Dynatrace (DT) Q3 2025 Earnings Call Transcript

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Dynatrace (NYSE: DT)
Q3 2025 Earnings Call
Jan 30, 2025, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, welcome to Dynatrace fiscal third quarter 2025 earnings call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Noelle Faris, vice president of investor relations. Thank you.

You may begin.

Noelle Faris -- Vice President, Investor Relations

Good morning, and thank you for joining Dynatrace's third quarter fiscal 2025 earnings conference call. Joining me today are Rick McConnell, chief executive officer; and Jim Benson, chief financial officer. Before we get started, please note that today's comments include forward-looking statements, such as statements regarding revenue, earnings guidance, and economic conditions. Actual results may differ materially from our expectations due to a number of risks and uncertainties discussed in Dynatrace's SEC filings, including our most recent quarterly report on Form 10-Q that we filed earlier today.

The forward-looking statements contained in this call represent the company's views on January 30th, 2025. We assume no obligation to update these statements as a result of new information, future events, or circumstances. Unless otherwise noted, the growth rates we discussed today are non-GAAP, reflecting constant-currency growth, and per-share amounts are on a diluted basis. We will also discuss other non-GAAP financial measures on today's call.

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To see reconciliations between non-GAAP and GAAP measures, please refer to today's earnings press release and supplemental presentation, which are both posted in the Financial Results section of our IR website. And with that, let me turn the call over to our chief executive officer, Rick McConnell.

Rick McConnell -- Chief Executive Officer

Thanks, Noelle, and good morning, everyone. Thank you for joining us for today's call. We're proud that Dynatrace once again outperformed our guidance across all top line and profitability metrics. This is a testament to the team's disciplined execution, the strength of our AI-powered observability platform, and the significant business value we provide to our customers.

In Q3, ARR grew 18% year over year. Subscription revenue increased 21% year over year, and trailing 12-month free cash flow margin was 25%. Jim will share more details about our Q3 performance and fiscal 2025 guidance in a moment. In the meantime, I'd like to discuss observability market tailwinds, our platform differentiation, core growth drivers, and customer wins.

To begin, our conviction in the observability market opportunity continues to strengthen based on several factors. Cloud modernization drives observability demand and is evidenced by the now more than $220 billion in annualized hyperscaler revenue. Aggressive cloud expansion has, however, contributed to tool sprawl within organizations, resulting both in operational inefficiency and high cost. It's not uncommon for companies to have more than a dozen internal and external observability tools and aim to consolidate them into a more effective, unified, and lower-cost approach.

And the AI revolution adds another layer of complexity as organizations look to accelerate innovation, deliver better customer service, drive efficiency, and obtain a competitive advantage. Each of these market drivers is resulting in an explosion of data and a massive increase in its scale and complexity that are simply untenable for organizations to manage as they have previously. As a result, the need for comprehensive end-to-end observability has become mandatory, especially for larger organizations. We believe that an AI-powered observability platform with sophisticated analytic and automation capabilities is vital in providing the visibility needed for software to work perfectly, and customer feedback reflects just that.

This leads me to our primary technology differentiators. The core of the Dynatrace platform is a massive parallel processing, highly performant data store called Grail that maintains all observability, security, and business data types: logs, metrics, traces, real user data, and importantly, business events, all in context. Grail then enables us to uniquely apply AI to analyze billions of interconnected data points in real time to deliver answers, not just data and not just dashboards. We then leverage our contextual analytics and AI insights to automate responses and help avoid incidents.

It is our contextual analytics, AI, and automation that differentiate us from our peers. Our unified architecture has enabled us to deliver new observability and security capabilities that help customers adopt cloud and AI-native technologies with confidence. These include not only the inherent benefits of full stack observability to help customers anticipate and resolve issues in complex environments but also enrich business data with IT context to provide insights and recommendations for improved business outcomes. We have been introducing these and other new capabilities for SREs, platform engineers, and development teams to extend this differentiation to a broader array of end users.

Next, I'd like to highlight four key growth drivers for Dynatrace. Let's start with AI. As I mentioned, AI is a huge market driver of data. And with our long history in AI, Dynatrace has a unique ability to leverage this opportunity.

We parse it into two distinct buckets. First is AI ops, which includes the core AI capabilities we use to deliver observability, security, and automation to all customers. AI ops is and has been foundational to the Dynatrace solution for many years, and we keep innovating to enable customers to move from visibility to automation. Our AI-powered observability platform enables customers to automatically detect problems, analyze them, and drive automatic remediation actions using an AI system that we believe is the most advanced in our space.

We achieve this by leveraging multiple techniques, including causal, predictive, and generative AI, to rapidly assess billions of interconnected data points to identify, resolve, and prevent issues without tedious and error-prone manual overhead. Second AI driver for Dynatrace is the observability of AI workloads themselves. Secular innovation cycle around AI is being viewed as the biggest sea change ever in the technology landscape. What started with gen AI has quickly evolved to retrieval augmented generation or RAG, inference AI, and more recently, agentic AI.

As with Dynatrace itself, this evolution illustrates a migration from information and insights to automated response. And with the rapid pace of cloud and AI-native innovation, enterprises need an observability solution that can adapt to those changes in real time. With the enormous processing power of Grail, we are uniquely positioned to enable enterprises to adopt gen AI and other AI technologies successfully. Dynatrace can analyze LLM model performance and behavior, safeguard the quality of application input and output to prevent LLM misuse, deliver multi-model tracing for end-to-end observability, predict changes in cost, and calculate the business benefit and ROI.

We are already engaged with hundreds of customers in observing their gen AI initiatives. One such customer, a large insurance provider, found that they could accelerate the deployment of AI use cases into production by 60% with the help of Dynatrace AI observability. The second growth driver for Dynatrace is the substantial existing market for log management which we continue to see as being ripe for disruption. We are well-positioned to grow our market share given our unique approach.

Customers have broadly told us that legacy log management solutions are too expensive, provide too little value, and operate independently from existing monitoring tools. This creates operational inefficiencies that lead to delayed incident resolution, increased costs, security vulnerabilities, and dissatisfied customers. Our next-generation log management and analytics offering integrates logs, traces metrics and other core observability and security data types into a single platform, providing a holistic view of the health of IT ecosystems. Combined with our AI approach, teams can derive greater value from logs faster and extend them to security use cases.

Leveraging Grail is our data store. They can do so at enormous scale, and we enable log observability deployment and access without manual setup or the need to understand query languages. We now have well over 1,000 customers leveraging our log solutions. That's up 17% compared to last quarter, plus more than 50% of our new logos added over the past year are leveraging logs in their initial deployments.

The third growth driver for Dynatrace is the ongoing investment in our go-to market strategy. As a reminder, at the beginning of this fiscal year, we introduced go-to market changes focused on customer segmentation, partner enablement, and expanding our sales motion beyond application performance to include end-to-end observability and cloud modernization. At the beginning of the year, we made adjustments in our sales force to target IT 500 and strategic accounts. We have since accelerated the addition of sales rEPS during the second half of the year to increase capacity.

Our investments in partner enablement continue to gain traction. In Q3, more than half of the new logos in the quarter were partner originated. We are benefiting from increased customer interest in end-to-end observability and tool consolidation. In Q3, the dollar contribution of deals greater than $1 million grew 55% year over year.

Finally, our cloud modernization sales motion contributed to several key wins in the quarter, including one seven-figure TCV deal with a top private bank in India. They were moving their major banking platform to a microservices environment in the cloud and were struggling with frequent issues impacting end users, which their existing monitoring tools were unable to resolve. During the POC, Dynatrace provided deeper insights and proactively identified potential issues before they impacted end users. The final growth driver I wanted to cover is the Dynatrace platform subscription or DPS licensing model which continues to gain traction rapidly.

This customer-friendly licensing model allows trialing of new capabilities without surprise overages or premiums. Our DPS customers have full access to our platform, enabling them to adopt Dynatrace more broadly across their IT environment. And now that we have passed the annual anniversaries of several cohorts of DPS customers, we are seeing our thesis play out. In particular, customers that benefit from the value of Dynatrace consume more than customers on our legacy licensing model, and they expand earlier.

We now have roughly 1,500 DPS customers globally, representing over 35% of our customer base and roughly 55% of our ARR leveraging this approach. On average, the rate of consumption growth for DPS customers is nearly double the rate of our non-DPS customers. Next, I'd like to discuss several notable wins in the quarter that highlight why customers choose Dynatrace. A top Canadian bank signed an eight-figure TCV deal with Dynatrace, displacing an existing tool as part of their ongoing journey to simplify, digitize, and personalize their products.

Dynatrace's ability to automate processes and lower costs led to this key win. A large Midwest retailer signed an eight-figure TCV deal displacing their log provider and standardizing on Dynatrace. They were already benefiting from the flexibility of DPS which allowed them to adapt to changing business needs during their peak season. A major American automobile manufacturer concerned with the risk and cost associated with the deployment of harmful code into production environments signed a seven-figure TCV expansion with Dynatrace to automate change impact analysis and quickly validate service availability.

We won an eight-figure new logo deal with a British semiconductor and software design company. They were looking to reduce the number of issues occurring on the engineering side of the production process and increase their productivity. With Dynatrace, their IT teams can detect and resolve issues in production significantly faster, allowing them to meet their deployment goals. And more recently, we announced that we have become the official observability and performance analytics technology partner of the Visa Cash App Racing Bulls, also known on the track as VCARB, a Formula One racing team.

Every millisecond counts in F1, and the Dynatrace platform will be delivering real-time insights into vehicle dynamics, driver performance, and race optimization to give VCARB a competitive edge to maximize performance. Finally, we're excited to host customers, partners, and prospects next week at Perform, our annual customer conference in Las Vegas. This is going to be our largest customer conference yet with over 50 customers from around the world taking the stage to share their stories of how they are harnessing the power of Dynatrace to accelerate business-critical initiatives, drive innovation, and deliver more reliable software. To wrap up, we are highly enthusiastic about our opportunity ahead.

There's a common theme we've covered here today. Customers understand that a unified observability platform is mission critical. We have a significantly differentiated AI-powered observability platform, and there are several Dynatrace-specific drivers that we see supporting our growth. Jim, over to you.

Jim Benson -- Chief Financial Officer

Thank you, Rick, and good morning, everyone. Q3 marked another quarter of consistent execution as we once again surpassed the high end of our top-line growth and profitability guidance metrics, showcasing the durability of our balanced business model and ongoing demand for our leading AI-powered observability platform. Now let's review the third 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, ended the third quarter at $1.65 billion, up 18% year over year. Q3 net new ARR on a constant-currency basis was $68 million, down modestly from the same period last year and up 5% year to date for fiscal 2025. In Q3, we added 193 new logos to the Dynatrace platform. As we have stated in the past, we continue to target landing high-quality new logos that have a greater propensity to expand.

Our average ARR per new logo was over $140,000 on a trailing 12-month basis and up versus both the prior quarter and prior year. Our value proposition continues to resonate with enterprise customers that are outgrowing their existing DIY or commercial tooling solutions. They are seeking business value from tool consolidation and coming to Dynatrace for the depth, breadth, and automation of our unified observability platform. Once customers experience the benefits of the Dynatrace platform, they are often quick to expand their usage.

Average ARR per customer continues to grow and surpassed $400,000 for the first time, highlighting the continued adoption of the platform and value we provide to customers. Gross retention rate remained in the mid-90s, demonstrating the strategic relevance of the Dynatrace platform as it remains a mission-critical part of our customers' operations. Net retention rate, or NRR, was 111% in the third quarter. DPS licensing model continues to gain traction and adoption.

We now have almost 1,500 customers globally, representing more than 35% of our customer base and over 55% of our ARR. As Rick mentioned, our expectation when we launched DPS was that customers with full access to the platform would trial more capabilities and adopt Dynatrace more broadly within their IT environment. I'm pleased to say that thesis is proving itself out. What has become clear as DPS has started to mature and scale is that the customer-friendly approach to DPS pricing, which does not penalize customers for exceeding commitments, is leading to some customers to consume DPS on demand instead of renewing early.

This on-demand consumption is benefiting subscription revenue growth, which outperformed expectations nicely in Q3. However, it's important to note this revenue is not captured in our ARR or NRR metrics, which only include contractually committed revenue. Let me put some numbers around this to make the impact on our financials clearer. In Q3, we had $7 million of on-demand consumption in our subscription revenue.

This contributed to 150 basis points of year-over-year subscription revenue growth. On a year-to-date basis, we had $12 million of on-demand consumption revenue. The fact that DPS makes it easier to consume the platform is positive for Dynatrace. The outcome of customers expanding and broadening their usage of the platform, whether that be contractually committed or on demand, drives continued subscription revenue growth.

Going forward, we believe investors should assess the underlying health of the business by taking into consideration both ARR, which will still be the largest growth indicator, and on-demand consumption revenue. Our expectation is that as DPS grows and scales, so too will on-demand consumption with likely variability and seasonality quarter to quarter. Moving on to revenue. Total revenue for the third quarter was $436 million, up 20% year over year and exceeding the high end of guidance by $8 million.

This beat includes absorbing a $3 million FX headwind from the strengthening U.S. dollar. Subscription revenue for the third quarter was $417 million, up 21% year over year and exceeding the high end of guidance by $7 million as reported and $10 million in constant currency with the upside primarily driven by the on-demand consumption dynamic I just mentioned. Shifting to margins, non-GAAP gross margin for the third quarter was 84%, down slightly from the prior quarter and prior year due to increasing cloud hosting costs as we migrate more of our customers to our SaaS solution.

Non-GAAP income from operations for the third quarter was $131 million, $11 million above the high end of guidance, driven by increased revenues flowing through to the bottom line. This resulted in a non-GAAP operating margin of 30%, exceeding the top end of guidance by 200 basis points. Non-GAAP net income was $112 million or $0.37 per diluted share. This was $0.04 above the high end of our guidance.

We generated $38 million of free cash flow in the third quarter. Due to seasonality and variability in billings quarter to quarter, we believe it is best to view free cash flow over a trailing 12-month period. On a trailing 12-month basis, free cash flow was $406 million or 25% of revenue. As a reminder, this includes a 650-basis-point impact related to cash taxes.

Pretax free cash flow on a trailing 12-month basis was 31% of revenue and up 25% year over year. On a related tax note, as part of our ongoing strategic tax planning efforts, we completed an IP-related transfer to a Swiss subsidiary, resulting in a noncash $321 million tax benefit to our GAAP net income and EPS. There was no impact to non-GAAP net income or EPS. And while the impact of this IP transfer to fiscal 2025 cash taxes is insignificant, we do expect it will have a more meaningful impact in fiscal 2026 and beyond.

More to follow on this in our May earnings call. Finally, a brief update on our $500 million share repurchase program. In Q3, we repurchased 732,000 shares for $40 million at an average price of $54.64. Since the inception of the program in May 2024 through December 31st, we repurchased 2.7 million shares for $130 million at an average price of $48.89.

Moving now to guidance. Let me walk through some of the assumptions and insights underpinning our updated guidance. First, based on our learnings from early DPS cohorts, we believe it is likely that on-demand consumption will be an ongoing and growing part of our subscription revenue stream as the DPS contracting model matures. To put a finer point on this, going forward, subscription revenue growth will be driven by a combination of upfront ARR growth and on-demand consumption on the tail end of contracts for those customers that choose not to renew early once they've exceeded their upfront commitment.

Second, the trend of larger and more strategic deals related to observability platform architecture and tool consolidation initiatives continues to grow. The sales funnel is weighted heavily to these types of deals. While we believe this trend is a net positive for Dynatrace given our highly differentiated AI-powered platform and positions us well to capitalize on these opportunities, it also introduces increased variability in terms of both closed timing and deal certainty. Third, we continue to mature the go-to market adjustments we made in the beginning of this fiscal year.

As we expected, it takes time for new rEPS to build relationships and positively impact sales productivity. Fourth, while the demand environment for observability remains healthy, we do not assume a material change in the macro environment as enterprises continue to be cautious in their spending. Finally, with 40% of our business denominated in foreign currency, the strength of the U.S. dollar since our last call creates a sizable headwind.

We now expect FX to be a headwind of $38 million to ARR and $17 million to revenue. This represents an incremental headwind of $28 million to ARR and $10 million to revenue. And with that as context, let me outline our updated outlook. We are raising our constant-currency full-year guidance across all top-line growth and profitability metrics.

We are increasing our full-year ARR growth guidance 75 basis points at the midpoint to $1.705 billion to $1.715 billion. This represents 16% to 16.5% growth year over year. We are raising our total revenue growth guidance 150 basis points at the midpoint to $1.686 billion to $1.691 billion, representing 19% growth year over year. And with the uptick in on-demand consumption revenue, we are raising our subscription revenue growth guidance 250 basis points at the midpoint to $1.609 billion to $1.614 billion, representing 20% growth year over year.

This growth rate represents a 350-basis-point increase from the midpoint of guidance that we provided at the beginning of this fiscal year. Turning to our bottom line, we are raising our full-year non-GAAP operating income guidance by $13 million. This translates to non-GAAP operating margin guidance of 28.5% to 28.75%, up 50 basis points at the high end of the range and up roughly 75 basis points from where we landed in fiscal 2024. We are raising our non-GAAP EPS guidance to a range of $1.36 to $1.37 per diluted share, representing an increase of $0.05 at the midpoint of the range.

This non-GAAP EPS is based on a diluted share count of 303 million to 304 million shares. This EPS and share count guidance excludes the impact of any potential share repurchases in Q4. We are raising our free cash flow guidance to $415 million to $420 million, an increase of $19 million at the midpoint, representing a free cash flow margin of 25% of revenue. Excluding an expected 650-basis-point impact from cash taxes, this represents a pre-tax free cash flow margin of 31.5%, which is up 150 basis points from fiscal 2024.

Looking at Q4, we expect total revenue to be between $432 million and $437 million. Subscription revenue is expected to be between $410 million and $415 million. From a profit standpoint, non-GAAP income from operations is expected to be between $104 million to $110 million or 24% to 25% of revenue. Keep in mind we have some seasonal expenses in the fourth quarter, including incremental spending for our Perform customer conference and a structural reset of payroll taxes.

We believe it is best to look at margins on a full-year basis. Lastly, non-GAAP EPS is expected to be $0.29 to $0.31 per diluted share. In summary, we are pleased with our third quarter fiscal 2025 performance. The observability market is healthy and growing.

We have a proven track record of disciplined execution, balancing top-line growth with expanding profitability and free cash flow. While we continue to maintain a prudent approach to the near-term outlook, we are optimistic about the long-term growth opportunities 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 for questions. Operator?

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question is from Matt Hedberg with RBC. Please proceed.

Matthew Hedberg -- Analyst

Great. Thanks for taking my questions, guys, and congrats on the results. Jim, we're getting questions on the on-demand piece, so I wanted to kind of ask a little bit of a question there. It seems to be ramping rapidly, which I think is a good thing for long-term adoption of DPS.

I guess when you think about your Q4 assumption -- guidance assumptions, do you have any sense for what your -- what's implied there for on demand in 4Q? And I know it's early, but when we think about next year, how should we sort of -- what's the conceptual framework for thinking about on demand for fiscal '26 as we think about ARR next year?

Jim Benson -- Chief Financial Officer

Yeah. Thanks for the question, Matt. I'd say we're learning as the DPS model evolves, and you're absolutely right that what we're seeing is exactly what we wanted to see play out, which is with DPS, customers have a vehicle that is a very frictionless model for them to consume more of the platform. And we're seeing that play out that customers that are on DPS consume at two times the rate of customers that are on the SKU-based platform.

So DPS is really all about driving consumption. I would say this phenomena with on-demand consumption is even something that we didn't expect initially when we came up with DPS, that what we're finding is that this means that customers are exceeding their commitments early, and we're finding that some customers are just willing to go in a period of on demand. Now for us, it's all about subscription revenue. I mentioned in the prepared remarks that we improved our subscription revenue guide from the beginning of the year to now 350 basis points.

Obviously, a component of that is on-demand consumption. And so you really do need to look at Dynatrace, both ARR growth, which is obviously a primary kind of leading indicator. And then what we're seeing here with on-demand consumption, we do believe this will grow as DPS grows because it's uncommitted. It's something that obviously we're going to continue to build a level of caution in.

But if you just look at where we're at year to date, $12 million, and you're absolutely right, it has rapidly grown. Now it will vary by cohort class by quarter. But if you just equate that, even though it's uncommitted kind of in ARR terms, that's 80 bps of ARR. And so it's a good model.

For the fourth quarter specifically, we've modeled like mid-single digits in that because -- again, because it's uncommitted, you don't know exactly what it's going to be, but we're very, very pleased with what we're seeing here with DPS because it is driving the consumption that we were hoping it would.

Operator

Our next question is from Fatima Boolani. Please proceed.

Fatima Boolani -- Analyst

Good morning. Thank you for taking my questions. Just to riff off of Matt's question, Jim, how should we think about the net retention rate trajectory as you continue to see sort of this decoupling or breakage, if you will, between customer consumption behavior and contracted ARR on the grounds of greater DPS consumption and usage? Thank you.

Jim Benson -- Chief Financial Officer

OK. So that's a very good question, Fatima. So as I said in the prepared remarks that neither ARR or NRR has on-demand consumption embedded in it. That is just contractually committed business.

But because we're seeing this phenomena with ODC that it will not show up in the ARR metric, that does not mean that you will not see with DPS NRR accretion. As a matter of fact, even though we're very early days with the cohort classes with DPS, we are seeing DPS customers expand at a greater rate and pace than SKU-based customers. I admit this is probably a bit of sampling bias with that. But now that we have 55% of our ARR on that, I'd say the sampling bias component will start to diminish.

And so you will see NRR, but you will see NRR at the time of an expansion. And because we have on-demand consumption -- and just maybe a clarification for investors is most of our ARR that's on DPS is multiyear contracts. So I think the -- it's called 80-plus percent of our ARR are multiyear contracts. So the way to think about this is customers' contracts in, call it three one-year commitments individually.

And so when you have a customer that may be in year one of their contract that's going through this on-demand consumption component, they don't necessarily have to expand early. They can just go on demand. Then they go into year two and think of it as the clock resets. Now they're obviously consuming at a greater rate and pace.

So you will get an expansion. Sometimes you'll get an expansion early in year one, and sometimes you won't get an expansion until later in the contract life. So NRR will benefit. It's just the timing of when do you see ODC and when will you see NRR.

And I think as DPS grows and matures, you will see it more reflected in NRR.

Operator

Our next question is from Will Power with Baird. Please proceed.

William Power -- Analyst

OK, great. Thanks. Hey, Rick, I wanted to come back to some of the introductory comments around AI. You laid out a nice suite of tools that are designed to help on AI fronts, whether it's observing LLMs or helping with agentic work.

I just -- I guess I wonder if you could just help highlight where are you seeing the most traction today? And is it something that's starting to benefit you? And what's the outlook there? And is there any way just to kind of help conceptualize revenue or ARR contribution around all that?

Rick McConnell -- Chief Executive Officer

Thanks, Will. And sorry to you all for a bit of a raspy voice this morning, but we'll get through it together. The AI piece, for us, is an absolute tailwind, I would say, across the board. It started with generative AI.

It went to RAG. It's continuing with inference. It's moving on to agentic AI. All of this is moving, if you will, from analytics and data to inference knowledge, analytics, and onward to agents that are driving behavior and automation.

And in many ways, we think about our AI strategy at Dynatrace as mirroring that because we're also moving from overall observability to deep answers and intuitive results all the way through automation. And so we believe that AI is a huge tailwind because at the end of the day, it's driving enormous amounts of data, increases in its complexity, and our ability to manage that complexity through a sophisticated observability platform is of paramount importance to our customers. One last point, the hundreds of customers that we have already using AI observability with Dynatrace are really across the board in sectors and industries. So we see AI being adopted very broadly.

They're interested in observing AI workloads, and we believe it is a tailwind for our AI observability capabilities as a result of that.

Operator

Our next question is from Keith Bachman with BMO Capital Markets. Please proceed.

Keith Bachman -- Analyst

Hi. Thank you. I have a question, maybe just sneak in a clarification. If I look at your ARR guidance implied for Q4, if I'm doing the math right quickly, it suggests sort of a mid-60s numbers again in terms of net new, which is down year over year.

And I know you said -- I think you said that the DPS contracts or the consumption-based element maybe is mid-single digits, but it's still declining year over year pursuant to your guidance. I just want to see if there's anything you can help us understand because it sort of starts the jumping-off point as we begin to fine-tune our models for FY '26. And then just a clarification, Jim, I know you said you'd give us more help on taxes. But just philosophically, as we think about '26, we're trying to set our free cash flow.

Is the change -- is the cash tax impact just broadly, is it a help, hurt, or neutral, just to help us think about our free cash flow estimates for '26?

Jim Benson -- Chief Financial Officer

Thanks for the questions, Keith. Relative to the ARR guide, I think the primary driver of the ARR guide, we obviously had 15% to 16% growth last time. We're now three-quarters of the way through the year. You have one quarter left.

So we certainly lopped off the low end of the range, and we did inch it up on the high end. And I'd say we inched it up probably more prudently largely because I said in my prepared remarks, we actually have the funnel. The funnel is pretty heavily weighted to maybe even more so than last year, heavily weighted to very large, strategic binary deals. And when you have a funnel that's weighted that way, you have 90 days left in the year.

We're not necessarily expecting the same level of execution that we did last year. We ran the table last year. And so the good news is we think this is a good net positive for Dynatrace because as customers thinking about consolidation, we're actually in a good position to compete with those opportunities, so we think it's a net positive relative to a trend. Obviously, near term, it does introduce a level of close timing variability and deal certainty.

So that's kind of the -- maybe the way to think about it on the ARR front. And I think that trend will continue. Even though we're not providing fiscal '26 guide, our expectation is this continued trend will continue into fiscal '26. And relative to taxes, the very simple way to put it, Keith, is, as you can imagine, we know we are a significant cash taxpayer, 650 basis points of cash taxes as a percent of revenue.

And so we've been doing what we can around strategic tax planning, and this IP-related transfer to Switzerland will lower the tax rate for the company. So this will be a benefit to lower cash taxes in fiscal '26. So it's not a headwind. It's a tailwind.

I'll share more about the extent of how much of a tailwind that will be. It will build over the years, but you will see benefit in fiscal '26 from lower cash taxes.

Operator

Our next question is from Pinjalim Bora with J.P. Morgan. Please proceed.

Pinjalim Bora -- Analyst

Thank you, guys. Congrats on the quarter. Jim, I just wanted to understand the NRR dynamics one more time, if you might. It seems like the DPS tool overages has increased, you said, $7 million last quarter.

I think you said low single digits or something like that. So that is a headwind to ARR, I understand, but that $7 million is a quarterly number. So the headwind to ARR, would that be an annualized number? And then obviously, from the last quarter, you would have caught up with some of those contracts, which should be a tailwind to ARR, if you have. But it seems like you might not have caught up in three months.

It can take maybe more than that. So I'm trying to understand what is the net of this? Because NRR did down tick sequentially. And I'm trying to understand if you net it out, is that 100% -- the downtick from last quarter, is that 100% because of this dynamic would you say?

Jim Benson -- Chief Financial Officer

Yeah. I don't know if I would necessarily. The NRR downtick is a result per se of kind of this phenomena of what's going on with ODC. I would say we -- for the quarter and -- actually the -- I would say, year to date, we talked about our go-to-market changes with our go-to-market changes really being oriented around customer segmentation and applying more resource at the top of the pyramid, global IT 500 companies.

And the good news is, while it takes a while to build relationships, we are starting to see some green shoots from that effort. And so we're starting to see pipeline grow in that space. We are starting to see deal closures in that space, and so I'd say we feel good about the traction even though it's still early days. I'd say the -- below the IT 500, which we call the commercial segment, admittedly, the commercial segment, we're not seeing the same level of performance in the commercial segment around expansions.

And so like everything else that there's areas that you need to tune in the model. So for us, we're getting traction in the areas we've been focusing on. We need to tune the model a little bit more for the commercial segment where expansions were a little bit less, and that was -- that's probably the area that has pressured NRR. And just relative to making sure people understand how DPS works, I try to use the example of a multiyear contract, for which most of our DPS contracts are.

They have three one-year individual commitments. So this on-demand consumption phenomenon does not necessarily mean the customer needs to do a renewal. By definition, they're not up for renewal for three years. You're in year one, but they burn through their year one commitment early, which means they're consuming more of the platform which is exactly what we wanted.

The customer does not necessarily want to do an early renewal in year one because maybe the amount of overage was not substantial. The unit pricing reduction they would get maybe wouldn't be as impactful to go through a broad effort, so they're willing to then go into the following reset year. So think of it as year one, you get on-demand consumption. You're done with your year one maybe.

Now you're in year two. But when you're in year two, this clock starts at zero again. So think of it as a contract that's maybe a $6 million TCV, $2 million a year. They spend $2.2 million in the first year with 200 of on-demand consumption.

Following year, the clock starts at zero again. Now granted their run rate is higher, so the likelihood may be that they'll do an early expansion in year two increases because maybe the benefit of doing it then. But that's just kind of how it works. It's not necessarily that because you're on on-demand consumption that you'll see the following quarter in expansion.

It doesn't necessarily work that way. It does work that way in some cases, but because we're very early in the renewal cohort class, sometimes it happens. Sometimes customers just go through a reset.

Rick McConnell -- Chief Executive Officer

And Pinjalim, I would just add that this is a reason that we are suggesting that we increase view not just on ARR but also on subscription revenue as we look ahead because both of these metrics are going to increasingly matter in a DPS world.

Jim Benson -- Chief Financial Officer

And the only other thing I would say, Pinjalim, that I didn't answer in your commentary about the way that -- you were saying, "Hey, can you annualize maybe this impact that we saw $7 million?" I would say that it's uncommitted. So yeah, you could annualize it because as DPS grows, you would expect that, yes, that's kind of the way to generally think about it. I'd say because it has variability because it's uncommitted, I'd say we're always going to apply a bit of caution. But your -- kind of your mental model is the right one.

If you did annualize that value, that is the amount of kind of the equivalent, uncommitted ARR that it would equate to, and then it's a matter of what's the timing by which the customer does an expansion to then see that show up in ARR.

Operator

Our next question is from Mike Cikos with Needham & Company. Please proceed.

Mike Cikos -- Analyst

Hey, team, thanks for taking the questions here. I just wanted to cycle back on the go-to-market changes that you guys announced earlier this year and just get an update. I wanted to get a sense of where we are in recognizing the sales productivity gains from those changes and really what gives management here the confidence. Because I know in Rick's prepared remarks, he had cited the fact that you guys are looking to accelerate this transition.

Can you give us an order of magnitude on that front?

Jim Benson -- Chief Financial Officer

Yes. That's a very good question. I won't belabor what we've done around the go-to-market change because you do know that. So we're three quarters in, and we certainly didn't expect productivity improvements three quarters in.

Your transitioning accounts, especially when you're in strategic accounts, it does take a while to establish relationships. I'd say the green shoots and leading indicators, Mike, that we look at is are we starting to see, call it, rolling four-quarter pipeline improve, and the answer is yes. So the first thing you want to know, people are settling in. They're establishing new relationships.

What's the first thing we're going to see? Well, we'd like to see that the rolling four-quarter pipeline is improving. We are seeing that. And so we are seeing, in some cases, some deal closures in that segment already. So this -- you're already seeing maybe an improvement in deal closures in that segment, penetration in that segment, and then within customers that we already had deeper expansion.

So I'd say we're still -- we are not at the point of showing an improvement in productivity, but we do feel like where we're at is about where we would expect. As I mentioned, that was the focus, which is strategic accounts. There is some work for us to do to tune the commercial segment to get the commercial segment to improve the expansion level that we're seeing. We're not necessarily seeing the same level of activity there.

But again, you're always tuning the model. I think that's something that we'll continue to work on as we head into fiscal '26.

Rick McConnell -- Chief Executive Officer

Mike, I would just add also that last quarter, we reported on having north of 30% of our reps with less than one year of tenure. We continue to add reps, and so we continue to be in a situation where in which we have 30% or greater than 30% of reps with less than one year of tenure. So productivity will expect to increase as that 10-year increases over the course of time. Also on the partner side, we continue to see traction there.

More than three-quarter of the deals are transacted through our partner ecosystem, and we're now seeing greater than 50% of new logos transacted through a partner, which is net new business, which we'd like to see as well.

Operator

Our next question is from Sanjit Singh with Morgan Stanley. Please proceed.

Sanjit Singh -- Analyst

Yeah. Thank you for you for taking the questions, and, Rick, I hope you feel better. Coming back to some of the color, Jim, that you provided on the structure of the DPS contract. That was super helpful, noting that they're multiyear contracts.

I guess the question is, what's going to be the triggering event for an expansion if, let's say, a customer is in sort of year one of DPS, their renewal is not for another two-plus years? How do you sort of see that? How do you sort of see that playing out? And I guess the context here is within these sort of year-one, year-two, year-three dynamics. Are there step-ups in commitments? Or are they sort of like $1 million in year one, $1 million in year two, $1 million in year three? Just a little bit more clarity on what the average DPS contract is sort of constructed.

Jim Benson -- Chief Financial Officer

Yeah. It's a very good question, Sanjit. I guess I'll take your last question first that there are customers that they will -- we have a variety of models with DPS. Some are what we call ramp deals.

So think of it, to your point, it's a one in year one and two in year two, three in year three, so it ramps. That's for some customers. Some customers have a TCV deal where it's over the contract life, so their DPS is over the contract life. Some customers have maybe, to your point, a two, two, two, you're using my example, that it's -- they have the same volumes, but they have them in equivalent resets.

And it varies, so it's hard to equate all of them. But the way it will work even -- regardless of kind of the vehicle that you're on, it becomes a customer decision, right? And again, for us, what we're looking for the customer to do is get more value from the platform and consume faster. That ultimately is what we're looking to have happened. Now whether it shows up as an on-demand consumption for the dynamics I mentioned or whether it shows up maybe in an earlier expansion, to some extent, we're indifferent.

They're getting more value of the platform, which means they're consuming faster. I'd say we are seeing that there are triggering events to your point, depends upon how fast you're consuming. And if you think a recontract or we kind of doing an early repackage would result in a significantly improved unit price, you might be willing to go through that. And then there are customers that just, in some cases, what they'll do is they budget for what they would consider a minimum commitment, and they're more than happy to have overages because they budget for overages.

And they say, "All right. For this contract life, I have 100% conviction I'll spend to the minimum commitment. I'll budget for more for on-demand consumption," and so those will be customers that will stay. And then there are customers that, again, depending on how fast they're consuming, it might not be worth a repackage because they don't see the benefit on unit pricing.

And so it varies. And so what it's going to mean is, call it, the NRR improvement that you're going to see is going to be staged, depending upon the profile of those different customers. Again, the timing of that is difficult to call. But we kind of bring you back to -- there are benefits to this model to subscription revenue growth.

It's just a dynamic that probably there's been a very clear focus on ARR. And I do think, going forward, you're going to need to look at ARR, plus you're going to need to look at this dynamic of what's going on with on-demand consumption combined. And you'll probably see it play out better in subscription revenue than ARR in the near term.

Operator

Our next question is from Andrew Nowinski with Wells Fargo. Please proceed.

Andrew Nowinski -- Analyst

Thank you for taking the question. It sounds like you're seeing a lot of positive tailwinds as it relates to most of the leading indicators in your business with the pipeline improving. I think you said more traction through partners and more business transacted through partners. But if you look at the new logo adds, I guess they were down year over year.

Is that related to the commercial segment weakness you talked about? Or is there something else going on there?

Jim Benson -- Chief Financial Officer

I'd say, yeah, we are a bit light on new logo from a unit perspective, but I continue to remind you that we're very focused on the quality of the land, which is landing them at the right size. And we actually saw very, very healthy lands in the third quarter. We talked that -- I think last quarter, we were just a little bit over 130,000 average land size on a trailing 12-month basis. We were well over 140.

So if you look at the individual quarter, the individual quarter for Q3, by itself, had very, very large land sizes on average. And so yes, we want units, but we want units that have the highest propensity to expand. Those units tend to be units that land north of $100,000. So we're pretty pleased, I'd say, with the land size.

You are right. We'd like to increase the volume. And in the commercial segment would be obviously an area that we'd like to see more new -- obviously, legacy units in the Global 500 as well, but I'd say where you're going to see a larger volume is going to be in the commercial segment.

Operator

Our next question is from with Koji Ikeda with Bank of America. Please proceed.

Koji Ikeda -- Analyst

Yeah. Hey, guys. Thanks so much for taking the questions. So just from a real high level, just trying to understand, is ARR and NRR, as it's defined today, no longer the right metrics to gauge the health of the business? Maybe why or why not from a long-term perspective? And then with on-demand becoming a much bigger part of the story, is there a way to maybe talk about qualitatively how subscription NRR compares to reported NRR? Maybe how DPS NRR compares to subscription NRR, if you could.

Jim Benson -- Chief Financial Officer

I would not go so far as to say that ARR and NRR are not important metrics. Those will remain important metrics for Dynatrace. I'd say what you can't do is you can't look at them in isolation. Because of the DPS contracting vehicle and the fact that we are getting what I would say is delayed ARR growth from on-demand consumption, you need to look at both ARR and NRR and ODC together because I think that is -- those are the best measures of kind of the health of the business.

And I'd say just qualitatively, again, when you talked about NRR and ARR and how they'll behave, I think the way they're going to behave is they're going to behave the way they have historically. Maybe with the exception of you may see with the advent of DPS, you may see more on-demand consumption earlier. You may see expansions later. And so could be early expansions, in some cases, as I mentioned.

But I actually think if you look at it combined, there may be a delay in when you see ARR show up given the dynamic of where DPS is. But again, let's go back to what is it about. It is about driving consumption. It is about driving future subscription revenue.

That's what DPS is doing. It's just showing up in two different metrics.

Rick McConnell -- Chief Executive Officer

That brings us to the end. Thank you all for your engaged questions, and of course, your ongoing support. To close, we remain very enthusiastic about the growth opportunities ahead of us, especially given the market, as well as Dynatrace-specific tailwinds that we covered on this call.To those of you joining us in Perform next week, we very much look forward to seeing you in person, and we look forward to connecting with many of you at IR events over the coming months. We wish you all a very good day.

Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Noelle Faris -- Vice President, Investor Relations

Rick McConnell -- Chief Executive Officer

Jim Benson -- Chief Financial Officer

Matthew Hedberg -- Analyst

Fatima Boolani -- Analyst

William Power -- Analyst

Keith Bachman -- Analyst

Pinjalim Bora -- Analyst

Mike Cikos -- Analyst

Sanjit Singh -- Analyst

Andrew Nowinski -- Analyst

Koji Ikeda -- Analyst

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