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spk08: Good day and welcome to the New Relic third quarter fiscal year 2021 earnings conference call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. Please note this event is being recorded. I would now like to turn the conference over to Peter Goldmacher, Vice President, Investor Relations. Please go ahead.
spk03: Peter Goldmacher Thank you, operator. Hi, everyone. Thanks for joining our Q3 fiscal 21 earnings call. We published a letter on our investor relations website a little less than an hour ago and hope you all had a chance to read our letter together with today's earnings press release. Because of the level of detail we provided across these two documents, Today's call will begin with Lou providing brief opening remarks, and then we'll dive right into your questions. During the call, we will make forward-looking statements, including about our business outlook and strategies, which we base on our predictions and expectations as of today. Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors in our most recent 10K and upcoming 10Q to be filed with the SEC. Also, during this call, we will discuss certain non-GAAP financial measures. We have reconciled those to the most directly comparable GAAP financial measures in our earnings release. These non-GAAP measures are not intended to be a substitute for our GAAP results. And finally, this call in its entirety is being webcast from our investor relations website, and an audio replay will be available there in a few hours. With that, I'd like to turn it over to Luke.
spk06: Thanks, Peter, and good afternoon, everyone. And thank you for joining us for our third quarter fiscal 21 earnings call. Joining me today are CFO Mark Sackleton and our President and Chief Product Officer Bill Staples. Before we get to Q&A, I wanted to make a few comments about the quarter and the journey we're on as a company. I encourage you to read our investor letter, which we published today in conjunction with the press release. In it, we described some important updates that we're making across our company to better serve our customers. From the beginning, New Relic has existed to help developers build more perfect software. That's an important and noble mission, and we're just getting started. We want to empower every professional developer around the world, estimated to be 28 million today and growing rapidly, with easy access to the power of observability as part of their daily workflows. Over the past year, we've made important changes to our go-to-market and product strategies, all in service of simplifying the observability market. And our financial results of third quarter reflect the early response from customers to these changes. Specifically, there are three key areas I want to highlight. First, we are orienting every part of our business to focus on the customer. Every team across E-Relic has a renewed focus on delivering increased value to our customers. Our product teams have completely reimagined our entire platform experience. Our go-to-market teams introduce new pricing, packaging, and sales motions. And our customer success teams have transformed our onboarding training, all in the service of making it easier for our customers to try, buy, and grow with the new RelicOne platform. The second item, beginning with the launch of new RelicOne pricing last July, we are transitioning to a consumption business model. In this new model, customers love that they are paying for what they use and that they have complete visibility into their spending. No surprise bills or penalties. no shelfware, and a very high correlation between price and value. This is resonating with our customers. And third, we are continuing to make adjustments as we innovate. As we progress through this important transition, we will continue to learn from our customers and use those learnings to refine our price and go to market. We've fundamentally transformed our product, sales, and customer success strategies, and we continue to make changes in the name of better serving our customers. On a personal note, I want to congratulate Bill Staples, who was recently promoted to president, in addition to his responsibility as chief product officer. Since joining New Relic a year ago, Bill has had a tremendous impact on our business, serving as the chief architect of our product and corporate strategy, including the launch of New Relic One last summer and our transition to a consumption business model. I also want to thank Mike Christensen, who, after serving for President and COO for the past year and a half, is moving into an advisor role and remaining a director of the company. In 2019, I asked Mike to step into an operating role to help me in the day-to-day operations of the company. His main focus was to add more structure to our business and to help us build out our business strategy. With this complete, he has decided to step down from the day-to-day operations role at the end of Q4. He will remain on our board and continue as a strategic advisor to me, starting in April. In summary, while we're pleased with your early momentum and feel good about our path forward, it's important to note that we're just getting started executing on our consumption model. We'll continue to focus on making it easier for our customers to do business with us and get more value from New Relic One. With that, let's move to Q&A.
spk08: We will now begin the question and answer session. To ask a question, you may press star then one on your touchstone phone. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question today comes from Kingsley Crane of Barenburg. Please go ahead.
spk13: Good afternoon. Thanks for taking my question. Really appreciated the extensive detail in the letter addressing the transformation from subscription model to a consumption model and why it's so much more than just a revenue model transition. While it's still early days, could you share with us some of what you've learned over the past few months that has either most surprised you or that you found most valuable?
spk06: Certainly, I think one of the key learnings is for some customers, they love to step up to a large commitment that would show up in ARR. because they have a good understanding of what their construction will look like over the next year, and they like those unit economics. However, there's a meaningful portion of our customers who intend to continue to grow with us, but would prefer to sign up for a smaller upfront commitment, which shows up in what they are. But they have a few things that they prefer that lead to that decision. First off, they have an easier internal approval process for that. Second, they know they're not going to overpay. And it's important to note that in our model, unlike some other models in our space, there is no penalty for over-consuming. It's not like if you go above your committed amount, all of a sudden, your economics get a lot worse. So it's a customer-friendly model where they can have confidence that if they do sign up for a lower commitment, they're still going to get, they won't get penalized for that, for consuming at a higher rate. And given the uncertainty that's going on broadly, it's really hard to predict what their consumption may be a year out or further. And so they prefer to just pay as they go for that overage. So that's one of the things we learned and we're fine with, again, because to our point on the consumption model, as we continue to focus on driving customer value, our customers are going to send us more data and they're going to add more users. And those are the primary mechanisms by which we recognize revenue. And so we like that and we focus on those fundamentals. We expect to see our customers grow with us and that to show up in our top line.
spk13: That makes perfect sense. I like the example in the letter, too, about the nontraditional applications like parking meters and pricing scanners. I thought that was interesting. So last question would be the commentary on the changes to sales incentives in fiscal 22, including eliminating incentives for upfront commitments. I thought those were important. So how quickly can we expect the sales force to adapt to these kinds of changes, and should we be expecting any dips in productivity per rep?
spk06: Well, we've been signaling to our sales force for some time that we're moving up. We obviously have been signaling, more than signaling, that we're moving to this model, but we've been signaling to the sales force that the compensation plans for next year will... will really align well with the customer's success and New Relic's success. So we've been preparing them for that. That having been said, we're still in a period of transition, and during those times of transition, some people may decide not to take the next step of the journey, whereas others will be excited to continue on that journey. So we're managing through that change and we're prepared for that. But we absolutely are focused on setting ourselves up for success next year in particular as we align our compensation plans with the consumption model that we're committed to.
spk04: And if I could just add to that, Lou, and it's not going to be abrupt. We've done some modifications this year and in the fourth quarter where we're kind of softening the abruptness of it by starting to transition those plans into what they'll be next year. So, you know, as we said, we've been educating on this for quite a while, and we've already started that transition as we go through the rest of this year. Okay, that's very helpful.
spk13: All right, thanks again, Chris.
spk08: The next question comes from Sandeep Singh of Morgan Stanley. Please go ahead.
spk02: Thank you for taking the questions, and hello to everyone on the team. you know, good quarter in Q3. I had a couple of questions that I wanted to work through. First, I want to get prepared for what we should expect over the next several quarters in terms of this consumption model. And so, Marco, I was hoping you could walk me through What do you think the impact is going to be in terms of revenue, maybe in terms of ARR, in terms of customers committing to a lower level of initial commitment? And then what is the team's hypothesis on how long it will take for actual consumption to exceed contracted consumption? Any sort of modeling or simulations you've done around that behavior? That would be very helpful.
spk04: Sure. Happy to go through that. And I guess I'll start with just the ARR guidance in Q4, as we mentioned, is going to be flat versus Q3. And I'm sure people have some questions around that. And even internally, we too, when you first look at that, I think it can be surprising that When we look at our business, we say we just came off a good Q3. We look at our business, how we're doing relative to our objectives, where we want to be in this transition, et cetera. You know, it feels like things are going well and, you know, relative to the last Q4, et cetera. Why is that number flat and kind of what's going on? And first of all, there are three primary reasons why the guidance is flat for Q4. The first is the change in model. The second is large deal dynamics. And the third is entitlements. And let me go through all three of those a little bit. And, you know, it's a long-winded answer to the question, but I think it's important for folks to really understand this. And so when we look at the change in model, if you think about our business, uh, you know, we just reported, you know, call it 670 million, 670 million of ARR. Q4 is our biggest renewal quarter. And so you say, you know, 25, 30% of our renewals, our business is coming up for renewals in Q4, 175, 200 million of business that's going to be renewed in this quarter under our old model. with that would have renewed at a higher rate, a higher level of subscription. If you look at last Q4, we had 116% dollar-based net expansion rate, you know, and that says that that $200 million in renewals would have grown by, you know, 32, call it 30 million, again, round numbers. That $200 million in ARR would have grown to $230 million in ARR. And what we're saying is now, as we move to this model, that $200 million in ARR is going to renew at $200 million in commitments. And so that's a $30 million delta right there. And we're fine with that because customers are more comfortable committing to less than they expect to spend. We're confident that These customers are getting in, they're using the product, they're embracing the platform, and we're confident that their spend is going to grow over the course of the year, but it's going to be on their terms. They're going to be paying for what they're using, a much more customer-friendly and focused model. And so their spend will increase over time. But unlike the ARR, where we'd see that bump in revenue right away, starting in April, we're going to recognize the revenue according to how they're consuming, and we'll recognize the revenue until they hit their commitment level, and then it'll be exceeding the commitment level. We'll get most of that bump in revenue in the latter half of the year. And so, we think it's, you know, Q3, Q4, the second half of the year, where that consumption revenue starts to kick up and really starts to improve the overall economic and start to improve the overall revenue line, and we think that's where it starts to kick in. Now, the second bullet point I mentioned around the ARR number for this quarter has to do with large deal dynamics. In this quarter, we have two large customers, And for various reasons, they want to reduce their overall level of commitment. This happened last quarter. We mentioned the investor letter. There are $4 million. And in this quarter, we have these two customers within the low eight figures. And these are two customers that are huge users of New Relic. They're going to continue to be New Relic users in fiscal 22. And in fact, over the last 12 months, their consumption has actually been increasing. but they're just not comfortable with that commitment. So these are customers where the ARR is going to be down. They're going to be consuming that commitment, and then any increases will be back-end loaded in the year. That's like the revenue side of things. And then the third factor affecting ARR is entitlements. And if you remember, we opened up our platform when we announced the new platform in August, and we said everyone can use as much as they want for free through December. And that had the effect of depressing results in Q2, in September, as people said, why would I pay for more when I can use it for free? So that depressed Q2 a little bit added a bit of a boost into Q3. It also pulled forward some of the deals that may have happened in Q4 into Q3, into the December quarter where people wanted to take advantage of that. of that entitlement and what we had said was going to be an expiration. So those are the factors. But overall, I think it's the latter half of this year where we think this transitionary period will kind of have worked its way through and we'll start to see the benefits and the ongoing consumption increases hit the top line.
spk02: Thank you, Mark, for that detailed explanation. I have a couple of just follow-ups based on your answer. In a hypothetical customer, like in a traditional subscription model, if they sign a 12-month contract, it was sort of recognized straight line. But let's say that actual consumption on a run rate basis happens in month three or four of a 12-month contract. Should you expect the revenue recognition to be accelerated that early, or do they have to sort of
spk04: surpass their total initial commitment before any sort of excess revenue is recognized this gets into you're starting to get into the details of revenue recognition and variable consideration which we put a little bit about that in the letter and uh happy to talk to anyone about that um you know separately but in general in general we would recognize a we have to estimate what we think their usage is going to be over the life of the term, so over the 12-month term, and recognize it roughly in connection, you know, try and smooth it out over the course of the remaining contract. So if a customer in month three or month four really starts exceeding their, you know, planned usage, we would probably recognize a portion of that starting you know in month three month four um but we of course you know we don't know is it going to go down in the future and things so so it's it's it's really toward the end of the contract where we get a lot more confidence of what their actual spend is going to be so in general i would say the bulk of the increases are recognized nice late in the late in the term they don't have it they don't they don't have to have consumed their full commitment before we start to do that but in general it's back and loaded
spk02: I appreciate it, Mark. And then the last one, I promise I'll yield the floor. In terms of how you guys are thinking about metrics in this sort of transition period, have you guys given any thought to giving things like user accounts or data ingest or something to give a sense of how the consumption behavior is happening? Because it seems like the metrics, whether it's ARR or revenue, might not be giving the true picture of the underlying growth of the business.
spk04: yeah we've thought a lot about that we are you know we've got a lot of new metrics in the in the company since uh since we've done this um and and you know from a public standpoint we talked about net revenue retention uh talk about that a little bit and we give an example there for our larger customers we will be including that for our customer base as we go forward as a key metric starting next year in Q1 in the spring. Otherwise, it's really about data ingest and users. And the data ingest, we've Talked about that, gave some information about that last quarter. This quarter, we again talked about that. Data ingest year over year grew about 70% last year. And when you look at the chart, the investor letter, you can see that there was an inflection point as it was growing once we introduced New Relic 1 in the summertime. And just last quarter, it grew in the 15% range in the quarter. And so that's something we look at very closely. And then the user growth, what's happening with user growth. We haven't made any definitive decisions about which of those metrics we're going to be using. disclosing publicly. We have to do that. We recognize those are important things, and we just want to do it right, and we want to make sure we have enough data to be comfortable with the underlying trends. We're still pretty early. in the model, and so we're still continuing to learn, but we definitely have to figure out and make sure that we disclose enough to get people comfortable with the underlying trends.
spk02: Understood, Mark. Appreciate the thoughts.
spk08: The next question is from Jennifer Lowe of UBS. Please go ahead.
spk00: Great. Thank you. Maybe just to follow up a little bit on Sandra's question and, you know, how we should think about this playing out through the next fiscal year. You know, it sounds like we should, if we look at the growth guidance for Q4, it sounds like it's probably still a couple of quarters after that before you'd really see any meaningful inflection in the growth rate as these contracts take time to season through. Is that a reasonable expectation, or could we see it happen sooner? How should we just think about when the growth rate bottoms and when it starts to climb back up?
spk04: I think it's the second half of next year before it starts climbing back up. And once we're there, it's similar to the transition of folks who went to a subscription model from the licensed and on-prem. You go through the transition period and you have this dynamic of the ARR-based revenue falling off and the consumption revenue not yet picking up. So there's that trough. And I think You know, it depends on how quickly folks are consuming and, you know, relative to their upfront commitments and things like that. But we feel like it's the second half of fiscal 22 where, you know, that starts to turn upward.
spk00: And then just in the shareholder letter, there was a reference that, you know, in the September month, you talked about last quarter that there was this 15% expansion in on conversion to the new contract, and that was a little, it was less, you know, 0% in Q3. And I'm curious, you know, I know there's a lot of variability in that, you know, how much of that difference is due to just bigger numbers averaged across a bigger population causing a different result versus something strategically different in the way you were approaching customers on those conversions?
spk04: I would say there's something to, you know, a couple large customers had a big impact there. On the other hand, we are seeing something across the board, and this is one of the learnings Lou alluded to in the first question, and where we've realized that customers are much more comfortable committing below their projected spend, particularly when the, you know, The penalty for committing more is you have shelfware. The penalty for committing less is you pay at the same rate, which is logical, but they're going to drive people down to committing a little bit below what they expect to use. We went in thinking that customers would commit to between 80% and 120% of their expected usage. What we're finding is some customers commit more, but only the case where they're already blowing through what they've already contracted for. And those customers then will commit to a higher number. In most cases, they're going to commit to a lower number than they expect to use. In Q2, I think we were more involved and learning, and we were pushing still to get that uptick. you know, we had just rolled it out. We still had to go to market organization and even internally, you know, senior levels, we were still kind of focused on this. Let's get a, let's get an uptick. What we realized is, you know, when you're looking for transactional efficiency and customer friendliness, it's much better to basically let the customer decide and, and help, help them understand the dynamics of, and work through that, but ultimately let the customer decide, and customers are more comfortable under committing. And I think that's in keeping in line with what we want to do, which is be customer friendly. We're okay with that because the key thing is what happens after they sign that agreement? How does their consumption track? And that's what we want to follow, and that's what we want to keep seeing grow.
spk00: Okay. And just one last one for me. Just looking at the operating income guidance for Q4, I know there were some references to being a bit behind planned on AWS spending and maybe catching that up in Q4. You also referenced maybe some sales compensation designed to make them whole given the transition. How should we think about the puts and takes feeding into the operating margin guidance for Q4 and how that might play out even beyond Q4?
spk04: Yeah, so the primary driver there is our migration to the cloud and cloud spend. So in Q3, we had a slightly better gross margin than we had anticipated. There was some prereq work that we needed to do to continue to accelerate the move to the cloud that held up some of that migration. Now, as we get into Q4, we'll be spending to kind of catch up what we didn't spend in Q3 as well as the increase in Q4. So that will put pressure on our gross margin in Q4. As we go forward, we are migrating to cloud. We've got this double bubble where we're paying for the cloud spend. as well as our internal data centers. You know, there's not much, you know, you look at a couple months and there's not much that's going to be happening there. Unfortunately, we're still paying for them. And as we talked about when we first announced this last spring, the, you know, the gross margins are, I think next year will probably be comparable to the second half of this year. And then as we get into fiscal 23, you know, the second half of that year, they'll start to improve and, you know, get back to closer to where we were as the crowd migration is completed and, you know, the old data center spend is completely rolled off.
spk00: Great. Thank you.
spk08: The next question comes from Rishi Joya of PA Davidson. Please go ahead.
spk05: Hey, guys. Thanks for taking my questions and appreciate all the detail in the shareholder letter. I wanted to ask, first starting on NRR, can you maybe walk us through a few of the puts and takes, you know, I guess, A, Does that capture churn to the extent that there are six-figure customers who in the span of a year do churn off either completely off or downgrade to the point that they're no longer in the $100K bucket? Mark, I believe you had said you plan on disclosing this metric for all customers, not just $100K customers in the future. I just wanted to make sure I understood that correctly. And maybe... Wanted to understand, you know, if we look at the historical trend in that, I mean, we've seen this, the NRR metric for even the six-figure customers decline about 20 points in the span of six, seven quarters. So maybe walk us through that, and then I've got a follow-up.
spk04: Sure. And just one clarification. um we we expect to use nrr for um i don't think it will be all our customers that we more likely our customers over 25k or some threshold as we go forward just because at the low end there's so much um so much back and forth and they're pretty transient in the pay-as-you-go segment and things so so just you know more to come on that one as we get into next next year um but uh you know that that number does reflect customers who were paying uh you know if they came in and out in the last uh 12 months they would not be in there so if you know it's six months ago they a big customer came in and then a month ago they they left that would not be in that number but if they were a customer you know in the in the prior 12 months and they dropped that would be captured in that number so You know, that number is more of a historical and backward-looking number, and, you know, it tends to follow, you know, overall revenue performance. But I think it breaks it down a little bit better. So we recognize it's been declining. I think as we go forward, that will follow our overall revenue trends where it's likely to be a little depressed for the next couple quarters and then start to turn up as we get into the back half of fiscal 22 and beyond and once we've made once we've completed the transition or we have the vast majority of our customers on the consumption model i think then it starts to give a real accurate view of what's going on and then it'll be reflective of okay what's what's going on with overall consumption
spk05: Great. That's helpful. Just on the consumption versus subscription, I'm sure an overwhelming majority of the business today is subscription. What's the ideal mix-up? You're looking at getting 100% of customers on consumption, be it with some level of commitment up front. What's the general timeline for how long you would expect that to take? Is that a matter of you know, four quarters where it would go from being a vast majority subscription to a vast majority consumption, longer than that, anything there would be helpful as well. Thanks.
spk04: Sure. We would like to get, you know, we feel like we'll have more than half our business on consumption by the end of this fiscal year, so by the end of March. That's a target of ours. And, you know, and then as renewals are coming up, we would, our goal is to get every renewal on a consumption model. And so, you know, there are certain reasons you can't do that, you know, but by and large, I think we're going to be able to do that. So you go through the renewal cycles. We have some multi-year deals that take some time. But you fast forward a year from March, by then, you know, more than two-thirds, more than three-quarters of our business should be on consumption. You know, you've got some site licenses at the high end, you know, some other things that will prevent us from getting 100%. But our goal is to get as much as possible. In terms of commitment levels, I think what's come across probably already very clearly is we're not concerned with the upfront commitment level. and asking for that, we want our customers coming to us and saying, you know, I want to commit more because I'll get a better deal. I'm so confident that I'm going to be using a lot more New Relic. I should get a better deal. And that's a better position to be in. It's customer-driven. And then when we're having a negotiation with the reps, it's, look how much money I'm going to save you. And so, you know, I fully expect that a fair amount of our business will be committed to going forward. But the difference is, I'd like to have it being customer driven commitments, as opposed to, you know, our internal, you know, our internal, you know, battling back and forth, you know, pushing the customer to make commitments. All right, great. That's helpful. Thank you.
spk08: The next question is from Robert Muzek of Draymond James. Please go ahead.
spk14: Great, thanks. It's good to see your data ingest increased quarter over quarter. Can you just help us understand what's driving the uplift in data ingest specifically? Is it more tracing and increased application monitoring coverage, or are customers ingesting more metrics and logs, and that's driving the growth of the increase?
spk06: I'd like Bill to take that one.
spk12: You bet. Thanks, Robert. Yeah, it's actually really exciting to see the growth in data ingest. This quarter, the Fog team released several new capabilities that unlock more data ingest and increase uses of the platform, including our partnership with Confluent and availability of a New Relic connector for Kafka. It allows customers to ingest Kafka topics into New Relic One without writing a single line of code. We announced a partnership with Kentik to provide network insights Snowflake integration, syslog ingest for logs, Lambda runtime logs integration, improvements to synthetics that allow proactive monitoring of non-HTTP connections, real-time Java profiling, and dozens and dozens of other improvements as the product team is really focused on accelerating that data and user growth. So really, it's across the board. We see growth in dimensional metrics, a lot of expansion in logs,
spk14: and across the board and 70 growth in the first three quarters of this fiscal year we're really proud of great and just one more question for me if i can in this question over with jennifer but you mentioned that existing customers who renewed on the new model this quarter showed no ar uplift instead of ar can you share what the uplift was in terms of total spend if we annualize the increase in q3 spend or is it just too early to do that at this point
spk04: it's too early to do that what we're saying is their arr the total amount they committed was flat so if it had been 100 million in arr they committed to spend 100 million now what will that spend be over the next 12 months um you know that it's too early to tell there but that's what we're very focused on is is aligning the whole company of driving that consumption So, you know, we fully expect it to be more than 100, and just how much more is up to us to drive and for the customer to get, you know, see the value and really expand their consumption.
spk14: Great. Thanks a lot.
spk08: The next question is from Atai Padron of Oppenheimer. Please go ahead.
spk07: Thanks. And thanks again for the letter. A lot of detail there. We'll have to digest that later. But, Mark, I just want to go again into trying to make sure I understand the timeline for you to get really good clarity whether this is working or not. You've talked about the second half of fiscal 22. But in reality, at the end of the fiscal 22, you still are going to have, I don't know, 30%, 40% of revenue that hasn't converted to consumption yet. and you won't even know the expansion patterns of the customers that will expand in the next two, three quarters. So it's really second quarter or second half of fiscal – well, first half of fiscal 23, I guess late calendar year next year, right, that you're really going to have better insights whether the consumption is working, whether the expansion of the consumption is working as you think it should.
spk04: I think obviously the longer the time, the better visibility we'll have. But there's this couple quarter delay between the time of commitment and the time when you get a lot of that revenue increase. And so if you think about a portion of our business giving that increase in the Q3, another portion of Q4. I think that the amount of that impact grows each quarter. and so when will it be fully realized i think it will be fully realized for uh you're right uh you know probably sec until we have the vast majority a year you know three quarters after we have the vast majority of our customer base moved over that's when you'll really see the true um the true model kick in and the true uh true performance but before then you'll see You know, I think we'll see the characteristics start to impact it and the curves start to shape upward. When you talk about how much we're seeing and when can we get data, we've got a cohort of customers that signed up in September of last year. Now, this is a smaller cohort, but we've got, you know, it's in the meaningful, in the many hundreds of customers that signed up in September. We now have four months of data around what their pattern has been. And We've got this concept of running cold or running hot, and I would call it Goldilocks in the middle. Are they on target to use less than their commitment? Are they on path to hit their commitment, or are they running hot? Are they on path to exceed their commitment? Obviously, we expect over time the vast majority of customers to run hot and exceed their commitment. When we look at their behavior and that cohort of September customers, when we look at their October, November behavior, and then we look at their January behavior, You know, the ones that were running very cold are running cool. The ones that are running cool are now running, you know, neutral. The ones that are running neutral are running warm, et cetera. They're moving up that stack, if you will. And so we're seeing that type of behavior. And when you get to next September, we'll at that point have a 12-month period where we'll see, all right, what did they commit? what was their consumption pattern and how they do relative to commitments. So we're going to get good data in the next few quarters. And in the meantime, we get all these interim data points that we see to see how we're doing. And we can adjust depending how things are going and make modifications along the way. So we'll get some indications along the way. But you're right. I look forward to the day a couple years from now where our entire customer base on this, we've worked through all these, and we have great data about how our customers consume. But before then, I think we'll still have enough to really understand our business.
spk07: Got it. I guess I'm trying to tie what you said now to Lou's first point that he mentioned, that the focus is on the customer and reduce all friction and do whatever it is that the customer needs to try, buy, and grow, if I remember. That was a commentary. I'm trying to think, can you give us some color as to when do you think you're going to be more firm on your demands from the customer? And what I mean by that, it sounds like you're letting them blow through their capacity commitments and without necessarily going right away to taxing them. At what point do you say, all right, quote, unquote, enough is enough, and at this point, move to the left, you'll have to pay this, or move to the right, you have to pay that? Because I'm just wondering whether over the next 12 months, If you're going to assume a very lax attitude towards customer behavior, again, the true upside here of the long-term expansion of bandwidth in your platform, it's going to take time for that to show in dollars.
spk06: Okay, I'll take that one. So in this new model, when a customer exceeds their consumption, they automatically go into an auto billing situation so that there is no firm conversation required as part of their agreement with us. So if they exceed their annual consumption in month six, on month seven, they receive an invoice, and we recognize that revenue. So, and this is why we love that it's customer friendly. The customer will observe how those bills grow, and then they may say, hey, that New Relic spend is growing, but I'm seeing more value. Now's a good time to reach out to New Relic and ask, if we commit more today, will we get better unit economics? So we just think that's a far more healthy relationship than having in our model today, and I think this is generally the model in our space, is having the rep chase the customer to try to force them to work on the vendor's timeframe. This is a natural win-win. We're going to obsess on delivering the value so the customer grows their consumption, and that will at some point turn into some level of overage. Now, it's important to note that that overage is not punitive. It's not like when you go over this heavy fee that makes them feel regretful in the relationship or is not having overcommitted to the relationship, and that is different from what others have done in this market. So I hope that helps you better understand the situation. There is no need for a nasty conversation or a difficult conversation.
spk07: Got it. Maybe, Lou, on that, you know, you talked about the two large customers that decided to start with a lower commitment. Can you tell me how common that behavior was with $100,000 customers or even smaller customers? Was that something that was common or rare?
spk06: I'm going to have Mark answer that one.
spk04: You know, I think it's specific, customer-specific and situation-specific. But we have – I think most customers are willing to come in at the level of their current spend. You know, a normal course, that's an easy budget process. Like, oh, we were spending that this year, last year, let's spend that again. So if you look at the mode, that's probably it. But if you look at the mean, it's... I mean, the meme was quiet, I guess. We gave that number. But you have some customers who are just a little concerned. Budgets are tight, and they say, you know, it's easier to spend a little bit, commit a little bit less, and I'll look good because I saved some money. Now, at the end of 12 months, did they actually save money? Maybe, maybe not. Our goal is to hopefully we've convinced them of the value, and they've seen the value, and they end up spending more. But that's up to them. So, you know, it's hard to say. And I think we see that, you know, we see that behavior throughout the stack of customers. It's not only a large one. We do have some small customers. We have some customers who said, I'm going to make zero commitment. I'm going to go to 100% pay as you go. And the economics, the union economics are much worse for the customer. But they're more comfortable doing that.
spk07: Very good. Good luck, guys. Thanks.
spk08: The next question comes from Yoon Kim of East Capital Markets. Please go ahead.
spk11: Thank you. So obviously, there's a lot of focus on this new pricing model. and the impact on the models that we all have to maintain and track your transition. But the pricing change was done to attract new customers and more successfully ramp with existing customers. So can you just talk about any change you made in your go-to-market plans to market this new pricing model to the right customers? and also to the right people at those target customers. For instance, are you targeting the individual developers and departments, or are you also at the same time targeting the C-level people, including CIOs, with this new pricing model? Just kind of curious on what the plan is in the near term at least, and what are you learning out there as you market this new pricing model?
spk06: Bill, I'd like you to speak to this, please.
spk12: Yeah. The short answer is we're targeting both. For our existing customer base, as renewals come up, we are focused on converting them to this new consumption, this new pricing model and then consumption. And as Mark and Lou have talked about, that's going well so far. We're also targeting individual developers and new customers. And that starts with our new perpetual free tier that we introduced last July. This is a really generous offer because we believe the power of observability should be available to every developer. And it's a generous free tier. It gives 100 gigabytes of ingest and a full stack user for free. And as we reported last quarter, we've seen incredible engagement with that free offer. I believe we said last quarter 10x the number of customers who previously were in that $1,000, $2,000 spend are now engaging in that free tier. This quarter as well, we saw continued demand for that free tier offer and increased conversion to that pay-as-you-go model by those small individual developer and small business customers. In fact, we just passed our 1,000th newly converted pay-as-you-go customer just this week. So we're excited by that emerging opportunity to acquire new customers and really build developer mindshare around our platform.
spk11: Great. So in those renewal situations, obviously it's a new pricing changes and structural changes in the deal. Are you able to bring in the C-level executives to kind of introduce exactly what you guys are doing and try to get maybe a bigger wallet share of other projects that's ongoing or being planned? Just kind of try to understand exactly what the initial response is from those customers when you're renewing with existing customers and whether or not you're able to communicate this new pricing model effectively to the C-level people.
spk06: Yeah, I'll take that one. Sorry. As you can imagine, as the spend level increases, so does the seniority of the people we engage with. And we've got a good history of working at the senior level to drive strategic relationships. In fact, if you look at some of the results from quarter including deferred revenue, you can see we did quite well in some large deals that show some of those numbers. I'd say that what they like about this new model is, first of all, the predictability of the spend, the tool consolidation value proposition. CTOs love that they have a single place for all their telemetry data, and it's cost effective to have all their telemetry data in one place. They love standardizing on one per user product, full stack observability that combines the capabilities of many, many products often from many vendors. So it's a great story that resonates with CTOs. But what we like about the model we're embracing is we can grow our way there naturally, and so that we can enter an account at relatively low spend, grow naturally with them, and then at the appropriate time have that executive conversation, which is a far easier one to have than when you're just coming in directly into the top without that history and context.
spk11: Great. So do you expect a ramp in perhaps your professional services headcount to help your customers ramp and increase usage?
spk06: We are organizing around a chief customer officer organization whose primary responsibility is to drive growth and consumption of the platform and our customer base. And so one of the things... I continue to say internally, the real account management and, quote, selling happens the day after the customer AR commitment happens. And so we're going to have a dedicated organization that obsesses on that. And so the line has blurred between what is, quote, pre-sales and post-sales. It's just continuing customer education to help them understand the value of consuming more, adding more data.
spk11: Okay, great. Thank you so much.
spk08: The next question is from Michael Turris with KeyBank Capital Markets. Please go ahead.
spk01: Hey, guys. Thanks. One for Mark, one for Lou. Mark, the two large customers that are reducing their commitment, how much visibility do you have into why? In the past, when this has happened, it's included a sense of something overcommitted in terms of how much they just thought they'd use their product. So what do we really know about why they're reducing here?
spk04: It's Every one of these, we talked about having that occur in Q3. We are expecting that to occur in Q4. Everyone's a little bit unique. But it generally comes down to, I think, more of a not just uncertainty around their budgeting process or internal budgeting issues that they have as opposed to anything else. And it's a lot easier to get smaller numbers committed upfront And, you know, if they're asked to reduce the budget, you do that, and then you end up, you know, you say, either I'll do something or I'll go back for forgiveness later on because inevitably budgets free up or somewhere along the line. So I think that's a big part of it is just the perception, depending on what goals they have around, you know, how they procure and things. I think that's a big part of it. And then just the notion that people feel like, wow, I'm going to get more efficient. And they want to get more efficient. And they think, you know what, we're going to be able to be more efficient with this. And I think some people go into the year thinking that's the case. And sometimes it is. If we're doing our job well, really, you know, making sure they understand the value, selling the new use cases, making sure they understand all the capabilities of our platform, we're confident that, you know what, they're going to increase their consumption, and they're going to realize, you know, I want to get efficiencies by using more New Relic, and I'll get efficiencies across other parts of the organization because I'm using more New Relic, not that they're going to ultimately consume less New Relic.
spk01: Did you quantify for us the dollar impact of those two reductions?
spk04: Yeah, we said low eight-pagers. Okay.
spk01: And then – For Lou, something that's not about pricing or contracts, some of your competitors have broadened into areas, including further left in development cycle, workflow, security. You've probably got a lot on your plate right now, but... Are you thinking that you'll be rolling out those kinds of answers, some types of ancillary services and expanding the offering, or are you really focused on being a very pure play observability company right now?
spk06: I'm going to let Bill speak to that because he's been doing a lot of internal communications of our three-year strategy. We're very excited about it, but Bill, why don't you answer that question?
spk12: You bet. Yeah. Uh, I could ask that question all the time, as you can imagine. And there's one thing I've learned after 25 years in this business. If you chase competitors, tail lights, you never win. We're really focused on executing our strategy because we believe it holds more value for customers and investors over the long haul. And we believe we're in the early days of observability. We're focused, um, on empowering every engineer on the planet with data-driven engineering practices that help them plan, build, deploy, and operate their systems faster and with higher quality of service. We have the world's most powerful telemetry data platform. It's capable of ingesting petabytes of data with incredible economics. providing blazing performance and analytics and intelligent services that correlate in action data with very low upfront investment. We have a single user experience that spans everything from infra to APM to synthetics to logs. And we deliver it with a radically simple pricing model that's easy to understand, plan for and manage, and gives customers the flexibility to commit to only what they want and pay for only what they use. That's the strategy, and the benefits of our technology approach we're confident are going to become clear every quarter ahead. So we're really focused on driving innovation that helps our customers grow their usage. It's expressed through more data in the platform and more engagement by more users over time. Thanks, Phil.
spk08: The next question is from Ruth Sankanga of J&P Securities. Please go ahead.
spk10: Hi, thanks for taking the question. So we appreciate the disclosure of the data ingest growth in the investor letter. And in regards to the margin pressure stemming from the AWS data center transition, is there a certain point of inflection where that would begin to be offset by improved unit economics, kind of similar to the data overages with your own customer base, as Lou alluded to earlier?
spk04: So the biggest factor weighing on our gross margin is the migration fact that we're double paying right now. As we migrate to the cloud, we're paying for that full cloud spend. I guess we have a data center in the cloud. And we have a data center, a number of them around, you know, in the country that we're paying for. And so the biggest positive impact on our gross margins will be once we roll off the expenses associated with those, you know, retiring internal data centers. In terms of the overall economics, there are a lot of things we can do to improve the processing cost of our data and our data costs. And we continue to do those. Right now, we're focused on enhancing the customer experience. and more focused on getting data in than the specific. So if it comes to spending a dollar to attract more data or optimize our data center, we'll probably err on the side of attracting more data right now but you know over the over the next couple years we're going to continue to to improve that and and do those efficiency improvements you know we look at it over the long term we ingest a massive amount of data now Two years, five years from now, you know, we're going to laugh at how much we're doing now because it's going to be such a big number. And at that point, you know, we want to make sure that the union economics at that point are better than they are today. And so, you know, we're confident we can get there. But in the near term, you know, we're going to invest where we think is most appropriate. And that's to grow, you know, grow the overall data we get in.
spk10: That's helpful. Much appreciated.
spk08: The next question is from Sterling Audi of JPMorgan. Please go ahead.
spk09: Yeah, thanks. Hi, guys. One just real quick question. If you look at the pace of migration to the new, you know, pricing platform, how would you characterize that pace relative to what you were thinking even a quarter ago? Is it on track, faster, or slower?
spk06: Yeah.
spk09: Yeah.
spk04: Um, I think it's I think we started a little slower when I look back at September where we just introduced it and last quarter. Um, and I think we're getting, we're accelerating so that we're by the end of this quarter, we'll be about on track. And then I, I feel good about our ability to, to, uh, even exceed perhaps, you know, our initial impressions of, uh, you know, and, and, and we're getting better at, at, at selling it. The customers are now understanding it. Um, you know, and so I think that's helping. And we're even seeing cases where people have signed multi-year deals. And initially, we had thought, you know what, we're going to have to wait for three years because they just signed a three-year deal. And when we start talking to the customer, you know, we're realizing, wow, you know, we could potentially change out that deal. It's better for, you know, both parties to get on a different arrangement, and perhaps, you know, we'll be able to migrate that customer over before three years. So I would say it started a little slower. We're pretty much on track now, and, you know, longer term, I think we'll be able to exceed, you know, initial thoughts.
spk13: Thank you.
spk08: This concludes our question and answer session. I would like to turn the conference back over to Amy for closing remarks.
spk06: Well, we thank you all for participating in this quarter's call. We'll look forward to seeing many of you in the upcoming conferences and reconvening this quarter. Thank you all.
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