New Relic, Inc.

Q2 2022 Earnings Conference Call

11/8/2021

spk00: Good day and welcome to the new RELIC second quarter fiscal year 2022 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. 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.
spk09: Hi, everyone, and thanks for joining our Q2 fiscal 22 earnings call. We published a letter on our Investor Relations website about an hour ago and hope everyone's had a chance to read our letter together with today's earnings press release. Today's call will begin with prepared comments from Bill and Mark, and then we'll open up the line for your questions. During this call, we will make forward-looking statements, including about our business outlook and strategy, 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 10-K and upcoming 10-Q 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. And with that, I'd like to turn the call over to Bill.
spk05: Thank you, Peter, and welcome to the call, everyone. This quarter marks the completion of our turnaround and the beginning of a new chapter of growth at New Relic. We made the bold move one year ago this quarter to disrupt the observability market, and it's great to see the strategy beginning to show its strength in our financial results. Mark's going to walk us through the detailed numbers in just a minute, but I'd like to first walk you through our progress against each of the five priorities I laid out for our company in the last earnings call. Our top priority is to return our revenue growth to market growth rates. As a consumption business, this demonstrates our ability to create value that customers are willing to pay for in a competitive market. We are pleased to report revenues of $196 million for the quarter, 18% year-over-year growth, up from 11% last quarter and 14% a year ago. and the highest year-over-year growth rate we've reported in six quarters. The primary driver for this was twofold, customers consuming in excess of their commitments as well as higher retention rates. Our second priority is to complete the migration of our business to the new business model. Our goal is to migrate more than 80% of the business by the end of this fiscal year. 76% of committed revenues are now on the new model. That's a five-point improvement from last quarter. Our third priority is to grow the number of paying customers. During our turnaround, we focused on migrating our customers to the new business model and ensuring that we were retaining their business. Some of our smaller customers moved to our free pricing tier. This led to the decline and then plateau of our total paid customer counts over the last several quarters. This quarter, our total paid customer count is growing again, with over 14,300 customers now paying for services from New Relic. The primary way we're driving this growth is through a 100% self-service, product-led growth funnel, starting with the New Relic One free tier. Since introducing that offer one year ago, thousands of developers have signed up for New Relic One, and nearly 5,000 have entered credit cards, an increase of more than 1,500 since it reported last quarter. These customers provide an excellent, qualified customer funnel for our direct sales teams and partners to nurture to higher levels of growth. We also landed a healthy number of new logos driven by our sales team's efforts this quarter, including greenfield opportunities, as well as several competitive takeouts against the major vendors. A great example of this is one of our biggest ever new logo wins in Europe, a UK-based fintech company with a total contract value of $3.5 million. This account started as a small proof of concept with a primary competitor already in the account, but we ultimately ended up displacing them entirely when the customer determined that we were able to better solve their problems with our all-in-one platform. The contract was fulfilled through our AWS marketplace, further demonstrating the strength of that alliance. We're also seeing customer win-backs from competitors. For example, one customer who transitioned away from New Relic in 2020 recently returned to our platform. As the customer's business grew, they began to experience sizable technical gaps and surprise bills from the competition, a reoccurring theme. One of our partners spotted this opportunity to better address the customer's needs and ended up reintroducing them to New Relic One and completely displaced the competitor in the account. Our fourth priority is to methodically deliver platform innovation and greater value to our customers. This quarter was another hallmark of innovation from our product organization. In addition to the thousands of small and sometimes not so small improvements across the platform, we made two major new services for purchase available this quarter, Pixie and Network Monitoring. While it's still early days, we're seeing healthy adoption of these new workloads. Last month, we also introduced New Relic I.O., short for Instant Observability. IO is another product-led growth initiative that offers a dramatically simplified approach to observability with a large and growing catalog of ready-made telemetry sources, dashboards, and alerts to help new and existing customers realize value in minutes. In late October, we also announced New Relic CodeStream, an industry-first innovation that we believe increases our ability to reach more developers and expands the observability TAM. CodeStream empowers developers to instrument their applications, collaborate with fellow engineers, and debug production issues directly from inside their development environment of choice. As part of this release, we announced a strategic partnership with Microsoft to reach millions of engineers through direct product integrations now available in VS Code, Visual Studio, Azure DevOps, Microsoft Teams, and GitHub, among other popular developer tools. Coinciding with the Code Stream launch and to assist in monetizing this new cohort of users, along with other capabilities of the platform, we announced a new core user type, a lower-priced offer specifically crafted for code-focused developers who have not yet embraced observability or are only occasionally pulled into code-related incidents and therefore don't have a paid user license. This new user type will be available for purchase later this month, and we anticipate will begin to be a source of new paid users in Q4. The core user serves as an on-ramp to observability and will lead to more full platform users over time. Our fifth and final priority is to improve our internal execution efficiency and cost. We realize that while we showed strong progress this quarter, in order to reach our full potential and achieve competitive growth rates, all areas of the business need to move faster with less friction, more alignment, and greater efficiency. Fundamental to all of that is great people. We made recruiting, retaining, and developing our talented employees a top focus this past quarter. We were able to dramatically lower attrition rates, and we achieved our strongest hiring quarter in three years. Our sales organization is beginning to really hit its stride. More of the sales team achieved their quarters in Q2 than the past six quarters. Our internal engagement survey shows employee morale across the board is improving, and we remain focused on fostering a strong internal culture. On the financial efficiency front, GAAP gross margins was 67%, and non-GAAP gross margin remained at 69% for a few reasons. First, I encouraged the team to accelerate our move to public cloud in international regions so we can better serve customers outside the U.S., This increased cost short term, but I believe will lead to more opportunity, lower churn, and better customer experience medium to long term. Second, data growth continues to be strong. Data is our major driver of cost and continues to put pressure on our gross margins, especially while we're straddling both on-premise data centers and public cloud. But data will attract more users where our profit margins are higher. Pulling forward these investments impacts margins over the near term, but we believe investing in these opportunities today will provide meaningful operational benefits and attractive returns over the medium to long term. For more details on our business, please refer to the investor letter we've published on the website. Today is an exciting inflection point for New Relic, and yet the most exciting part for me is the road ahead. I believe we're still in the early days of observability, and we're playing the long game. The long-term success of any business is not the early moves made by the many, but the strategic moves made by the few. And in this regard, I believe the bold decisions we made the last four quarters and our tenacious execution against them show New Relic has what it takes to be a market leader. We anticipate there will be more unexpected setbacks and challenges along the way, such as the way of any business. But we'll tackle them the same way we did the last four quarters, by living our company values, being authentic and true to who we are, and boldly and with passion and a sense of connection work to serve customers and investors to whom we're accountable. Only New Relic is taking a developer-first approach to observability. It's in our DNA, and it has been since the founding of our company. There are 27 million professional developers and many millions of SRE, IT operators, and other professionals who don't practice observability today, and to whom we are bringing a powerful message. data-driven approach to engineering so they can stop relying on opinions and alignment meetings to prioritize, plan, and execute. Only New Relic is taking a data-centric approach to observability. Other than monetize app after app, Only New Relic allows engineering teams to ingest all types and all sources of telemetry for just 25 cents a gigabyte. We then connect those data sets and the engineering teams that surround them with a full estate view of their systems and the dependencies between them. Only New Relic has shifted to a true platform consumption business model that allows enterprises to eliminate blind spots and standardize on New Relic One across their engineering organization with a simplified user and data pricing model so they only pay for what they use. For these reasons, I believe the road ahead is going to be even more thrilling than the journey we took to get here. I am so grateful for employees, for their dedication to New Relic throughout the turnaround, for living our core values and giving their all despite a global pandemic, despite fierce competition, despite the great resignation. With adversity comes strength, and with the challenges of the past year behind us, I'm more confident than ever in our ability to solve our customers' hardest problems and reach our full potential as a company.
spk08: With that, over to you, Mark. Thanks, Bill, and good afternoon and good evening to everyone on the call. I'd like to briefly recap our financial results and then spend some time discussing some important elements of our financial model. For our second quarter of fiscal year 22, we reported revenue of $196 million, which ahead of the guidance we set in the first quarter for between $181 and $183 million. GAAP loss from operations was $47 million, and non-GAAP loss from operations was $6.4 million, ahead of the guidance we provided for a loss of between $13 and $15 million. GAAP EPS was a loss of 84 cents, and non-GAAP EPS was a loss of 10 cents. ahead of our guidance for a loss of between 11 and 15 cents. This top-line beat is driven primarily by customers consuming in excess of their commitments, as well as by stronger retention rates. We are pleased with our results this quarter and excited to have returned to year-over-year top-line growth acceleration a quarter ahead of the timeline we previously discussed. As Bill mentioned, our number one priority continues to be to get back to market revenue growth rates. in the intermediate term, and Q2 was another positive step along that path. We are providing third quarter revenue guidance of between $198 to $202 million, and a non-GAAP operating loss of between $10 to $12 million. We are also increasing full-year revenue guidance from a range of between $730 to $735 million to a range of between $778 to $782 million, an increase of $47.5 million at the midpoint of the range. With regard to our non-GAAP operating loss, we are now guiding to a full-year loss of between $35 to $39 million. an improvement from our previous guidance of a loss of between $53 to $55 million. This increase in top-line guidance is driven by three current trends that we have seen in the business, including, first, we are seeing increases in consumption above commitments from our customers. Second, we are seeing healthy renewal patterns from customers that have been on the consumption model for a year. And finally, customer retention has improved from both a unit and a revenue perspective. We continue to see positive signs that our product investments and strategy focused on customer success are paying off. There are a few other things that we'd like to highlight for this quarter. As we have said, there are two main reasons we have exceeded our guidance. The primary reason is that consumption in excess of commitment has been stronger than our models estimated, and this shows up in our revenue as variable considerations. The purpose of variable consideration is to ensure that revenue recognition reasonably approximates revenue from customers that are consuming in excess of their commitments in order to avoid any large spikes in revenue at the end of a commitment period. Because it is difficult to forecast consumption, especially at the beginning of a commitment, our model is set to take a more conservative approach towards forecasting consumption for the purposes of variable consideration at the beginning of a contract. we are able to create a truer, more accurate estimate of consumption over the term of the commitment as we get more and more data points to build a consumption forecast. This means that revenue recognized as a function of variable consideration tends to be conservative at the beginning of the commitment period and grow over the duration of the commitment period, assuming the consumption in excess of commitment remains consistent or grows over time. So far, most of our accounts of variable consideration have been consuming at a steady to slightly increasing rate. As we move forward and get a larger historical data set, we will continue to refine our models and work toward developing more and more accurate forecasts. The second important contributing factor to our top-line results is improved churn. Overall churn in the quarter was once again down sequentially and year-over-year as renewal rates continued to improve. The factors driving this improvement were better products, better contracts, and better customer service. We expect to continue to drive down churn and improve renewal rates, but it will take a while for this to get reflected in NRR, given NRR is a backwards-looking metric. Also, it's worth noting that we had a nice sequential increase in active customer accounts greater than $100,000 this quarter. and our percentage of revenue from active customer accounts over $100K ticked above 80% for the first time. I also want to take a moment to discuss the difference between commitments and consumption, both of which are important factors in driving our top-line growth. When we talk about customers increasing their commitments, we mean the overall contract renewal commitment of a cohort of customers in aggregate, net of churns. We saw an uptick in commitment to NR1 renewals in Q2. Consumption is what a customer actually consumes during the course of a commitment period, typically a year for us. In an aggregate, we are seeing consumption track ahead of commitments. That was the case in Q2, and we are seeing stronger performance in the Q3 and Q4 cohorts, largely due to better product and more familiarity and comfort with the model, both internally and externally. In particular, the amount of time and energy our go-to-market teams are spending with customers to make sure they are engaged and successful with their platform continues to increase, and that translates to more value. As Bill mentioned, non-GAAP gross margin was flat at 69%, driven primarily by acceleration of our move to the public cloud in EMEA and APJ. Also, we've been focused on driving data growth and we're seeing results across our customer base. These factors have moderated our expectations for gross margins in the short term, and we now expect relatively flat non-GAAP gross margin in Q3, improving to the low 70s range in Q4, a modest change from the previous guidance for low to mid-70s range in Q4. However, we remain confident in our ability to continue to improve gross margin as we complete our worldwide move to the cloud and drive towards our goal of high 70% to 80% gross margins in the intermediate term. In terms of our operating margin, as Bill stated in his fifth objective, we are focused on improving efficiency across the organization. That said, we continue to prioritize top line growth over near term bottom line results. This may impact near-term costs and expenses, but we believe will have long-term benefits. Finally, we want to remind everyone that the move to a consumption model changes the dynamics of deferred revenue and RPO, and those metrics are less useful in understanding the momentum of the business. We've provided more details around these dynamics in the investor letter. And now we'd like to turn over to your questions. Operator, please go ahead and open it up. Thank you.
spk00: Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. And the first question comes from Kingsley Crane with Barenburg. Please go ahead.
spk05: Hi, thank you. So why is today specifically the end of the turnaround? And then looking ahead, what now stands in the way of you getting back to market growth? Hey Kingsley, thank you for that question. And I know you follow this pretty closely, so you know a lot of this, but to kind of wrap it in a nutshell, we felt it was really important to mark this one year anniversary of the turnaround that we planned and initiated last Q2. As you know, at that time, we faced a series of quarter reports where we saw increased competition and declining revenue growth. And we set out with a bold new vision to better capture value for our customers and compete in the market. We consolidated our underlying data platform and integrated all of our product experiences. We streamlined and simplified our packaging and pricing and shifted our business model from subscription to consumption. For four quarters now, we've been innovating new platform experiences, shifting our go-to-market motion from driving contractual commitments to true value realization, and diligently migrating customer contracts onto our new consumption pricing model. We've been sharing our progress along the way, and you all have been patiently waiting results in our financials. With those operational changes complete and our year-over-year revenue growth accelerating to rates Beyond what we demonstrated even when we announced the business model changes a year ago, we feel now is the time to mark the completion of that turnaround plan and the beginning of a new chapter of growth for New Relic. In terms of the second part of your question, you know, as we look ahead, it's really about the execution and increased efficiency of execution against our strategy. Strategy is sound. The business model is working. Customers are consuming the value at increasing rates. And from here on out, it's about focusing on refining and continuing to execute with ever greater efficiency for the strategy that we put in place. That's really well said, Bill. It should be gratifying for you and the team. Just one quick follow-up. You've mentioned New Relics IO's potential to lower the barriers to entry for the product. CodeStream can introduce the power to new dubs. You also have the new updated seat-based pricing model. When you look at all these three initiatives, how much more white space of user growth do you think you've unlocked? Oh, great question again, Gaines. I think it's incredible. You know, if you think about the observability market today, say a million engineers practice observability across all of the major vendors. As we know from IDC and other market studies, there are 27 million professional developers in the world and many millions more working in IT and operations. And all of them can benefit from a more data-driven approach to engineering. What CodeStream does is it really unlocks greater access to observability data and insights. by fostering an open ecosystem where any community, whether it's open source or a commercial vendor or a customer or partner of ours, can contribute through open source ready-made observability quick starts that can, with a few clicks, allow data to flow into our platform and for customers to get insights and start to action. You don't have to be a professional observability expert in order to get value from New Relic One anymore. I believe that opens up a greater access to observability to both developers and operators. And then CodeStream, as you said, is a really exciting new innovation because it completely changes the game of observability. Today, observability is very reactive. It's very operationally heavy and focused on incident response. And what CodeStream has done is taken that same production telemetry data set that we've been talking about all year long and collecting at scale on behalf of our customers and opens up new use cases to developers who today don't even get involved in operations or maybe they only get pulled in occasionally. But it takes that data and puts it into their flow, into the developer tools they do use every day to write code and fix bugs. And so it opens up the platform to potentially millions, greater millions more developers over the mid to long term. Super interesting. Thanks again. Thank you.
spk00: The next question comes from Rob Oliver with Baird. Please go ahead.
spk03: Great. Good evening, guys. Thanks for taking my question, Bill. I have one for you, and then I had a follow-up for Mark. So a bit of a follow-up to Kingsley's question. You guys have made some considerable improvements and enhancements to the product. There was a great buzz at FutureStack around Pixie, and I think Chex supporting you guys, that's really been an enhancement in terms of containers on the platform. I'm probably too early to talk about revenue associated with it, but can you talk about what, say, Bixie Network Monitoring and now CodeStream, what that's doing in terms of the conversations that you're having with some of these accounts and how much of a needle mover it is in discussions both with new customers and about converting to the new model? And then I had a follow-up. Thanks.
spk05: Yeah, thanks for highlighting that innovation. It's so exciting to see the product organization really moving the needle in terms of differentiated value for our customers. You mentioned Pixie, great buzz at FutureStack when we announced the integration with New Relic One and open sourcing it. We also had a great moment here at KubeCon just a few weeks ago with some major updates and roadmap announcements there. And we were really pleased to see the number of GitHub stars which is the number of developers who express interest in the open source project itself actually continue to just skyrocket. It actually exceeds now many, many popular open source projects in this same space from New Relic as well as major competitors. In the customer conversations as well, early interest and adoption is very healthy, and the sales team is fully enabled and has great sales play around the value proposition of Pixie. So we're excited to see that starting to get unlocked. Same thing with network performance monitoring, the partnership with Kentik. We've got joint customer lists being worked and go-to-market there that is early stages, but also appears to be strong. And CodeStream just launched not very many days ago, so it's very early, but the buzz has been really exciting. The partnership with Microsoft, a big highlight. And there are millions and millions of developers who use Microsoft tools as one of the most popular developer platforms in the world. And so we're grateful for their partnership and reaching new audiences for us. And also with our own customers who happen to use Microsoft tools, a great opportunity for them. I'll note as well, the CodeStream product, while it takes advantage of the Microsoft platform, integrates with VS Code, Visual Studio, GitHub, Microsoft Teams. It also does support non-Microsoft platforms as well. So IntelliJ, another very popular development environment, Slack.
spk03: jira um all of those platforms also already supported out of the box we're excited to take advantage of those flywheels as well got it very helpful caller thanks bill appreciate it and mark just one for you um you guys you know nice move in terms of percentage of uh of uh customers that have converted you're it's you're now up to uh 76% of business on the consumption model. I think you guys had, or you had traditionally said like maybe 80 would be the ceiling. And should we now potentially think of that not being a ceiling given the success you guys are having converting customers at a meaningful pace? Thanks, guys.
spk08: Sure. I think what we said is we target 80% for the end of March, the end of this year. We're obviously well on our path toward that. And the ones who aren't there generally are in multi-year agreements that aren't coming up for renewal until such point after next March. I don't think 80% is the ceiling. I think we will get beyond that over time. And at some point, we'd love to have our entire business there. but it'll just take time given that these contracts have to run their course. Oftentimes these are multi-year, multi-million dollar contracts that'll take a little bit more time, but we certainly would love to get, and we do expect to get, over 80 as we go forward beyond next March. Okay.
spk03: Thanks for that clarification. Appreciate it. Thanks, guys.
spk00: The next question comes from Jack Andrews with Needham. Please go ahead.
spk07: Good afternoon and congratulations on the results. I wanted to see if I could ask one product and one financial question, if I may. So on the product side, just to follow up on the last question regarding Pixie, I was wondering if you could just frame for us how important is the EVPF capability that you have, and are there other use cases that you could sort of apply Pixie's technology to?
spk05: Yeah, thank you for that question. EDPF is a very low-level insertion point that we use to capture system signals from the Linux operating system, in our case with Pixie. And it allows us with the Pixie platform to easily capture that and turn it into telemetry data that developers can consume. We've initially started a Pixie platform to center around the standard metrics and events and log information that today customers would have to spend time deploying agents and custom instrumentation for. We unlock that automatically for them with Pixie so they don't have to do that upfront work. But it's also an extensible platform, so customers can go in and, using very simple, lightweight scripting, capture any data actually flowing through the network or through the kernel of the operating system that they so choose to capture, and also evaluate that locally on the Kubernetes environment or send it back to our cloud for retention, advanced correlation, and visualization. You know, it unlocks enormous potential across many use cases, not just traditional application or infrastructure laundering, but potentially security, network, advanced developer profiling, application profiling, and so forth. So it's a very powerful platform to expand value on over time.
spk07: I appreciate that color and just follow up question. Um, is there a way to frame what type of net expansion rate you're seeing, um, upon renewal for the, um, the, the commitments that the customers are committing to now?
spk08: Yeah. So, uh, you know, I, I would, I think we have to separate, talk about two things. One is commitments and one is consumption. And, you know, we didn't know how to cohort that's come through the Q2 cohort has been on the, on the program for one year. And when we look at commitments, commitments are what a customer committed to a year ago in aggregate and what that same set of customers committed to at the end of the first year, we see that commitments have gone up.
spk02: So, you know, increasing commitments over the renewal period.
spk08: And when we look out in the forecast for Q3 and Q4, we see that type of behavior continuing. And the other thing that's driving is consumption. And as we've said, consumption is running ahead of commitments. And that happened in Q2.
spk02: When we look at Q3 and Q4, we see that kind of behavior continuing where they continue to consume at a rate that exceeds their overall commitment.
spk08: And so those are the two things that are driving, you know, overall top-line growth and, you know, to put out the Q3 and Q4 forecasts that we've done. Got it.
spk02: Thanks very much.
spk00: The next question comes from Sanjeev Singh with Morgan Family. Please go ahead.
spk02: Thank you for taking the question. And congrats on the really strong results this quarter. When I look at the sequential dollar growth in Q2, I might be off, but it looks like the biggest sequential dollar increase in multiple years, which is very impressive.
spk04: And last quarter, Q1, was up $8 million. This quarter is up $16 million. So in the spirit of the previous question, I guess one that would be for Mark, when we think about that sequential dollar increase, How much would you say came from, you know, lower churn being a driver relative to Q1? How much sort of came from expansion? And then how much sort of came from net new sort of coming onto the platform? Any way to frame up, you know, across those three buckets?
spk08: So the continue improved churn is certainly having an impact. We've mentioned that now for a couple quarters, and I think we're doing a good job there. We still have room to go, and so I think our goal is to continue to improve that going forward. So that's had an impact. I think the larger impact is the consumption ahead of commitment for our customers. The third piece was I think new customers, you said. That has an impact also, but our customers that come on board tend to be coming on board at a pretty low level of spend. So even when we get good numbers of customers, the total dollar amount added is pretty modest. And then once they've spent the first dollar, every dollar they spend thereafter is an expansion dollar. So the new tends to be pretty modest. But the big driver is the fact that customers are consuming ahead of demand. Point to our investor letter where we have a description of our consideration and how that's done and what we've done there. And I would take a look at that.
spk02: Environmental consideration in broad terms is the way we align revenue recognition with how our customer consumes.
spk08: By design, we took a very cautious approach early on. Our models are getting better and better as we get more data, and we're able to have more accurate, better predictive models. And so I think that's also having an impact on how we recognize revenue.
spk04: That's super encouraging here, Mark. And then just one follow-up, also more data-driven. As you look at the Q2 cohort along the dimensions of also paid data ingest growth, how did growth in those two metrics compare to the Q1 cohort or some of the recent cohorts?
spk02: Any color there would be helpful.
spk08: So the Q2 cohort is the first cohort that has anniversaries, right? That's the September cohort was the first one that has been through a full year.
spk02: And so we've got Q3 and Q4 doing, for example, you know, we're seeing in terms of overall consumption levels, I think Q3 and Q4 are running slightly ahead of Q2.
spk08: Now, remember, Q2, the initial cohort was up to start.
spk02: Back then, we were still emphasizing commitments, and our compliance had our field emphasizing commitments more so.
spk08: So that cohort was up 15%. The subsequent cohorts were up a little less when they renewed onto our new model. So I think you have to really think about that. But overall, we're seeing stronger results as we go through these cohorts. And I think that's driven by our product is getting better and better, obviously, but it's also more familiarity with the model, both on the part of our customers and as well as our go-to-market organization. You know, it was a big change, obviously, when we introduced last August or July-August, and then we changed our comp plan in April. That was another big move. And, you know, we're still relatively new at this. We've been doing it for a couple quarters, and I think we've learned a lot, and we're getting good at it, but I still think we have, you know, a lot we can learn and things we can improve.
spk04: Really appreciate all the time, Mark. Thank you very much.
spk00: The next question comes from Eric with JMP Securities. Please go ahead.
spk05: Yeah, thanks for taking the question. Congrats on a good quarter. Kind of consistent with some of the other questions. How can we think of the contribution from the commitment versus the overage? Where are you trying to Where are you referring customers or how are you recommending customers approach their commitment levels?
spk08: So our primary goal is consumption. Our comp plan is driven by consumption, not commitment. You know, in the old model when it was subscription-based, we were looking at commitments. We're no longer doing that. The sales compensation plan is all around how much a customer consumes over the life of their contract. So that is the primary driver for us. Sure, obviously a bigger commitment is better than a smaller commitment, but that's not the real motivating force. The motivating factor for us is to get people to send us more data, and we feel like that is a leading indicator to more and more people getting value out of that data. So users will come, continue to migrate to the platform, so we'll be able to grow user growth as well. But really, most of what we do is driven around driving more data and more users. At the end of the day, that's how customers get value, and that's what we want to do is make sure they continue to get value and continue to increase their consumption. so is that to suggest the majority of revenue is coming from the consumption side um there's a mix it's a mix and you know if you look at each each cohort it might there it might might be adjusted one way or the other as with the multi-cohorts It's too early for us to really draw, I say, broad generalizations. We've had, you know, one quarterly cohort come through. It was a relatively modest number of customers in the hundreds. You know, we've got now thousands in this model that we'll continue to learn from as we go through and as they start to hit their anniversary dates.
spk05: Okay, then real quick on the net retention rate. Your net retention rate for sub $25,000 accounts is higher than it is for the greater than 25,000. Can you explain what the basis or why that dynamic is?
spk08: I think the big reason there is small numbers, a small base. You've got customers that are paying us a couple thousand dollars, and all of a sudden they go up to $20,000. You can see the number of 25 paying above customers you have is growing nicely. We've got some paying over $100. That adds up in a hurry when the base is real small versus the other base. It's much tougher to get a big percentage change off our high bases.
spk05: Okay, that makes sense. Thank you.
spk00: The next question comes from Michael Turth from KeyBank Capital. Please go ahead.
spk06: Hey, congrats on the quarter. Bill, really big picture question. Obviously, you've done an amazing job on execution, and now you've got a strong – strong double-digit growth rates. So perhaps the focus shifts to product strategy even more so. So at this point, how would you really differentiate what you're doing strategically from some of the other strong players that are out there? I know you talked about developers, but there are other monitoring or observability companies that also have developer-focused products. So how do you really differentiate from what some of the leading well-known players are doing in the field?
spk05: Yeah, thanks, Michael. And it's a great question. I would start by reminding everyone, if you think about this space, it's largely been driven by all vendors, including New Relic prior to the new strategy we laid out last year, to be focused on collecting telemetry and helping developers react to incidents in production and so there's a variety of ways to do that but every company in this space is focusing on that incident response process when you step back though and you think about where engineers spend their time and what they're motivated by it's all around innovation it's around creating value for their business and customers and a lot of their time is spent on planning that, building that innovation, validating with customers, and testing it, and then deploying it into production. And we have this fundamental belief that the production telemetry we collect today to help customers, our engineers, troubleshoot your software, prioritize the right investments, create better customer experiences. And not only is that going to help accelerate innovation,
spk02: prevent outages to begin with, create more customer value, but it also is very beneficial to New Relics and our investors, right?
spk05: Because today, when you think about just the use cases that are reactive in nature, it's a very small subset of the total engineering population. When you think about all engineers, it could be many, many times greater TAM than the current observability TAMs. And so that big picture view for us is, like, how can we unlock that telemetry data across the software lifecycle? That's the fundamental premise by which we took the shift to the user and data pricing model last year, and it's also the strategic impetus behind new innovations like I.O. and tooling.
spk02: and you're going to see more of that over time. And then you've increased the take rate of pay-as-you-go, but the percentage of paying customers there had decreased.
spk06: How do you increase that conversion efficiency, and how can we really measure the current pricing model where – is actually increasing users and expanding user adoption within the enterprise. How can we measure that?
spk08: Well, you know, for us, one of the key things is just getting them using the platform. And so we will invest, and we mentioned we've driven some investments to push those numbers, and we want to get more people just using the platform. And a lot of people think that's just new organizations, and that's not necessarily the case. This could be additional people within an organization just trying it, just hearing about us, really get the word out and get them to understand the power of the platform. And so we want to make it as easy as possible to do that.
spk02: You know, we have confidence that we will be able to once they are using it.
spk08: they'll get value and they will continue, they'll grow. And ultimately, you know, if they're not paid, hit the 100 gig limb or add people and become paying customers. And then, you know, we've seen a lot of evidence that once they get to, you know, the paying stage, then they continue to grow from there and ultimately become, you know, much larger and more significant accounts. So, you know, our goal, I would say our primary goal is to get people into the funnel and using Deployed and using the product And then we look at all those conversion rates. At the end of the day, for us, it's primarily about getting people to start using the platform because we do have confidence and we've seen a lot of evidence that once they start using it, they will go on to pay it and become larger and larger customers.
spk06: Thanks for taking the questions, and congrats on the big turnaround.
spk00: The next question comes from Yoon Kim with Loop Capital Markets. Please go ahead.
spk01: Thank you. Congrats on a good quarter, Bill and Mark. Can you talk about the success you had in adding new 100K-plus customers in the quarter? I think it was your best performance in a while. Can you talk about whether these new 100K-plus customers are relatively new customers who joined over the past 12 months or so because they were attracted to the new pricing model, or are they just simply existing older customers who are now committed to the platform? And then also... Should we expect to see this 100K plus customer account continue to move higher at this new faster rate as your enterprise sales capacity continues to ramp up?
spk05: Yeah, thank you. I'll take that. And, you know, I'd first start with a short answer to your question, are these relatively new customers or from the existing base? I think the answer is definitely yes. It's both. Um, I'll start with maybe some of the numbers on the self service side that we find exciting and are highlighted in the investor letter. Um, since we introduced that three tier and then add your credit card and move to pay go model last year, we now have 5,000 customers, um, in that model and increased from 3,500 last quarter, certain additional 1500. And, um, this quarter alone. And we noted as well an increase from 69 customers to 109 this quarter, spending more than 25K, and an increase from four to six spending more than 100K. So those customers are a great example of new 100K customers that came up through that three-tier pay-to-go model. within the last year and are now spending in excess of $100,000. From our existing base, customers who may have been using the platform for a while and now with the consumption model and the full platform access they get for it are expanding at a greater rate and spending now in excess of $100,000. I would expect us to be able to continue to grow that pool across the more than 14,000 customers that we now have consuming services from New Relic One.
spk01: Okay, great. And then I have a question for Mark. It seems like a variable consideration that Can you at least qualitatively address how much of your revenue is driven by this consumption in excess of commitment? And has that mix been changing meaningfully quarter over quarter? Thanks.
spk02: Well, it certainly has been changing quarter over quarter.
spk08: Since a year ago, the number would have been zero. If you go back to Q2 of last year, last September quarter, we had early, you know, you get into the first couple quarters, by design, we took a cautious approach to how we recognized gravel consideration.
spk02: And so it was Q3 and Q4, we get better data. data sets we get better models and it started to to take up and then when you get into the the september actually took so that's where you got to be equal so it has been increasing uh
spk08: I think a lot of it's attributable to the fact that we expect that to continue to grow over time.
spk02: I would say not over the past year because, again, it's harder to get as big a percentage increase.
spk08: But we do expect customers to continue to consume more than they commit, and certainly our, you know, the guidance and things we've given are indicative of that.
spk01: Okay, great. Thank you so much.
spk00: The next question comes from Derek Wood with Cohen. Please go ahead.
spk05: Great, thanks, and I'll echo my congratulations. Mark, I'll double-click on this variable consideration factor again. It just sounds like there's some moving parts on the mechanics of REBREC.
spk07: And in the past, you've given us some sort of percentages and compare
spk03: Help us think, you know, what that kind of has looked like in year one of a contract and how you see that shifting now that you get more data and better predictability and all that in year two and how the mix could, you know, shift or the shape of the REBREC curve could shift in year two.
spk08: I think this is triple-clicking. Just wanted to mention, not double-clicking on it. So, you know, we... As I mentioned, we started out appropriately cautious in it. And, you know, in a perfect world, you'd be able to do this completely linearly. Obviously, we don't live in a perfect world. We don't have a perfect crystal ball. So our assumptions are changing every month, every quarter as we get more and more data. And also remember, customer behavior is changing. Some folks who are over-consuming, maybe they have a drop. A lot of the folks who are consuming at a low level all of a sudden start to ramp up, and we've got to make an assessment of is that ramp up going to be sustained, or is that just a one-time event? And we've got to make these, we've got to put together forecasts with the best available information. as we get as we get better and better at this we get a greater historical data set you know we'll have more is a larger a larger history that we can draw on that says you know this kind of behavior typically results in this sort of behavior over the rest of the contract period and so we will be able to continue to improve refine uh those models um you know it's it's I think over the course of this year, we've certainly gotten better at it. And so I would say when you look at the, you know, the percentage of, you know, the skew toward Q4, the fourth quarter of the contract in our September cohort, that was probably a little bit larger than we expected to be in subsequent quarters. But, you know, and we'll just continue to improve that over time.
spk03: understood that's helpful um and maybe one bill for you um you know you guys put out a blog talking about price differences between um aws and datadog were a couple ones you compared to talked about being disrupted with the consumption-based pricing model you called out some competitive displacements on this call with you know cost being one of the reasons
spk05: So I guess my question is, how prevalent of a complaint is pricing in the market, and how much opportunity do you see out there in displacing other vendors? Yeah, I regularly hear from customers about the price points and the pricing structure of observability. It's what drove us to tackle that as one of the first parts of our turnaround plan last year to structure the pricing differently. It's not necessarily a cost question. It's more of a value question. For the dollar you're spending, are you getting as much out of it as you would like? And regularly price does come up in competitive conversations. And when you look at New Relic versus a competitor, the customer doesn't necessarily spend less or save money by going with New Relic, but they feel they get much more value because the way we've priced it with very low data lets them instrument more of their system and understand more what's going on. Everyone's operating in blind spots today because of the cost structure. And then the user component gives the enterprise much more predictability because you know, engineering headcount doesn't spike or have seasonal variability as much as maybe your infrastructure does. So that combination, user and data pricing, a lot of customers find advantageous because it lets them instrument more and have more predictability.
spk09: Great. Thank you.
spk00: The next question comes from Rishi Jaluria with BA Davidson. Please go ahead.
spk08: Hey, guys. This is Richie Julia with RBC now, no longer Dave Davidson. Thanks so much for taking my question. Just two quick ones from me. First, I wanted to drill down on gross margins. Can you give us an update for what the outlook on timing for completing the migrations looks like? And in the investor letter, you talk about maybe the 80% gross margin target being pushed out by more than two years. If the mix of data versus customers stays at the level it is. Can you explain to us why that's the case and why would the data side be lower gross margin? Then I've got to follow up. Thank you. Uh, sure. So, um, as you know, we've been, we've been, uh, you know, getting out of our data, our data centers in Chicago, moving to the cloud that's been happening. We started out a couple of years ago. Uh, I think that was, we talked about that, um, and, you know, kind of running its course being largely complete by the end of fiscal 23. Uh, in addition, um, what we've been doing is, is opening up and moving to the cloud internationally. So in the Asia Pacific region and in EMEA. And so that was something we had planned over a longer time horizon. But we pulled forward a bit given our results. And as Bill mentioned earlier, the quicker we can do that, the better for our customers, the better off for our business long-term. So we would take a little bit of short-term hit on gross margin and make those investments to get the benefit over the longer term. In terms of the profit margin of each of our users versus data, We intentionally priced our data at a very low price and a low profit margin because we want to make it a no-brainer for our customers to send us all their telemetry data. And so we felt like going in with a number that is a little bit eye-popping. People, I think, sort of think, wow, can you really do it for this cheap? We want to make it really easy for them to just say, yeah, sure. It's cheaper for you to take it than for me to store it and handle it. And so we wanted to do that specifically to get that data and make sure that we get as much, you know, we make that as easy a decision for the customer as possible. And on the other hand, Our users are much more profitable, and that's what ultimately drives the profit, the bottom line profit of the business is getting those users. And over time, we think that Nix will get back towards the two-thirds, one-third. We mentioned right now this past quarter it was closer to 60-40 users' data. And if it stays that way for a while, we're fine with that because, again, we feel like there is long-term value in getting that data. All right, wonderful. That's helpful. And then I just wanted to go maybe to another competition question. And I appreciate the color you gave us on customer win-backs, which I think is really great to hear. Just overall, if we think about your competitive win rates, How has that been trending over the past year as you've gone down, you know, both the pricing and product transitions? Thanks.
spk05: Yeah. It's definitely growing stronger each quarter. The product transformation of the last year, I guess the best evidence of that is the strength of that three-tier and pay-as-you-go model. You know, when there's, zero between the customer and the value other than the product. The product has to stand in its own. Customers have to be able to give value and be willing to put in that credit card. And the numbers there speak for itself. And that also translates to very large customer accounts where, you know, some of our multimillion-dollar contracts, those engineers are now benefiting from the integration of the platform, the simplification we've done, the removal of friction. And it's helping us not only retain customers, as we've talked about, on lower return rates, but attract and win competitive deals. I think, you know, it's obviously a very competitive market out there, but the moves we've made both from a pricing and product perspective, but even more recently from a go-to-market motion perspective, shifting the incentives for our field to be really focused on customer value and, you know, winning the loyalty and trust of our customers all work together to win new accounts and keep them happy customers for the long term. All right, great.
spk08: Thank you so much.
spk00: This concludes our question and answer session. I would like to turn the conference back over to Bill Stable for any closing remarks.
spk05: Thank you, operator, and thank you all for joining the call today and for your questions. Obviously a very exciting quarter for New Relic. We thank you again for your patience as we've worked through our turnaround plan and completed this quarter. We're looking forward to reporting on our success in future quarters and growing the business and excited to meet you as we continue to get out on the road and continue meet with our customers and investors throughout the quarter. Thanks again for your interest in New Relic. Have a great day.
spk00: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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