point of it is to drive more dedication of observability spend to Dynatrace with those customers and also garner some new logos in that space that we don't have today. So that's really the focus. And then to Rick's point, it's also leveraging partners kind of in the broader ecosystem.

Speaker 3

And certainly at the bottom end of the pyramid, it's an inside sales motion, which we've had in the past, but adding more capacity there with an inside sales motion. But all of these changes are designed to drive better productivity and to drive an acceleration in bookings and ultimately ARR growth.

Speaker 9

Okay. And I think maybe just tying back to the guide, these actions are accounted for the deceleration you're seeing despite all the hyperscalers seeing accelerating growth and growth that's anywhere between high teens to 40% plus?

Speaker 3

Yes. I would say what we're doing is we're trying to build some prudence that when you make go to market changes like this, we're mindful that sometimes these changes can cause reps to pause. You have reps that are learning new accounts, reps that are building relationships, things of that nature. And that we are trying to build in some prudence that there may be some near term impact from this account movement. As I said, I think it was to Sanjit, what could allow us to do better is if we if as we transition through this, if this disruption that we're modeling doesn't occur, then we could deliver a better outcome.

Speaker 3

And that's certainly what we're striving to do.

Operator

Our final question this morning comes from the line of Fatima Boolani with Citi. Please proceed with your question.

Speaker 10

Hi, good morning. Thank you for taking my questions. Just Jim for you, I wanted to unpack the dollar based net retention rate performance in the quarter. I know macro hasn't necessarily gotten worse, but I was hoping you could speak to some of the puts and takes on that hitting 111% or a 2 point sequential deceleration in the quarter. And if you can paint a pathway for us as to the time and slope of re expansion in this metric, especially when I superimpose some of your commentary around how successful the consumption trends under the DPS selling vehicle are going.

Speaker 10

So I was hoping you could bridge the gap for us in terms of some of the lightness and the compression this quarter and how we can get back to a path towards your historical 120 percent level? And a quick follow-up, please.

Speaker 3

Right. So I'd say you're right that the NRR was just it was I'd say it rounded down from 112 to 111. So a little bit lighter, but I think that's largely driven by the fact that we had a very, very strong new logo quarter. And so sometimes you have quarters where new logos are stronger than expansions. We had a very good new logo quarter.

Speaker 3

You did highlight some important things to make sure we comment on is DPS as a vehicle, still early days, making good traction 18% of our customers, now call it 30 plus percent of our ARR. The fact that these customers are consuming faster is a think of it as a leading indicator. It is a leading indicator that if they consume faster, it means they're getting more value out of the platform. It means they're consuming at a faster rate, which means that is a leading indicator of a future expansion. We're relatively early days with DPS.

Speaker 3

So you think of the cohorts that we have that we've only been at it for a year. And so it will take a little bit of time for this to manifest itself in expansion and in NRR, but that is the expectation. And the leading indicator we're seeing is DPS as a contracting vehicle is doing exactly what we thought, which is allows customers to access the platform without committed SKU based items that they are dollar based commitment. They're leveraging as much of the platform. We believe that you we believe that you will see an earlier expansion that otherwise would have occurred under a SKU based model.

Speaker 3

I think we will see some of that in fiscal 2025. But I think exiting fiscal 2025 is where you'll see even more of that.

Speaker 10

I appreciate that. And just on the point of new logo and new logo growth, I know historically you've talked about an algorithm between acquiring the logos and going down the expansion path with your very loyal and very large customers who have that propensity to spend. But I'm curious if you can please comment on how you're thinking about the new logo trajectory in fiscal 2025 in the context of rebalancing some of your sales capacity resources and straddling the quality versus the quantity dynamic of a new logo acquisition? Thank you.

Speaker 3

Yes, it's a great question. I would say the model hasn't fundamentally changed as far as you know that I'd say today of our ARR, 40% of our ARR roughly comes from new logos, 60% from expansion. That's not going to change fundamentally. Your comment about quantity versus quality of we are very focused on the quality. I'm not as focused on the quantity.

Speaker 3

What we have found is that if we land customers at greater than $100,000 of ARR, they expand much faster. Obviously, what you've seen is this growing trend of architecture decisions. You're going to have some quarters like we had in the Q4 where you're overweighted in that area and they're very, very, very, very large. So I'd say we're focused more on the quality of the land. Some of these go to market changes that we've outlined, I think are again geared towards more quantity, a little bit in the mid market, but I'd say it's primarily quality.

Speaker 3

And so they'll call it the equation we think about is call it roughly 40% of the ARR coming from new, 60% from expansion and I think that's probably going to continue.

Speaker 2

All right. Well, thank you all for your questions and ongoing support. We saw Q4 as a very strong finish to fiscal 2024 and establishing momentum as we head into the new fiscal year. We are quite bullish about the opportunity or end to end observability decisions to come. We look forward to connecting with you at upcoming IR events over the coming weeks and we wish you all a very good day.

Operator

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Dynatrace Q4 2024
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