“We are raising total revenue by approximately $19 million at the midpoint to $1.67 to $1.68 billion, and we are raising our subscription revenue guidance by $17 million at the midpoint to $1.59 to $1.6 billion.”

In context

“Jim Benson (Chief Financial Officer): Thank you, Rick, and good morning, everyone. Q2 was another quarter of consistent execution by the DynaTrace team. As we once again surpassed the high end of all our top-line growth and profitability guidance metrics. Our ability to execute successfully in this dynamic macro environment is a testament to the growing criticality of observability in the market, our highly differentiated AI-driven observability platform, our global team's ability to demonstrate exceptional business value to our customers, and the strength and durability of our balanced business model with healthy growth and profitability. Now let's review the second quarter results in more detail. Please note, the growth rates referenced will be year over year and in constant currency unless otherwise stated. Annual recurring revenue, or ARR, was $1.62 billion, up 19% year over year. This is an increase of $273 million compared to the same period last year and above our expectations, driven by solid expansion bookings, particularly in Europe, and an improvement in booking seasonality related to our move to six-month sales compensation cycles. Q2 net new ARR on a constant currency basis was $61 million, up 3% year over year, bringing net new ARR for the first half of fiscal 2025 to $106 million, up 10% year over year. In Q2, we added 143 new logos to the DynaTrace platform. As we have shared in the past, target landing high-quality new logos have a greater propensity to expand. In Q2, average ARR per new logo came in at roughly $130,000 on a trailing twelve-month basis, in line with our target land size. Our experience has been that customers that land over $100,000 have the greatest propensity to expand. As Rick mentioned, we continue to attract enterprise customers. They've outgrown their existing DIY or commercial tooling solutions and are coming to DynaTrace for the depth, breadth, and automation of our end-to-end observability platform. Turning now to retention. Gross retention rate remained stable in the mid-nineties, demonstrating the strong customer value inherent in our offerings. Net retention rate came in at 112% in the second quarter, slightly above expectations driven by early expansions incentivized by our move to six-month sales compensation cycles. Our DPS licensing model is rapidly gaining traction. We closed roughly 250 DPS deals globally in Q2. Total DPS customers now represent nearly 30% of our customer base and 50% of our ARR. We believe DPS customers with full access to our platform will trial more platform capabilities and adopt DynaTrace more broadly within their IT environments. This should lead to faster consumption, possibly an earlier expansion, and a future net retention rate accretion. And we're seeing early signs of this playing out with DPS customers leveraging twice the amount of capabilities and growing consumption at two times the rate compared to our SKU-based customers. We also see DPS as a catalyst for customers adopting our emerging and adjacent solutions. As Rick highlighted, a major US airline signed a seven-figure DPS expansion this quarter. Through their original DPS contract, they were able to trial logs on GRAIL, which delivered immediate value from having contextual analytics across data types. The flexibility to trial through DPS led to their decision to deploy DynaTrace end-to-end and displace their existing log management and other open-source tools. Moving on to revenue. Total revenue for the second quarter was $418 million, up 19% year over year and exceeding the high end of guidance by $11 million. Subscription revenue for the quarter was $400 million, up 20% year over year and exceeding the high end of guidance by $10 million. The revenue upside was driven by strong bookings performance and a modest benefit from DPS on-demand consumption for customers reaching their annual spend commitments early. Shifting to margins, non-GAAP gross margin for the second quarter was 85%, in line with the prior quarter and prior year. Non-GAAP income from operations for the second quarter was $131 million, $15 million above the high end of our guidance range, driven by revenue upside and lower payroll spend associated with the timing of hiring in the quarter. This resulted in a non-GAAP operating margin of 31%, exceeding the top end of the guidance range by more than 250 basis points. Non-GAAP net income was $113 million or $0.37 per diluted share. This was four cents above the high end of our guidance range. We generated $20 million of free cash flow in the second quarter. Due to seasonality and variability in billings quarter to quarter, we believe it is best to view free cash flow over a trailing twelve-month period. On a trailing twelve-month basis, free cash flow was $436 million or 28% of revenue. As a reminder, this includes a 600 basis point impact related to cash taxes. Pre-tax free cash flow on a trailing twelve-month basis was 34% of revenue and up 39% year over year. Finally, a brief update on our $500 million share repurchase program. In Q2, we repurchased 835,000 shares for $40 million at an average share price of $47.90. Since the inception of the program in May 2024, through September 30th, we repurchased 1.9 million shares for $90 million at an average share price of $46.71. We plan to continue to buy back shares opportunistically based on market conditions, underscoring our confidence in the business, our conviction in the long-term opportunity ahead, and our commitment to delivering shareholder value. Moving now to guidance. Let me walk through some of the key assumptions and insights underpinning our updated guidance. First, we do not assume a material change in the macro environment. While the observability demand environment remains healthy, enterprises continue to be cautious in their spending. Second, we continue to benefit from the growing trend of large observability architecture and vendor consolidation deals. As we have said in the past, these deals equally come with an increased level of timing variability. Third and most importantly, from a go-to-market perspective, we continue to work through the maturation of our sales model. Through the first half, we are pleased with how our team has executed while minimizing disruption as we implemented these changes. Having said that, this is still an ongoing progression. We are mindful that more than 30% of accounts transitioned to new sales reps, and it takes time to establish relationships and positively impact sales performance. In addition, the acceleration of hiring new sales capacity has resulted in a higher mix of less tenured and therefore less productive reps compared to historic levels. Further, as part of our go-to-market changes, we introduced six-month sales compensation cycles. This resulted in an improvement in booking seasonality in the first half, but it's unclear the magnitude of impact these semiannual sales plans will have in the back half of the fiscal year. Factoring this all in, we believe it is best to maintain a prudent posture on ARR guidance and not get ahead of ourselves until the benefits of these changes manifest in an improvement in sales productivity. With that, let's start with our updated guidance for the full year with growth rates in constant currency. We are maintaining our ARR guidance of $1.72 to $1.735 billion, representing 15% to 16% growth year over year. For net new ARR, we expect Q4 to be higher than Q3, consistent with the second half of fiscal 2024. We are raising our revenue guidance by 100 basis points to account for the strength in our second-quarter performance. We are raising total revenue by approximately $19 million at the midpoint to $1.67 to $1.68 billion, and we are raising our subscription revenue guidance by $17 million at the midpoint to $1.59 to $1.6 billion. Both now represent 17% to 18% growth year over year. This ARR and revenue guidance factor in foreign exchange rates as of October 31st, resulting in no material changes compared to our prior full-year guidance. Turning to our bottom line, the strength and resilience of our financial model are evident in our ongoing margin performance. We continue to invest in future growth opportunities while finding efficiencies in other areas. We continue to prioritize our investments in R&D innovation, customer success, and strategic go-to-market areas such as GSI partnerships, demand generation activities, and targeted sales capacity. With this in mind, we are raising our full-year non-GAAP operating income guidance by $7 million. This translates to non-GAAP operating margin guidance of 28% to 28.25%, up roughly 25 basis points at the high end of the range. We are raising non-GAAP EPS guidance to $1.31 to $1.33 per diluted share, representing an increase of four cents at the midpoint of the range. This non-GAAP EPS is based on a diluted share count of 303 to 305 million shares. This EPS and share count guidance excludes the impact of any share repurchases in Q3 and Q4 due to the opportunistic nature of our program. We are raising free cash flow guidance to $393 to $404 million, an increase of $6.5 million at the midpoint, representing a free cash flow margin of 23.5% to 24% of revenue. Excluding the expected 650 basis point impact from cash taxes, this represents a pre-tax free cash flow margin of 30% to 30.5%. As a reminder, our first and fourth quarters tend to be our seasonally strongest cash-generating quarters, with our second and third quarters being our lowest. We expect third-quarter free cash flow to be lower than historic levels due to the timing of billings and cash tax payments. Looking at Q3, we expect total revenue to be between $425 million and $428 million. Subscription revenue is expected to be between $407 million and $410 million. From a profit standpoint, non-GAAP income from operations is expected to be between $117 million to $120 million, representing 28% of revenue. Non-GAAP EPS is expected to be $0.32 to $0.33 per diluted share. In summary, we are pleased with our second-quarter fiscal 2025 performance. We have a proven track record of consistent execution. While we remain prudent in our approach to the near-term outlook, we continue to be optimistic about the growth opportunity in front of us and the maturation of our go-to-market evolution to go after it. And with that, we will open the line to questions.”