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Edited Transcript of DT.N earnings conference call or presentation 4-Sep-19 9:00pm GMT

Q1 2020 Dynatrace Inc Earnings Call

Sep 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Dynatrace Inc earnings conference call or presentation Wednesday, September 4, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John Van Siclen

Dynatrace, Inc. - CEO & Director

* Kevin C. Burns

Dynatrace, Inc. - CFO, Treasurer & Secretary

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Conference Call Participants

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* Bhavanmit Singh Suri

William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications

* Heather Anne Bellini

Goldman Sachs Group Inc., Research Division - MD & Analyst

* Joe Goodwin

JMP Securities LLC, Research Division - Analyst

* John Stephen DiFucci

Jefferies LLC, Research Division - Equity Analyst

* Matthew John Swanson

RBC Capital Markets, LLC, Research Division - Senior Associate

* Mohit Gogia

Barclays Bank PLC, Research Division - Research Analyst

* Rakesh Kumar

UBS Investment Bank, Research Division - Associate Director & Equity Research Associate of Software

* Richard Hugh Davis

Canaccord Genuity Corp., Research Division - MD & Analyst

* Sterling Auty

JP Morgan Chase & Co, Research Division - Senior Analyst

* Michael George Bowen

ICR, LLC - MD

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Presentation

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Operator [1]

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Good afternoon. My name is Sheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dynatrace, Inc. Fiscal First Quarter 2020 Earnings Conference Call. (Operator Instructions)

Michael Bowen, Investor Relations. You may begin your conference.

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Michael George Bowen, ICR, LLC - MD [2]

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Thank you, operator. Good afternoon, and thank you for joining us today to review Dynatrace's first 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 Act of 1933, as amended, and of Section 21E 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 second 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 cautionary language in today's press release and to our final IPO prospectus, which is filed with the SEC on July 31, 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 comparable GAAP financial measure can be found with our first 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?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [3]

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Thanks, Michael. And I'd like to start by thanking all of you for joining us today on our first conference call as a public company. We're excited to have completed our successful IPO on August 1. This represented an important milestone for Dynatrace and one that further enhances our brand awareness and ability to execute the company's long-term growth strategy. We were also very pleased with the first quarter financial results where we achieved 43% ARR growth to $438 million and strong total revenue growth driven by subscription and services revenue, which increased 36% year-over-year. We continue to focus on building a balanced business with strong growth and cash flow for greater durability over time.

As this is our first quarter as a public company, I wanted to provide a brief overview of Dynatrace's transformation, our value proposition and our market opportunity in addition to providing details on key drivers behind our recent performance. Dynatrace is a market-leading software intelligence company purpose-built for the enterprise cloud. Every company and every industry is transforming into a software business. How they interact with their customers, assure quality experiences, optimize existing revenue streams and create new ones, success or failure comes down to the software supporting these efforts. Dynatrace software intelligence sits at the core of these digital transformations to assure that this run-the-business software always works perfectly for every interaction, every transaction and every user journey.

Let's step back a moment and talk about how we got here. Dynatrace is now 14 years old. We spent the first 9 years building a category leader in APM, application performance monitoring. In 2014, after sending a dozen of our top product lines off to determine how monitoring would work in the future, we made a bold decision to reinvent our platform from the ground up and, in so doing, refresh our entire business model. This team realized that the cloud would disrupt the entire ITOM world. Everything would change. And if we seize the opportunity, we could redefine the market.

Although we were already widely recognized as the APM leader, we decided to disrupt ourselves and, in so doing, disrupt the market. The result was the 2016 launch of Dynatrace, an all-in-one, full stack, cloud monitoring platform with a powerful AI engine at the core. With the complexity, scope and frequency of change these modern cloud ecosystems would experience, we chose to put answers first versus simply pumping more data on glass and hoping IT teams could keep up. This answers-first approach brings highly differentiated value to our platform use cases of APM, cloud infrastructure monitoring, digital experience management and AI Ops.

This new platform has been driving the company's growth ever since. At the end of our June quarter, the new Dynatrace platform comprised 75% of our total ARR, up from 70% at the end of our March quarter and up from 39% a year ago. The remaining 25% of ARR relates to our Classic product set, which continues to actively transition to our Dynatrace platform. We are now 5 quarters into what we believe is a 10- to 12-quarter transition, and our Classic customer-to-Dynatrace conversion program continues to run ahead of expectations.

After launching the new platform, our go-to-market motion has also evolved. We believe our customer acquisition process has become much more efficient, with most customers now discovering and exploring Dynatrace through a frictionless free trial. We then further nurture our land-and-expand sales process through a growing number of direct enterprise sales resources, value-added resellers and system integrators. With a platform that instruments and baselines the entire cloud stack automatically, implementation is dramatically streamlined, and we're seeing a growing number of customers expanding beyond the traditional 5% barrier that continues to hinder outdated Gen 2 approaches.

At the end of our fiscal Q1, we had 1,578 Dynatrace platform customers, an increase from 1,364 at the end of the prior quarter. Consistent with prior quarters, the majority of these new customers to Dynatrace were net new logos to the business, with the balance converting to Dynatrace from our Classic base. And once again, our net expansion rate across all Dynatrace customers was over 120%, consistent now for the past 5 quarters on increasingly larger customer cohorts.

Given our innovative AI-powered platform and streamlined go-to-market strategy, we believe we can capture a meaningful share of the $18 billion and growing TAM we estimate is in front of us. With about 10% of our target 15,000 global enterprise accounts having adopted the Dynatrace platform, and what Gartner estimates to be only 5% of applications instrumented from an industry perspective versus what we believe is a longer-term target that ranges between 30% and 50%, there is plenty of growth potential to build a very large company over time. And when you add to this both ongoing cloud and application expansion and our ability to add additional platform use cases, we believe there is significant opportunity to further expand our TAM as time goes on.

Now let me provide some insights into several new and expansion customers to illustrate our value differentiation along with the power of our land-and-expand approach. First, one of our new logos in Q1 was a large U.S. government agency that is moving to a hybrid multi-cloud environment as part of an overall IT modernization program to improve access to benefits and services for hundreds of thousands of policyholders. As with many Dynatrace customers, the move to the cloud brings with it an exponential rise in complexity for resource-strapped IT organizations. The advanced automation of Dynatrace and the answers-first approach leveraging Davis, our AI engine, has allowed this agency to dramatically reduce performance issues, improve operational efficiency and accelerate their cloud migration and modernization efforts. As a side note, the U.S. federal market is a relatively new market for us, for which we see tremendous opportunity over time.

The next example I'd like to share is an expansion customer, a major European auto manufacturer that has been moving to a hybrid multi-cloud environment spanning across their own data centers plus AWS, Azure and Google Cloud Platform. They have been using a competitor's Gen 2 APM product and found it inadequate for their new stack environment. It was proving too cumbersome, too manual and with limited cloud native observability. Although this customer started with a small taste of Dynatrace for an initial set of workload several months ago, after experiencing the advanced automation of Dynatrace, their IT team was able to roll out an additional 2,000 hosts and dozens of applications in just a few weeks after acquiring additional licenses. With the continuous intelligent monitoring of Davis, their development and operations teams now focus on building value for their company versus wasting time via using dashboards, poring through logs or searching for answers to problems that may or may not be impacting users. Bottom line, this auto manufacturer has gained greater efficiency, which translates into greater speed for innovation and their digital transformation.

The final example I'd like to share is a customer who converted from our Classic products to the new Dynatrace platform. This is a company in the business of managing and running a large car auction marketplace. With our Dynatrace offering, they saw an opportunity to modernize their own application and infrastructure environment and shift to Azure. As we get proof-of-concept with Dynatrace as part of our conversion process, a number of application teams that we had never been able to access previously became interested. Before the cloud, these teams were separate. But with their new enterprise cloud, these teams were sharing cloud resources and software services. As a result, with the conversion came an up-sell to expand coverage to more than 2x the workloads, and there's potential for more. This conversion from Classic to Dynatrace took only 6 weeks from start to finish, and that includes the planning and change management process time. This is very common. The time and effort to convert is short while the value realized from doing so is very compelling.

Switching to the product front for a minute. We continue to innovate organically. In Q1, we announced expanded support for Kubernetes, a dynamic container orchestration environment we have automatically instrumented and monitored for some time now. In the quarter, we extended our automatic analysis of Kubernetes performance, now delivering full-stack analysis of Kubernetes clusters, their containers and the application workloads within, in a single solution, fully leveraging our AI engine data. In addition, we introduced first-day support for Red Hat OpenShift 4 environments, adding to our Google, AWS and Azure coverage for Kubernetes, making it easier than ever to continuously observe and manage an enterprise multi-cloud environment.

In addition, we extended our observability coverage for hybrid clouds with the announcement of 1 agent support for CICS and IMS workloads on IBM mainframes along with their associated integration and middleware frameworks. Now Dynatrace customers can maintain their end-to-end visibility from a mobile or IoT device through mainframe regions and back. This unique deep application and infrastructure observability allows our mainframe customers to understand the impact of cloud application workloads on extensive mainframe resources and optimize their behavior to better leverage these critical compute resources.

With 25 major releases per year and hundreds of minor releases to Azure cloud ecosystem, currency and comparability, we continue to increase the capabilities and scope of our market-leading software intelligence platform for our enterprise customers.

As we look forward, fiscal 2020 is shaping up to be a very exciting year, and we couldn't be more excited about our future. We have reinvented our business on a fresh new technology stack ideally suited for today's dynamic multi-clouds. Our shift to subscription is essentially complete. The conversion of our Classic customer base is approaching the halfway mark. And the efficiency that our new platform affords us is evident in our strong profitability profile.

There's a massive opportunity ahead of us, and we plan to capture it with continued commercial investments in sales and marketing and ongoing innovation in R&D. We're excited to now be operating as a public company as we focus on building long-term success for our customers, long-term value for our shareholders and a great place to work for our employees.

With that, let me turn the call over to Kevin Burns, our CFO. Kevin?

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Kevin C. Burns, Dynatrace, Inc. - CFO, Treasurer & Secretary [4]

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Thanks, John. It is great to connect with both existing and prospective shareholders in our first call as a public company. I'm pleased that we have strong financial results this year, which were even better than the ranges we shared in our S-1. Before discussing our results in detail as well as our guidance for the second quarter and fiscal '20, I want to first review the important aspects of our business and revenue model, considering that some of you may be new to the Dynatrace story.

As outlined in our S-1, and as we discussed during our road show, our focus and the long-term future of the company is the Dynatrace platform. All revenue associated with the Dynatrace platform is recognized on a ratable basis and reported as subscription revenue. With respect to our Classic offering, maintenance and SaaS revenues are recognized ratably and run through the subscription revenue. Perpetual and term licenses for our Classic offering are recognized on delivery and reported as onetime license revenue on the P&L. Classic license has declined significantly and is now down to an insignificant percent of our revenue. Overall, we believe our transition to a subscription model is substantially complete, and this is becoming apparent in total revenue growth.

Now let me turn to our first quarter fiscal '20 results. Our key financial metric as an organization is annual recurring revenue. For the quarter, ARR was $437.6 million, an increase of 43% year-over-year. The Dynatrace platform continues to increase as a percent of total ARR and was $326.3 million at the end of June which, as John said, was 75% of our total ARR. The remaining 25% of our ARR relates to our Classic offering, and we expect the majority of Classic customer base to convert to Dynatrace over the next 2 years, with most of the remaining conversion activity to occur in the next 4 to 6 quarters. As a reminder, the ARR growth opportunity is not the conversion. It is getting customers onto the Dynatrace platform because from there, we can expand our footprint in ways that simply were not possible before. In addition, for investors new to Dynatrace, we do not charge a conversion or upgrade fee to move to the new Dynatrace platform. And as a result, all of our ARR expansion is either footprint expansion or new logos to the business.

If we quickly break down these 2 ARR growth drivers, during the quarter, we added 214 net new Dynatrace customers, ending the quarter with 1,578 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. In addition to a steady flow of net new customers, our dollar-based net expansion rate remained above the 120% threshold that we have experienced over the last 5 quarters since we ramped our efforts on the Dynatrace offering with existing customers. We will continue to confirm this net expansion level on a quarterly basis. And at the end of the fiscal year, we plan to share the specific net expansion rate for the year. Importantly, please keep in mind that our net expansion rate excludes the upfront expansion that occurs when Classic customers convert to the Dynatrace platform. So our reported net expansion rate only takes into account expansion with customers after they are on the Dynatrace platform.

Turning to revenue. Total revenue was $122.6 million. This was an increase of 25% on a year-over-year basis. The acceleration in total revenue growth is being driven by the strong growth in subscription revenue, which was $108.1 million, an increase of 39% year-over-year. For the quarter, Classic license revenue was down to $3.8 million and represented only 3% of our quarterly revenue. Please keep in mind that this will be going to 0 over the next 4 to 6 quarters as we wrap up the Classic conversion program. From a growth standpoint, we believe the best way to think about our revenue growth is the combination of subscription and services revenue, which was $118.8 million in the quarter, representing 97% of total revenue and an increase of 36% on a year-over-year basis.

Before moving to our profit metrics, I would like to point out that I will be discussing non-GAAP results going forward, unless otherwise stated, and that our non-GAAP measures exclude stock-based compensation, amortization of acquired intangibles and other items as outlined in the press release.

Our non-GAAP gross margin was 82.3% for the first quarter, an improvement compared to 80.7% in the first quarter of fiscal '19. Gross margins are benefiting from increasing subscription margins due to the efficiency of the Dynatrace platform, which has 1 code base, and over 90% of our customers are on a version released in the last 30 days. Our non-GAAP operating income for the first quarter was $27.1 million, resulting in a non-GAAP operating margin of 22%, up from 13% in Q1 of '19. The increase in operating margin is largely driven by the fact that we are in the final stages of completing our transition to a subscription model as historical revenue was negatively impacted when we moved from an upfront perpetual to a subscription model. In addition, we had some margin overachievement in the first quarter of '20 that was driven by a combination of revenue and the shifting of certain expenses from the first quarter to the balance of the year.

Finally, please keep in mind that our first quarter expenses do not include the cost of being a public company, which will show up in G&A going forward. Non-GAAP net income was $9.3 million, and net income per share was $0.04 based on 238.6 million shares outstanding.

Turning to our balance sheet. As of June 30, we had cash and cash equivalents of $57.5 million. When looking at our leverage at the end of the first quarter, our net debt was $945 million. On a pro forma basis, taking into account the $590 million of net proceeds from the IPO, our net debt as of June 30 would have been $355 million. This represents a leverage ratio of 3.3x our trailing 12-month adjusted EBITDA of $106.4 million.

Since the end of the first quarter, we had paid down $436 million of debt and our current debt balance is $567 million. Going forward, the business will naturally delever due to our healthy cash margins, and we will steadily pay down debt over time, which we believe will create value for equity holders. The last balance sheet metric that I want to share was our RPO, which was $614 million, up 83% over Q1 of last year. The current portion of RPO, which we expect to recognize as revenue over the next 12 months, was $354 million at the end of Q1, an increase of 62% year-over-year.

Looking at cash. For Q1, our unlevered free cash flow was $45.8 million, and it was $172 million on a trailing 12-month basis. To be clear, we have seasonality, and we'll also have quarterly fluctuations in our unlevered free cash flow as we convert our customers from Classic to Dynatrace as this may impact the timing of how and when we invoice our customers.

Before moving to guidance, I'd like to review a few items that will impact our GAAP results for the second quarter of fiscal '20. First of all, we incurred cash fees of approximately $14 million related to the IPO and structuring that will hit the P&L or APIC in the second quarter. These are in addition to the IPO commissions that were netted against the IPO proceeds discussed previously. Second, as a result of the spin of the Compuware mainframe business, we will also be recording a cash tax charge in the second quarter of $273 million. Please keep in mind that we received $273 million from the mainframe business pre-IPO, and that these funds will be used to pay the federal and state taxes, a majority of which will be paid in the second quarter of fiscal '20 and the balance in early calendar year '20. Overall, this is a neutral cash item to Dynatrace. Finally, as disclosed in our S-1 and based on our IPO value, we are recording a onetime mark-to-market stock comp charge in the second quarter of $145 million.

Now let me turn to guidance. For the second quarter of fiscal '20, we expect total revenue to be in a range of $123 million to $124 million, representing year-over-year growth of 21% to 22%. We expect our non-GAAP operating income to be in the range of $24 million and $25 million and non-GAAP net income of $0.04 per share. This assumes approximately 270 million shares outstanding. For the full fiscal year, we expect ARR to be in a range of $545 million to $550 million, representing year-over-year growth of 35% to 36%. Total revenue is expected to be in a range of $521 million to $524 million, representing year-over-year growth of 21% to 22%. We expect our non-GAAP operating income to be in a range of $112 million to $115 million and our non-GAAP net income in a range of $0.20 to $0.22 per share. This assumes approximately 278 million shares outstanding for the fiscal year.

In summary, we are very pleased with our performance in the first quarter and look forward to building a track record of success as we operate as a public company. We believe Dynatrace's financial profile is unique, including to out scale growth and cash flow. With a large TAM in front of us and a market-leading position, we believe the company is very well positioned for the long term.

With that, we will open the call up for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Sterling Auty of JPMorgan.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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I wonder if you can peel back the onion a little bit and just update us on where you are or where you finished the quarter in terms of the legacy conversions, look at what's in front of us and what kind of experience you're seeing in terms of the pace of those conversions.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [3]

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So as we said, the conversions are nearly halfway through at this point. 75% of ARR is now on Dynatrace, but the conversion process is about halfway through now after 5 quarters. We believe, as we've talked about, that it's a 2.5- to 3-year conversion process, the majority of those converting over the first 2 years or so, and we're very pleased with where we are right now. We're a little ahead of our internal plans and goals.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [4]

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All right. Great. And then the one follow-up is, as you think about the 3 areas of monitoring: APM, infrastructure and logging, can you give just some kind of qualitative color in terms of the momentum that you're seeing in each one of those buckets on the new platform?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [5]

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Well, as you know, and maybe some of those who are listening in, so our platform since day 1 has always assumed complete full-stack observability. So whether if you're in the APM, an APM full-stack customer, you get cloud infrastructure with it, and the AI Ops pieces as well, log comes with it, et cetera. So from that standpoint, most of our opportunities we enter through APM since that's our -- sort of been our legacy and that's what customers know us for and the market knows us for best, that has plenty of momentum, as you can see, in the numbers.

As far as cloud infrastructure-only environments, that's an expansion for us, and we're seeing good traction in that expansion. I mean one of the unique characteristics of our platform is that our AI engine is at the core. And therefore, when someone adds a component, a new module, like infrastructure-only to extend the view, they also get the AI engine that stitches everything together along with their full-stack hosts. So that's the -- and that's the same with the digital experience management as well. You add that to the portfolio or to the platform, and the AI engine also absorbs that view into the full stack, AI-powered, answers-first view.

So from that standpoint, we're seeing good traction on all those additional modules. But we do think about it, and the way we present ourselves to the market is much more of a platform than a set of piece parts.

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Operator [6]

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Your next question comes from Matt Hedberg of RBC Capital Markets.

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Matthew John Swanson, RBC Capital Markets, LLC, Research Division - Senior Associate [7]

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This is actually Matt Swanson on for Matt. You guys have had a very well-established international presence. Could you just talk a little about what you're seeing from a demand environment? And just from some of the recent earnings, we've heard some uneasiness in certain regions, so just what you're seeing out there.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [8]

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So appreciate the question. And you're right, we do have a pretty mature footprint, 40% to 45% of our business comes from outside North America. We haven't seen a real shift in demand sort of negatively in any region. Part of that may be that we focus exclusively on the more modern cloud environments, the dynamic multi-cloud environments, and those are sort of central to everyone's digital transformation around the world. And so that may be part of the difference of what's keeping us, at least at this point, more resilient.

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Matthew John Swanson, RBC Capital Markets, LLC, Research Division - Senior Associate [9]

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That's really helpful. And then it's really interesting to hear you talk about the U.S. federal opportunity. Could you just expand a little bit more? I know you said it's early days but maybe how you look at that vertical and maybe what investments or -- in technology or go-to-market you think you might need to make to capitalize on that in the future.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [10]

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Sure. The U.S. federal market is a very different market than the commercial market. Those who've ever been close to it or watched those or talked to others about it, it requires a longer-term investment horizon. And so we hesitated to put that longer-term investment in place until we had a quality team and a quality sales leader who really understood that market space. And so the last couple of years, we started the investment. We're starting to see the payoff begin. But as I said and you reiterated, it's early days but promising.

One of the things that is important in this environment is to make sure you get FedRAMP certification, which we're in the process of. And that's also an important component to help build momentum, long-term momentum, in the federal space.

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Operator [11]

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Your next question is from Heather Bellini of Goldman Sachs.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [12]

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I just have 2 questions. One, wondering if you can share with us any trends that you're seeing in the AI Ops marketplace, in the AI Ops integration that you're offering? And then secondly, I wanted to ask a little bit about the competitive environment. There was a competitor of yours who, I guess I think it was early August, talked about kind of changing landscape from a competitive standpoint but just wondering if you could kind of walk us through what you've been seeing.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [13]

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So from an AI Ops standpoint, we're seeing -- and I sort of reiterated some stories there just a moment ago about customers, both new and existing, and even converting customers, the -- having AI at the core of our platform and really shifting from data on glass to an answers-first approach where the answers come automatically in a very precise fashion so that it's extremely actionable and the answers come within seconds of degradations and anomalies ranked by user impact, that's serving us extremely well from a differentiation standpoint. And more and more customers are -- CIOs and CTOs have it on their shortlist of additional automation for their IT organizations because they know they're resource-strapped. So that's going extremely well. And as far as folks actually utilizing some of our new sort of open APIs to bring new data sources into the Dynatrace AI environment, that's been going well also. It's fairly early days. It's been 6 months since we've had those APIs available. But with some of the use cases around ServiceNow integration, F5, load balance kind of integrations, a number of things that are more out of the box now, it's accelerating. So we're very pleased there.

As far as the competitive landscape in general, it -- definitely, the observability space is getting a lot of interest these days. We view observability as obviously a really important component for modern cloud environments, but we also see it as just the first step, that the real value comes in the advanced automation and advanced analytics that come on top of the observability. And that's where we see the AI Ops investment that we made when we reinvented the platform really paying off.

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Operator [14]

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Our next question is from Jennifer Lowe of UBS.

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Rakesh Kumar, UBS Investment Bank, Research Division - Associate Director & Equity Research Associate of Software [15]

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This is Rakesh Kumar sitting in for Jennifer Lowe. So you just reported 40% ARR growth plus -- ARR growth, which is certainly impressive. I was wondering if you could talk about how you think of levers of ARR growth that are related to net new logos versus conversions and expansion on conversion.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [16]

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Do you want to take that, Kevin?

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Kevin C. Burns, Dynatrace, Inc. - CFO, Treasurer & Secretary [17]

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This is Kevin. So yes, as I'm sure you can see over the last couple of quarters, our ARR growth has been over 40%. And as we've discussed during our road show and in our S-1, it really is a great combination of new logos to the business. As John mentioned earlier, majority of the additions in the quarter were new logos to the Dynatrace franchise. And then the other nice thing we're seeing is a really healthy net expansion rate. So not disclosing the total number at this point, but it was north of 120%. Over the last 3 quarters when we talked about that on our road show, it was almost in the high 130% range. So it really is a combination of getting new logos to the franchise. And then once they're on the Dynatrace platform, we're expanding very nicely.

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Rakesh Kumar, UBS Investment Bank, Research Division - Associate Director & Equity Research Associate of Software [18]

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Got it. And then I have a follow-up. I was wondering if you could talk about sales productivity trends and how long is it taking products to ramp and hiring plans that you have for the year.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [19]

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So we're not disclosing sort of our -- all the hiring pieces and sales and et cetera, et cetera. But what I will say is that we're in a better position than we've been in for 2 or 3 years now from a hiring standpoint. Part of it is the momentum in the business, of course, attracts talent. But also, I think some of the positive online job site reviews relative to the company is also helping. So from our standpoint, we're doing extremely well, meeting our hiring goals, attracting talent and retaining talent.

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Operator [20]

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Your next question is from Bhavan Suri of William Blair.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [21]

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Congratulations there, a nice job out of the quarter -- out of the gate there. I guess maybe I just want to touch first on the DEM attach rates. Obviously, you sell that as a separate SKU there. I'd love to understand a little bit more about what you're seeing there in terms of adoption and the attach rates and how that's trended in the recent quarters.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [22]

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And so the digital experience management area, which is sort of the user experience components, has been -- we've had that module in our Classic product set for a while. It was just detached, sort of a separate product set. In the Dynatrace platform, it's an integrated module where the AI engine pulls everything together into a single, stitched-together view from every tap/click slate all the way through of all the infrastructure components to the back end in a full-stack view. So we are seeing continued momentum in the attach rate. It's interesting that the cloud -- as we move to the cloud, a lot of interest went to just building the foundation. But what we're starting to see now is an acceleration in -- back to the numbers that we had 3, 4 years ago in our Classic world from an attach rate standpoint.

I don't have the exact stats of the attach rate. We're talking about how we want to bring that forward and present to the market and the investment community. But it's been healthy. And any place where there's users attached, e-commerce, home banking, go down the list, those are perfect opportunities for solid attach rate for the DEM module.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [23]

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Yes, John, that's helpful. I guess maybe a more strategic question, and maybe I should have asked this one first. But as you think about sort of the automatic instrumentation, the automation features of the new Dynatrace platform, it feels like it should make it easier for you to achieve greater penetration within customers because it's much easier to deploy and manage. I guess is that the right way to think about it? Because if you think about historically -- maybe talk about it a little bit, the average percentage of applications monitored by Classic customers and what's that looked like historically. And sort of does that become meaningfully higher with Dynatrace platform because of the automatic instrumentation, detection, the way the platform lights up? I'd love just to understand sort of the trends you've seen. As customers switch, sort of what that -- you're seeing an expansion rate, obviously but love to know sort of numbers of applications or sort of -- and is that the right way to think about sort of that shift?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [24]

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Yes. Sorry, if I misunderstood the first question, I thought you meant digital experience management piece.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [25]

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I did. I was -- this is a more strategic. You did. You answered the DEM.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [26]

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Fair enough. But you're spot-on that the automatic nature -- and I mentioned it in the expansion customer that I was talking about just a few minutes ago that people start with a taste, try a few modules. Does this really work as advertised? Can my people really wield the weapon, in other words? And the minute they get the hang of how easy it is, the expansion is quite rapid. It's been much more rapid than the -- than our Classic product set and continues to show up in the net expansion rate. So yes, the bulk of the net expansion today is additional applications. Going forward, we believe it will be a nice, consistent mix between additional applications and additional cross-selling of modules.

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Operator [27]

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Your next question is from Richard Davis of Canaccord.

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Richard Hugh Davis, Canaccord Genuity Corp., Research Division - MD & Analyst [28]

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One of the areas that we've seen some of our companies try to pivot into is kind of government and things like that. Have you -- to what extent do you feel that that's an opportunity? And some companies -- I can't recall if you have FedRAMP or not, but that's one of the checkmarks and things like that. To what extent do you see that as an opportunity over the long run?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [29]

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Yes. As I was saying, it's a huge opportunity. I mean I don't know where the U.S. government falls as far as a consumer of technology these days. It used to be like one of the top #6 or -- 5 or 6 countries worth of spend. So it's a good -- it's definitely a good-sized market space. But we're early days in it mainly because it requires an ongoing investment for a while before you see the uptake, which we're now just starting to see beginning with. From a standpoint of FedRAMP, that's something that's in process, important piece of the project. But I think that just -- we're excited about that opportunity going forward. I thought the example, customer example, was pertinent. And I look forward to a lot more stories and success in that part of the market.

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Operator [30]

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Your next question comes from John DiFucci of Jefferies.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [31]

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My question goes back to the ARR question. So Kevin, as you point out, grew 43% this quarter. That's 3 consecutive quarters of ARR growth in the 40s, which accelerated from the low 30s prior to that. And we all know that ARR is a prelude to future revenue. I guess my question is how sustainable is that accelerated growth. And it doesn't have to stay in the 40s, but those are pretty impressive numbers. And I'm just trying to understand because we get the question a lot from clients, like, okay, when the Classic ARR goes away -- because you pointed out, I think, Kevin, that, hey, listen, when we convert, there's -- we see much broader adoption with the new Dynatrace platform. But you're also seeing the net retention, that's really high, too. So just trying to understand, like did something change out there in the market, too? Like maybe that's a second question but it related. And how should we be thinking about that ARR growth going forward?

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Kevin C. Burns, Dynatrace, Inc. - CFO, Treasurer & Secretary [32]

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Yes. I think I'll jump in, and maybe John can add to this as well. But I think there's a couple of things that are behind us right now that are working in our favor. First of all, we've been ramping our sales organization over the last 12 to 24 months, and we expect to continue to do that. So that will increase some bookings. So that's one growth driver. The second growth driver John mentioned is ease-of-use and implementation. The ability to scale up the Dynatrace platform for existing customers is much more rapid and automatic compared to second-generation monitoring. So that's driving a higher net expansion rate. So I think the combination of those 2. And then as we're adding new logos, it's been a core focus of the company over the last 12 months as well, that has tremendous opportunity. Our average ARR of the Dynatrace platform per customer today is north of $200,000. We think each one of those customers can be $1 million ARR opportunity for us over time, so a lot of opportunities to continue to expand ARR in both new logos and in our base.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [33]

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Okay. Is there anything -- and maybe, John, is there something else in the market, too? Because APM, as you guys know, especially from your experience back with the Classic, it's always made a lot of sense, right? And it's -- there was a lot of promise even in the early 2000s and a lot of companies went after the opportunity: Compuware, Dynatrace, Gomez and then all the others. And -- but it never really became -- they have never really fulfilled this promise. But we're seeing something today in Dynatrace and also in others. And there is a lot of questions. Competition is something that wasn't asked a lot about right now and -- on your call, but it will be, right, because those other companies are doing well, too. I'm just trying to get a sense of is there enough room for others to continue to do well. Has something changed in the market that's also helping you?

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John Van Siclen, Dynatrace, Inc. - CEO & Director [34]

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I think there is a big disruptive shift that's going on around cloud. We've talked about it before. This isn't just applications going to the cloud and everything else is status quo. This is a shift to the data centers to hybrid multi-clouds. And that's requiring an entirely new set of tooling. So think about the 20, 30 years' worth of tooling that's been out there all having to change over the next 5 to 10 years, that's accelerating a shift to a modern set of platforms. And I say platforms because in the cloud, you can't go after it in the old way with a bag of tools. You have to think about it in a much more holistic way because the entire stack is software.

So with that disruptive shift and that class of what were traditional ITOM use cases, you really have a dramatic shifting moment. We saw that 5 years ago, we came to market 4 years ago with an initial sort of offering to get our feet wet. We took it to enterprise 3 years ago, starting in 2016, and we haven't looked back. So we're really pleased with the competitive position. I mean we -- the foresight we had is paying off. And the -- this disruptive moment is only beginning, it's in the early innings, for sure. And I think that's what we're seeing. And that's why the TAM expansion is so great and so rapid.

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Operator [35]

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Your next question comes from Raimo Lenschow of Barclays.

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Mohit Gogia, Barclays Bank PLC, Research Division - Research Analyst [36]

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This is Mohit Gogia on for Raimo. Congrats again on the first quarter out of the gate. My question is on the product road map. If you can shed more light on across -- if you look at -- obviously, it's a unified platform, but if we look at the different use cases, I guess, across APM, logs and infrastructure and monitoring along with AI Ops, I'm just wondering if you can give us a sense of the product priorities that you have. Like, are those more focused in some of those areas? Or is it more consistent across the board? And I have a follow-up question to that.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [37]

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No. It's a good question. And thank you for your -- for the kind words. Our investment is consistent across all of them really. They're all monetizable modules. And when you have something that's monetizable, then you're going to put some effort into it. So we have teams on every one of those what we think of as key use cases. The -- we're extremely strong in APM, as you would expect. That, we believe, is a high ground. It's very difficult to do well at scale. And at the same time, it's essential for the way CIOs and CTOs and even CEOs now think about their digital transformations. But we are -- we do have significant investments in cloud infrastructure monitoring in the AI Ops space and in the digital experience space, which we also feel as a very strategic high ground for us as well.

So in order to cover the cloud, we've had to do all of these pieces because we do think of it as a full stack. And so what we're doing now is sort of breaking out different pieces of the puzzle in the stand-alone sort of components for extensibility and reach beyond just the full stack view that we started with, if that makes sense to you.

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Mohit Gogia, Barclays Bank PLC, Research Division - Research Analyst [38]

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That's helpful color, guys. A follow-up to that is, the other part of the question is the pricing model. So I mean I'm just wondering if you can give us more color on what you are seeing in the pricing environment because some of your competitors are sort of like talking about some new pricing models or maybe from customer conversations, you are hearing the same, so just wondering if you can give us more color on the pricing environment that you're seeing.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [39]

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From a pricing standpoint, we have been, I would say, we listen to customers. I mean I really do believe that you need to make sure that your customers are happy, that you're easy to do business with than the rest. And I think we're being smart with how we manage our pricing and our licensing models. We have a fair amount of flexibility. We have a direct sales organization. 90% of our sellers are outbound in the market. We sell to enterprise customers who expect some flexibility. And we're pretty good at adapting license strategies that fit customers and help them expand our product set widely within their organizations. And I think you see that with the net expansion rates. I mean if we are really difficult and challenging, you just wouldn't see that. So I'm happy with how we're pricing. I'm happy with our flexibility in our licensing models. And I can only speak for ourselves, but that's where we sit today, no need to change.

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Operator [40]

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Your next question comes from Erik Suppiger of JMP Securities.

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Joe Goodwin, JMP Securities LLC, Research Division - Analyst [41]

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This is Joe Goodwin on for Erik. I was hoping you guys can give us some color on what portion of customers are using Dynatrace for applications running on containers and then anything around how fast the containers business is actually growing.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [42]

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So I don't have the exact numbers on Dynatrace customers running on containers, but what I can tell you is that nearly 100% of the Dynatrace customers are cloud-based customers. And the container world has been around for a little while now whether they started with Docker or what have you. But what we've seen in the last 18 months of the rapid shift toward Kubernetes, it's really been interesting to watch as people look for portability platform across sort of a multi-cloud strategy. And whether that's 15% to 20% of our customers or whether it's more than that today, I'm not sure. But what we do hear from customers in surveys and so on, we've done is that cloud-native workloads and container-orchestrated environments are going to sweep through our enterprise customers to the tune of 80% to 90% over the next couple of years.

I should probably add on that, it's actually a great situation for us because we're purposely built for dynamic containerized environments. So it's great from our standpoint to see the rapid rise of this kind of dynamic orchestrated environments.

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Joe Goodwin, JMP Securities LLC, Research Division - Analyst [43]

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Understood. And then just a quick follow-up, can you provide any insight on how much of a drag on gross margins was the cost of supporting the Classic product during the quarter?

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Kevin C. Burns, Dynatrace, Inc. - CFO, Treasurer & Secretary [44]

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So this is Kevin. Yes, so we -- as you know, we have a superefficient Dynatrace stack, 1 code base all of our customers are tethered in when their data is in the cloud or behind firewalls, so superefficient there. The Classic product is winding down, and we will see some margin expansion over time from a gross margin standpoint. But we're not really breaking down how much of -- how many dollars are going to be pulled out of that business. But we will continue to see, as we've seen, gross margin expansion going forward.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [45]

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Yes. I think the point is, is that the Classic product set is not as efficient as Dynatrace. And you can sort of expect that from a totally new stack, 4 or 5 years old versus some of the Classic products that go back 12 to 15 years in the technology stack.

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Operator [46]

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There are no further questions at this time. I will turn the call over to John Van Siclen for closing remarks.

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John Van Siclen, Dynatrace, Inc. - CEO & Director [47]

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Yes. Thank you. And I'd like to thank all of the investors and analysts for your time today as well as I'd like to thank the many customers we have, partners and employees who helped us build a very strong company. And we're excited about the path we're on. We're excited about the opportunity ahead. And we look forward to updating all of you in what's about 60 days from now. Thank you very much. Good evening.

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Operator [48]

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This concludes today's conference call. You may now disconnect.