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Good afternoon. My name is Rob, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the New Relic First Quarter Fiscal 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
Mr. Tony Righetti, Investor Relations, you may begin your conference.
Thank you, operator. Good afternoon, and welcome to New Relic’s first quarter fiscal year 2020 earnings conference call. Joining me today are New Relic’s Founder and CEO, Lew Cirne, and CFO, Mark Sachleben.
Today’s conference call contains forward-looking statements. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements. All information provided in this conference call is as of the date hereof and New Relic assumes no obligation and does not intend to update these forward-looking statements, except as required by law.
For more information about factors that may cause actual results to differ materially from forward-looking statements, please refer to our earnings release issued today, as well as the risks described in our most recent Form 10-K and subsequent filings with the SEC. Copies of these documents may be obtained by visiting New Relic’s Investor Relations website or the SEC’s website.
Our commentary today will include non-GAAP financial measures. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends, but note that these measures may not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. Reconciliations between GAAP and non-GAAP metrics for our reported results can be found in our earnings release issued today.
At times, we may offer incremental metrics to provide greater insights into our business or results. This additional detail may be one-time in nature and we may, or may not, provide an update in the future on these metrics. I encourage you to visit the Investor Relations section of New Relic’s website to access our earnings release issued today, supplemental materials that accompany our earnings release, periodic SEC reports, a webcast replay of today’s call, or learn more about New Relic.
With that, let me turn the call over to Lew.
Thank you, Tony. The first quarter of fiscal 2020 closed with year-over-year revenue growth of 30%, driven largely by our continued focus on moving upmarket by leveraging our expertise in application code visibility and cross-selling into our significant installed base. While revenue was above our guidance for the quarter, we did not execute well enough to meet quarterly sales and headcount targets. This resulted in a lower-than-expected deferred revenue balance and net dollar-based expansion rate.
We are not pleased with these results, but we do believe they are an anomaly limited to the first-half of the fiscal year and largely the consequence of our moving aggressively to complete go-to-market and product-related organizational transitions. At the same time, this was compounded by the release of a new product and user interface platform against the backdrop of a seasonally soft quarter.
Longer-term, we anticipate the benefits of these initiatives, which align our operations to a common, powerful platform, New Relic One. The culmination of nearly two years of engineering time, we view the New Relic One platform as the foundation for the next decade of New Relic’s innovation.
We reimagined the user experience and developed a pan-enterprise, entity-centric, data model that makes visualizing up and downstream dependencies possible across a customer’s entire environment. The opportunity cost of this effort was a delay in revenue-generating product introductions, as well as future – fewer feature and integration releases over this period. This is having an adverse impact on the customer lands and expansions in the first-half, but we believe the investment in New Relic One was compulsory for durable growth over the long-term.
The logic underpinning our strategy with this platform originated from the early recognition that our user base would gradually adopt open source standards, microservice architectures and containers. As it turns out, this trend, which we call observability and is an expansion of our current monitoring market, emerged at a faster rate than we initially projected with a different competitive landscape.
We believe New Relic One enhances our competitiveness broadly today with much of the future benefits being derived by users adhering to observability trends. Developers operating in this fashion prefer composable and configurable dashboarding, distributed tracing, metric and logging tools, in conjunction with the application instrumentation data that only New Relic can provide. To address the needs of this group, we plan to continue increasing both the extensibility and the programmability capabilities of our platform.
Expanding our access to third-party telemetry through extensibility will augment our out-of-the-box instrumentation and act as a first step to giving our customers a single platform for observing their entire environment. We released monitoring for AWS Lambda in May and expect to deliver logging and AIOps products in the coming quarters. All three of these products leverage our strategy of ingesting telemetry from an increasing number of sources, from New Relic agents, cloud providers, and from open source technologies.
We also envision New Relic One’s programmability capabilities as being a differentiating feature whereby customers and partners create their own applications on top of New Relic One, and those applications drive digitally transformed businesses. As we expand New Relic One’s extensibility and programmability capabilities with additional products, we are advancing our ability to deliver a single platform for managing the performance of our customers’ digital businesses.
On the operational side of the business, we accomplished two critical objectives during the first quarter: One, we completed an operating model change in the product organization, which after a few quarters of transition resulted in a general manager structure consisting of five entrepreneurial-minded teams focused on core revenue-generating groups: application monitoring; client side; infrastructure; logging; and AIOps. We expect our innovation velocity and accountability to increase under this model and thereby further enabling us to address a larger share of a growing, multi-billion dollar market.
Two, the sales organization is now under a regional hierarchy with unique strategies shaped by local leaders. This has been an ongoing effort for approximately the past year and included establishing new offices and the expansion of our European Region, as well as bringing in new leadership to EMEA. Our international markets, EMEA and APAC, are key growth drivers for us and are expected to demonstrate the most significant improvements as a result of this initiative by the end of fiscal 2021.
We believe these operational initiatives, combined with our investments in New Relic One, will improve our potential for future growth. However, the training and enablement associated with the new platform release in conjunction with operational changes and record headcount growth from the second-half of fiscal 2019, resulted in companywide dislocations that are expected to impact productivity throughout the first-half of the fiscal year. We are maintaining our full-year top and bottom line guidance ranges based on the stability we expect in the second-half of fiscal 2020.
I’ll now turn the call over to Mark to provide more color on the financials.
Thanks, Lew. Before turning to the financials, I would like to offer the following additional color on sales and headcount attainment. First, the quarterly sales shortfall is primarily attributable to EMEA being significantly soft and partially to underperformance in the U.S. The recent changes to the sales structure and, in particular, EMEA, are expected to improve both short and long-term execution.
Second, headcount growth in Q1 was lower than expected across the company. I would like to note that the second quarter of fiscal 2020 will be the first full quarter of regional go-to-market operations and the GM product model. The respective leaders are moving quickly to build scalable processes and hire appropriately, which we anticipate will lead to headcount building steadily throughout the year.
Now turning to the financials. Revenue was $141 million for the first quarter, up 30% year-over-year. We ended Q1 with 881 paid business accounts with ARR over $100,000, up 18% compared to a year ago. This growth represents both new logos landed, as well as installed base expansions derived from increased usage, expanded application coverage and the cross-sell of additional products.
Our annualized dollar-based net expansion rate in Q1 was 109%, compared to 118% from a year ago period. The decrease was driven by the lower amount of upsell activity this quarter relative to our total installed base. We believe Q1 will be the low point for the fiscal year and, while we expect an improvement in Q2 compared to Q1, we anticipate a year-over-year decline in this metric in Q2 as well.
At the end of Q1, enterprise business was approximately 62% of ARR, up from around 55% as of the same period last year. Non-APM bookings during the quarter were greater than 40% of new ARR with the combined contribution from New Relic Insights and New Relic Infrastructure above 20% of new ARR.
In terms of geographic split, U.S. revenue was $96.6 million for the quarter, up 30% year-over-year, while non-U.S. revenue for the quarter grew to $44.4 million, also up 30% year-over-year.
For Q1, our non-GAAP gross margin was 85%. Non-GAAP operating income was $7.4 million, or 5% of revenue, compared to $8.7 million, or 8% of revenue in the same quarter last year. Non-GAAP operating income was ahead of our expectations, primarily because of lower-than-expected headcount growth, lower sales commissions and lower bonus payments. Overall, our non-GAAP net income attributable to New Relic per diluted share was $0.19, compared to $0.15 in the same quarter last year.
Turning to cash flow. Cash from operations was $36.5 million. Free cash flow, defined as cash from operations minus capital expenditures and capitalized software development costs, was $18.9 million.
Turning to our balance sheet. We ended the first quarter with approximately $769 million of cash, cash equivalents and short-term investments, up from last quarter’s $745 million total. Elsewhere on the balance sheet, our total deferred revenue ended the quarter at $255 million, up 40% year-over-year, but down 6% sequentially. This result was slightly below our expectations.
Now I will turn to our outlook for the second quarter and full fiscal year 2020. For the second quarter ending September 30, we expect revenue to be in the range of $143 million to $145 million. We expect non-GAAP operating income of $5 million to $6 million. This would lead to non-GAAP net income attributable to New Relic per diluted share in the range of $0.14 to $0.16.
We expect deferred revenue to decline on a percentage basis in the low-to-mid single digits sequentially. Please note that Q2 2019 results included an anomalous payment covering two years and totaling $16 million that equates to an $8 million deferred headwind in Q2 fiscal 2020.
For the full fiscal year 2020, we expect revenue to range from $600 million to $607 million, which is unchanged from prior guidance. We expect non-GAAP operating income of $20 million to $25 million, also unchanged from our prior guidance. This would lead to non-GAAP net income attributable to New Relic per diluted share in the range of $0.55 to $0.63.
Before moving to Q&A, I would like to provide the following to assist with modeling the remainder of the year. We are maintaining our 84% to 85% gross margin outlook and updating the following cash items to reflect lower-than-expected first-half deferred revenue.
Cash from operations we expect to be between $100 million and $110 million, which is down from $115 million and $125 million; and free cash flow we expect to be between $40 million and $50 million, which is down from $55 million and $65 million. Capital expenditure expectations remain between $50 million and $55 million.
And with that, I would like to open the call for questions. Operator, please go ahead.
[Operator Instructions] And your first question comes from the line of Sterling Auty from JPMorgan. Your line is open.
Hi, guys. This is Matt on for Sterling. Thanks for taking…
Yes, thanks. Hi, guys. We’ve heard from a number of companies, Pluralsight, PTC and others about being behind schedule in terms of hiring. Are we getting to a point where just the unemployment rate is actually making it more difficult to hire the candidates that you normally would expect to get?
I think for our company at our scale, that’s not the number one factor. It’s really an issue of focus and discipline, which we need to apply more of than we have. We’ve started on that effort to really get serious about executing on our hiring plan. So I think this is more under our control.
Okay. And then one follow-up is, with that net expansion rate, given where you are with New Relic One, why should we not read into this that instead of execution, it’s actually a competitive issue that you need all these elements in New Relic One in the market today, and you’re at a competitive disadvantage until they get out there?
We certainly have multiple factors that are contributing to that net expansion rate. The sales distraction that we had in Q1 around moving to a geo model, and the operational distraction moving to a GM model on the product was a factor. We had execution challenges broadly – with, in particular, in Europe.
But yes, the third factor is that the competitive environment has evolved as the market has become more dynamic. And so there’s more for us to do more work involved in winning a deal today than there was a couple of years ago. But we still feel great about our long-term competitive position.
We think New Relic One has unique capabilities, and that the customer feedback on it is very encouraging. And yet we recognize this is – this can help us as we’re introducing a new user interface to our customers. We want them to adopt it at a pace that’s comfortable for them rather than to force it onto them on our timeframe. And so we’ve been thoughtful and how we introduce it in the market to make sure it works well with how our customers are approaching using our software.
So that all adds up to. We’re managing this transition to the new platform, I think, with a lot of focus and with a lot of enthusiasm for where we’ll go. But in Q1, there was that tradition, that transition that we went through and it had impact on our short-term performance.
Got it. Thank you.
And your next question comes from the line of Jack Andrews from Needham. Your line is open.
Good afternoon. Thanks for taking my question. I wonder if you could just shed some more light on in terms of where you are, I guess, educating your customer base regarding the benefits of New Relic One. Is this more of a self discovery journey on their part, or are there specific things that you’re really doing to highlight the capabilities around this, and specifically, maybe around the programmability feature, which you felt was very differentiated?
All right. I’m glad you asked. So we launched New Relic One in May right around when we had our last earnings call, and that was the first release. And we did make it a release that any New Relic customer could use and discover on their own, but that we are not aggressively pushing out into the market due to just how big a release this was and how we wanted to make sure with a natural time for our customers to adopt and we want to observe how customers are using it.
We’re encouraged by what we’re seeing on customer usage, given that it’s been one where they’ve discovered it largely on their own. For example, our dashboarding capability, we see a 40% month-over-month uptick, or increase in engagement on that feature in the month of July.
So we’re encouraged by that. And and I remain incredibly excited about the programmability capabilities, which we plan to release in the near-term, but we have not released yet to our customers. What we have done since the launch of New Relic One is enabled our field technical field to build applications on to top of New Relic One for our customers.
So we are kind of the first people developing on top of the platform for our customers, and the feedback is resoundingly positive. But obviously, in order for this to work at scale, this needs to expand beyond our own people developing application on New Relic One to the community and that’s what’s coming out shortly. So we’re heads down on getting that ready. We’re excited about its potential and we got to just focus on making that successful.
I appreciate that. Just as a follow-up, could you shed some additional light on what prompted the operating model change in the product organization into what looks like five groups now?
Certainly. So prior to that change, we’ve had a monolithic product organization. So one product leader responsible for all of our products. And as the business has grown and we now have as many skews as we do, we felt like, especially with the introduction of New Relic One and having a common platform that can integrate all these products, now is the right time to have entrepreneurial leaders fully accountable for the growth of their products and fully empowered to deliver the products that will compete and will win in their market segments and drive business growth.
And so we’re already seeing the benefits of that model change. We’re early in that, but I’m very pleased with the change. And it’s an area of focus for us, because we – we’ve highlighted the competitive environment is evolving and it’s time for us to really be far more focused on delivering products that delight our customers.
Great. Thanks for taking my questions.
The next question comes from the line of Rob Oliver from Baird. Your line is open.
Great. Thanks for taking my question. Lew, one for you. And then I had a quick follow-up for Mark. Just I know you mentioned the evolution of the competitive environment and things like open source, microservice architectures and moving to observability. I know those aren’t new for your users.
So what I’m trying to tease out here is, has the buying decision moved away from your core user to somebody up the stack? And is that the New Relic One move? And can you talk a little bit about your lands this quarter, and if there were multiple product lands and any other evolution in the market? Thanks, and then I had a quick follow-up.
Sure. So when we think about how the market is evolving, in particular, towards extensibility, we feel like it factors into our product strategy in three ways, three pillars to our product strategy. The first is extensibility. We need to ingest more types of data into the New Relic platform. Examples of types of data could be open source data from open source projects, or log data, or dimensional metric data. So that’s the extensibility part of our strategy.
The second is intelligence, being able to do more with that data and be smarter with it. And our AIOps capabilities that come out of our acquisition of SignifAI are real key part of that part of the strategy.
And the third leg of the stool is programmability, which I spoken to. So as it relates to the market, I’d say, we’ve always had a strength with the development, the developer, the development manager and the VP of Engineering and the CTO, all the way up that track. That – what we are developing to complement that is a go-to-market focus on the operations professional and they tend to make decisions around infrastructure. We have a strong infrastructure product and it attaches very well.
So our highest attaching product well over 30% of our customers have purchased it, but the ASPs are relatively low. And we feel like the best way to focus on growth with ASPs infrastructure product is to focus on the operations professional who is a peer often to the development leader.
Great. That’s helpful. Thanks. And then just one follow-up, Mark. I know you’ve talked a little bit about some of the success you guys have had with parking some technical sales, people at larger accounts and just wondering, is the hiring shortfall in that technical sales area and maybe to Sterling Auty’s question earlier, is that just a harder person to hire somebody that, that is selling much broader visibility platform than APM? Thanks, guys.
Yes. So the hiring shortfall, I would say, was more across the Board. It wasn’t concentrated in one area. I think there’s some issue back in the technical sales area, but I wouldn’t say any more so than in other parts of the organization. We are – we continue to see success and we continue to aggressively move to grow out our services capability and to do that with customers. And those folks do take quite a while to ramp up.
So, the team we – the people we hired at the end of last year that we continue to hire are getting ramped. And so they are helping. Our seeing is it’s taking more effort, more time on our part, part of those technical teams to get renewals and to get upsells. So I think it’s – they are higher calorie, but we continue to see success there and in places where we have deployed them. We feel like we’ve got great success in those accounts.
And your next question comes from the line of Sanjit Singh from Morgan Stanley. Your line is open.
Hi. Thank you for taking the question. I want to talk a little bit about guidance. And, Mark, I think there was – in your script, you said that the second-half doesn’t assume an improvement in the overall business. Given the product roadmap, given some of the challenges you saw in Q1, what gives you the confidence that, that business will impact or improve in the second-half, as you think about the full-year guidance?
Well, as Lew talked about the product roadmap, we feel like we are delivering what customers want. We – we’ve got some of the organizational transitions behind us now. So those are starting to take place. They’re starting to see the results of those. And in EMEA, as we talked about, it’s going to take a little bit longer. But with the GM model, the accountability that comes along with that change, we’re starting to see positive improvements already.
And so we’ve given guidance that we feel comfortable with – we feel confident with for the rest of the year. We still feel good about our billion-dollar revenue run rate target for the end of fiscal 2022. And so we feel like we’re on a good – we feel good with that. There are going to be some bumps along the way, as we’ve seen in the first-half, but we do feel confident in our overall journey towards that milestone.
Got it. And then maybe, Lew, as a follow-up. I had a question on the state of how monitoring is conducted out there in the market? And specifically, is, in your view, the sort of agent-based approach to application margin, is that evolving in and of itself? And what do you think the implications are for New Relic if we’re going from less of an agent-based model to more of a distributed tracing approach? Any thoughts there?
Certainly. Well, I think that there is no question that agents have a place in many circumstances in many environments, including distributed tracing use cases. However, agents are a primary source of data, but can’t be the only source of data that our customers will rely on in order to observe the entire environment.
So that’s why when I spoke about our price strategy, step one of our strategy is extensibility. And so we want to embrace data not only coming from our agents, which is highly valuable, highly differentiated, and let’s take, for example, a large enterprise. If they want to put visibility into as many applications as possible – as quickly as possible, they have no choice but to take an agent-based approach. They’re not going to rewrite all their software to instrument it by hand.
However, there will be pockets that want to instrument by hand or want to use other sources of telemetry to observe the application. But they don’t want to be going to different products and different tools to see that data. They see – they want to see it all in one place. That’s why our extensibility strategy is so important. And what I’ve got the team very focused on is delivering on our extensibility vision within the next couple of quarters.
And so you’re going to see us make announcements throughout the rest of this year and certainly in – some in the near-term. And that’s going to complement the other two pillars, which are intelligence and programmability. Once all of that data is in our cloud and presentable to our users, our customers recognize and are demanding that they go beyond simple static dashboards. They want to build applications that leverage this data. And only New Relic One is going to enable our customers to do that. And so we’re very excited about what that will do to give us a leapfrog opportunity that should really put some daylight on the differentiation.
That’s very helpful. If I could just speak one quick follow-up to that, in terms of New Relic DB, which has sort of been the architecture behind the platform for several years. Has that changed and evolved commensurate with the New Relic One roll out, or are you storing and handling data in a dramatically different way? And is that capability available today?
Well, what I’d say is, we have evolved the capabilities of NRDB, which is still running at a massive scale and we’ve had many customers come to us saying, they’ve used us in complement with other monitoring products that may have specializations and other parts of the stack, say, infrastructure or logging. And on big launch days, they’ve told us that only New Relic could handle the load.
So we have – what we believe to be the most scalable architecture for gathering this telemetry data at scale. How have we evolved it? What we’ve been hard at work on is evolving the data collection technology to also work really well with logs. And as I mentioned in our last earnings call, our early research shows that is dramatically faster than logging solutions built on open source technologies. And most of our competitors, even if they’re already offering logging as a service, our built on open source technologies that just don’t perform well at scale on a multi-tenant environment compared to ours.
So we’ve also been hard at work involving our technology to consume what’s called dimensional metric data. And that’s what open source tools like Prometheus and other kinds of tools that modern – many modern shops are using. So that evolution is mostly complete. We’re tying up the loose ends on it. And then with that, we will have the capability to bring in all of that extra data, along with the agent data that we’ve always been good at collecting.
Very helpful. Thank you, Lew.
Your next question comes from the line of Jennifer Lowe from UBS. Your line is open.
Good afternoon. This is Fatima on for Jen. Thank you for taking our questions. Mark, maybe to start with you on some of the commentary you shared with respect to and some of the execution softness there. We’re wondering if perhaps some – there are some macro elements that could potentially have exacerbated that? And how are you thinking about some of the higher-level macro-related dynamics as it relates to Brexit impacting the demand environment and sales cycles and purchasing patterns there? And then a follow-up, if I may,
Our primary focus has been on the execution challenges there. At our size and scale, we feel there, like there’s good opportunity there. And that, that it’s more internal issues than external macro issues for us. We had a new leader start in the middle of the quarter. He’s come in and made some additional changes. So, we’ve – I think, we’ve got those largely behind us now and it will take time to rebuild the team. But I feel like it’s generally more within our control than macro issues.
Understood. That’s really helpful. And then just with regards to product uptake, you talked about Insights and Infrastructure combined being in excess of 20% of non-APM ARR bookings. And I’m wondering if you can give us some more specificity or granularity around the infrastructure offering, because in the past, I know you and Lew both have talked about the blurring of the lines, if you will, between infrastructure monitoring and app monitoring. So wanted to better understand sort of what mechanisms you have in place to really drive that attach and penetration at a faster velocity? And that’s it from us. Thank you.
Sure. So we have not broken out anything beyond the over 20%. I will say that Insights is more than half of that, although Infrastructure continues to sell well. That said, I think we’ve got to be more aggressive with our infrastructure product. We – we’ve talked about going more after ops buyer, and really there are a couple of things. Infrastructure, as Lew mentioned, is our highest attaching product with over – about a third of our customer base using that. But the spend is – the average spend is – was well below we think.
So we’ve got to do a couple of things. One is, we have to expand the infrastructure sale to be beyond just the application environment. We want to cover the whole of state. So we’ve got to be better at that motion and that sales process.
The second thing is, we’ve got to lead at some point. We want to develop the capability to lead with infrastructure getting us into new accounts. And so that’s something that we’ll be working on as as we go forward. So, we’re very focused on the infrastructure product and making that being a kind of a first-class citizen in New Relic’s portfolio. And so that’s something that we’ll be spending a lot of time doing. And with the GM model, I think, that really helps us.
We now have someone that GM of that – the infrastructure product. That person wakes up now every morning thinking about how am I getting more infrastructure in our customers hand? How am I delighting those customers more successfully? And I think that accountability is going to really help.
That’s very helpful. Thank you.
Your next question comes from the line of Derrick Wood from Cowen and Company. Your line is open.
Thanks, guys. So you described the headcount target shortfall as a reason for maybe the weaker results, or perhaps the weaker Q2 guide. Could you touch on how the changes impacted sales headcount retention and whether you’re having to do more backfilling than you normally would coming out of a Q1? And then maybe remind us what the typical time is to ramp the productivity for new reps?
Sure. The – typically, take the end of that first. Typically, we talked about a year, ramping productivity from a sales rep standpoint. And I think that also extends to the technical sales folks that support the Representative. Obviously, that unit is a critical component and developing both parts of that unit is a critical component to be successful in the field.
In terms of sales rep attrition, that’s actually was, I think, that was a strength of ours in the first-half – first quarter. We saw, I would say, lower than what you would expect in a Q1 in terms of sales Representative attrition. So I think that’s been going well. On the other hand, we did hire a lot of reps throughout fiscal 2019. And so we’ve got to make sure that they can – they continue to stay and ramp and that we’re successful in ramping them.
Okay, nice color there. And, again, we talked about kind of the sale structural changes, but I’m curious how much impact are you seeing from the kind of the demand side, maybe customers taking longer to make additional purchases, you had a major upgrade, they may want to look to absorb this and look at the new roadmap? I mean, do you think that, as customers upgrade and these new products roll out, we see this kind of pent-up demand free up perhaps as we move into the second-half?
I’m – it’s a strong and healthy market and growing. And with that growth – and with the scale that we happen to be at, that does attract more competitors. And so that is impacting, I think, in a number of calories and days involved in completing the equivalent sale, say, a couple of years ago. And so that’s how I characterize the impact of it. So I wouldn’t say – necessarily say, it’s market demand so much as the effort involved in completing the sale.
Okay. All right. Thanks for taking my questions.
Your next question comes from the line of Chris Merwin from Goldman Sachs. Your line is open.
Okay, great. Thanks very much. I just wanted to ask about the log product. I don’t believe that’s been launched, correct me if I’m wrong. But just based on the feedback you’ve heard from customers, you’re finding that they want a log solution that’s really adjacent to some of the vendors that they’re already taking, or is this something that would be more of a replacement? And then I just had a quick follow-up.
What’s driving it from our customers is, they’re very interested in our logging product, because they don’t want to leave New Relic when they need log data to diagnose a problem. It’s all about time to repair.
So if they have another log product that they purchased for solving production performance or availability problems, and that may be an open source offering, or maybe a commercial offering, they feel real value seeded on New Relic, especially if those logs are in context, if, for example, we can see the specific log messages that were emitted by an application when that specific application was having a problem. That’s often harder to do when you don’t have the benefit of a application visibility like we have, or sometimes even impossible to do. So that’s why our customers are excited about it.
Now by contrast, there are some customers that use logging products to keep a year’s worth of data, so that they might want to handle some kind of security, use case or see if whether there was a vulnerability in the past or compromised in the past. That’s not what we’re aiming for in the use case. We’re not going after the security buyer, et cetera.
So we certainly expect to coexist with log solutions in many customers. But we want to deliver the most integrated fastest time to detect and repair solution by integrating logs with everything else we have in New Relic.
Okay, great. And then just on enterprise customer growth, it looks like that slowed a little bit year-on-year. Was that just all related to some of the sales execution challenge, as you pointed out? And if we do see recovery there, will that be show up more in the form of new logos or expansion within the base?
I think that was attributable to the sales shortfall that we mentioned. And that going forward, we expect that number to – the increase to generally slow over time as the base gets bigger. As you know, those are customers that, that either come into the franchise over $100,000 or a growth through that number.
But I think what we’ll see going forward is, we expect the number to continue to increase at a declining – at a slightly slower rate. And the expansion rate, we have the situation where a lot of our expansion comes from customers that are in over $100,000. So I would differentiate the two – those two numbers a little bit. Our expansion rate is driven primarily by growth in accounts that are already paying us $100,000. And so I think that’s where what drives the expansion rate versus the absolute number of over $100,000. payers.
Okay, great. Thank you.
Your next question comes from the line of Michael Turits from Raymond James. Your line is open.
Hey, guys, thanks for taking my question. Lew, last quarter, it seems that the – it isn’t clear that the non-APM piece of the business were a little bit below the long-term targets in terms of the trajectory and you’re making lots of moves to accelerate that. But But APM seem like it was above target to the long-term goals.
What really, I mean, obviously, there’s some execution stuff. But what’s really changed? Because it seems as if APM is slowed down to, so what specifically is slowed, I would assume, mostly from a competitive perspective? And who you’re saying? What kind of competitors for APM? And is it really just now people want to buy APM as a multi-siloed product?
Well, and just to speak a bit about our APM product, Gartner Peer Insights is a mechanism by which customers actually vote for their favorite products. And we’re rated number one with our APM product. So it is strong, and I feel like there’s still a strong and growing market for it. But that kind of, as I mentioned a little earlier, we need – our customers are asking us to do APM and extensibility of ingesting more data beyond what APM does automatically.
Some parts of an enterprise just want to drop in an agent and see that visibility in an effortless way. Other parts of the enterprise want more control over their instrumentation they’re willing to use manual instrumentation, or open source monitoring solutions to help them with that.
And so what we’re focused on delivering for our customers is a place to put all of that data, the data we automatically surface with our agents, as well as data that may come from other sources, and put that all into our cloud. And I feel like that’s what our customers are asking for and where the market is headed.
And that’s very different from customers don’t want ages in their applications, because they do for many kinds of workloads, very important, especially when you want to go strategic with having a story for instrumentation visibility across the entire state, you want to do that with the least amount of cost and effort possible. And so the way to do that as rapidly as possible is with an agent approach. And then you complement it with something a little bit more manual, when it makes sense to do that in those instances.
Lew, that all makes sense to me. I guess, I was trying to get to where to drill down a little bit more on the competition, which competitors are you seeing? What do they look like…?
Sure. I mean – yes, we see competitors for a few angles. There are open source solutions that customers are deciding to install on site and invest the time involved in managing that on sort – on-premise stuff. We see infrastructure centric solutions that have a historical strength in dashboarding and in collecting data from lots of sources, lots of – and infrastructure.
We’ve, for many years had this sort of same list of competitors in the APM space. I’d say what’s evolved has been some of these open source and infrastructure-centric vendors coming in as the markets clearly, much larger, more interesting, it’s attracted more types of competitors, all kind of responding to the customer demand to kind of see inside everything they need to see in real-time to deliver great performance and availability results.
And your next question comes from the line of Erik Suppiger from JMP. Your line is open.
Yes. Thanks for taking the question. First off, can you give us the headcount and what the hiring was in the quarter? And then secondly, can you talk a little bit about the timing of how long the hiring has been an issue? If it takes about a year for people to reach productivity, but it’s not clear to me why this would cause such a – an impact if it just started this quarter?
So the – to answer the first question, the headcount was just under 1,800 people as of the close of June 30. That was an increase of roughly 40-ish or so from our last Q that was filed. And so, in terms of that hiring rate, that’s something that we were certainly disappointed in. As I mentioned, it was across the Board.
How does that impact in-quarter performance? Well, it’s – I think some of the distractions and things are the transitions we went through organizationally had more of a impact in terms of the performance for the quarter. I think the hiring shortfall was more geared toward the expense beat that we had, when we talked about the fact that our operating income was above what we had planned. That was driven by a lower-than-expected headcount.
Okay. So the hiring was not a factor in terms of the pipeline or in the billings piece, is that correct?
That’s correct. The hiring was not a big impact on the – missing our sales targets.
Okay. All right. Thank you.
And your next question comes from the line of Steve Koenig from Wedbush Securities. Your line is open.
Terrific. Thank you very much. So question for you, Lew. You laid out a really compelling product vision and your roadmap for getting there, what you need to do? So I’m wondering, to get where you want to be in terms of executing to your plan and the numbers, does the new product vision really need to mature with those use being out in mature to get where you want to be on your financial targets? Or is it more in the near-term a matter of educating your customers that their investment in APM will be preserved? And getting through the sales reorg that you’ve done, or do that products really – the new products really need to get mature for you to be back on track?
That’s a great question. I would say, we certainly need to deliver on these products and deliver confidence that these products are on track to meet our customers’ needs. And a lot of that we expect to happen out of the gate. For example, our infrastructure product is very strong, but we’ve not put the appropriate level go-to-market focus on fully leveraging the product we have there with infrastructure.
And so our place to go from small departments within our existing accounts to full estate, that’s largely the go-to-market effort that we’ve recently kicked off in – with great focus in energy and scrutiny. Other products like logging are going to be new to the market. And that’s why we focus it on the use case I described it to an earlier question around troubleshooting, which is our strength.
We think we’re going to offer a lot there. But I really think that the general manager model we’ve moved to where these general managers are fully accountable, not only to delivering great products our customers love and tell their friends about, but also the business results that come from selling those products.
There are entrepreneurs that are accountable for delivering those results, and that’s a big change for us that I think is going to yield a lot of benefit. And they’re focused on exactly these questions like, how rapidly can I deliver the very best product that will drive business growth at New Relic.
So that’s helpful. I guess, if you were to timeline the incremental improvements to your results that will come about from, say, the sales reorg, the product reorg, the product organization reorg, getting some of the new SKUs out, like how do those things fall out in terms of a timeline? Like what benefits from which of those initiatives come first?
Well, I’d say, the – we don’t want to get too precise with timelines. But I would say that in the coming quarter or two, we need to deliver extensibility, right, ingesting more data from logs, from dimensional metrics from these other places. So that’s work that we have to deliver in the next couple of quarters.
When we do, there’s a backlog of customer demand that want to use that technology. And that will influence their thinking when they think about standardization decisions, particularly enterprise customers that really want to understand the roadmap before they make a seven-digit commitment.
So those are important milestones that we’re very focused on. And they can have – they could have a short-term benefit, or shorter-term benefit. But we – given the execution challenge we had in the quarter, I don’t want to set expectations too high on specific timeframes rather just show that we are working with urgency to deliver these capabilities, because our customers are asking for it and we believe it’s going to really help our position in the market.
And your next question comes from the line of Keith Bachman from Bank of Montreal. Your line is open.
Hi. Thank you. I’m going to go in a little bit different order given that last question. You’ve taken down your cash flow targets for the year by, call it, $15 million. And I’m going to assume that that’s due to the DR moving lower, but if you could confirm that?
And the follow – the second part of that is, if you – if, in fact, you’re lowering DR expectations, why not lower the revenue expectations commensurate with that even if it’s more back-end loaded?
Yes. The – I will confirm that that’s largely driven by the decline in DR, that guidance. And I would say, the shortfall in the first-half of the year has a big impact on revenue for the year, as you know, with AAR coming – the ARR model. The second half of the year, we’ve talked about the guidance for Q2, and then you can interpolate sort of the results for the second-half. And those numbers have less – every quarter, the ARR has less and less of an impact on the revenue for the year.
And so I think the guidance we’ve given, we are comfortable with on the revenue portion. And then the – you have – you do the math and the gymnastics around the DR to come up with your own view on the timing of when that ARR is going to come in.
And your next question comes from the line of Gray Powell from Deutsche Bank. Your line is open.
Great. Thanks for taking the questions. So I’m traveling today hopefully, I have the math right here. But I think billings guidance implies high-teens normalized growth in Q2. Just how should we think about that growth rate in the second-half of the year just directionally same better or worse?
We’re not giving guidance beyond the – what we’ve given in terms of revenue for the year and the billings for the – for Q – or the DR for Q2. Typically, we are getting – becoming more and more of an enterprise company. I will say, our seasonality in the past has been such that the first-half tends to be a little bit softer than the second-half, given the the enterprise buying cycle in December and then our Q4 in March. We do expect those trends to continue. But we’re – at this point, we’re not giving further color on the specifics in Q3 and Q4.
And your next question comes from the line of Rishi Jaluria from D.A. Davidson. Your line is open.
Hey, guys, thank you for taking my questions. I think, first, let me just start one comment that you made in the prepared remarks, Lew, was the adoption of microservices and the like has happened faster than you expected, which has been a little bit of headwind. Just help me understand, why would greater adoption of something like Kubernetes be a headwind, given that you have an actual Kubernetes monitoring product and actual strategy around microservices. And arguably, it’s less competitive of a space in kind of the core API? And then I’ve got a follow-up.
Sure. So I think from a macro perspective, it’s all great in terms of our market opportunity and our position within the market. But in the last several quarters, while we made the – I believe the absolute, the right call, but it was a trade off call to focus on New Relic One, which was a long-term bet for the future. We did that the expense of doing smaller features, incremental features that could have further enhanced our capabilities in these microservice environments.
Let’s take, for example, in some microservices environments, customers want to complement our APM agents with more manual instrumentation, because the nature of their application just isn’t well suited to automatic instrumentation that our agents do. And that happens a little more often in microservices environments, because you’ve got many, many different services, many kinds of services. And so automatic instrumentation is harder to do, and we’re the best at it, nut it’s still may not be sufficient.
So in that case, being really good at flexible and consuming data from other places rather than just our agents is really important. And that’s why I spoken to why we’re so focused on extensibility in our platform to deliver on that. Now so let’s say, we had focused on that earlier at the expense of the kind of more foundational work we did in strengthening our platform for the future. Then we would have had more capabilities in that area and perhaps we would have captured more business in the short-term.
However, I feel like when we look down the road, we wouldn’t have the same strategic position that would set us up for the maximum impact that we now have now that we’ve got New Relic One in the market. So that’s how we think about the tradeoff. I take it as a good secular tailwind that’s moved to microservices, but it did have some short-term impact to the business while we are focused on the long-term.
And that is all the time we have for questions. I will turn the call back over to management for some closing remarks.
Well, thank you all for joining the call. I just wanted to share a couple of thoughts before we sign off. When I found it, New Relic, in 2008, the founding idea was let’s deliver amazing software that end users love and tell their friends about and they’ll be the foundation upon, which we build a great company. And so those founding principles are still deep in my heart today.
I’m very excited about the opportunity we have in front of us. And I feel like – and I’m really proud of a lot of the work we’ve done. It’s great that when Gartner asks their peer rights – peer insights customers about who their favorite vendor is and application performance is monitoring, we have received the highest rating and then most number of ratings, the highest score, the highest recommendation rating.
So we do good work – really good work in what we do. But as this market is evolving, the call is upon us to up our game again, and that’s an exciting challenge for us. But what really excites me about that challenge is how large this opportunity is and how relevant our strengths are in pursuing that opportunity.
So, we’re not pleased with the results of the quarter, but I’m more excited today about New Relic’s vision of roadmap than I ever have been. And we – we’re just getting started in our journey. And so we thank you for your questions and we thank you for coming on the call. And we’re excited to keep working on delivering visibility for our customers and help them deliver great digital businesses.
This concludes today’s conference call. You may now disconnect.