Dynatrace Holdings LLC (DT) Q1 2021 Earnings Call Transcript

Dynatrace Holdings LLC (DT -0.48%)
Q1 2021 Earnings Call
Jul 29, 2020, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Dynatrace first-quarter fiscal year 2021 earnings call. [Operator instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to Noelle Faris.

Noelle Faris -- Vice President, Investor Relations

Great. Thank you, operator, and good morning, everyone. With me on the call today are John Van Siclen, chief executive officer; and Kevin Burns, chief financial officer. Before we get started, please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance.

These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these factors is contained in Dynatrace's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking statements included in this call represent the company's view on July 29, 2020. Dynatrace disclaims any obligation to update these statements to reflect future events or circumstances.

As a reminder, we will be referring to some non-GAAP financial measures during today's call. A detailed reconciliation of GAAP and non-GAAP measures can be found on the investor relations section of our website. And lastly, references to growth rates will be in constant currency unless otherwise noted. And with that, let me turn the call over to our chief executive officer, John Van Siclen.

John?

John Van Siclen -- Chief Executive Officer

Good morning, everyone, and thank you for joining us on our Q1 fiscal '21 earnings call. Since early May, when we last reported earnings, the COVID-19 pandemic has continued to impact families, communities and businesses around the world. You don't have to go far to find friends or family impacted by this unprecedented situation. And I truly hope that you and your loved ones have remained safe and healthy.

Despite the challenging economic backdrop resulting from the COVID pandemic, digital transformation projects continue to be prioritized as essential as companies strive for greater agility, efficiency and speed to market. And Dynatrace continues to be considered an essential component for sustained digital transformation success. I'm pleased to report that the solid business performance we saw in April continued throughout our fiscal Q1. For the quarter, ARR was up 39% year on year, and subscription revenue was up 37% year on year.

And once again, we coupled our strong top line growth with strong bottom line results as well. With a resilient value proposition well suited to the digital transformation macro trends we see ahead and a predictable subscription business delivering growth and profitability at scale, we continue to be optimistic about our future opportunity and the durability of our business for long-term value creation. Based on the strength of our Q1 results and the ability to grow through the difficult economic backdrop, we have increased our annual guidance for revenue and profitability, as Kevin will discuss in a few minutes. There are three areas that I'd like to highlight this morning that give us confidence in our ability to achieve our increased guidance for fiscal 2021.

First, the essential role that Dynatrace plays in the success of our customers' digital transformations. Second, with digital transformation taking place in modern dynamic multi-cloud, how Dynatrace is well positioned to continue growing ARR by adding new customers and expanding our platform across our growing base. And third, how we plan to continue investing in both commercial expansion and ongoing innovation to expand market share and take advantage of the large and rapidly growing TAM we have in front of us. Thousands of companies have embraced digital transformation as a primary way to drive revenue, provide services, engage customers and collaborate among teams.

For these reasons, we are beginning to see an acceleration of digital transformation projects around the globe. According to a recent May survey by Fortune magazine, 75% of CEOs anticipate accelerating their digital transformation projects. Customers tell us that they consider Dynatrace an essential element of executing a successful digital transformation as they drive toward greater agility, efficiency and business effectiveness. Despite the global pandemic continuing to delay some new sales cycles, customers' confidence in Dynatrace and the intelligent observability we provide into the dynamic multi-cloud ecosystems underpinning these transformations is reflected in our strong first-quarter results across all key operating measures.

As we discussed in early May, our approach to the pandemic was to immediately focus on our 2,400 Dynatrace customers worldwide to help them through their work-from-home transitions and shifting cloud workloads, ensuring customer success in times of challenge, help strengthen long-term relationships, an important part of our growth strategy. This approach also helped us maintain a net expansion rate above 120% for the ninth consecutive quarter. A great example of how digital transformation continues to fuel our expansion efforts within our base is a large brick-and-mortar retailer with an expanding digital footprint. This customer first brought Dynatrace in to bring application observability to their cloud modernization project.

During the initial deployment, the retailer experienced firsthand how Dynatrace's rapid automatic rollout and unified AIOps approach to identify service impacting issues, save them time, money and resources across more than just application use cases. Dynatrace's unified data model allowed them to tear down silos among teams, create more effective collaboration, accelerate innovation, simplify operations and drive greater online and in-store success. This drove the recent decision to standardize on Dynatrace across infrastructure monitoring, log analytics and digital experience monitoring in addition to APM. Consolidating multiple disparate tools while gaining the power of unified observability, advanced automation and AI-powered intelligence is a powerful combination of value as more of our customers strive to do more with less.

And it's this unified platform value that we believe will allow us to continually expand our ARR per customer over time from the $229,000 on average we see today to what we believe can be over $1 million per customer as we did with this retailer. While we increased focus on back-to-base selling during Q1, we are also excited to have added some fantastic new enterprise relationships around the globe with organizations like National Grid, MGM, Texas Health and Human Services, Yale University and Banco Sabadell. Digital transformation continues to happen across all industries, even those currently challenged by COVID. Take the US airline, a new logo for Dynatrace this past quarter.

Despite the fact that travel is down dramatically on a year-over-year basis, this customer came to Dynatrace to optimize conversions from initial customer contact to booked tickets. The airline has taken a classic multi-tool approach to monitoring with different digital teams favoring their own tooling. This left them with silos of data and blind spots to how users were truly experiencing the revenue-driving booking application. With mobile usage increasing rapidly and the need for greater efficiency rising quickly, they knew their approach had to change.

After demonstrating the power of connecting applications, infrastructure and user experience observability with conversion funnel KPIs, the airline quickly rolled out Dynatrace into production. Within days, actionable answers about conversion bottlenecks and optimization opportunities allowed the airline to make high-impact improvements to maximize passenger revenue. After experiencing the speed, efficiency and simplicity of the Dynatrace platform, compared to their previous tools, customer commented, "You guys are Usain Bolt and the other guys are simply weekend joggers." We believe this powerful unification of cloud observability data with business value metrics will continue to drive our new logo growth as we penetrate deeper into our target global 15,000 account base. As we enter Q2 with work-from-home disruptions largely behind us and digital transformation projects continuing to accelerate, we see the opportunity to increase the balance of our sales efforts by increasing our focus again on new logos.

Our pipeline is strong and our differentiation is compelling. The resulting do much more with much less effort and cost value proposition is powerful, especially now when IT and development organizations feel more and more pressure to move faster and accelerate their digital transformations. Speaking of market position and opportunity. This brings me to my second point.

Not only is the general macro trend of digital transformation fueling our business, so are the disruptive trends shaping modern cloud environments. As we've said before, nearly all our customers use Dynatrace for the intelligent observation and optimization of modern cloud workloads. These clouds may be public, they may be hybrid or what we see more and more often now, they are multi-cloud, multi-public with hybrid back-ends where critical systems of record and many run-the-business applications still reside. More often than not, Kubernetes is used for container orchestration and more and more look to multiple dev ops teams utilizing the latest cloud-native techniques to rapidly build, deploy and manage applications and workloads at web-scale.

With this combination of complexity, dynamism and frequency of change, only an automatic AI-assisted observability platform will work. The ongoing innovation across our platform continues to put us in a strong position to take advantage of these disruptive shifts in the cloud platform and cloud-native application landscape. Let me give you a quick example of what I'm talking about here. A SaaS solution provider for K-12 school administration, serving over 12,000 educational organizations and 80,000 schools, as this organization approached their renewal date for one of their existing monitoring tools, they brought in Dynatrace and another company for a three-way bake off.

While skeptical at first that Dynatrace was different, three things became clear during the evaluation that made Dynatrace the clear choice. First, the automation and AI at the core of our platform showed how they could quickly, continuously and intelligently observe and understand their dynamic Kubernetes environment, something that was highly manual and left them searching for answers with their current tooling. Second, they realized that with instant and precise answers, they could speed product delivery by automating large parts of their dev ops delivery pipeline that previously had required manual steps, burning precious time and valuable resource. And third, the power of the Dynatrace-run solution became clear as the customer expanded the scope of the pilot beyond APM, as they further investigated Dynatrace for an infrastructure monitoring initiative.

By leveraging our common data model and unified AIOps approach across both infrastructure and application use cases, they realized they could eliminate silos between their cloud operations and applications teams, smoothing collaboration and accelerating innovation. With IDC, Gartner and other leading industry analysts predicting the continued expansion of dynamic multi-cloud environments as the platform of choice for global enterprises and the rise in AIOps as a requirement for allowing resource scrapped IT and development organizations to do much more with much less effort and cost, we believe the Dynatrace value proposition and platform differentiation will continue to serve us well, both in gaining new enterprise cloud customers and an expanding ARR per customer over time. Now, let me touch on the third point, investing in growth. Given the fact that we are fortunate to be in an industry category that is well positioned to continue thriving during a difficult economic environment and we have a highly differentiated platform well positioned for the disruptive cloud trends ahead, I want to reiterate that we are continuing to invest aggressively in growth.

We expanded our global team by over 90 employees in Q1, with over 100 more already signed on to start throughout Q2. Sales, customer success and R&D continue to be the primary areas of investment for us as we expand our customer base on our platform footprint. We also recently completed our FedRAMP certification at moderate impact level, which gives us broader access to the massive digital transformation effort of the US government. We've doubled our sales investment in US federal government over the past year and expect to see this business segment continue to grow at an accelerated rate.

On the product front, we are committed to investing in ongoing innovation. Our largely European-based R&D organization continues to expand, including a new lab recently opened in Vienna, Austria. And we continue to expand the capabilities of all five monetizable modules as well as bring greater scale, fault tolerance and extensibility to the platform itself. This past quarter, we extended scalability and fault tolerance for our largest customers, allowing them to extend hybrid clusters across geographically distributed clouds with full fault tolerance in case one of their cloud operation centers should go down.

For our many Kubernetes customers, we announced extended AI-powered support for advanced observability of Kubernetes infrastructure, container and application workloads. Now, our customers can get a unified view across all tiers to better understand, manage, troubleshoot and optimize their growingly complex Kubernetes clusters and cloud-native applications that run on them and the back-end data sources in middleware these modern cloud applications depend on to operate effectively. And we continue to mature our infrastructure monitoring and log analytics module with greater coverage of cloud services, including all 80 of the core Azure services. I think it's important to note that when we add coverage, we don't just add a data feed for a service.

We had one agent automation, unified dependency understanding across all cloud dimensions with Smartscape, an AI understanding with Davis to provide ease of ongoing operation and intelligent answers and insights for greater efficiency and lower ongoing cost. It's gratifying when all this work, all our innovation and value is recognized by third parties. But it's especially gratifying when the feedback comes from your customers. During the quarter, G2, a leading peer review site, had reviewers rank observability platform leaders across several use cases.

Dynatrace came out No. 1, including No. 1 rankings across cloud infrastructure monitoring, AIOps platforms, application performance monitoring, container monitoring, digital experience monitoring and session replay categories. Our platform expansion continues to gain traction with our customer base, with a number of Dynatrace customers now using three or more modules, up 44% over the past six months.

We're grateful for the support and recognition of our many customers and pleased our reputation as the modern cloud observability leader continues to grow. So let me summarize, as I covered a fair amount this morning. Our opportunity is large and growing rapidly. It's fueled by powerful macro trends of digital transformation and dynamic multi-cloud adoption.

We have proven the resilience of our value proposition in times of challenge and the power of our differentiation to both acquire new logos as well as expand rapidly within our base. This combination, along with the investments we continue to make in commercial expansion and ongoing innovation, put us in a strong position in a market segment that will continue to sit near the top of the strategic IT priority list for some time to come. With that, let me turn it over to Kevin for a deeper look into our financial results and guidance. Kevin?

Kevin Burns -- Chief Financial Officer

Thank you, John, and good morning, everyone. As John mentioned, we have a strong start to our fiscal '21 with solid growth in ARR, revenue and earnings. There is still a fair amount of uncertainty in the global economy, but our solid first-quarter results demonstrate that digital transformation is critical for business success. As we look ahead, we continue to be optimistic about our sustainable growth potential.

So, let me start with a quick review of the first-quarter financial highlights and then move on to our outlook. Annual recurring revenue continues to be one of the key financial measures to understand the momentum of our business. ARR grew to $601 million. That's up 39% year over year, an increase of $164 million on an as-reported basis, compared to the year-ago period.

The two drivers of ARR growth are new logo customers and our Dynatrace net expansion rate. As we mentioned on our last call, over the last few months, we increased our sales focus to help our existing customers establish their work-from-home and digital transformation efforts. This contributed to our strong net expansion rate, which remained over 120% for the ninth consecutive quarter. ARR per Dynatrace customer also increased to $229,000, up over 10% year over year.

We added 85 net new customers in Q1, bringing our total Dynatrace customer count to 2,458 customers. As expected, the combination of our increased focus on our installed base, coupled with a more challenging business environment, led to a moderation in new additions to the Dynatrace platform in the first quarter. With a solid pipeline of new logos for the second quarter, and we believe new logo adds will be roughly 450 for the remainder of this year, this would be consistent with the new logo additions for the same period last year and ahead of our initial guidance assumption coming into the year based on the resilience of digital transformation projects and the essential role Dynatrace plays in ensuring digital transformation success. Moving to revenue.

Total revenue for the first quarter was $155.5 million, $5.5 million above the high end of our guidance and representing an increase of 30% on a year-over-year basis. The strength in total revenue growth is being driven by 37% growth in subscription revenue, partially offset by the expected decline in classic license revenue, which now represents less than 1% of our quarterly revenue. With respect to margins, we continue to see a healthy expansion in our gross margins as the subscription revenue mix increases. Total non-GAAP gross margin for the first quarter was 85%, up two percentage points from last quarter and up 3 percentage points from Q1 of last year.

We are very pleased with our margin performance, primarily due to the efficient way we manage our platform, coupled with modest cost savings related to the macro shutdown. Our non-GAAP operating income for the first quarter was $50.8 million, above the high-end of our guidance of $40 million due to revenue and gross margin upside expansion and lower-than-expected operating expenses due to prudent expense management as we evaluated the business environment over the course of the quarter. This led to a non-GAAP operating margin of 33%, up 11 percentage points from the first quarter last year. While this performance shows the operating leverage potential inherent in our business, given the strength of our platform and the growing TAM we operate in, we do intend to accelerate intelligent investments in innovation and commercial expansion as we move forward in fiscal '21.

As a result, consistent with what we communicated last quarter, we do expect margins will come down from Q1 levels as we move throughout the fiscal year. Non-GAAP net income was $36.9 million or $0.13 per share, $0.03 above the high end of our guidance. Turning to the balance sheet. As of June 30, we had $250 million of cash, and our long-term debt was $510 million.

Given the strength of our cash flow and confidence in the business, we recently reinitiated our program to further reduce our outstanding debt. As a result, we made a principal repayment of $30 million in early July, reducing our debt balance to $480 million. Since our IPO, we have consistently improved our leverage ratio, which ended the first quarter at 1.6 times ours trailing 12-month adjusted EBITDA. Our leverage ratio is down over 50% from our post-IPO leverage ratio of 3.3 times EBITDA.

As a reminder, our unlevered free cash flow can be a bit lumpy on a quarterly basis, with our strongest cash generation occurring in the last quarter of the fiscal year following the seasonality of growth bookings and renewals. Therefore, we believe the best way to look at our unlevered free cash flow is in our full year or trailing 12-month basis to smooth out the effect of quarterly seasonality. For the first quarter, unlevered free cash flow was $37 million. We were very pleased with our Q1 performance, which was nicely above our internal expectations.

On a TTM basis, unlevered free cash flow was $141 million, which was 24% of revenue. We continue to expect to deliver full-year unlevered free cash flow margins of 29 to 30%. The last financial measure that I would like to discuss is our remaining performance obligation, which at the end of the quarter was $857 million, an increase of 40% over Q1 of last year. The current portion of RPO, which we expect to recognize as revenue over the next 12 months, was $503 million, an increase of 42% year over year.

Our healthy RPO expansion has benefited from the move to a subscription business combined with the general increase in the duration of our new subscription agreements. Now, let's move to guidance. As a reminder, all references to growth rates will be in constant currency, unless noted. As I mentioned earlier, after initial pausing on some expenses as we evaluated the business environment, we do plan to increase investments in the second quarter and the remainder of the fiscal year.

These will include additional hires to accelerate commercial expansion, further expansion in our labs to support innovation and ongoing investments in our customer success initiatives. As a result, we should expect to see higher operating expenses throughout the remainder of the year, resulting in lower operating margins versus Q1, which ran well ahead of our expectations, primarily due to the strength of our revenue. With that as backdrop for the second quarter, we expect total revenue to be in a range of 159 to $161 million, representing year-over-year growth of 25 to 26%. We expect Q2 subscription revenue to be in a range of 149 to $150.5 million, representing year-over-year growth of 30 to 32%.

From a profit standpoint in Q2, we expect non-GAAP operating income to be in a range of 43 to $45 million, 27 to 28% of revenue, and non-GAAP EPS of $0.09 to $0.10 per share, assuming 288 to 289 million shares outstanding. We estimate a Q2 cash tax rate of approximately 30% due to higher state cash taxes in the quarter. For the full year, ARR guidance is 698 to $708 million, 23 to 25% growth. We expect total revenue to be in a range of 646 to $656 million, representing year-over-year growth of 20 to 22%.

We expect our subscription revenue to be in a range of 603 to $612 million, representing year-over-year growth of 26 to 27%. I would also like to highlight our fiscal '21 expectation with respect to our Dynatrace net expansion rate. As John mentioned earlier, and we've noted in our earnings release today, we have achieved nine quarters with a net expansion rate above 120%. It continues to be a strong part of our business.

Our current guidance assumes we'll continue with helping net expansion rates above 120% for the remainder of the fiscal year. This compares to our initial guidance assumption of 115%. And we are comfortable increasing this base in our Q1 performance, ongoing conversations with our customer base and the strength of our pipeline and renewals. For the full year, we expect non-GAAP operating income to be in a range of 166 to $175 million and non-GAAP EPS of $0.46 to $0.49 per share.

This assumes a tax benefit between 6 to $8 million in the back half of the year. We still expect our annual effective cash tax rate of approximately 11%, but will have quarterly variability. And I mentioned this earlier, but just to reiterate again, we continue to expect unlevered free cash flow margins to be approximately 29 to 30%, resulting in 187 to $195 million of unlevered free cash flow. Finally, we expect 288 to 290 million diluted shares for fiscal '21.

We feel great about the resilience of the business and are confident that our growth will continue to be driven by a healthy balance of existing customer expansion combined with new logo growth. We are firming up the details of a virtual investor day for early September, and you can expect a release with more specifics shortly. We look forward to sharing more details about our business strategy, market opportunities, product vision and continued investment in the development of new capabilities to fuel our future growth. With that, we will take your questions.

Operator?

Questions & Answers:

Operator

[Operator instructions] Your first question comes from the line of Matt Hedberg with RBC Capital Markets.

Matt Hedberg -- RBC Capital Markets -- Analyst

Hey, guys. Thanks for the time. And John and team, congrats on the strong results. Very impressive.

John, you talked about accelerated digital transformations post-COVID, which is great to hear and really caught my attention. Can you talk about the level of monitoring at some of these customers? And I think you called out a large retailer in particular. Where were they at pre, from a monitoring perspective? And where are they at now when they go all-in at Dynatrace?

John Van Siclen -- Chief Executive Officer

Now, thanks, Matt. Appreciate it. Yes, so what we're seeing just in general is sort of thesis that we had going into the quarter. But we, of course, guided cautiously, in case there were things we didn't see happening.

But I think throughout the quarter, we saw much more resilience and the thesis of Dynatrace being essential for digital transformation really playing out. And what -- as companies move to greater degrees of digital transformation, they're accelerating their cloud journeys, because that's what underpins digital transformation. And they move their applications more rapidly from just a lift-and-shift model to true cloud-native application designs. And as they do this, it seems great with agility and speed, but the complexity under the hood goes through the roof, and it's that complexity that we simplify.

Without instrumentation and sort of that kind of observability at scale, which requires advanced degrees of automation and AI to be able to handle that level of complexity when you're talking about billions of dependencies with these microservices floating across multi-clouds, Dynatrace starts to shine even brighter. And so what before COVID seemed like we can take our time and maybe we can still do it with our current investments of disparate tooling quickly becomes, there is no way we can accelerate digital transformation without making a change in our instrumentation model, in our observability model, in our automation model and so on. And so, that's what we're seeing is that it's -- as digital transformation accelerates, the need for a Dynatrace-class solution even goes up. And that's why we saw the beginnings of it in our fiscal Q1, and we continue to see it as we look out into Q2 and beyond with the sales cycles we're now in.

Matt Hedberg -- RBC Capital Markets -- Analyst

That's great. And then Kevin, on ARR, 39% constant currency growth is super-impressive, especially when you consider -- I think last year, you were at 43% growth. But I believe that saw a benefit from classic Dynatrace customers that this quarter didn't see. I guess, to that point, can you remind us roughly what the benefit was last year on that class of conversion? Because I think if you were to normalize for that, you might have even had similar ARR growth.

Kevin Burns -- Chief Financial Officer

That's right. So, if you look back and maybe take the last six quarters, our average ARR growth on a constant currency basis is in the low 40%. When you break it out and you just look at new logos and expansion for our Dynatrace customers when they're on the platform, that growth rate was about 39%, 40%. And again, this quarter, on a constant currency basis, apples to apples, we grew 39%.

So, most of the reduction in ARR really came as a result of the fact that we've moved our customer base over to the Dynatrace platform and are expanding on that now.

Matt Hedberg -- RBC Capital Markets -- Analyst

Super helpful. Well done, guys.

Kevin Burns -- Chief Financial Officer

Thank you.

Operator

And your next question comes from the line of Jennifer Lowe with UBS.

Jennifer Lowe -- UBS -- Analyst

Great. Thank you. Maybe just quickly on the ARR and continuing that train of thought, Kevin, you mentioned the assumption now is 120% of net new relative to 115% prior. But there's also a lot of discussion on the focus on new logo acquisition and that being a big emphasis as we move through the remainder of the year.

So, can you just parse through, with the increase of ARR guidance, is that purely a function of the change in the assumption around net retention, or are you also factoring in better new logo acquisition? What are sort of the puts and takes there, because it seems like there's a few different drivers mentioned?

Kevin Burns -- Chief Financial Officer

Sure. If you -- so if you sort of take a step back, we set that 115% bar in a period of uncertainty three, four months ago. Given the strength of the business in the first quarter, be it combination of new logos, which are stronger than we had expected when we started the quarter, and also a healthy net expansion rate, really our guidance -- or our guidance, I should say going forward, is a combination of new logos growth better than we were expecting about 90 days ago and a step-up in the net expansion rate. So, we're seeing strength from where we were 90 days ago in both segments of our business.

If you look at the back three quarters, we were expecting about 450 new logos, which is fairly consistent with where we were last year. We had a healthy pipeline there. And the Dynatrace net expansion rate, we're doing a great job of cross-selling and expanding the platform in our existing customers. So, a combination across the board.

Jennifer Lowe -- UBS -- Analyst

And maybe just one more from me on that net new logo focus and sort of the specificity on the target there. Did you introduce any changes in the sales compensation to preferentially encourage them a bit more on net new logo, or is it more just sort of strategic, hey, this is where you want your guys to be focused? Any color there would be helpful as well. And that's it from me.

John Van Siclen -- Chief Executive Officer

This is John. Thanks, Jennifer. There's no real changes year to year on sort of new logo incentive. We do have an incentive for sales to continue to drive new logos.

We have such a fantastic platform for built-in expansion. And so, we've -- for the last couple of years, we've had that new logo incentive to sell. And the balance seems to be working. And as Kevin said, based on sort of pipelines and what we see in our sales cycles, we're quite confident in that new logo growth again this year.

Jennifer Lowe -- UBS -- Analyst

Great. Thank you.

Operator

And your next call comes from Heather Bellini with Goldman Sachs.

Heather Bellini -- Goldman Sachs -- Analyst

Great. Thank you so much, guys, for taking the question. I just had a couple. One, and I know you mentioned this in your initial comments about back to basics.

But just wondering, versus the start of the quarter, which was obviously a period of great uncertainty, not that we're fully out of the woods yet, but what are conversations like today? And then also from a lead gen perspective, I guess, a little bit following up on kind of what Jen was asking with new logos, what have you done differently in this new environment of no travel to generate new logo demand? And kind of how have the conversations evolved? Meaning are customers becoming -- were they way more hesitant in the beginning of the quarter and now things are starting to progress back to where you feel like pipeline build is kind of on pace with what it was prior? I don't know, if you could share any thoughts on those, that'd be great.

John Van Siclen -- Chief Executive Officer

Sure, Heather. So, what happened at the beginning of the quarter, and it's not unexpected. I mean, I think many of the folks wrote about this, maybe yourself as well, that in the disruption of everybody scrambling to work from home and the scrutiny around which projects were going to rise as essential and which ones were going to fall as nonessential, that process took several weeks out of the quarter. And so, we anticipated that.

We pivoted to what makes a ton of sense, of course, which is we'll take care of your base. So, it's -- back to the base was a key part of our early part of Q1. It served us extremely well, and we generated a number of new logos as well as a very strong new logo pipeline for the balance of the year. The conversations have really only changed in the discussion around why is this project essential, Mr.

Customer, or around how Dynatrace is an essential part of your digital transformation, let's discuss how, where and how we can expand the value of the platform for you. So, it's just centered maybe a little bit differently from the standpoint of, it's not just a project, it's an essential project for digital transformation. So, more pointed, if that makes sense. On the new logo front, what we're seeing there, again, is a pretty clear conversation that cuts to the quick immediately, which is around that sort of essential nature of the project.

If it's not essential, nobody wants to spend time on it. If it's essential, it actually moves more effectively or sort of more predictably through the sales cycle, because it had to be blessed early by the higher up management that this program would be essential. So we're seeing that dynamic in the new logos, which is actually very, very helpful. And as I said before, we have the bless -- we're blessed with being in a category that when times get tough, people turn to their applications, they turn to their digital transformations, they turn to sort of that digital side of their business where they can get closer to customers, they can be more agile, they can save cost and they can drive new revenue streams.

And we're essential to that movement and a nice place to be.

Heather Bellini -- Goldman Sachs -- Analyst

Thanks so much.

Operator

Your next question comes from Sterling with JP Morgan.

Sterling Auty -- J.P. Morgan -- Analyst

Yeah. Thanks. Hi, guys. I actually want to circle all the way back to Matt Hedberg's question.

One of the things that is a frequent topic of conversation with investors is the idea that Gartner report talking about 5% of applications are currently monitored. And I think investors are trying to get a handle on, with the digital transformations, where does that percentage go to? And obviously, based on your qualitative comments, the answer is higher. But is there any sense, as you're seeing that shift to the cloud, does that 5% of apps become 50 or 25%, or just any qualitative commentary around that would be helpful.

John Van Siclen -- Chief Executive Officer

Sure, Sterling. The shift to the cloud is actually -- has an interesting dynamic with it. In the sort of siloed world of the data center where you had different applications on different stacks of hardware connected by physical networks, and now that's all moved to sort of a virtual pool of resources, there are many more applications and services that are involved in a digital business than ever before. So, we're seeing customers want to take their sort of application monitoring and observability up into that 60-plus percent of applications, all Tier 1, most of Tier 2 and even into some Tier 3 zones.

So it is increasing with the cloud, and it's just a dynamic of how the cloud sort of operates and how the services become interconnected in the cloud. So, as companies do digitally transform, there continues to be application expansion for sure. But I also don't want you to think that the only expansion that we're doing is because of the application layers. We're actually starting to get much stronger in the cross-selling across the non-application hosts and services as well as more and more sort of extensions into digital experience and digital business analytics.

And those are super-valuable. I mean, I gave the example of an airline. It was really the user experience and the connection with digital KPIs that drove that opportunity from just a, why should I replace my current monitoring systems? It's because it wasn't helping with digital outcomes that were critical, of course, over the last few months. And so, it's that sort of comprehensive platform capability across all these modules and how they work together in a unified platform on Dynatrace that really is a key to why we believe we can raise that net expansion rate back up to 120% plus and continue that for the foreseeable future.

Sterling Auty -- J.P. Morgan -- Analyst

Very helpful. Thank you.

Operator

And your next question comes from the line of Kash Rangan with BAML.

Kash Rangan -- Bank of America Merrill Lynch -- Analyst

Hi. Good morning. Congratulations. I was wondering if you could give us some metrics that would represent the monitoring side of the business versus the APM side.

And if the term is really that large, and obviously, you have the metrics to prove that, you have new logos that you've guided to be very positive, your net expansion rates trended quite high, your win rates in the monitoring space seem to be quite high, why would the company not reconsider raising its longer-term growth forecast? Because you're, after all, being very successful in the brand new markets? That is one. And secondly, if you could give us a little more commentary on the replacement of legacy monitoring lenders. What exactly is happening there? And why are you winning there? That would be great.

John Van Siclen -- Chief Executive Officer

Sure. Let me try to parse those questions a little bit. So, the first one just regarding sort of metrics between APM and sort of the cross-selling, I think last quarter, I talked about 25% of our customer base -- our growing customers using three-plus modules, which is really sort of -- those are the platform customers, ones that have really moved themselves from sort of tool thinking to platform thinking. And just gave another stat that over the last six months, that's actually increased 44%.

So just to share with the group here and our investment community that the cross-selling that we've been talking about for the last year is taking off. And so, think about us maybe as a -- where a year ago, we might have been at 80% APM and 20% emerging products, think of us as a 70 and 30% emerging products. But also remember that the base of customers is expanding rapidly as well, all right? So maybe that gives you a little bit of color. And I'm going to expect that trend to, of course, continue as we drive to sort of more and more platform customer usage over time.

So, I think that that's key. The second one, as far as growth rate, well, we're pretty pleased with the growth rate that we have right now. If and when that moves up, we'll continue to guide. But you're going to find us to be relatively conservative company from a guidance standpoint.

We think that's a proper way to automate and -- I'm sorry, proper way to guide. And we just think that's prudent. OK?

Kash Rangan -- Bank of America Merrill Lynch -- Analyst

And who are you winning the monitoring business against, the legacy or the modern vendors? If you -- any color, that should be --

John Van Siclen -- Chief Executive Officer

Right. Right. Yes, sorry about that third piece there. It's a combination of both, OK? So it's actually an interesting dynamic.

We're seeing more and more movement to sort of what we had called in the past greenfield is where you sort of have a do-it-yourself approach taking over, no real incumbent. Because as people move to the cloud, they realize their prior investments in Gen 1 and Gen 2 tooling no longer works in dynamic multi-clouds. And so, that's going to do it yourself world, it's starting to actually show up as an observability project world, OK? So we're starting to see that -- beginnings of that trend. That's about 40% of what we see in the market, and that's up from about 30% a year ago.

We still see an incumbent in our base. We have been clear that we still land on the application layer. It's where we're best known, sort of that APM segment or what we call our APM module. And there, it's sort of the classic Gen 2 and Gen 1 competitors that are in that space.

And as time goes on, our differentiation becomes much more valuable and our win rates continue to climb against all those competitors. And as I said -- 60% of the engagements we enter into these days.

Kash Rangan -- Bank of America Merrill Lynch -- Analyst

Thank you, John.

Operator

And your next question comes from the line of Raimo Lenschow with Barclays.

Raimo Lenschow -- Barclays Investment Bank -- Analyst

Hey. That's a new version. Can I stay on that subject? So if you think about it, there are kind of initiatives out from a lot of different players around this, and everyone is coming from a different angle with new product announcements, etc. Like, if you think from your perspective, what's the main thing that people, that you think, where you kind of have the lead and should kind of continue to strive? Because like you see the logs guys, the infrastructure monitoring guys, all of them coming into the middle ground with observability.

Like can you talk a little bit about the complexity of what you did over the last couple of years in terms of kind of redoing the product and bringing it all together under one umbrella? And then I have one follow-up.

John Van Siclen -- Chief Executive Officer

Sure. So, yes, let me step back just quickly, because our reinvention of our platform was not simply to bring together these observability data sources plus some other ones like topology code and some other data elements. That was part of it, because we knew that the cloud required a different kind of observability than just layer by layer by layer, you have to see it as a sort of a homogeneous whole, a unified whole. But we also built in automation and AI, which -- and that differentiation becomes more and more essential as IT and development organizations try to move faster with fewer resources that, of course, they would like to have in order to accomplish all the application and digital transformation needs that they're being tasked with.

So, it really is a combination of that observability, plus automation and plus AI that really set us apart from a differentiation standpoint as we attacked the modern cloud market. So, keep that in mind. When we look out and we see sort of this world that's coaxing use cases, where that other players see as well where they might be coming off of infrastructure or log, we still believe that that application layer or that application thinking that we bring is really pretty vital, because it's applications where IT and the business connect. The underlying plumbing of a cloud stack is interesting to make sure that cloud platform is working properly for the applications that run on it.

But the connective tissue with the business is there in that application layer. And so, when we think about -- going forward we think about not just that connecting the plumbing with the allocation, we also think about user experience, business KPIs and the rest also connecting. And so, it's that complete end-to-end stack of platform value components that really make a difference for us. So, I think that when you take the airline example or whether you take the retailer example or you take the K-12 example that I gave, every one of those required a much more complete set of modules in order to solve their digital transformation efforts than just observability alone.

Raimo Lenschow -- Barclays Investment Bank -- Analyst

OK. Yes, makes sense. And then the -- congratulations on bringing the leverage down. So, now you're at a level that is kind of like way into kind of the normal range, like how do you think about that trajectory going forward? Because it's a classic, hey, obviously, software doesn't do a lot of that.

But then, if you do financial science, you just kind of realize, OK, well, it's actually decent level to carry and it's kind of -- it's also kind of a decent thing. How do you think about that going forward?

Kevin Burns -- Chief Financial Officer

Sure. So, first of all, we're super-pleased with the progress we've made since IPO and well ahead of plan of actually delevering the company. In July, as I mentioned in the prepared remarks, we did pay down another $30 million of debt. Our debt balance is now about $480 million and a fairly low interest rate.

And given our cash generation capabilities, our net leverage will be below zero in the very near future. If we think about sort of cash usage outside of that, I'd probably push that conversation out to our analyst day when we can talk about some of the areas where we can explore that cash usage and where we can put it to work. But for now, for the next couple of quarters, it's certainly just focused on getting that leverage ratio down a little bit more.

Raimo Lenschow -- Barclays Investment Bank -- Analyst

OK, perfect. Congrats. Thank you.

Operator

And your next question comes from the line of Bhavan Suri.

Bhavan Suri -- William Blair & Company -- Analyst

Hey, guys. Thanks for squeezing me in here at the end. Congrats, really nice set of numbers. I guess, I wanted to touch on two quick things.

One, on sales force productivity, you had a part of sales force pass to sort of that shift to Dynatrace platform. And John, you've talked about productivity improving and then sort of saying, OK, now we have capacity to go drive customer expansion, which again, you did really well to get to 120% or north of 120%. How much do you think of that capacity is available for these new logo adds? And how much do you think you have to ramp higher and sort of meet the customer targets this year and then obviously kind of going into next year?

John Van Siclen -- Chief Executive Officer

Let me take that in a couple of pieces here. So, the first one is the sales capacity expansion or really general commercial expansion, for us, continues. And that hasn't stopped. It's one of the things that we kept our foot on the gas throughout the early COVID period, even in those times of uncertainty there.

So, that's continued to scale. Some of that capacity that's freeing up from conversions as well as being added to the business is helping us drive pipeline growth and sort of momentum in the business that Kevin talked about and is shared in our guidance here. So, with some headwinds, of course, because of economic uncertainty in certain sectors of our business, which are more heavily impacted, as well as certain geographies that have also been a little more impacted, I think that capacity growth is right now going to sort of driving our current growth trajectory and not sort of propelling it one step beyond it. But I'm still really pleased with where we are from a growth standpoint.

And as I said, it's reflected in our guidance. I think that going forward, just from a investment standpoint in the business, we talked about not only commercial expansion, but also continued innovation expansion. And I've shared some of that success we're having with cross-selling, which of course, comes with maturing in some of those additional modules. But I'm really excited to be able to share some of the plans ahead when we did our investor day in early September.

And I think you'll also see some of the -- some of what's coming when we get to that point. So, stay tuned and excited to share in a couple of months.

Bhavan Suri -- William Blair & Company -- Analyst

Got it. One quick one for you or Kevin. I know it's something that's starting to come up a little bit more, but what did you guys see in '16 around the election? Because you've obviously put up the new logo count out there, which is new for all of us as a guide. But there's always been this concern, does spending slowdown or people postpone decisions kind of going into the election or postelection a little bit depending on results.

And again, you guys went public in '15. But sort of what do you see? What do you expect? What are you hearing from customers around concerns around that or no concerns or haven't come up? I'd love to just get some color on how you're thinking about what plays out again, not for the next few months, but as we get closer to November, which is actually a few months. So, yes, I'd love to get that color.

John Van Siclen -- Chief Executive Officer

Well, whether it's surveys that we read, like the one that we shared from Fortune or whether it's actually direct conversations with customers, digital transformation is a long-term trend. It definitely transcends elections and it's not something that's going to get pushed one way or the other. It's on a long-term macro trend trajectory. And that's what we're hearing.

And so, that's what gives us confidence. From a government standpoint, digital transformation is a critical part. Again, it's a long-term trend. It's beyond election year kind of spending.

And yes, so I'm excited about that opportunity as well, which I highlighted in this earnings call in particular. So, we don't see a real issue with elections, because this really is an exciting long-term macro trend environment as businesses rebate themselves into digital businesses.

Bhavan Suri -- William Blair & Company -- Analyst

Yes. No. Fair enough. And congrats on the federal opportunity, too.

I'll hop off. I know we're running late. Thanks for taking my question, guys, and congrats again.

John Van Siclen -- Chief Executive Officer

Great. Thank you. I appreciate it. Maybe I should -- with that sort of -- yes, one, more?

Noelle Faris -- Vice President, Investor Relations

We can sneak in one more.

John Van Siclen -- Chief Executive Officer

One more question, all right. One more question.

Operator

Your final question comes from the line of David Hynes with Canaccord.

David Hynes -- Canaccord Genuity -- Analyst

Hey. Thanks. Thanks, guys. I'll keep it quick.

So, Kevin, maybe this one is for you. As I think about the drivers of net expansion, what's having a more significant impact? Are the follow-on deals getting larger, or are they coming more frequently?

Kevin Burns -- Chief Financial Officer

In terms of net expansion, it really is a combination of both, right, given the different verticals that we operate in. We are seeing expansion -- footprint expansion happening more rapidly than we have seen over the last couple of years. That may impact a little bit in the quarter in terms of just deploying something kind a little bit again, but basically, we had a -- helping that expansion rate in the quarter. And then the second piece is in terms of the new logos -- I'm sorry, I missed this -- I missed the second piece of the question, David.

David Hynes -- Canaccord Genuity -- Analyst

No. I was just talking about are the follow-on deals getting larger, or are they coming more frequently? Nothing about new logos. I think you hit on it, it's a combination of both.

Kevin Burns -- Chief Financial Officer

So the size of the deals are staying fairly interesting, I'd say. It's just becoming a little bit more rapid in terms of install and expansion in our customer base.

John Van Siclen -- Chief Executive Officer

Yes. Sure. Exactly.

David Hynes -- Canaccord Genuity -- Analyst

And then, John, maybe a quick follow-up for you since you mentioned -- said in the response to Bhavan there. Is there a common incumbent across the federal environment? And just how do you think about the scope of the opportunity there?

John Van Siclen -- Chief Executive Officer

Yes. It's a good question. It's not dissimilar to the commercial market where there's a number of incumbents. But then those who are more advanced in their cloud transformations are already seeing them fall away.

So, again, there's do-it-yourself. There as well that we enter in on and provide a platform to simplify that world and eliminate the disparate tooling challenges that you run into when you take that kind of do-it-yourself approach. So, it's really not that different. It's just that they're big project-based as opposed to commercial, which moves a little bit faster.

That's why we hesitated our investment in US federal until about two years ago. And now we're investing aggressively, because we see the US government being much more active and much more purposeful in their digital transformation efforts. And thank you, everybody, for joining us this morning. We're excited about the business.

We had a great start to our year, and we look forward to sharing more with you both at our investor day and again at our next earnings call in October. Thank you very much.

Operator

[Operator signoff]

Duration: 64 minutes

Call participants:

Noelle Faris -- Vice President, Investor Relations

John Van Siclen -- Chief Executive Officer

Kevin Burns -- Chief Financial Officer

Matt Hedberg -- RBC Capital Markets -- Analyst

Jennifer Lowe -- UBS -- Analyst

Heather Bellini -- Goldman Sachs -- Analyst

Sterling Auty -- J.P. Morgan -- Analyst

Kash Rangan -- Bank of America Merrill Lynch -- Analyst

Raimo Lenschow -- Barclays Investment Bank -- Analyst

Bhavan Suri -- William Blair & Company -- Analyst

David Hynes -- Canaccord Genuity -- Analyst

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