Ladies and gentlemen, thank you for standing by, and welcome to the Dynatrace Second Quarter 2020 Earnings Conference Call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions. I would now like to hand the conference over to your speaker today, Mr. Michael Bowen, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon and thank you for joining us today to review Dynatrace's second quarter fiscal 2020 financial results. With me on the call today are John Van Siclen, Chief Executive Officer; and Kevin Burns, Chief Financial Officer. After prepared remarks, we will open up the call for a question-and-answer session. Before we start, I'd like to draw your attention to the Safe Harbor statement included in today's press release. During this call, we'll make statements related to our business that may be considered forward-looking within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21-E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact are forward-looking statements, including statements regarding management's expectations of future financial and operational performance and operational expenditures; expected growth and business outlook, including our financial guidance for the third-fiscal quarter and full year 2020. Forward-looking statements reflect our views only as of today. And except as required by law, we undertake no obligation to update or revise these forward-looking statements. Please refer to the cautionary language in today's press release and to our Form 10-Q, which was filed with the SEC on September 5, 2019; and our other SEC filings for a discussion of the risks and uncertainties that could cause actual results to differ materially from expectations. During the course of today's call, we'll refer to certain non-GAAP financial measures as defined by Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed and a reconciliation of the differences between each non-GAAP financial measure and the comparable GAAP financial measure can be found within our second fiscal quarter 2020 earnings press release in the Investor Relations section of our website at dynatrace.com. With that, I'd like to turn the call over to our chief executive officer, John Van Siclen. John?

Thanks, Michael. And I'd like to start by thanking all of you for joining us today. We are very pleased with the company's performance in the second quarter, which resulted in financial results and were better than our top line and bottom line guidance. I'm especially pleased that ARR increased by a robust 44% year-on-year to $471 million, with our new Dynatrace platform now making up 80% of total ARR, up from 75% a quarter ago. Fueled by continued strong growth in ARR our subscription plus services revenue what we see as the best measure of growth on our P&L, increased by 37% year-over-year, up from 36% last quarter. As we look ahead, we remain optimistic about the business outlook as our new Dynatrace platform continues to be adopted by a growing number of new enterprise customers, and each quarter, we are proving our ability to expand rapidly within our growing customer base. This optimism is reflected in the increased top line guidance that Kevin will detail in a few minutes. We're also proud that our rapid growth is complemented by strong operating margins. Not only did our top-line results exceed our Q2 guidance, our bottom line delivered stronger-than-expected results as well. We run a very efficient business with gross margin at 83% and EBITDA at 25%. We continue to be cash flow positive on an operating basis while investing across the board in growth. As we've said before, we believe in running a balanced business, a unique combination of growth and profitability at scale. We believe this balance, combined with our focus on investing aggressively in commercial expansion and continuous innovation provides Dynatrace with attractive durability over the long term. Let me now turn to four major advancements made in our fiscal Q2. New logo expansion; customer net expansion…

Thank you, John, and good afternoon, everyone. I'll start by providing a more detailed review of our second quarter performance, and then I will finish with our outlook for the third quarter and increased full-year guidance. Following my remarks, we will open the call for questions. Our key financial metric focused on business momentum is annual recurring revenue. For the second quarter, ARR was $470.9 million, an increase of 44% year-over-year. The Dynatrace platform continues to increase as a percent of total ARR and was $376.8 million at the end of September, which was 80% of our total ARR. The remaining 20% of our ARR relates to our Classic offering. We continue to track very well here and expect to be substantially complete with moving our customers to our new platform in the next four quarters. As you may recall, we started the conversion program with our sales organization six quarters ago, and to-date, we have converted more than 50% of the Classic base. And we are actively working with the remaining customers on conversion programs and timelines. Overall, we have had a very good line of sight to completion, and we are very pleased with the success of the program and the benefits that have been realized by our customers once on the new platform. Circling back to total ARR. There are two ARR growth drivers in our business. The first is new logo customers, and the second is our Dynatrace net expansion rate. If we quickly break down these two ARR growth drivers, during the quarter, we added 250 net new Dynatrace customers, ending the quarter with 1,828 Dynatrace customers. Consistent with recent quarters, net new customers were a healthy balance of adding new logos to the franchise as well as Classic customers moving to the Dynatrace platform.…

[Operator instructions] Your first question will come from the line of Sterling Auty of JPMorgan.

This is Matt on for Sterling. Thanks for taking my question and congrats on the quarter. So, the first question is just wanted to kind of get a sense of the traction that you're getting from customers that are buying those three main solutions of the APM infrastructure and logging. And the follow-up is just in regard to pricing structure in logging, how do you guys feel about that given where Datadog is and also, the changes being made at Splunk? Thanks.

Sure, Matt. So, from a competitive landscape perspective, we haven't seen much change, honestly, since we last talked. What we see in our world, as you know, we land with APM sort of as a core strength, the application, user-experience segments. That serves us well. The market is in needs our kind of platform for dynamic web-scale workloads. And where we're seeing more and more customers hit what we call the micro services wall as we go forward where they have just classic tooling that just can't keep up with the scale or dynamism of those environments. So, our competitive position continues to be very strong. We continue to win against all competition in that area and as evidenced with the new logo growth as we go forward. The other modules are what we've talked about is expand plays and the cross-selling into the infrastructure-only hosts, which we consider also part of logs going to that offering for us. That is starting to expand well. But most of our expansion and as I've said before, continues to come from just more Dynatrace into more application workloads -- cloud application workloads because they're so underpenetrated, it's a very straightforward expansion opportunity for us. So that continues to be the strongest. Maybe the last thing I ought to say in the competitive landscape front is we really don't overlap, certainly not yet, with some of these other competitors coming out of the infrastructure space. They're still trying to bring together their observability solutions, something we've had for the last four years. And we continue to increase the value of our platform, driving better business outcomes with things like user experience capabilities, and as I noted in my comments earlier, Digital Business Analytics.

Great, thank you, guys.

And our next question will come from the line of Matt Hedberg of RBC Capital Markets. Please go ahead, your line is open.

Congrats on the quarter. Certainly, seeing ARR accelerate at scale is impressive, and I think in your prepared remarks, you're clearly having success converting Classic customers. But I guess on the new customer front, can you talk about what percentage of those are greenfield wins versus competitive displacements?

Sure. In general, the greenfield is about 1/3 of what we see. We see more competitive displacements, whether that's actual head-to-head sort of bake-off with someone or we're replacing sort of a combination of tools in more of a do-it-yourself kind of setup. So, that's been consistent for us over the last year, couple of years.

That's great. And then seeing the net expansion north of 120% is great. And I guess I think on the roadshow, you guys talked about maybe 5% of the industries is currently monitoring their apps. Kind of I guess I'm wondering, when you look at some of your more sophisticated customers, do you have a sense for sort of what percentage of their apps are being monitored?

Our best estimates are even at the high end, they're in the 20% to 30% range with the Dynatrace, but they all want to get to 50-plus. So, there's plenty of headroom. And those at the very top end, most customers are really are in that 5%, probably on average, growing number getting up to 10% because the expansion of our new platform is so easy. But still early days, and there's still a lot of headroom just on that application side before you even get to the cross-sell into additional ITOM use cases.

Makes a lot of sense, guys. Thanks again.

Your next question will come from the line of Heather Bellini of Goldman Sachs. Please go ahead, your line is open.

Hi, this is Caroline on for Heather. I was just curious about the retention rates of the customers that have been converting over to the new Dynatrace platform. Curious as to how that has been trending. And then also, are you seeing those customers add additional workloads as they convert over?

So, from a conversion standpoint, the new platform is extremely sticky. The use cases are wider. The value is quicker to realize. The connective tissue between sort of the infrastructure and application monitoring with driving better business outcomes is clearer and more straightforward. So it's been a great advantage to us as we move people across on to the Dynatrace platform. The second part of the question?

Second part is just in terms of the renewal rate, and I'll take it, Caroline. So, if you look at where we've been, we've moved about $100 million off of the Classic stack over last six quarters of the member sales organization. That's translated at time of conversion to about $123 million on to the Dynatrace platform. So, we're seeing those customers, when they move off of Classic, expand on to the Dynatrace platform. That's true foot for an expansion. Included in that math is churn -- is a little bit of churn. And I'd say, we're in line with sort of industry-standard churn rates.

Got it, that’s helpful. Thank you.

Your next question will come from the line of Jennifer Lowe of UBS. Please go ahead, your line is open.

Great, thank you. I wanted to go back to some of the earlier conversation in the prepared remarks about big digital transformation project as an opportunity for Dynatrace to come in and really help customers execute on their vision with moving applications into the cloud and then having the sophistication to manage and monitor those applications. And given that there's a lot of players usually involved in those types of digital transformation projects, be it SIs or hyperscalers or other platform solutions, I'd just be curious where in the process Dynatrace comes into those types of transactions. And are there any relationships that help you get in the door to discover where those opportunities exist?

Sure. Good question. Sometimes, we do come in with system integrators. They are responsible sort of as the general contractor for a lot of the larger projects, and they look for the variety of pieces that they need in order to do a proper migration and then scale out of these enterprise clouds. So, we have some very good relationships with the global SI base as well as regional cloud integrators that have sprung up around what is OpenShift or Cloud Foundry, AWS, Azure, et cetera. So that is an important part of our go-to-market portfolio, but we still find the majority of our opportunities through our direct sales organization. And as we talked about before, we target the global 15,000 enterprises. We now have about 1,800 of them penetrated, so a little over 10%. But still a lot of headroom to go. But it's the direct sales organization that finds the cloud architects and application architects coming in through, whether that's DevOps or the operations side of the business, and brings Dynatrace in usually at the time of scale-out of an enterprise cloud. Not when the first applications go into AWS or Azure, but when the company actually has a strategic initiative to build out a much broader multi-cloud strategy.

Great, thank you.

Your next question will come from the line of Bhavan Suri of William Blair. Please go ahead, your line is open.

Thanks for taking my question and congrats. I wanted to touch first on the infrastructure monitoring SKU. Obviously, the end-to-end value proposition of the platform is obviously compelling, but there are some organizations that may want to start out using the infrastructure-only. You offer a separate SKU there, obviously. Can you talk about what level of interest you're seeing and uptake in the infrastructure-only SKU? And then I guess, in cases where you sold it, how successful have you been in migrating those guys up to the full platform?

So Bhavan, we rarely land with infrastructure-only. We use that to expand. The reason a customer -- first, the reason integrators or sales folks land, they will land in full stack application side where folks have sort of a high pain. We have the industry-leading solution there. So, it's pretty obvious that they're going to focus there first. The reason people come to us for the infrastructure-only host extension is because once they get the hang of the value of our integrated AI engine, Davis, they realize that to see that live topology all at once and have it all sort of monitor 24x7 by an intelligent assistant, it makes their life so much easier across a much wider landscape. So that's how we go-to-market today. Maybe that will change in the future, but I don't think that's dissimilar to some of our competitors, land in a position of strength and expand from there.

Got it. That's helpful. Maybe touching on one other product, the DEM, obviously. You talked about the digital experience, seeing attach rates ticking up. I think we talked about it last quarter. I guess as you think about that, just an update on what you're seeing there as people have come back sort of out of DMPs, especially their transition to the cloud. So just trying to get some of the color on what you're seeing there, too. Thank you.

That's an interesting one as well. A couple of years ago, there was a low demand for digital experience as everybody were just standing up their clouds and they were spending more time just trying to figure out how to make the infrastructure itself work and try to get it in shape for business-critical workloads. But now we see the workloads starting to hit the cloud platforms at an accelerated rate. And with this, the appreciation of understanding user experience has climbed dramatically. Our attach rate's up considerably over a year ago and the scale-out of the digital experience module continues to get great traction in our customer base. I gave an example just a few minutes ago of one customer, but pretty much anyone who has some kind of an e-commerce or some kind of an important customer-facing application is a great candidate for extended DEM use from Dynatrace.

That was really helpful. If I could squeeze one more product one in. You obviously announced a new product. I'm focusing on product just today, as you can tell, but the new Digital Business Analytics module obviously sounds really interesting. You've obviously had AI, but just, a, can you just talk a little bit about module, who you sell it to; and the pricing and interest from customers. Thank you.

Sure. So, currently, the folks, the landing zone is really with the operations folks who want to connect with the digital business owners and provide more value and service to that group. Over time, as we build out the analytics and some of the integrations with some of the other business analytics tooling that the business folks use, we're hoping to actually break into the business budgets as well. And that's a key part of driving full TAM expansion in this area for us as we go forward. The way we're pricing this module initially is through data ingestion. But over time, we'll expand that monetization opportunity, as I said, some additional analytics become available and some other pieces that we have on the road map to extend our functionality in this area to fit the business user needs. As we just said -- let me just add real quick that this is a product extensionary that we've been eyeing for a while. We're really excited about it customers are excited about it because it gives them a direct connection between some of this sort of metrics and problem determination, items under the hood directly with business outcome metrics. And that connective tissue to be that tight is something that every customer looks for as they try to drive their digital business initiatives forward.

Especially in real-time, yes, yes.

Yes. Especially in real time, exactly.

Thanks guys. Thanks for taking my questions. Congrats.

Your next question will come from the line of Richard Davis of Canaccord. Please go ahead, your line is open.

Thanks. Clearly, the analytics AI engine will sell because it has a name Davis, so we'll just leave it at that. I appreciate that part. So, in any case, I've been talking to a bunch of investors lately. So, one of the things that they get confused on is that sometimes they think Dynatrace and other firms like Google are kind of like an either/or decision. And in our field checks, at least what we found, and I think you guys have said the same thing, is that this is not the case. And so, could you kind of flesh out how like a Google Analytics and a Dynatrace are complementary not competitive? I'm just trying to help people understand the difference on that. Thanks.

Sure. Well, our business analytics are directly connected with performance, user experience, and connected all the way down into infrastructure and virtual network elements that may or may not be affecting performance issues. So, what we do is we surface and connect this digital business data with that entire full-stack footprint. And nobody does that. Everybody sort of sits on the surface and sort of bubbles along, Google, Adobe, et cetera. What I was alluding to as far as integrations with some of these other solutions that the business side of the house utilize day-to-day, I'm alluding to the sort of tighter integration with some of these other tools like a Google, where they're complementary with each other and brought together and connected, they can be a lot more powerful than each one sort of separate on their own. So that's still for us to do. But as you pointed out, we see them extremely complementary. No head-to-head overlaps there.

Got it, super. Thank you very much.

Your next question will come from the line of Walter Pritchard of Citi. Please go ahead, your line is open.

Thanks. Wondering if you could help sort of quantify the order of magnitude increase when you're selling Business Analytics into a customer. Maybe not initial sale, but how do you see that opportunity progressing relative to what those customers who bought it, either DEM or ACM plus subscription on logging.

Well, today, I would say that from the sort of -- if you're asking what's the order of magnitude of the monetization, I'd say that it's in the sort of a 10% of sort of host unit, maybe probably not $1 per $1 with DEM. DEM is sort of more pervasive at the moment. But over time, it should be equivalent to what the DEM module brings, which is -- think of it as maybe $0.50 on the dollar of host units. So that's the way we think about it. That's what we believe we can achieve as we build out the functionality in this area. The value is certainly extremely high when you can bring business metrics tied with performance and user experience together in real-time for digital business owners. So that's the way we see it today, and that's why I say over time, it's going to continue to scale out in monetization as we add additional value to the solution or to the module.

Got it. And then let me just touch more kind of a question. You saw a nice uptick in new customers in the quarter versus last quarter and well above where you were in 4Q. Wondering if that incremental customer count was more attributable to the brand-new customers or the conversions. I think you mentioned pretty healthy new customer activity, but just curious if you can quantify that and especially in the context of the acceleration in customer adds.

Yes. Well, so new customers, net new logos to the business continue to be the majority of the Dynatrace growth, quarter-over-quarter growth. And the stat that I think Kevin gave you, which is 58% over trailing 12 months, 58% of the new customers added to the Dynatrace platform, somewhere a little over 900 customers there, 58% have been new logos to the business. So, we have a healthy sort of new logo expansion going on in the company, and that's even with a little bit of distraction in our sales organization on the conversions, which we figure is taking about maybe 20% of their time right now until that's behind us. So healthy new logos, as you point out, and room to increase that rate as we free up the sales organization in four short quarters here.

Okay, great. Thanks for the clarification.

Your next question will come from the line of Brent Thill of Jefferies. Please go ahead, your line is open.

Hey guys, thanks. This is Parthiv on for Brent. Just to follow-up on to Walter's question, the new platform customer uptake for the quarter, is that maybe a new marketing motion or some sort of new initiative that maybe is yielding early results? Maybe a little bit more color there will be helpful.

No. I don't think it's that. I think what we're seeing are a couple of things. Obviously, we have an expanding sales organization, so that certainly helps. But what we're also seeing is that the gen 1 and gen 2 monitoring solutions are not just working okay in the dynamic clouds that are now sort of scaling out in production at enterprise level, they actually just don't work. And so, customers are in a scramble. And I think it's what's creating the buzz around this concept of observability. And we've been talking about the fact that the cloud will disrupt everything, and that's why we reinvented our platform for this moment. And we're starting to see it play out in growing scale. And we're sort of lining up with the scale on Kubernetes in some ways because of this. That's why we call it the micro-services wall because that's what customers hit. So as that continues, and that trend continues, I do think our new logo expansion to the franchise will continue to be robust.

Okay, got it. Thanks. And then good to see a strong net expansion, but I wanted to ask about the initial land motion. Maybe what are you seeing in terms of the number of APM hosts deployed on that initial land in the recent cohort of customers relative to what you saw in the past.

The initial land is very consistent with where it's been, in the 90,000 to 100,000 initial land. I mean it's healthy versus a lot of competitors out there that land in very small mid-market footprints. But for us, and you start thinking into enterprise-class customer, that's a pretty modest bite to start with. The exciting thing is that while the land is nice, it's the expansion that has accelerated for us versus our Classic product world. And we're seeing that in the net expansion rates being healthy, and I believe we'll continue to see that over time as we get more comfortable with sort of the cross-selling of some of these other modules into the customer base.

Okay, got it. Thanks. Congrats.

Your next question will come from the line of Raimo Lenschow of Barclays.

Thanks for squeezing me in and congrats from me as well. A quick one. If you John, if you've like a lot of the questions on the call were obviously around like product and how -- observability because you have so many different players. But then you guys are just offering something that is very unique in the market because none of the other APM guys have really rewritten, and you guys are solving one of the most complex issues out there. The question is now like, where are their customers in terms of understanding that in terms of like the microservices wall that you're talking about and that eventually a lot more stuff has to come to you. Are we still in the early innings of that, and hence, your confidence about just kind of growing the customer base coming your way?

We are in the early innings. And it's as fast as we can get out there and have customers to suspend disbelief just long enough to believe that something else, something out there could actually do all this. And it's why we do a proof-of-concept with every customer. It's to show them, not just the Dynatrace advantage, but show them that it actually is true. But it's a key part of our sales motion. The other thing I just wanted to sort of point out here before the call is over is I know there's this talk about how suddenly competitive this space seems to be. I got to tell you that the monitoring space has had dozens and dozens of companies in it for decades now. It's always been a competitive space. It's just that you've sort of forgotten about the fact that they all got swallowed up a handful of big players and turned into sort of suites of tooling. But Dynatrace has competed in a noisy, competitive market for over a decade quite successfully and built a category leader because we think and build product differently. We don't just try to put more metrics out than somebody else. What we try to do is actually solve customer problems and help them drive better business outcomes. So, I think that you're right. We're in a good competitive position. We don't just do observability, we actually do automation and intelligence, which drive greater business value. And I'm really excited about where we are in a competitive position at the right time in the market as this transition to enterprise cloud and the dynamism of these orchestrated workloads -- microservices workloads really hit production at a high level.

Yeah, okay. I leave that as a very good remarks. Thanks, John.

Thank you.

There are no further questions at this time. I'll turn the call back over to the presenters.

Yes. Well, thank you very much for your time this evening. I appreciate it, and I look forward to catching up in 90 days. Thank you, everyone.

And this conclude today’s conference call, you may now disconnect.