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Edited Transcript of NEWR.N earnings conference call or presentation 5-Nov-20 10:00pm GMT

·38 min read

Q2 2021 New Relic Inc Earnings Call San Francisco Nov 6, 2020 (Thomson StreetEvents) -- Edited Transcript of New Relic Inc earnings conference call or presentation Thursday, November 5, 2020 at 10:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Lewis Cirne New Relic, Inc. - Founder, CEO & Director * Mark Sachleben New Relic, Inc. - CFO & Corporate Secretary * Michael J. Christenson New Relic, Inc. - President, COO & Director * Peter Goldmacher New Relic, Inc. - VP of IR * William Staples New Relic, Inc. - Chief Product Officer ================================================================================ Conference Call Participants ================================================================================ * Erik Loren Suppiger JMP Securities LLC, Research Division - MD & Equity Research Analyst * Jennifer Alexandra Swanson Lowe UBS Investment Bank, Research Division - Analyst * Khanh Minh Ngo Needham & Company, LLC, Research Division - Research Analyst * Mark Joseph Rende Morgan Stanley, Research Division - Research Associate * Matthew Melotto Parron JPMorgan Chase & Co, Research Division - Analyst * Rishi Nitya Jaluria D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst * Robert Cooney Oliver Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst * Robert S. Majek Raymond James & Associates, Inc., Research Division - Senior Research Associate * William Kingsley Crane Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good afternoon, and welcome to the New Relic Second Quarter Fiscal Year 2021 Earnings Conference Call. (Operator Instructions) 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. -------------------------------------------------------------------------------- Peter Goldmacher, New Relic, Inc. - VP of IR [2] -------------------------------------------------------------------------------- Thank you, operator. Hi, everyone. Thanks for joining our Q2 fiscal '21 earnings call. We published a letter on our Investor Relations website about 30 minutes ago, and we hope everyone's had a chance to read the letter together with today's earnings press release. Because of the level of detail we provided across these 2 documents, today's call will begin with Lew providing brief opening remarks, and then we'll just dive right into your questions. During this call, we will make forward-looking statements, including about our business outlook and strategies, which we based 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-Q and upcoming 10-Q to be filed with the SEC. Also, during this call, we will discuss certain non-GAAP financial measures. We've 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 the call over to Lew. -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [3] -------------------------------------------------------------------------------- Thanks, Peter, and good afternoon, everyone, and thank you for joining us for our second quarter fiscal '21 earnings call. With me on the call today to answer your questions are President and COO, Mike Christenson; CFO, Mark Sachleben; and Chief Product Officer, Bill Staples. Before we get to the Q&A, I just want to make a few comments. First and foremost, I want to thank everyone at New Relic who made efforts to get the latest version of New Relic One out the door in Q2. As we spoke within the last call, this was a huge accomplishment for our company. Second, I want to share my optimism about how the changes related to this momentous launch have set New Relic apart from our peers. While our financial results are mostly in line with the guidance we shared at the end of the first quarter, I don't think they fully reflect the early momentum we are seeing in the business. To that extent, I'd like to make a few quick points before we move to Q&A. First off, ARR. ARR was in line with our guidance, but a little softer than we had hoped. We saw a significant number of customers take advantage of the entitlements that we offered, which effectively delayed some deals. The good news is we are seeing our customers put a lot more data into our Telemetry Data Platform, which we view as a leading indicator for spending intentions. As we discussed on our last call, our new strategy is to offer the market-leading and mostly a single source of truth for all our customers' operational data. We believe this data gravity well will attract more users to our platform, which will ultimately lead to increased revenue growth. If you recall, when we had entitled all our customers with unlimited access to our platform, that allowed us to get comfortable with our product and pricing transition, and it would build demand within our customer base. While these entitlements effectively hit gross margins and delayed some sales cycles in the quarter, we saw a large number of customers sending us substantially more data. In the last month, we saw our data ingest rate grow at over 7% month-on-month, which would annualize to over 100% on a year-on-year basis. Not only are our customers broadly spending more data, they're also sending us more types of data, which indicates that our customers are embracing New Relic One as a complete platform. Since our July launch, we have more than doubled the number of customers who send us log data. The second point I wanted to make is about our transition from a subscription model to a consumption model. With the launch that we discussed in the last call, we are now moving to a consumption-based model that aligns the interest of New Relic with the interest of our customers. Customers love that they now only need to pay for what they use and they have control over what they use. And we believe this aligns our interest with theirs, and that will also result in a stronger growth rate in the future. The last point I want to make is regarding dollar-based net retention. As you know, dollar-based net retention is a function of new ARR and churn, and we dropped below 100% for the first time ever last quarter. Our transition to a consumption model has had an impact on new ARR in Q2. And regarding churn, we continue to see a substantial portion of our installed base in the hospitality, travel and leisure industries struggle. And we're working to serve as a great partner to them during this time of difficulty for them with the belief that, that partnership will be recognized by our customers when they bounce back. We do expect next quarter for our churn to improve on an absolute basis, which is significant because 3Q is typically our second largest renewal quarter in the year. With all that said, operator, you can please open the line for Q&A. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) The first question is from Sanjit Singh of Morgan Stanley. -------------------------------------------------------------------------------- Mark Joseph Rende, Morgan Stanley, Research Division - Research Associate [2] -------------------------------------------------------------------------------- Mark Rende on for Sanjit Singh. To start off, I wanted to dig into some of the moving pieces with the new pricing and product packaging. I think -- generally, when you think about it, how many renewal cycles will it take to get the vast majority of the base onto this new pricing model? And then maybe 1 follow-up after that. -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [3] -------------------------------------------------------------------------------- Sure. I'll let Mike Christenson take that question. -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [4] -------------------------------------------------------------------------------- We're hoping it will be 1 cycle. We made huge progress with 1 month to go in the quarter. And now as we're going through 3Q, it's a very small number of transactions that are staying on legacy model. So we hope we can get virtually a complete transfer in 1 renewal cycle. -------------------------------------------------------------------------------- Mark Joseph Rende, Morgan Stanley, Research Division - Research Associate [5] -------------------------------------------------------------------------------- Got it. And then maybe a follow-up. Just trying to get some help with some like-for-like math on the new pricing model. You had a deal of kind of the same value on an annual basis on the old pricing model and new pricing model. Is there an associated headwind in year 1? And what are you guys thinking about an uplift in like customer lifetime value as they move to that new pricing model? -------------------------------------------------------------------------------- Mark Sachleben, New Relic, Inc. - CFO & Corporate Secretary [6] -------------------------------------------------------------------------------- I'd take that. This is Mark. I'll take that one. So when we look at the customers that transition to the new pricing model in the last quarter, as Mike said, we've been really selling this for 1 quarter. We saw that -- excuse me, more than 2/3 of those customers had an uptick in spend. And if you look at the net change in committed amount from the ARR in the old model to -- consumption model to the new model, the committed spend was up about 15%. And so that's one measure. On the other hand, when we look at the customers that have reduced their commitment, it's really all about their consumption and their rate of consumption. Because in talking to customers, we know that some customers were uncomfortable with a certain level of spend, given these are challenging times, budgets are tight, so they would reduce their committed spend. But what we've seen, even in a short period of time, is some of those customers continue to consume at a higher rate than they committed to and -- which says to us that over time -- obviously, over the course of a 12-month period, their spend would be up from what it was in prior periods. So that's what we're looking at very closely, is this -- really, the rate of consumption that our customers will be achieving and how that changes over time. And that's going to be one of the biggest driving factors as we go forward. -------------------------------------------------------------------------------- Operator [7] -------------------------------------------------------------------------------- The next question is from Jack Andrews of Needham. -------------------------------------------------------------------------------- Khanh Minh Ngo, Needham & Company, LLC, Research Division - Research Analyst [8] -------------------------------------------------------------------------------- It's Khanh on for Jack. How should we be thinking about SKU? What SKU mix will look like within your $100,000 customers in the future between full stack and applied intelligence? What SKU are you pushing your sales teams to sell? And which SKU do you expect will generate greatest account expansion? -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [9] -------------------------------------------------------------------------------- Bill, do you feel comfortable taking that one? -------------------------------------------------------------------------------- William Staples, New Relic, Inc. - Chief Product Officer [10] -------------------------------------------------------------------------------- You bet. Happy to talk about it. I'll actually talk across the 3 SKUS. I think we mentioned last time, our new user and data pricing model starts with data-based pricing for ingest. That's the telemetry data platform at $0.25 per gigabyte. Extremely competitive price point for ingesting all types of telemetry data. And as we mentioned last time, we anticipate that making up, on average, about 30% of our customers' total bill. The remaining amount then would be between full stack observability and our AI product. And the early customers converting to this model are bearing out what we previously had proposed. About 70% of the remaining spend is in the full stack observability and AI space. Majority of that is on the user model for full stack observability. The applied intelligence product is -- v1 launched just in quarter 1, and so it's still gaining adoption steam. We're happy with the early adoption. But it represents a total -- a small amount of the total spend at this time, and we anticipate it will continue to grow. But given the maturity of the full stack observability product and the price point that we can command for that, it will continue to make up the majority of spend for customers. -------------------------------------------------------------------------------- Khanh Minh Ngo, Needham & Company, LLC, Research Division - Research Analyst [11] -------------------------------------------------------------------------------- Great. And can you provide some details on the changes you've made to your sales team and quota plan to sell the 2 commercial SKUs? Are there any differences in the quota between telemetry data platform and applied intelligence? And how are you incentivizing new LANs during the new packaging scheme? -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [12] -------------------------------------------------------------------------------- We -- it's Mike. We did not make changes to the quota plans as a result of this launch of the product. The key contracting vehicle that we have with our customers is an annual commitment. That stays the same. It has components for users in data, but the field is compensated on the aggregate commitment. So it really didn't require a change in the comp plan. We do have incentives in our comp plan for new logos and new LANs. Those -- we had them last year. We're continuing with that this year. We feel that, that has been helpful. And as we go through 3Q and then 4Q, this December quarter we're in now, and then March, we'll make decisions on any other new ideas we have in terms of adjustments based on how we perform and the feedback we're getting from the market on their receptivity to this model. -------------------------------------------------------------------------------- Operator [13] -------------------------------------------------------------------------------- Next question is from Kingsley Crane with Berenberg. -------------------------------------------------------------------------------- William Kingsley Crane, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [14] -------------------------------------------------------------------------------- Congrats on the quarter. We thought the recent momentum of product announcements as well as this 5-year partnership with AWS are great reminders of the hard work that you've done in New Relic. On AWS, you've worked with them for some time now. Could you remind us of what is specifically incremental here? Is it the consolidated billing? -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [15] -------------------------------------------------------------------------------- This is -- sorry? -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [16] -------------------------------------------------------------------------------- Yes. -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [17] -------------------------------------------------------------------------------- This is a... -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [18] -------------------------------------------------------------------------------- I was going to say, Mike, please take that. Yes. -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [19] -------------------------------------------------------------------------------- It's an extensive collaboration on the product side. So we're doing product integrations. We're collaborating on development. And then we are also, for the first time, really collaborating on go-to-market. The goal -- the overriding goal for this is to help our customers move to the cloud faster, cheaper and with lower risk, to make it easy for AWS customers to find and buy New Relic and to make it easy for AWS customers to use New Relic for observability of their AWS services. I think the important thing here is we have a meaningful portion of our business today that is our customers monitoring workloads running on AWS, and that happened really without an extensive collaboration between the 2 companies. Now we hope to see a dramatic increase with this new agreement, again, both on the product integration side and collaboration and on go-to-market. So it's committing senior leadership attention and resources from both companies to try and move this business to a significantly higher level for us. -------------------------------------------------------------------------------- William Kingsley Crane, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [20] -------------------------------------------------------------------------------- Okay. That's helpful. It already looks really promising. One quick follow-up is that you've mentioned some of this incremental data ingest that you're seeing on the platform. And I think you've also mentioned some traction in free-tier users. One question would be, have you seen any traction with increases in users in the enterprise base? Or is it still too early there? -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [21] -------------------------------------------------------------------------------- We're seeing... -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [22] -------------------------------------------------------------------------------- We are seeing increased -- sorry, I'll take that one, Mike. We're seeing increased usage pretty much across the board in terms of ingest, in particular. It's broad-based. It's the large customers. It's small customers. It's number of accounts. It's amount of data per typical customer and the number of types of data for the customers. So we're encouraged that -- it's a pretty strong validation that the market wants a single place to put all your telemetry data, do that cost effectively. And now we think that our job is to, with that data gravity well, attract more users, drive more value, and then, of course, ARR -- revenues will follow. -------------------------------------------------------------------------------- Operator [23] -------------------------------------------------------------------------------- The next question is from Rob Oliver of Baird. -------------------------------------------------------------------------------- Robert Cooney Oliver, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [24] -------------------------------------------------------------------------------- Great. Mike, one for you. Just on the pressure on the ARR line, obviously, some of it understandable given the changes you guys have made to the pricing model. Historically, you guys have done very well with some big logos in travel and hospitality. So just wondering if -- try to tease out a little bit what -- how much of that weakness came kind of from that macro and how much came from the pricing changes? And then I had a very quick follow-up. -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [25] -------------------------------------------------------------------------------- So I'll split the change in ARR into 2 pieces, the new part and the lost ARR part. On the new side, as we've said, we need to improve -- dramatically improve sales productivity, and we've been focused on changes to improve output. This quarter was -- the September quarter is always a hard quarter because of July and August. As you're finishing up the summer, it always feels like you have to do a full quarter of business in 1 month. And we compounded that with the change in the business model and the open entitlements where we gave everybody the ability to explore the full platform through the end of the year. So it slowed down our close rates. When I look at the quarter, we had the capacity. We've done -- we did a lot of great training to get people prepared to be able to present this new model to the market. We had the biggest 2Q pipeline ever. We just struggled to close at the levels that we wanted to close. And our expectation is we're gaining momentum. We're getting comfortable with how to present this to the customers. So we expect to improve that in 3Q. With respect to the loss side, we continue to see pressure from the pandemic and the economy on some customer sectors. We've talked about travel, hospitality and things of that sort. So we've seen some pressure there. We've seen some general pressure across the portfolio, and we had 1 instance where 1 of our customers bought another of our customers and had a pretty significant consolidation of spend that impacted us this quarter. So it's -- I kind of put it into 3 buckets. The -- just a general, you always lose some ARR for whatever reason, but we had the COVID and recession impact on travel and hospitality, and then we had this 1 event with 1 customer. -------------------------------------------------------------------------------- Robert Cooney Oliver, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [26] -------------------------------------------------------------------------------- Great. And then, Mark, just a quick follow-up for you. Earlier, I think it was Sanjit's question, you -- about the kind of spending uptick eventually you see from customers who flip on this. I think you mentioned 15%, if I got the number right, sort of on average. And is that coming from -- is that the expectation? In other words, were you seeing that prior to -- I know Lew had mentioned that you guys have seen really sort of meaningful upticks in data ingestion. Just wanted to understand, have those upticks in data ingestion been sort of consistent with what you guys had expected? Could it -- or could it drive upside to that sort of a number? -------------------------------------------------------------------------------- Mark Sachleben, New Relic, Inc. - CFO & Corporate Secretary [27] -------------------------------------------------------------------------------- Sure. So the conversion rates are roughly in line with what we've been seeing in our trials. Overall, they're pretty close. I think a little below, but on the other hand, it was the first quarter we were going through that. And so I think we'll see them rise. We'll get them to rise as we get more comfortable with that process. So I think that's been good verification of what we thought coming in. In terms of the data increase, I think there are 2 things we want to look at or talk about. One is the overall level of data ingest, and Lew mentioned that early on. We've been talking about that. We're seeing our customers send us more data. And I think a lot of that is due to the entitlements that we offered. There are other things too, the free tier and things like that. But once -- one of the critical metrics we want to look at is what happens when a customer signs up on the New Relic One pricing deal. And so we look at the customers -- all the cohort of customers, the first cohort that was signed up at the end of September 30, they're -- all of a sudden, they're on the new pricing, new New Relic One, they're often going. And then we want to look at what's happening to their data ingest, because they're paying for data ingest right away, right? The other folks are still in the entitlement phase. So now they're paying. So what happens to that data ingest growth? And so we've got 1 month of data. It's not much. It's really short. But we like what we see. That's been -- the data that those customers are bringing in is growing very nicely. As we go forward, we're going to look at that. At the end of December, we'll have 1 month of data of what's going on with those customers. The critical thing here is as they bring in more data, we're also going to be looking at how many seats they have, how many users are using the FSO, right, full stack observability, because we feel like that data growth and the different types of data, that is going to ultimately drive the number of users. And so I think that's going to be a lagging metric, but ultimately, we're going to be measuring both of those things very closely. I think it starts with the data and then goes to the users. And we want to see that consumption rise over time. So as we go forward, we're going to be looking very closely at sort of the equivalent of a net consumption run rate -- net consumption expansion rate, if you will, that sort of metric. And that's what we'll be really looking to drive because that's what's going to be -- that's going to show really what our customers are doing and how they're growing. -------------------------------------------------------------------------------- Operator [28] -------------------------------------------------------------------------------- The next question is from Jennifer Lowe of UBS. -------------------------------------------------------------------------------- Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [29] -------------------------------------------------------------------------------- Great. I wanted to touch maybe just quickly first on ARR. We talked about some of the puts and takes there, but something that came up in the last call was that there was also a thought that there could be some downshifting of customers into the free tier and that I think you've given sort of a $15 million to $20 million impact potentially associated with that. Are you seeing that at this point? Is it something that could happen? What's sort of the latest thinking around that effect? -------------------------------------------------------------------------------- William Staples, New Relic, Inc. - Chief Product Officer [30] -------------------------------------------------------------------------------- So we... -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [31] -------------------------------------------------------------------------------- Go ahead. -------------------------------------------------------------------------------- William Staples, New Relic, Inc. - Chief Product Officer [32] -------------------------------------------------------------------------------- Yes. I'll definitely talk a little bit about free tier. You probably remember from the past announcement, we introduced this really generous perpetual free tier to developers. It gives them 100 gigabytes of data every month and a full stack observability user for free. It's not a free trial like some of our competitors. It's a perpetual free tier and replaces what previously costed thousands of dollars in subscription costs per year. And we're doing that because we believe we're really in the early days of observability, and we want to encourage every developer, including tens of millions of developers today, to make observability part of their daily workflow without any strings attached. We're really encouraged by the early signs of success with free tier. We anticipated that downshift in revenue and it's actually been less than anticipated. And in the first few months, we're seeing 10x the number of developers actively engaging with the platform at those previous couple of thousand dollar spend level. So we're really cautiously optimistic that these developers will realize the power of the platform, make it part of their daily workflow and bring it into their enterprises to consume a much higher levels than in the past. -------------------------------------------------------------------------------- Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [33] -------------------------------------------------------------------------------- And I wanted to also ask about the open entitlements and what happens at the end of this calendar year when those expire. These customers have put a fair amount of data into New Relic. Presumably, the aspiration is then they start paying for that. But you're certainly seeing some gross margin headwinds there. So first, how do you think about December 31, 2020? Do you expect some of those data volumes to retrench? Or do you expect gross margins to expand? What does the business look like once we kind of get through this period? -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [34] -------------------------------------------------------------------------------- There's a lot we're going to learn over the quarter. We see that all as encouraging signs. It's certainly -- there's market demand for more data in our platform. We think that a meaningful number of those customers that just translates into more pipeline, more opportunity for us to pursue when they do move to this model. And then there will be some customers who will manage their data ingest with more precision to fine-tune their consumption of our platform, and they can see that by the hour as a New Relic customer. So I think that offering the customers that flexibility and that transparency, again, will attract more customers and will result in better growth to our business. Long term, as we complete our transition to the cloud and we focus on many ideas we have to further improve the -- our -- the cost of ingesting data, we think that we can return to that -- the gross margins in the 80% range. And so that is a long-term goal, even a medium-term goal, I'd say. But we'll have more to report on that after we get through the current quarter. -------------------------------------------------------------------------------- Operator [35] -------------------------------------------------------------------------------- The next question is from Sterling Auty of JPMorgan. -------------------------------------------------------------------------------- Matthew Melotto Parron, JPMorgan Chase & Co, Research Division - Analyst [36] -------------------------------------------------------------------------------- This is Matt on for Sterling. Looking through the shareholder letter, I noticed you guys were talking about some customers didn't have enough time to understand the changes from going from a subscription to a consumption-based model. I was wondering how long do you think it will take for customers to understand the implications? And in addition, how much of the revenue in this quarter was driven by this new pricing model relative to subscription in new deals? -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [37] -------------------------------------------------------------------------------- So we -- obviously, we announced this and had a relatively short window to educate customers on this new model and begin to convert them over to this new model. And in some cases, customers had approval processes or there were already negotiations underway. And it was just -- it was too difficult to actually transition to the new model. So we simply renewed them on the existing model -- the legacy model. About 3/4 of September's deals were on the new model. And since that we closed September, that number has been going up pretty significantly. So I think it was just a -- I would describe it as -- you came out with a new announcement. Business was underway in many cases, and we wanted to make a transition, but we didn't want to force customers in this quarter if it was too complicated or too challenging for them to do that. Going forward, we expect that virtually all of our customers will trend -- all of our customers will transition to this new model. -------------------------------------------------------------------------------- Matthew Melotto Parron, JPMorgan Chase & Co, Research Division - Analyst [38] -------------------------------------------------------------------------------- Great. That's very helpful. And then I guess just one follow-up. Just kind of unpacking some of the moving parts on ARR. So you've talked about some of the churn this quarter, the free perpetual tier, the decision to offer existing customers to use -- the unlimited use for the product. How do you think about those moving parts in terms of how it relates to driving ARR acceleration? How should we think about those moving parts going forward in ARR? -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [39] -------------------------------------------------------------------------------- Going forward, it's users and data, right? We want to get more users using the platform, more -- sending us more data, sending us different types of data, using all of the capabilities of the platform. So our focus with our existing customer and new customers is to get them on the platform, let them experience the platform, understand how it can help them and growing users and data. -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [40] -------------------------------------------------------------------------------- It's probably worth repeating what -- also that a key component of ARR is obviously lost ARR in the quarter, and we do expect that to improve in the current quarter on an absolute dollars data system, therefore, substantially on a percentage basis. -------------------------------------------------------------------------------- Operator [41] -------------------------------------------------------------------------------- The next question is from Robert Majek of Raymond James. -------------------------------------------------------------------------------- Robert S. Majek, Raymond James & Associates, Inc., Research Division - Senior Research Associate [42] -------------------------------------------------------------------------------- Following up on a prior question, you mentioned that the average uplift so far around -- conversion has been around 15%. And I know you don't have a lot of data yet, but has that average uplift remained somewhat consistent? Or did that figure perhaps start to tick up in the October cohort? -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [43] -------------------------------------------------------------------------------- October being the first month of a quarter, it's hard to say. We expect to develop more -- I don't know how to say it, get better experience with our customers and how they're embracing this new model and how the pricing affects them. Obviously, there are customers, as Mark said, that go up. And on average, that's been about 15%, including the ones that actually have a slight -- have a reduction in spend. So we think that as people explore all of the entitlements, use the full capabilities of the platform, by the time we actually get to their renewal, they may look very different from the way they look today. They may have more users, may have more data when we come to their renewal, hopefully, because they've been exploring the full capabilities of the platform. So I'm hesitant to say, hey, the 15% is going to grow through this quarter, but that is the whole point. And not as a price increase, but because they -- more people are using the platform and they are using it in a broader way. -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [44] -------------------------------------------------------------------------------- Yes. And Mike, I would just add, again, as we think about the world in subscription versus consumption, we're moving to consumption. And when you go through renewal, think about the customer going through a renewal these days. They're sitting there, they've got budget pressures. They've got a lot of uncertainty in the external environment, and they're saying, what do I want to do? How much do I want to commit and spend? And from our standpoint, that's an easy conversation to have to say, just commit what you're comfortable committing, right? Because it's all about what you're consuming. And so that number could be 15%, could go up, could go down a little bit. But again, the critical thing is, once the -- once that transaction has been completed, what happens then? And we want to make sure that they really enjoy getting all that data, that they give us more data. That continues to grow and then the users grow as well. And so again, that's the -- it's just -- it's different than -- I just want to emphasize how different that consumption mentality is versus where we had been, which is all subscription mentality. -------------------------------------------------------------------------------- Robert S. Majek, Raymond James & Associates, Inc., Research Division - Senior Research Associate [45] -------------------------------------------------------------------------------- Got it. And just one follow-up for me. With the longer sales cycles this quarter, have you heard any customer pushback? Or is it just really timing, where the customers currently just enjoying the open entitlements that you're offering? -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [46] -------------------------------------------------------------------------------- I -- we have not heard customer pushback. In many cases, there's still a bit of a negotiation. It's like any commercial transaction. But this has been very well received by our customer base. And when you think about it, as I said earlier, 3 quarters of the September deals were on the new model. That's with virtually 0 notice, right? They had a renewal or they were doing a deal, we converted them to the new model in 30 days. That's a pretty powerful statement, and it's increasing from there. -------------------------------------------------------------------------------- Operator [47] -------------------------------------------------------------------------------- The next question is from Rishi Jaluria of D.A. Davidson. -------------------------------------------------------------------------------- Rishi Nitya Jaluria, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [48] -------------------------------------------------------------------------------- Two here. First, going back to the AWS partnership, obviously, nice to see that. Would you anticipate maybe building out similar sort of partnerships or integrations with the other hyperscale cloud platforms? And how should we be thinking about the potential there? And then I've got a follow-up. -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [49] -------------------------------------------------------------------------------- The short answer is yes. Short answer is yes. We actually run today on AWS, but we also run on Google and IBM, and are having conversations with Microsoft. So we do believe in a multi-cloud world, and we need to have similar partnerships with the other players. -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [50] -------------------------------------------------------------------------------- And I'd say like what's motivating this is our strategy is to reach every professional developer with our observability platform. And we want to meet them where they are with an experience that flawlessly integrates -- our mission is we want to be even more seamlessly integrated with those cloud providers, offering they may have that has some overlap with ours. So that's what we're trying to strive for and what's driving it is like a customer success that will ultimately lead to happier customers, which will be more users, more gigabytes of data and then revenue growth. -------------------------------------------------------------------------------- Rishi Nitya Jaluria, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [51] -------------------------------------------------------------------------------- Got it. That's helpful. And then I just wanted to square back to the Q3 revenue guidance, which -- and I know we've walked through a lot of the puts and takes, but maybe just want to make it a little bit more explicit. So we're calling for a sequential decline in revenue from Q2 to Q3 in spite of the fact that you are guiding to ARR actually being up next quarter, and ARR has been flat to slightly up this quarter. Can you maybe walk us through the assumptions that you have modeled in, in the Q3 outlook? And how much related to churn and downgrades? And how much of that is just general conservatism given the unknown in the environment? Maybe help us kind of walk through how you're getting to that sort of range that you've guided us to on the revenue side. -------------------------------------------------------------------------------- Mark Sachleben, New Relic, Inc. - CFO & Corporate Secretary [52] -------------------------------------------------------------------------------- Sure. So from an ARR to revenue conversion standpoint, most of our deals come in at the end of the quarter, right? Everyone loves a quarter with little linearity. Unfortunately, that's not generally the way it works, right? Most of the business is in last month -- the last couple of weeks of the quarter. So incremental ARR in a certain period tends to drive revenue in the following period as opposed to the current period. So if you want to look at a revenue change in Q3 versus Q2, I really look to the incremental ARR that we achieved in Q2 as the driver for the revenue growth in Q3. And you can see that was generally flat. The other thing is, as we move to this model -- and right now, a very small percentage in total -- of our total business is on this -- on our new model, but more and more will be moving in that direction. And that -- I think there's a lag in when people are consuming and when that revenue shows up in your top line. And it also doesn't necessarily translate perfectly to ARR, right? Because the spend level is what's important as opposed to the commitment level. So those factors together, along with uncertainty around the overall environment, is what led to the guidance. -------------------------------------------------------------------------------- Operator [53] -------------------------------------------------------------------------------- The next question is from Erik Suppiger with JMP Securities. -------------------------------------------------------------------------------- Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Equity Research Analyst [54] -------------------------------------------------------------------------------- Can you hear me there? Can you hear me? -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [55] -------------------------------------------------------------------------------- Yes, we can hear you. -------------------------------------------------------------------------------- Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Equity Research Analyst [56] -------------------------------------------------------------------------------- Sorry about that. I'd be curious about the tenfold increase in the customers for the free tier. Where do you think those customers are coming from? Are they customers that are using their own organic observability technologies or are they coming from other competitors? And then I have a follow-up. -------------------------------------------------------------------------------- William Staples, New Relic, Inc. - Chief Product Officer [57] -------------------------------------------------------------------------------- Yes. We believe still, most of our business to win is greenfield developers who have not yet begun embracing observability but want to, and we're making that the focus. Of course, one of the major challenges that customers have is the proliferation of both open source and commercial solutions that offer capabilities in part, but not the kind of full stack visibility that New Relic offers. And so we believe by offering this platform approach with a pricing model that advantages us in terms of standardizing on New Relic for all of your observability needs will attract both customers who are using competitive products, but most importantly, be the most comprehensive solution for new customers and new developers. -------------------------------------------------------------------------------- Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Equity Research Analyst [58] -------------------------------------------------------------------------------- Okay. And then on the AWS relationship, I don't think I've heard of any of your competitors talking about 5-year relationships. Can you just talk a little bit about the exclusivity or nature of that relationship as it would -- how it would compare to how some of the others are working with AWS? -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [59] -------------------------------------------------------------------------------- It's not exclusive. It is a -- I would describe it as a serious commitment from both companies to build an important partnership for product integration and go to market. And that isn't a 1-quarter, 2-quarter, 1-year commitment. We wanted to make it clear that we -- this was a long-term commitment, an important part of our business going forward and were prepared to make that make a 5-year plan. And they were happy with that. I don't know how that compares to our competitors, but this is probably our most important strategic relationship at this point. -------------------------------------------------------------------------------- Operator [60] -------------------------------------------------------------------------------- The next question is from Keith Bachman of BMO Capital Markets. -------------------------------------------------------------------------------- Unidentified Analyst, [61] -------------------------------------------------------------------------------- This is Dan on for Keith. In your prepared remarks, you discussed the higher data ingestion rates. But can you maybe talk about what you're seeing in terms of monitoring second- and third-tier applications versus more mission-critical applications? -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [62] -------------------------------------------------------------------------------- It's a good question. I don't think we have hard data handy on it. But what I can speak to as an understanding of the trend is, applications are composed of many, many interconnected services, and it's stunning to see how interdependent, interconnected things are. So what people might think as the first true application, the customers often discover, boy, it has a dependency on something they didn't think of as first tier, but now by dependency is. And so the way they often discover that is on our platform. And so they have a desire to basically see everything that runs in production, particular anything that starts with the customer interaction, right? And you take one of our customers, it's a major global apparel company. And they've got -- a large portion of their business is online. And so the number of systems involved in delivering that apparel for the customer is mind-boggling, and it just drives a tremendous amount of telemetry data into our platform. Do we have all our questions, or are we... -------------------------------------------------------------------------------- Michael J. Christenson, New Relic, Inc. - President, COO & Director [63] -------------------------------------------------------------------------------- Yes. I guess, before jumping there, I just want to jump back to a question that was mentioned earlier. I tried to jump in, and of course, the 2020 phrase of, you're on mute, haunted me. But I just want to get back to the gross margin question briefly and our transition and migration to the cloud. As you know, we're going through that. We were pleased with -- the data ingests are growing, but of course, that puts pressure on margins. Our cloud migration is moving very nicely. And we are confident in our ultimate medium-term trail back to the 80 percentage range gross margins. But given the increased data that we're seeing in kind of this year, we expect gross margins for the full year to be in the mid-70s versus our earlier guide of -- I think it was upper 70s. So just wanted to get that out there. And then also, just talk -- just another comment around the movement in metrics. We've been getting a lot of questions about this from investors. And so just want to -- the expansion rate that I talked about, which is really ARR-driven, we're going to be looking at a net revenue retention or net consumption retention expansion rate going forward. We'll be talking about that and gradually transitioning to that as we go through the next quarters as we get more and more historical data with more customers on our new pricing. So you'll hear a lot -- we'll be talking about that a lot more going forward. And so you can look for that in the future quarters announcements. -------------------------------------------------------------------------------- Operator [64] -------------------------------------------------------------------------------- This concludes our question-and-answer session. I would like to turn the conference back over to Lew Cirne for closing remarks. -------------------------------------------------------------------------------- Lewis Cirne, New Relic, Inc. - Founder, CEO & Director [65] -------------------------------------------------------------------------------- I thank you all for joining the call today. I know it's a very busy evening. Many companies are delivering their results. I mean, in short version, we conviction in the strategy that we launched last summer. We realize we're very early in that transition, and so we don't have an awful lot of data. But the early data we have gives us encouragement that the market has demand for this approach and that is differentiated, and it's resonating well with customers. But that there's a lot of follow-through we need to do in execution in order to move the customer base over and move them from being subscription oriented to consumption oriented. But these are all the right moves, will result in the kind of growth rates that we aspire to as a company. -------------------------------------------------------------------------------- Operator [66] -------------------------------------------------------------------------------- The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.