Q3 2025 Dynatrace Inc Earnings Call
Speaker Change: please press star zero on your telephone keypad. 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.
Speaker Change: 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.
Speaker Change: Before we get started, please note that today's comments include forward-looking statements such as statements regarding revenue, earnings guidance, and economic conditions.
Speaker Change: 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.
Speaker Change: Unless otherwise noted, the growth rates we discussed today are non-gap, reflecting constant currency growth, and per share amounts are on a diluted basis.
Speaker Change: We will also discuss other non-GAAP financial measures on today's call.
Speaker Change: Thanks, Noelle, and good morning, everyone. Thank you for joining us for today's call.
We are proud that Dynatrace once again outperformed our guidance.
across all top line and profitability metrics.
This is a testament to the team's discipline and execution.
Speaker Change: The strength of our AI-powered observability platform and the significant business value we provide to our customers.
Q3, ARR grew 18% year-over-year.
Subscription revenue increased 21% year-over-year.
and trailing 12-month free cash flow margin was 25%.
are platform differentiation, core growth drivers, and customer wins.
Speaker Change: To begin, our conviction in the observability market opportunity continues to strengthen based on several factors.
Speaker Change: Aggressive cloud expansion has, however, contributed to tool sprawl within organizations, resulting both in operational inefficiency and high cost.
Speaker Change: Not uncommon for companies to have more than a dozen internal and external observability tools.
Speaker Change: 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.
Speaker Change: 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.
Speaker Change: 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...
Speaker Change: With sophisticated analytic and automation capabilities is vital in providing the visibility needed for software to work perfectly.
This leads me to our primary technology differentiators.
Speaker Change: 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.
Speaker Change: Logs, metrics, traces, real user data, and importantly, business events, all in context.
Speaker Change: 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 to help avoid incidents.
Speaker Change: It is our contextual analytics, AI, and automation that differentiate us from our peers.
Speaker Change: Our unified architecture has enabled us to deliver new observability and security capabilities that help customers adopt cloud and AI native technologies with confidence.
Speaker Change: These include not only the inherent benefits of full-stack observability to help customers anticipate and resolve issues in complex environments.
Speaker Change: but also enrich business data with IT context to provide insights and recommendations for improved business outcomes.
Speaker Change: 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.
Speaker Change: Next, I'd like to highlight four key growth drivers for Dynatrace.
Let's start with AI.
Speaker Change: And with our long history in AI, Dynatrace has a unique ability to leverage this opportunity.
We parse it into two distinct buckets.
AI Ops is and has been foundational.
to the Dynatrace solution for many years.
Speaker Change: 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.
Speaker Change: including causal predictive and generative AI to rapidly assess billions of interconnected data points.
Speaker Change: to identify, resolve, and prevent issues without tedious and error-prone manual overhead.
Speaker Change: The second AI driver for Dynatrace is the observability of AI workloads themselves.
Secular innovation cycle around AI.
Speaker Change: is being viewed as the biggest sea change ever in the technology landscape.
inference AI and more recently agentic AI.
Speaker Change: As with Dynatrace itself, this evolution illustrates a migration from information and insights to automated response.
Speaker Change: and with the rapid pace of cloud and AI native innovation.
Speaker Change: Enterprises need an observability solution that can adapt to those changes in real-time.
Speaker Change: 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.
Speaker Change: 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.
Speaker Change: We are already engaged with hundreds of customers in observing their Gen AI initiatives.
Speaker Change: 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.
Speaker Change: The second growth driver for Dynatrace is the substantial existing market for log management, which we continue to see as being ripe for disruption.
Speaker Change: We are well positioned to grow our market share, given our unique approach.
Speaker Change: Our customers have broadly told us that legacy log management solutions are too expensive, provide too little value, and operate independently from existing monitoring tools.
Speaker Change: This creates operational inefficiencies that lead to delayed incident resolution, increased costs, security vulnerabilities, and dissatisfied customers.
providing a holistic view of the health of IT ecosystems.
Speaker Change: Combined with our AI approach, teams can derive greater value from logs faster.
and extend them to security use cases.
Speaker Change: And we enable log observability deployment and access without manual setup or the need to understand query languages.
Speaker Change: We now have well over 1,000 customers leveraging our log solutions.
Speaker Change: Plus, more than 50% of our new logos added over the past year are leveraging logs in their initial deployments.
Speaker Change: The third growth driver for Dynatrace is the ongoing investment in our go-to-market strategy.
Speaker Change: As a reminder, at the beginning of this fiscal year, we introduced go-to-market changes focused on customer segmentation, partner enablement, and customer engagement.
Speaker Change: and expanding our sales motion beyond application performance to include end-to-end observability and cloud modernization.
Speaker Change: 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.
Speaker Change: In Q3, more than half of the new logos in the quarter were partner-originated.
Speaker Change: We are benefiting from increased customer interest in end-to-end observability and tool consolidation.
Speaker Change: In Q3, the dollar contribution of deals greater than $1 million grew 55% year over year.
Speaker Change: Finally, our cloud modernization sales motion contributed to several key wins in the quarter.
Speaker Change: including one seven-figure TCV deal with a top private bank in India.
Speaker Change: 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.
Speaker Change: During the POC Dynatrace provided deeper insights and proactively identified potential issues before they impacted end-users.
Speaker Change: Final growth driver I wanted to cover is the Dynatrace Platform Subscription, or DPS, licensing model, which continues to gain traction rapidly.
Speaker Change: This customer-friendly licensing model allows trialing of new capabilities without surprise overages or premiums.
Our DPS customers have full access to our platform.
Speaker Change: enabling them to adopt Dynatrace more broadly across their IT environment.
Speaker Change: And now that we have passed the annual anniversaries of several cohorts of DPS customers, we're seeing our thesis play out.
In particular, customers that benefit from the value of Dynatrace.
Speaker Change: 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.
Speaker Change: On average, the rate of consumption growth for DPS customers is nearly double the rate of our non-DPS customers.
Thanks for tuning in. See you next time.
Speaker Change: Next, I'd like to discuss several notable wins in the quarter that highlight why customers choose Dynatrace.
Speaker Change: A top Canadian bank signed an eight-figure TCV deal with Dynatrace.
Speaker Change: displacing an existing tool as part of their ongoing journey to simplify, digitize, and personalize their products.
Speaker Change: Dynatrace's ability to automate processes and lower costs led to this key win.
The
Speaker Change: A large Midwest retailer signed an eight-figure TCV deal displacing their log provider and standardizing on Dynatrace.
Speaker Change: They were already benefiting from the flexibility of DPS, which allowed them to adapt to changing business needs during their peak season.
Speaker Change: signed a seven-figure TCV expansion with Dynatrace to automate change impact analysis.
and quickly validate service availability.
Speaker Change: They were looking to reduce the number of issues occurring on the engineering side of the production process.
and increase their productivity.
Speaker Change: With Dynatrace, their IT teams can detect and resolve issues in production significantly faster, allowing them to meet their deployment goals.
Speaker Change: And more recently, we announced that we have become the official observability and performance analytics technology partner of the Visa Cash App Racing Bowls.
Also known on the track as V-Carb.
a Formula One racing team.
Speaker Change: Every millisecond counts in F1 and the Dynatrace platform will be delivering real-time insights
Speaker Change: into vehicle dynamics, driver performance, and race optimization to give VCARB a competitive edge to maximize performance.
Speaker Change: Finally, we're excited to host customers, partners, and prospects next week at Perform.
This is going to be our largest customer conference yet.
Speaker Change: with over 50 customers from around the world taking the stage to share their stories of how they are harnessing the power of Dynatrace.
Speaker Change: to accelerate business-critical initiatives, drive innovation, and deliver more reliable software.
customers understand that a unified observability platform is mission critical
We have a significantly differentiated AI-powered observability platform.
Speaker Change: And there are several Dynatrace-specific drivers that we see supporting air growth.
Jim, over to you.
Thank you, Rick, and good morning, everyone.
Speaker Change: 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.
Speaker Change: Please note, the growth rates referenced will be year-over-year and in constant currency unless otherwise stated.
Speaker Change: Annual Recurring Revenue, or ARR, ended the third quarter at $1.65 billion, up 18% year-over-year.
Speaker Change: Q3 net new ARR on a constant currency basis was 68 million dollars down modestly from the same period last year and up 5% year-to-date for fiscal 2025
Speaker Change: In Q3, we added 193 new logos to the Dynatrace platform.
Speaker Change: 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.
Speaker Change: Our value proposition continues to resonate with enterprise customers that are outgrowing their existing DIY or commercial tooling solutions.
Speaker Change: They are seeking business value from tool consolidation and coming to Dynatrace for the depth, breadth, and automation of our Unified Observability Platform.
Speaker Change: Once customers experience the benefits of the Dynatrace platform, they are often quick to expand their usage.
Speaker Change: 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.
Speaker Change: 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.
Speaker Change: Net retention rate, or NRR, was 111% in the third quarter.
Speaker Change: Our DPS licensing model continues to gain traction and adoption. We now have almost 1,500 DPS customers globally, representing more than 35% of our customer base and over 55% of our ARR.
Speaker Change: 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.
Speaker Change: 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.
Speaker Change: This on-demand consumption is benefiting subscription revenue growth, which outperformed expectations nicely in Q3.
Speaker Change: However, it's important to note this revenue is not captured in our ARR or NRR metrics, which only include contractually committed revenue.
Speaker Change: 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.
Speaker Change: On a year-to-date basis, we had $12 million of on-demand consumption revenue.
Speaker Change: The fact that DPS makes it easy 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.
Speaker Change: 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.
Speaker Change: Our expectation is that as DPS grows and scales, so too will on-demand consumption, with likely variability and seasonality quarter to quarter.
Speaker Change: 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.
Speaker Change: Subscription revenue for the third quarter was four hundred and seventeen million dollars, up 21% year-over-year and exceeding the high end of guidance by seven million dollars as reported and ten million dollars in constant currency.
Speaker Change: with the upside primarily driven by the on-demand consumption dynamic I just mentioned.
Speaker Change: Shifting to margins, non-GAAP gross margin for the third quarter was 84 percent.
Speaker Change: 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.
Speaker Change: 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.
Speaker Change: This resulted in a non-gap operating margin of 30%, exceeding the top end of guidance by 200 basis points.
Speaker Change: Non-GAAP net income was $112 million or 37 cents per diluted share.
Speaker Change: This was 4 cents above the high end of our guidance.
Speaker Change: We generated $38 million of free cash flow in the third quarter.
Speaker Change: 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.
Speaker Change: On a trailing 12-month basis, free cash flow was $406 million, or 25% of revenue.
Speaker Change: As a reminder, this includes a 650 basis point impact related to cash taxes.
Speaker Change: 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 non-cash $321 million tax benefit to our GAAP net income and EPS.
There was no impact to non-GAAP net income or EPS.
Speaker Change: 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.
Speaker Change: Finally, a brief update on our $500 million share repurchase program.
Speaker Change: In Q3, we repurchased 732,000 shares for $40 million at an average price of $54.64.
Speaker Change: 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.
Speaker Change: Moving now to guidance, let me walk through some of the assumptions and insights underpinning our updated guidance.
Speaker Change: 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.
Speaker Change: 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.
Speaker Change: Second, the trend of larger and more strategic deals related to observability platform architecture and tool consolidation initiatives continues to grow.
Speaker Change: The sales funnel is weighted heavily to these types of deals.
Speaker Change: 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 yield certainty.
Speaker Change: 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.
Speaker Change: Fourth, while the demand environment for observability remains healthy, we do not assume a material change in the macroenvironment as enterprises continue to be cautious in their spending.
Speaker Change: 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.
Speaker Change: We now expect FX to be a headwind of 38 million dollars to ARR and 17 million dollars to revenue.
Speaker Change: This represents an incremental headwind of $28 million to ARR and $10 million to revenue.
Speaker Change: And with that as context, let me outline our updated Outlook.
Speaker Change: We are raising our constant currency full-year guidance across all top-line growth and profitability metrics.
Speaker Change: We are increasing our full year ARR growth guidance 75 basis points at the midpoint.
to $1.705 to $1.715 billion.
This represents 16 to 16.5% growth year over year.
Speaker Change: We are raising our total revenue growth guidance 150 basis points at the midpoint to $1.686 to $1.691 billion, representing 19% growth year over year.
Speaker Change: 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 to $1.614 billion, representing 20% growth year over year.
Speaker Change: This growth rate represents a 350 basis point increase from the midpoint of guidance that we provided at the beginning of this fiscal year.
Speaker Change: Turning to our bottom line, we are raising our full-year non-GAAP operating income guidance by 13 million dollars.
Speaker Change: 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.
Speaker Change: We are raising non-GAP EPS guidance to a range of $1.36 to $1.37 per diluted share, representing an increase of 5 cents at the midpoint of the range.
Speaker Change: This non-GAAP EPS is based on a diluted share count of 303 to 304 million shares. This EPS and share count guidance excludes the impact of any potential share repurchases in Q4.
Speaker Change: We are raising our free cash flow guidance to $415 to $420 million, an increase of $19 million at the midpoint.
representing a free cash flow margin 25% of revenue.
Speaker Change: Excluding an expected 650 basis point impact from cash taxes, this represents a pre-tax pre-cash flow margin of 31.5%, which is up 150 basis points from fiscal 2024.
Speaker Change: Looking at Q4, we expect total revenue to be between $432 and $437 million.
Speaker Change: Subscription revenue is expected to be between $410 and $415 million.
Speaker Change: From a profit standpoint, non-GAAP income from operations is expected to be between $104 to $110 million, or 24 to 25 percent of revenue.
Speaker Change: Keep in mind, we have some seasonal expenses in the fourth quarter, including incremental spending for our Performed Customer Conference and a structural reset of payroll taxes.
Speaker Change: We believe it is best to look at margins on a full year basis.
Speaker Change: Lastly, non-GAP EPS is expected to be $0.29 to $0.31 per diluted share.
Speaker Change: In summary, we are pleased with our third quarter fiscal 2025 performance.
The observability market is healthy and growing.
Speaker Change: 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
Thank you.
Speaker Change: If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. We ask that you please limit to one question.
Speaker Change: Our first question is from Matt Heidberg with RBC. Please proceed.
Matt Heidberg: Great. Thanks for taking my questions, guys, and congrats on the results. Jim, you know, 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.
Matt Heidberg: Do you have any sense for, you know, what's your, what's implied there for on-demand and for Q, and I know it's early, but when we think about next year, you know, how should we sort of, what's the conceptual framework we're thinking about on-demand for fiscal 26 as we think about ARR next year?
Speaker Change: 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
Speaker Change: It 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 2x the rate of customers that are on the SKU-based platform. So DPS is really all about driving consumption.
Speaker Change: I would say this phenomenon 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
and Tom Pieper.
Speaker Change: 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
Speaker Change: 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
Speaker Change: It's uncommitted, and it's something that we'll continue to build a level of caution on. But if you just look at where we're at year-to-date...
Speaker Change: $12 million. And you're absolutely right. It has rapidly grown. Now, it'll 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
Speaker Change: 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.
Our next question is from Fatima Boulani. Please proceed.
Fatima Boulani: 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: Okay, so that's it. That's a very good question Fatima, so
As I said in the prepared remarks, that
Neither ARR or NRR
Jim Benson: has on-demand consumption embedded in it. That is just contractually committed business.
Jim Benson: But because we're seeing this phenomena with ODC, that it will not show up in the NRR metric.
Jim Benson: 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.
And so you will see NRR.
Jim Benson: 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
Jim Benson: You know, most of our ARR that's on DPS is multi-year contracts. So, you know, I think it's called 80 plus percent of our ARR are multi-year contracts. So.
Jim Benson: The way to think about this is is customers contract in call it three one-year commitments individually and so
Jim Benson: 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
Jim Benson: They can just go on demand and they go into year two and think of it as the clock resets. Now they're obviously consuming at a greater rate and pace.
Jim Benson: 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, when will you see NRR, and I think as DPS grows and matures, you will see it more reflected in NRR.
Jim Benson: Our next question is from Will Power with Baird. Please proceed.
I guess I wonder if you could just help highlight
Will Power: Where are you seeing the most traction today, and is agentic AI something that's starting to benefit you, and what's the outlook there? Is there any way just to kind of help conceptualize revenue or ARR contribution around all that?
Speaker Change: Thanks, Will, and sorry to hurt you all for a bit of a raspy voice this morning, but we'll get through it together.
Speaker Change: I would say across the board. Started with generative AI, it went to RAG, it's continuing with inference, it's moving on to agentic AI.
Speaker Change: 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.
Speaker Change: And in many ways, we think about our AI strategy at Dynatrace as mirroring that.
Speaker Change: and our ability to manage that complexity through a sophisticated observability platform is of paramount importance to our customers.
Speaker Change: 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.
Speaker Change: So, we see AI being adopted very broadly, they're interested in observing AI workloads, and we believe it is a tailwind for AI observability capabilities as a result of that.
Thank you.
Speaker Change: Our next question is from Keith Bachman with BMO Capital Markets. Please proceed.
Speaker Change: Hi. Excuse me. Hi. I think you have a question. Maybe just sneak in a clarification.
Keith Bachman: 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.
Keith Bachman: And I know you said, I think you said that the DPS contracts or impact or the consumption-based element maybe is mid-single digits, but it's
It's still declining year over year.
Keith Bachman: pursuant to your guidance. I just wanted 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 FY26.
Speaker Change: And then just a clarification, Jim, I know you said you'd give us more help.
Speaker Change: on taxes, but, you know, just philosophically, as we think about 26, we're trying to set our free cash flow. 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? Thank you very much.
Keith Bachman: 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 percent growth last time, you know, we're now three-quarters of the way through the year, you have one quarter left.
Keith Bachman: So, we certainly, we lopped off the low end of the range, and we did inch it up on the high end.
Keith Bachman: 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.
Keith Bachman: And when you have a funnel that's weighted that way, you have 90 days.
Keith Bachman: left in the year, you know, 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
Obviously, near-term, it does introduce a level of...
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continue trend.
We'll continue into fiscal 26.
Keith Bachman: Relative to taxes, the very simple way to put it, Keith, is...
Keith Bachman: You know as you can imagine we know we are a significant cash taxpayer 650 basis point, you know It's you know of cash taxes as a percent of revenue
Keith Bachman: 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.
Keith Bachman: 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
a benefit in fiscal 26 from lower cash taxes.
Speaker Change: Our next question is from Pendulum Bora with J.P. Morgan. Please proceed.
Pendulum Bora: Thank you. Jim, I just wanted to understand the NRR dynamic one more time, if you might. It seems like the DPS2 overage has increased. You said $7 million last quarter. I think you said low single digits or something like that.
Thank you.
Speaker Change: 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 a...
Speaker Change: annualized number and then obviously from the last quarter you would have caught up with some of those contracts which would 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
Speaker Change: 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 down tick from last quarter is that 100% because of this this dynamic would you say?
Speaker Change: 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 even for the I would say year to date
Speaker Change: You know, 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.
Speaker Change: 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
Speaker Change: our 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, um even though it's still early days.
Speaker Change: I'd say the below the IT 500, which we call the commercial segment, admittedly, the commercial segment
Speaker Change: We're not seeing the same level of performance in the commercial segment around expansions And so like every 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.
Speaker Change: We need to tune the model a little bit more for the commercial segment where expansions were a little bit less. And that's probably the area that has pressured.
NRR.
Speaker Change: And just relative to making sure people understand how DPS works, I tried to use the example of a multi-year contract for which most of our DPS contracts are.
They have three one-year individual commitments.
Speaker Change: does not necessarily want to do an early renewal in year one
Speaker Change: 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.
Speaker Change: You get on demand consumption, you're done with your year one, maybe, you know, now you're in year, now you're in year two, but when you're a year two, this clock starts at zero again. So think of it as a contract. That's maybe a six million dollar TCV.
$2 million a year
Speaker Change: They they spend 2.2 million dollars in the first year with 200 of
you know, on-demand consumption.
Following year, the clock starts to zero again.
Speaker Change: Run rate is higher. So the likelihood maybe 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
Speaker Change: that because you're on on-demand consumption that you'll see the following quarter an 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 recession.
I'll see you next time.
And, Pendulum, I would just add that this is...
Speaker Change: 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.
Speaker Change: And the only other thing I would say, Pendulum, that I didn't answer in your commentary about the way that
Speaker Change: You know you were saying hey, can you annualize maybe this impact that we saw seven million dollars
Speaker Change: You know, I would say that it's uncommitted So yeah, you could annualize it because as DTS grows you would expect that. Yes, that's kind of the way to Generally think about it
Speaker Change: 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
Speaker Change: Our next question is from Mike Sikos with Needham and Company. Please proceed.
Speaker Change: Yes, that's a very good question. You know, I won't belabor the what we've done around the go-to-market changes because you do know that. So we're three-quarters in.
Speaker Change: And we certainly didn't expect productivity improvements three-quarters in it, you know, you're transitioning accounts Especially when you're in strategic accounts, it does take a while to establish relationships
Speaker Change: I'd say the green shoots and leading indicators Mike that we look at is are we starting to see
Speaker Change: call it rolling four quarter pipeline improved. And the answer is yes. So the first thing you want to know, all right, people are settling in.
They're establishing new relationships.
Speaker Change: 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...
Speaker Change: We are seeing, in some cases, some deal closures in that segment already. So 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...
Speaker Change: We are not at the point of showing an improvement in productivity.
But we do feel like we're where we're at.
is about where we would expect.
Speaker Change: 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.
Thank you.
Speaker Change: Mike, I would just add also that last quarter we reported on...
Speaker Change: 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 in where in which we have
Speaker Change: We have 30% or greater than 30% of reps with with less than one year of tenure. So productivity will expect to increase as that tenure increases.
Speaker Change: We continue to see traction as more than 3 quarters of the deals are transacted through our partner ecosystem, and we're now seeing greater than 50% of new logos transacted through partner which is an added new business, which we'd like to see as well.
Thank you.
Speaker Change: Our next question is from Sanjeev Singh with Morgan Stanley. Please proceed.
Sanjeev Singh: Thank you for taking the questions, and Rick, I hope you feel better. Coming back to some of the color gem that you provided on the structure of the DPS contracts, that was super helpful, noting that they're multi-year contracts.
Speaker Change: I guess the question is, is what's going to be the triggering event?
Speaker Change: 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...
Speaker Change: Just a little bit more clarity on what the average DPS contract is sort of constructed.
Speaker Change: Yeah, it's a very good question Sanjay, I guess I'll take your last question first.
There are
Speaker Change: So, customers that they will – we have a variety of models with EPS. Some are what we call ramp deals. So, think of – to your point, it's a one in year one, a two in year two, a three in year three. So, they're ramps. That's for some customers. Some customers –
Speaker Change: have a TCV deal where it's over-the-contract life, so their DPS is over-the-contract life.
Some customers have...
Speaker Change: Maybe to your point a 222 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
Speaker Change: It's hard to equate all of them, but the way it'll work, even regardless of kind of the vehicle that you're on.
Speaker Change: It becomes a customer decision, right, that, and again, for us, what we're looking for the customer to do is get more value from the platform and consume faster.
Speaker Change: That, ultimately, is what we're looking to have happen. 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
Speaker Change: We are seeing that there are triggering events, to your point, depend upon how fast you're consuming and if you think a recontractor or a kind of doing an early repackage would result in a significantly improved unit price, you might be willing to go through that. Then there are customers that just
Speaker Change: 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.
Speaker Change: It might not be worth a repackage because they don't they don't see the benefit on unit pricing. And so it varies. And so what it's going to mean is the call it the NRR improvement that you're going to see is going to be staged depending upon
You know the profile of those different customers
Again,
Speaker Change: We kind of bring you back to that 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.
Speaker Change: Our next question is from Andrew Nowinski with Wells Fargo. Please proceed.
Andrew Nowinski: Thank you for taking the question. You know, it sounds like you're seeing a lot of positive tailwinds as it relates to most of the leading indicators in your business, you know, with the pipeline improving. Like you said, more traction through partners and more business transacted through partners.
Andrew Nowinski: If you look at the new logo ads, I guess they were down year over year. Is that related to the commercial segment weakness? We talked about or is there something else going on there? Thank you
The I'd say, yeah, we are we are.
Andrew Nowinski: 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.
Andrew Nowinski: which is landing them at the right size. And we actually saw very, very healthy lands in the third quarter. You know, we talked that I think last quarter, we were just a little bit over 130,000 on average land size on a trailing 12-month basis.
Andrew Nowinski: Yes, we want units, but we want units that have a highest propensity to expand. Those units tend to be units that land north of $100,000, so we're pretty pleased.
Andrew Nowinski: 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 we'd like to see units in the Global 500 as well. But.
Andrew Nowinski: You know, I'd say where you're going to see a larger volume is going to be in the commercial segment.
Speaker Change: Our next question is from Koji Ikeda with Bank of America. Please proceed.
Speaker Change: yeah hey guys thanks so much for taking the questions so just from a real high level I'm just trying to understand
Speaker Change: Is ARR and NRR, as it's defined today, no longer the right metrics to gauge the health of the business? You know, maybe why or why not from a long-term perspective?
Long-term perspective
Speaker Change: 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 and maybe how DPS NRR compares to subscription NRR if you could. Thank you.
Speaker Change: So I would not go so far as to say that ARR and NRR are not important metrics. Those will remain important metrics for dynatrace.
Speaker Change: 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.
Speaker Change: Together because I think that is those are the best measures of kind of the health of the business You know and I take this qualitatively again when you talk about you know NRR and ARR and how they'll behave
Speaker Change: 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.
Speaker Change: You may see expansions later. And so, could be early expansions, you know, 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.
Speaker Change: It is about driving future subscription revenue. That's what DPS is doing. It's just showing up in two different metrics.
Speaker Change: That brings us to the end. Thank you all for your engaged questions and of course your ongoing support.
Speaker Change: To close, we remain very enthusiastic about the growth opportunities ahead of us.
Speaker Change: especially given the market as well as Dynatrade-specific tailwinds that we covered on this call. To those of you joining us at 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.
Speaker Change: Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.
The End