Dynatrace Inc

NYSE:DT

Greetings. Welcome to Dynatrace's Fiscal Third Quarter 2024 Earnings Call. [Operator Instructions] Please note, this conference is being recorded.

At this time, I'll turn the conference over to Noelle Faris, Vice President of Investor Relations. Noelle, you may now begin.

Good morning, and thank you for joining Dynatrace's Third Quarter Fiscal 2024 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, 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 that was filed earlier today.

The forward-looking statements contained in this call represent the company's views on February 8, 2024. 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 rates and per share amounts are on a diluted basis. We will also discuss other non-GAAP financial measure 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.

Thanks, Noelle, and good morning, everyone. Thank you for joining us for today's call. Our Q3 results of balanced growth, profitability and free cash flow reflect our continued ability to execute successfully in a dynamic market. ARR grew 21% year-over-year. Subscription revenue increased 23% year-over-year. Non-GAAP operating income increased to $105 million or 29% of revenue. And we delivered a 25% free cash flow margin on a trailing 12-month basis or 30% on a pretax basis. These results are a testament to our market leadership, the strategic importance of our differentiated platform and the durability of our business model. Jim will share more details about our Q3 performance and fiscal 2024 guidance in a moment.

In the meantime, I would like to discuss the trends we're seeing in the market, highlights from our Perform customer conference last week and our continued rapid pace of innovation. I'd like to begin with three transformative megatrends that are driving the market. Last week at Perform, we called them Waves. First, cloud modernization continues to drive workloads to the cloud. Second, the AI revolution is sweeping across industries with the opportunity for enormous advancements in innovation and productivity. And third, the escalating threat landscape is increasing the need for more sophisticated cybersecurity protection. These megatrends are occurring amidst an increasing focus by organizations to leverage digital transformation to drive business transformation. But they also bring sizable challenges such as an explosion of data, a massive increase in its complexity, disconnected tools and a need for better analytics. And it is these challenges, especially with the exponential increase in AI workloads that have moved observability and application security from optional to mandatory.

But not all observability and application security tools are created equal. In this world of containers, micro services, hybrid and multi-cloud environments as well as limited resources, it is no longer feasible to use dashboards, alerts and manual triage to manage these workloads . Given this landscape, our approach is radically different in three critical respects. First, the Dynatrace platform enables contextual analytics. We will store all data types, logs, traces, metrics, real user data, business events and others in Grail, an integrated, highly performing and massively scalable data store. By keeping all of these data types together in context, we are able to analyze billions of interdependencies across applications, networks and infrastructure throughout the enterprise. These dependencies are continuously captured, providing virtually instant end-to-end awareness that is not possible to replicate without a unified data store.

Our second key differentiator is our hypermodal AI. For over a decade, Dynatrace customers have relied on the predictive and causal AI techniques of our AI engine, Davis. We expect to make our generative AI capabilities available on the platform through Davis copilot beginning this quarter, thereby bringing the Dynatrace platform to a much wider array of end users. These three AI techniques together deliver a game-changing solution with each making the other eternally more intelligent.

Our third key differentiator is automation. Organizations want broad-based situational awareness and analytics that can lead to an auto remediation of issues. Dynatrace one agent automatically discovers an entire cloud environment, dynamically instruments applications and consistently learns and updates without human scripting or user configuration. The result is a trusted foundation that supports workflows to automate resource optimization and progressive delivery, eliminating the need for manual troubleshooting. This is especially critical during business-impacting incidents.

Contextual analytics, hypermodal AI and automation are three key reasons why Dynatrace is considered a visionary leader in the market. And our customers view these elements as essential in enabling them to navigate the challenges brought on by digital transformation, an explosion of generative AI and the growing threat landscape. These differentiators enable us to deliver actionable answers, rapid resolution and incident prevention. They also drive purchasing behavior for customers across a variety of use cases, including enterprise-wide tool consolidation, cloud native application performance, faster software delivery, cost-effective log management at scale and secure cloud applications.

These trends, differentiators and advantages were certainly top of mind last week at our Perform conference in Las Vegas. It was a tremendously exhilarating event, where we hosted over 2,000 people in person, including customers, prospects and partners plus thousands more virtually. If you weren't able to participate, I encourage you to watch the replay of our main stage presentations and breakout sessions. We, along with several customers and partners, share insights on how these trends and challenges can present business transformation opportunities for customers, especially in the areas of driving innovation, optimizing cost and mitigating risk.

One example of how Dynatrace is helping innovation was from TD Bank. They drive to deliver legendary experiences for their customers, requiring consistently high application availability and performance. They found that by reducing a myriad of tool sets down to one, the team can now focus on driving innovation rather than maintaining complex relationships among tools. Lloyds Banking Group share their story of optimizing cost. They have teamed up with Dynatrace to measure and reduce proactively the carbon footprint of their IT ecosystem. Lloyds Bank is a thought leader in their approach to sustainability, looking to reduce the direct carbon emissions in their operational sectors by at least 75%. Dynatrace has helped Lloyds assess its IT carbon emissions, see where their sustainable efforts are most impactful and identify meaningful opportunities to optimize their digital infrastructure.

A standout example showcasing our ability to mitigate risk comes from the largest application security win in our history, which we closed in Q3. A leading global payment technology company chose Dynatrace because of our ability to immediately identify impactful common vulnerabilities, provide contextual understanding of criticality and pinpoint the exact location of their vulnerabilities, something their existing security tooling was not able to do. It is a fantastic mode of confidence in our security product from a very large organization.

As customers look for ways to drive innovation, optimize cost and mitigate risk, they know that consolidating their existing observability tools in standardizing on a unified platform is the optimal way to do it. As such, another great story from Perform last week came from the VP of Engineering at PicPay, Brazil's financial ecosystem app. He shared his experience using Dynatrace to help them achieve platform observability at massive scale. This encompasses 35 million users and hundreds of Kubernetes clusters with thousands of nodes. PicPay is a newer customer for Dynatrace. They realized that using multiple tools is costly and inefficient. With Dynatrace, they gained the benefits of visibility and automation through a single-unified platform.

PicPay is not alone. We are seeing increased demand in large strategic deals where customers are looking to make broader observability architecture decisions. We believe Dynatrace is in a great position to benefit from this trend, given our proven track record of helping customers eliminates siloed tools, significantly improve software availability and performance, reduce cost and drive organizational innovation and productivity. While these deals are a positive sign of future growth potential, near term, these larger deals add a degree of variability as customers require more time to make these strategic decisions.

We view this increasing trend to consolidate existing observability tools and standardize them on a unified platform as a significant opportunity for us. As such, we are continuing to invest in strategic go-to-market areas such as GSI partnerships, demand generation and targeted sales capacity while also continuing to prioritize investments in R&D.

In addition to the frictionless sales motion that we are driving with hyperscaler partners, we are seeing early positive signs of traction with the investments we've made with GSI partners, such as Accenture, Deloitte, DXC and Kyndryl. It was through one such GSI that we closed a 7-figure Q3 win with a major social media platform. The customer was looking to gain end-to-end visibility into their incredibly complex environment. Our ability to demonstrate the power of AI and automation to greatly reduce outages while saving costs drove the opportunity. We plan to continue to invest in these partnerships, to generate pipeline and gain efficiency as we maintain our focus on scaling the business.

We also plan to continue our investment in targeted sales capacity in the fourth quarter, weighting our resources toward the higher end of our target Global 15,000 market where the propensity to spend is far greater. We are confident that with the evolution of our go-to-market leadership team, we have the right skills and proven track record to scale the team and build the brand to seize this market opportunity.

I'd also like to call out the exciting addition in January of Laura Heisman, the former CMO at VMware as our new Chief Marketing Officer. In addition to our targeted go-to-market investments, we plan to continue investing in our R&D engine to extend our technology leadership position. The team's relentless focus on market-leading innovation was evident last week with the plethora of announcements and new solutions we unveiled to enhance our platform.

First, we announced the availability of Dynatrace AI observability, which enables customers to embrace AI confidently by providing insights into all layers of AI-powered applications, including large language models and generative AI to manage cost, experience, reliability and security.

Second, we announced Dynatrace open pipeline to empower customers with full control of data at the point of ingest, helping customers boost security, ease management and maximize the value of data.

And third, we announced Dynatrace data observability to help ensure that data collected through external sources outside of our one agent such as open telemetry, business systems and through Dynatrace APIs is reliable and accurate for business analytics, smart cloud orchestration and reliable automation. We believe these platform enhancements provide further monetization opportunities as customers drive more usage, more ingest, more storage and most notably, more queries and business analytics.

Before I turn the call over to Jim, I wanted to comment on our plans to acquire Runecast. Adding Runecast to the platform will extend Dynatrace contextual security protection and analytics with Runecast's security posture management. This will enable customers to address the risk of misconfigurations and compliance violations in hybrid and multi-cloud ecosystems based on AI-driven and automated real-time vulnerability assessments. Additionally, it will allow customers to perform threat detection and incident response with full context, detailing their security vulnerabilities, affected applications and attack factors. We are thrilled to welcome this talented team to our R&D organization. In closing, our Q3 results reflect the ongoing demand for automated observability and application security solutions. The durability of our business model and our ability to execute successfully in an evolving marketplace. Our unified platform with contextual analytics, hypermodal AI and automation differentiates us in the market and positions us well relative to competitive alternatives. We believe the market is moving toward us with a desire for fewer solutions, better insights and actionable answers leading to rapid incident resolution and prevention. And we plan to continue to invest strategically in go-to-market areas as well as R&D innovation to capture market opportunity and drive ongoing leadership while maintaining our commitment to balance growth, profitability and free cash flow.

Jim, over to you.

Thank you, Rick, and good morning, everyone. As Rick mentioned, Q3 marks another quarter of solid execution by the Dynatrace team as we once again surpassed the high end of our top line growth and profitability guidance metrics.

Our continued ability to execute successfully in this dynamic environment is a testament to the growing criticality of observability and application security in the market. Our platform differentiation, the value proposition we provide to customers and the ongoing durability of our business model.

Now let me review the third quarter results in more detail. Please note the growth rates mentioned will be year-over-year and in constant currency, unless otherwise stated.

Starting with annual recurring revenue, or ARR, total ARR for the third quarter was $1.43 billion, an increase of $263 million compared to the same period last year, representing 21% growth year-over-year. Net new ARR on a constant currency basis was $70 million in the quarter. In Q3, we added 209 new logos to the Dynatrace platform, roughly consistent with the year ago quarter. As I have shared in the past, we are focused on the quality of new logo lands that have a greater propensity to expand. In Q3, average ARR per new logo came in at roughly $140,000 on a trailing 12-month basis, consistent with Q2 and up 17% year-over-year.

We continue to attract 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. Our gross retention rate remained best-in-class in our industry in the mid-90s and contributed to a net retention rate of 113% in the third quarter, coming in at the high end of our expectations.

When we think about our net retention rate, there are three areas that drive customer expansion. One, growth of existing observability workloads; two, adding new observability workloads; and three, cross-selling new solutions like log management, analytics or application security.

We estimate that our customers are observing only 20% to 30% of their workloads today. We believe these three growth vectors provide us with significant opportunity to expand further within our installed customer base. And as we have highlighted last week at Perform, our innovation engine continues to deliver enhanced platform solutions to increase our upsell and cross-sell opportunities.

In addition, we believe our DPS licensing model will further contribute to growth in the net retention rate over time as customers gain greater access to newer solutions and encounter less friction in the buying process. We continue to see strong momentum and interest in this type of contracting model. In Q3, we closed over 150 DPS deals globally, bringing total DPS customers to roughly 400, representing more than 10% of our customer base.

Moving on to revenue. Total revenue for the third quarter was $365 million, up 21% year-over-year and $6 million above the high end of guidance. And subscription revenue for the third quarter was $348 million, up 23% year-over-year and $8 million above the high end of guidance.

With respect to margins, non-GAAP gross margin for the third quarter was 85%, consistent with the prior quarter and up 100 basis points from Q3 of last year, driven by ongoing cloud hosting efficiency efforts. Our non-GAAP operating income for the third quarter was $105 million, $8 million above the high end of our guidance, driven by the combination of revenue upside and disciplined expense management. This resulted in a non-GAAP operating margin of 29%, exceeding the top end of guidance by 200 basis points. Non-GAAP net income was $96 million or $0.32 per diluted share. This was $0.04 above the high end of our guidance range, driven by the items I just highlighted and a slightly lower tax rate driven by several discrete items related to additional foreign tax credits and incentives.

Our free cash flow was $67 million in the third quarter. As we've discussed in the past, we believe it is best to view free cash flow over a trailing 12-month period due to seasonality and variability in billings quarter-to-quarter. On a trailing 12-month basis, free cash flow was $340 million or 25% of revenue. As a reminder, this includes 500 basis points of impact related to cash taxes. Pretax free cash flow on a trailing 12-month basis was 30% of revenue and up 43% year-over-year.

Finally, we ended the third quarter with a robust balance sheet, including $783 million of cash and zero debt.

Before I move to the guidance details, I want to give you a brief update on the demand environment and trends we are seeing. The observability market opportunity is growing. The demand environment remains healthy and our pipeline continues to grow at a faster pace than our reported ARR growth rate. More specifically, within the sales funnel, we are seeing a growing number of larger and more strategic deals related to observably architecture and vendor consolidation initiatives, and we expect this directional heading to continue.

To give you a sense of the magnitude of this trend, the number of deals in the pipeline greater than $1 million of ACV, both new logo and installed base has increased 39% compared to the same quarter last year. We view the growing number of these deals as a sign that the increasing complexity of managing fragmented tools is becoming unmanageable, and customers are looking for a partner to help them drive business value in tool consolidation. And we believe our highly differentiated unified platform with contextual analytics, AI leadership and data-driven automation position us well to capture these opportunities.

At the same time, given the larger values of these strategic deals and the C-level approvals that they require, they introduced increased variability in terms of timing required to close. As such, we believe it is best to be incrementally more prudent in our near-term guidance.

And with that in mind, let's start with our updated guidance for the full year with growth rates in constant currency. We are lowering our ARR guidance by 100 basis points from our prior guidance to account for the incremental level of prudence related to the timing of the large strategic deals I just mentioned. We now expect ARR to be $1.485 billion to $1.495 billion or 18% to 19% growth year-over-year. As a reminder, we had $13 million of ARR expansions associated with early renewals in the fourth quarter last year. It was the first time in our history as a public company where we saw a sequential increase over our seasonally strongest third quarter, making for a difficult year-over-year compare this Q4.

Given our strong Q3 finish for revenue, we are raising our revenue guidance by approximately $11 million at the midpoint to $1.422 billion and $1.427 billion, up 50 basis points from our prior guidance and representing 22% growth year-over-year. We are raising our subscription revenue guidance by approximately $16 million at the midpoint to $1.352 billion to $1.357 billion or 24% growth year-over-year. This represents an increase of 150 basis points from our prior guidance.

Turning to our bottom line. The strength and resilience of our financial model is evident in our ongoing margin performance. We are committed to investing in future growth opportunities that we expect will drive long-term value while also optimizing costs to drive profitability. We continue to rebalance our cost profile to prioritize our investments in R&D innovation, CSM coverage and strategic go-to-market areas such as GSI partnership, demand generation activities and targeted sales capacity.

With this in mind, we are raising our full year non-GAAP operating income guidance, $9 million. This translates to non-GAAP operating margin guidance of 27.25% to 27.5%, representing an increase of 25 basis points at the low end of the range and 50 basis points at the high end of the range.

We are raising non-GAAP EPS guidance to $1.16 to $1.18 per diluted share, representing an increase of $0.06 at the midpoint of the range. This non-GAAP EPS is based on a diluted share count of 299 million to 300 million shares. We are raising our free cash flow guidance to $330 million to $335 million, an increase of $16 million at the midpoint, representing a free cash flow margin of 23% of revenue, up 50 basis points at the midpoint. And finally, this guidance assumes the acquisition of Runecast, which we expect will close by March 31. This technology tuck-in transaction will not have a material impact on our financial results.

Looking at Q4, we expect total revenue to be between $372 million and $377 million or 18% to 19% growth. Subscription revenue is expected to be between $353 million and $358 million, up 20% to 21% year-over-year. From a profit standpoint, non-GAAP operating income is expected to be between $85 million and $90 million or 23% to 24% of revenue. Keep in mind, we have some seasonal expenses taking place in the fourth quarter, including incremental spend for our Perform customer conference as well as a structural reset of payroll taxes. Non-GAAP EPS is expected to be $0.26 to $0.28 per diluted share.

In summary, we are pleased with our third quarter fiscal '24 performance. We have a proven track record of disciplined execution, balancing top line growth with profitability and free cash flow. We are building incremental prudence in our near-term outlook, while we remain optimistic about our intermediate-term growth opportunities and our growing differentiation in the market.

And with that, we will open the line for questions. Operator?

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jake Roberge with William Blair.

Rick, you've talked the past two quarters about the incremental go-to-market investments you're making. Can you talk about what you're seeing in the top of funnel and pipeline activity that continues to give you confidence to make those investments?

Sure, Jake. Thanks for the question. The short form is we continue to see pipeline growth in advance or higher than our ARR growth. So that's one element. As Jim indicated in his remarks, we see increasing deal size for increased deal sizes really across the board. These are strategic deals. They take a little bit longer to close, but we feel very positive about the pipeline growth that we're seeing at the moment.

Our next question is from the line of Brad Reback with Stifel.

Great. Like net new ARR growth has been [indiscernible] the best for the last kind of 5 or 6 quarters. What needs to improve, execution, economy or both to get back to a more steady growth cadence there?

Well, I would say that the pipeline coverage continues to grow. So that's a positive. We see, as I mentioned in the answer to the prior question, pipeline growth exceeding ARR growth, so that's good. We need to be able to convert that pipeline at a higher rate, and that's going to come with macro improvement that occurs over time. And also, obviously, with sales execution against these larger deals and larger transactions that we mentioned.

Our next question is from the line of Patrick Colville with Scotiabank.

I mean one of the juicy metrics you gave this quarter was the 150 DPS deals. I think you called out that 10% of customers are now in DPS. I mean, I guess, what impact is DPS having on NRR, if at all already? And if it's not having any impact right now, can you just give us a framework as to like when we think DPS might impact NRR ?

Thank you, Patrick. This is Jim. So for DPS, we've talked about this before. What the DPS contracting vehicle gives you is it gives you an ability to get full access to the platform with a unified rate card to a rate card for all of our capabilities as opposed to buying it on a SKU basis. So you commit to a dollar amount for a term and you draw down based on consumption against this rate card. So you can leverage all capabilities on the platform.

So because of that, it's a much more frictionless buying experience. So Patrick, the timing of when you get expansion is you get them on the platform and the expectation, and we've proven this with -- we've had DPS unlimited availability for probably 1.5 years now. And what we have found is that customers that are on such a contracting vehicle consume faster. So when they consume faster, it means it leads to incremental expansion rates.

We're at the very early phase of this. This has been generally available since April. So we're kind of -- I would say where you're going to begin to see this is when you start to see lapsing, call it, in the kind of roughly 12-month horizon. So we track it. And what we do see is that customers that are on a DPS contract consume faster than those that are not on a DPS contract. So our expectation is that we'll see that, but it will probably be in the fiscal '25 period.

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

Good to see you work up on stage making Waves. My question has to do with the timing of the large deals and the close process. Is the pipeline for new ARR is up 39%, then you've got DPS potentially kicking in next year. I'm curious, if you think the next fiscal year, which starts in a few months from now, could show better growth rates than this fiscal year, which obviously is a lagging indicator of the investments you've made in your new products, which [indiscernible] performed, where you expand go-to-market capacity and then towards large deals and the DPS, obviously.

Yes. This is Jim. I'll take that. Obviously, we're not going to provide fiscal '25 guidance on this call. I would say the thesis of the various areas that you talked about, certainly are growth drivers. I'm not going to comment on whether that leads to an acceleration in fiscal '25.

But what I will say, just to make sure that I was clear in the prepared remarks that when you step back and you say, what has fundamentally changed in the last 90 days relative to the pipeline? The pipeline remains strong. We have a growing number of very large vendor consolidation opportunities that I mentioned. So I'd say it's a net positive for Dynatrace because what we're seeing in the market is a trend towards customers doing or considering more tool consolidation, vendor consolidation because of the complexity of the environment of having a bunch of disparate tools. So this is a net positive we believe, for Dynatrace.

The only thing that has changed is that we are building an incremental level of prudence knowing that these deal sizes are very large. They're strategic and the timing for closing them can be a bit variable to pick within a 3-month window. So all we've done is, we tried to build a level of incremental prudence into the guide. There is no change in the demand environment. The demand environment remains healthy.

Kash, let me just add to that. First of all, thanks very much for attending Perform, that's exceptional. What I would say simply is that the market fundamentals here remain, in our view, very strong. And we like our position based on contextual analytics, hypermodal AI and automation to take advantage of a market that really requires this degree of automation to evolve because the number of IT resources that are available to do manual processing of IT workloads is constrained and observability, in particular, sophisticated observability and application security solutions like Dynatrace's are going to become more and more critical, in fact, mission critical in this market as we look at.

Our next question is from the line of Keith Bachman with BMO Capital Markets.

And it was nice to be at Perform last week. I had a question related to the past couple. If we look at the ARR growth and we layer in various scenarios for logs and analytics and security, it suggested a pretty significant degradation of what we'll call the residual business. And I just wondered, a, is that a fair way to look at it? And b, why do you think that's happening with the growth of your new offerings, again, it suggests a pretty significant degradation of residual for lack of a better word.

And Jim, just a clarification, if you could help set our models for next year. Will cash taxes also have an impact in incremental cash taxes on FY '25? Or is it sort of a one -- more of a onetime thing just so we can at least [ add those to ] the framework for our cash flow for next year?

Yes, I'll start with that. So the answer is, cash tax that we've seen, which has been, call it, roughly 500 basis points is going to continue. This is -- fiscal '25 is not a onetime. We are a full cash taxpayer because we are GAAP profitable, and we don't have NOLs or tax loss carryforward. So you should expect that the cash tax that we have in fiscal '25 will continue going forward. Obviously, there's always strategic tax planning efforts that we're going through. But as a general answer, you should expect that, that will continue.

Relative to the...

But to say, yes, sorry, just at the same rate though, right? It doesn't get incrementally worse. So it's the same, right...

I would say I'm not going to guide for fiscal '25. But I will tell you that as you become more profitable, you're going to pay more taxes. So whether that rate grows a little bit or not, I'm not going to say, but it's going to be at a minimum, what it currently is at.

Okay. Fair.

And relative to ARR, we don't unpack for you at a level of detail all the product categories. So I think I would kind of remind you a bit that we are still on the early phase of the journey for application security and for logs. So we've talked about those businesses exiting fiscal '25 being at $100 million ARR. We've been at AppSec a little bit longer than logs.

The -- but the point is that what you're going to see is we talked about logs in particular, that log starts with the POC. It then goes to a kind of smaller workloads in a production environment. The next phase in that journey is you have newer workloads in a production environment.

And then the last phase being you're kind of leveraging existing workloads. So we're still in the very early phases of that journey. So when you think about our kind of product cuts that today, logs and AppSec don't make up a material portion of our ARR. Certainly, the areas that we've been strong in all along around full stack infrastructure, DEM. Those continue to be the horses that drive most of ARR.

And I'd say what you should expect is that we're going to continue to see an acceleration in application security and in logs, but the hockey stick, so to speak, will happen in fiscal '25, that's our expectation.

Keith, I might add that quarter-over-quarter, we saw a 50% increase in paying logs, customers -- log management customers and an additional 30% increase in POCs on log management. So we do continue to see traction in this new offering.

Our next question is from the line of Matt Hedberg with RBC Capital Markets.

I guess for either of you, regarding the ARR commentary, and I think the uncertainty of large deal timing, did any abnormal large deals push out of the quarter? And I guess, are there things that either your sales force or partners are focused on to accelerate the closing of -- what sounds like a growing pipeline of these large deals that could ultimately start to have a positive impact on growth?

Yes. I guess I will take that. Relative to these deals that we're seeing and whether they had kind of some of them that pushed out of Q3, I'd say you always have deals that push out of a quarter that you pull into a quarter. But I would say nothing, Matt, that's like notable. These are deals that, as you can imagine, they've been in the funnel. They don't happen overnight. And as they progress, you get a better assessment of kind of the deal size and the deal timing.

And the good news is these deals, many of them have been growing as we've been working through the sales process. So we're actually in a good position relative to the health of the funnel. The only thing that has fundamentally changed is, as I mentioned, the timing. And the challenge with deals like these is there's not always a kind of compelling event for a specific date for them to close because if you're doing a vendor consolidation decision. There may be a kind of the timing of maybe a competitor solution that may have a contract up for renewal. So that may be one element of a compelling event.

But in general, that these are very strategic decisions for customers and so there is a serious and significant evaluation when they go through that. And we're just building an incremental level of prudence that nothing, as I said before, nothing has fundamentally changed in the demand environment is still healthy. The pipeline is still very robust.

As I mentioned in my prepared remarks that these deals that are over $1 million have -- in the pipeline are up over 39%. And I remind you that we had a huge Q4 last year. So this is a significant movement in the pipeline. It's just a matter of when you have very large deals like this to call it within a 90-day window is a little bit more variable. We tried to build a level of prudence into it.

I would just add, Matt, that with GSIs in particular, since you mentioned the partner front, we continue to be very enthusiastic about the evolution of the GSI partner opportunities, especially with some of the core GSIs I mentioned, like Accenture, Deloitte, DXC and Kyndryl. And those deals are inherently going to be bigger and take a bit longer to close as well. But we feel very good about our posture and position associated with the GSI evolution.

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

And I know a lot has been made on the ARR guide. And I just -- I really want to fine-tune it. I know, Jim, you've spoken about incorporating incremental prudence tied to these larger, more strategic deals. So the first question is, can you elaborate on what the magnitude of that incremental prudence is? I think that would help level set expectations as we're thinking about this change to the guidance philosophy or construction now.

And then the second point, which would go a long way in helping investors think about the guidance today, really, were it not for these larger, more strategic deals, which are taking longer to close. Excluding that, would management actually be raising the fiscal '24 constant currency ARR guidance today?

Well, you can imagine, the pipeline is just a basket of opportunities. There's large opportunities, small opportunities. So I think what we are seeing though is the funnel is becoming a bit more weighted to these large opportunities. And I will tell you that the guide that I provided last time, which was 19% to 20% growth, in the guide now, 18% to 19%, the way you should think about that is the difference in that of 100 basis points is literally just incremental improvements. Nothing else has fundamentally changed.

Terrific. I appreciate it.

Our next question comes from the line of Fatima Boolani with Citi.

Jim, just along these lines, historically, it's been very helpful for us to internalize your growth algorithm between new logo acquisition and the installed base expansion. So just bearing in mind some of your commentary on some of the expansionary behavior, the DPS uptake and what you're seeing in the pipeline, I was hoping you could help us flesh out for us what your expectations are as it relates to a new logo business versus a potential recovery on the installed base expansion side?

Yes. The way to -- I think I shared this before, that -- and I shared it in the last call that we thought that expansion rates would be in the 112% to 113% range in the near term. And I expect that to be the case for the remainder of this year. And we had said before that we're probably going to be in the low single-digit growth in new logos, but at higher land sizes. So our land sizes have been call it, roughly 140,000 on a trailing 12-month basis.

So those two underpinnings continue to be kind of the building blocks underneath that. And on the new logo front, it's because we're focusing on a larger set of customer lands that we have seen have a higher propensity to expand when we land at a larger size, they tend to expand. So those fundamentals won't change.

Obviously, when I provide fiscal '25 guidance, I'll give you guys a little bit more color on that, but those continue to be the kind of the major building blocks. And obviously, the other one being we continue to have best-in-class retention rate. So the product is very sticky. We don't have a lot of churn or down sell. So obviously, we don't expect any changes in that regard either.

Our next question is from the line of Ray McDonough with Guggenheim.

Rick, when we talk to some of your partners, it does seem like tool consolidation is accelerating, and you've hit on that throughout the call. But is that acceleration due to a change in control at a couple of your competitors? And if so, can you help us understand where those opportunities are coming from specifically? Is it some of your traditional APM competitors? Or are you seeing displacement opportunities in log management and other areas at this point? Obviously, you mentioned it's still early on for logs, but any color would be helpful.

Thanks, Ray. I would say a bit of all of the above by way of tool consolidation. AppDynamics continues to be a source of new logos for us in a material way. New Relic going private, certainly has created some disruption as has the acquisition of Splunk by Cisco, which creates certainly some degree of market confusion and apprehension that leads to opportunity for us. Having said that, it's all still relatively early stage in terms of some of these transaction announcements, and we'll have to see how they evolve over the course of time.

Our next question comes from the line of Gray Powell with BTIG.

Okay. Great. Thanks for -- let me ask a question here. So yes, I know you've gotten a lot on net new ARR trends. The statistic on $1 million ACV deals, that was really helpful. Is there a way to just help us think through like how much -- like what the normal sales cycle is for larger deals? And then just how much it's been extending in recent quarters as customers take on more like multiproduct deals?

Yes. The -- I mean, our normal sales cycle is 6 to 9 months, as you can imagine, that -- and it depends upon the -- whether it's a new logo or an expansion. If it's a new logo, you're going to be on the longer end of that because customers are doing a much more significant evaluation with the POC and things of that nature. So it varies between expansions and new logos.

And as I mentioned, Gray, that both -- these growing number of larger deals are not just new logos. We're actually seeing it also on the installed base side. So it's actually both. Because even where we have installed base customers, they also are leveraging DIY tools and in other cases, other commercial tooling solutions. So they are now beginning to make more tool consolidation decisions. And as I mentioned, the funnel is showing a 39% increase in that, and that's over kind of a year ago period that was very, very healthy. So I think it's a positive trend.

I would tell you that it does introduce a level of variability, as I mentioned, which is why we built more prudence into -- and it's hard to say, is it a month? Is it two months? It varies, right? It varies by -- in some cases, it could be a quarter. In some cases, it could be a month. I really couldn't tell you an average for it other than to say that when you are doing deals of this size, where -- because there is both people and process implications for customers because if they're using existing tools and they want to go to a new vendor, it has an impact on their organization, and it has an impact on the processes within their organization. So there's a serious evaluation that they go through, and you have to anticipate that as you're trying to determine a close date.

Got it. So it's like an extra month to three months, not like an extra 6 months, is that fair?

No, no, no.

Our next question comes from the line of Joel Fishbein with Truist Securities.

I have a follow-up to one of the earlier questions around the observability consolidation, which we're seeing in the market as well. Can you talk about the vendors that you think are positioned to compete with you on those observability deals? We hear ServiceNow making some noise and there are some others out there. I just want to know the competitive dynamics of those -- and you went to some great lengths to talk about your competitive differentiation, which we saw last week as well. So I'd love to hear, Rick, from you about who you're seeing in the market.

Well, I talked about some of the competitors already to some extent, I think, that are providing some opportunity based on the disruption in those areas. To extend that further, I would say, again, that I very much like our position recently these trends towards larger strategic deals based upon our core differentiation, especially at the higher end of the market.

And you had asked about ServiceNow. We actually still see them mostly as a partner as opposed to a competitor in the market. They just don't have the capabilities yet in observability and application security that we do. So it's more times than not, customers are asking us to integrate with ServiceNow versus compete with them.

Are there any other vendors that you think can match you guys from a consolidation perspective from a product perspective?

Well, at the high end of the market -- the higher end of the market at the Global 15,000, I would say that most of the deal flow and pipeline moves our direction. So in our target market segment, I think we have a very strong play and the biggest competitor, as we've said in the past, continues to be DIY.

Our next question is from the line of Adam Tindle with Raymond James.

I wanted to ask a strategic question related to Runecast. To start with, the motivation for that was posture management something that customers were asking before adopting AppSec or would you characterize this as maybe the start of a broader push into CNAPP. And then secondly, into that, just zooming out your kind of strategic view on cloud security, broadly speaking. There's been a lot of investment and a lot of growth in that space, a combination of agent and agentless technologies going on. I wonder where you think Dynatrace plays in that market? Do you see a holistic platform like a [ wiz ] type of player over time or attractive areas that you're going to pick and choose your spots?

Thanks, Adam. So first on the CNAPP front, I would say, yes, the intent here is to head towards CNAPP and use cloud security posture management as a way to escalate our vulnerability analytics capabilities that we have, and we really, really liked the Runecast team and technology, I should say, we like that technology and team quite a lot. It adds AI and contextual security protection analytics into what we're doing, which fits nicely into our portfolio, and in particular, it allows us to address the risks of misconfigurations and compliance violations added to our existing vulnerability analytics capabilities. So it is a very, very good fit in expanding it.

The broader question you asked, I would simply say that we continue -- we have mentioned time and time again in the past to see that observability and application security are converging. And the capabilities that we deliver in our platform generally with regard to things like contextual analytics and hypermodal AI, provide very, very strong capabilities in application security as well.

So in the outside market, we've been focused on leveraging the core elements of our observability platform to do application security better than others in the market in these types of spaces. So we are very enthusiastic about Runecast also continue to be very excited about our investments in AppSec generally.

Thank you. Our final question comes from the line of Will Power with Robert W. Baird.

I guess, Rick, it would be great to get your perspective on kind of tone of customer conversations that Perform being fresh here. Can you just -- how customers that you're talking to are thinking about, I guess, both budgets and priorities as we kind of head into 2024 here? And then any perspective with respect to how any of that might have changed versus those conversations a year ago?

Well, I would simply say that, obviously, Perform customers are a bit self-selected. They are existing -- generally existing Dynatrace customers or Dynatrace prospects. They've chosen to be there. So you get that flavor of the market.

Having said that, I would say that the conversations with a customer after customer after customer at Perform were absolutely exceptional. And the engagement was phenomenal. They are absolutely leaned in with regard to Dynatrace and the investments they're making in the Dynatrace platform, and they buy off on this notion that: number one, observability is becoming more and more critical amidst a world in which digital transformation is driving business transformation. And number two, that they can't do it in a manual way through dashboards and alerting, which leads to number three, that they need a platform that is driving analytics, AI and automation to enable them to do it better than they could do otherwise. And so that was the type of feedback that we heard is extremely positive. It was simply a fantastic event.

All right. That brings us to the close. I wanted to thank you all for your engaged questions as usual and your ongoing support. We -- as we've echoed throughout the course of this call, remain quite bullish about the opportunity that lies ahead. 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.

This will conclude today's conference. You may now disconnect your lines at this time, log off your webcast, and thank you for your participation. Have a wonderful day.