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Good day and welcome to New Relic Fourth Quarter and Fiscal Year 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded.
At this time, I would like to turn the conference over to Peter Goldmacher, Vice President of Investor Relations. Please go ahead.
Thank you, operator. Good afternoon and welcome to New Relic’s fourth quarter and fiscal year 2020 earnings conference call. Joining me today are New Relic’s CEO and Founder, Lew Cirne; CFO, Mark Sachleben; and COO and President, Mike Christenson.
Today’s conference call contains forward-looking statements. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections, financial guidance and future market conditions is a forward-looking statement. 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 information about factors that may cause actual result 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-Q, and subsequent filings with 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, which we believe provide an additional tool for investors to use in evaluating our operating results and trends. However, these measures should 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 financial results can be found in our earnings release issued today. At times, we may offer incremental metrics to provide greater insight into our business or results. This additional detail maybe 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, supplement materials that accompany our earnings release, periodic SEC reports, a webcast replay of today’s call or to learn more about New Relic.
With that, let me turn the call over to Lew.
Good afternoon and thanks to all of you for joining today’s call. We are living in unprecedented times. How many times have you heard that in the last two months? This actually is, probably the number one salutations for emails I respond to. This is the great truth that we all know and face and struggle and contend with everyday. We truly are living in unprecedented times.
And as it relates to software, the world needs software more than ever. Software is the lifeblood of the world. And to make that more clear, I’d like you all to take a thought experience with me. Imagine if this horrible virus, COVID-19 were actually COVID-89, that is what if this virus hit the world a mere 30 years ago. At that point in time, internet was virtually unknown to the world.
There are few people like me struggling to get their 28k modems to connect to BBS or to AOL. But for all intents and purposes internet was a toy, a fad and not capable of doing much at all. There was online shopping, there was no ecommerce, there was no way to get the supplies you needed delivered to you. There is no way to deliver education online. There is no way for our kids to do the incredible and important work they need to do right now to further their educations at home, with a help of a teacher or a resource instantly available online. There was no video conferencing, telephone calls were very expensive, long distance.
And so a world of COVID-89 would have been a disconnected world that truly would have been paralyzed and yet here we are finding our way through this incredibly difficult and yes, unprecedented times. In no small parts, thank the software. And New Relic’s mission is to instrument the internet and help companies of all sizes, organizations around the world deliver more perfect software. We’ve always believed our niche mission was noble and important. But now more than ever it’s indispensable.
We do have customers in the ecommerce vertical. We have customers delivering online education. We have customers delivering video conferencing. We even have customers that provide games and yes in all those segments, their traffic has spiked an unprecedented and unexpected ways. With our platforms, these facilities simply couldn’t deliver the performance and availability that people depend on now more than ever.
We help our customers by delivering a single, scalable, observability platform we call New Relic One. New Relic One brings together the performance and operational data our customers need from their applications, from their infrastructures, from their end user experience and from their logs. All in one place. We deliver it in a beautiful UI called New Relic One. When you think about these websites and these web applications and these digital applications and what they need to do, it’s important to know just how much data, how much telemetry needs to be captured in order to accurately and completely measures these digital properties.
It’s not uncommon for a customer to send us a few hundred gigabytes of telemetry a month, that’s a pretty small customer by our standards. We have some customers that sent us over three petabytes of telemetry data every month. That data could be coming from logs, it could have been coming from the applications, it could be coming from the infrastructure. What our customers continually tell us is that they love that they can use New Relic and only New Relic as the single place to put it all, at this scale.
We built NRDB from the ground up to the multi-tenant at work at petabyte scale. Unlike other people who approach this, we built on some very fine Open Source database technologies. Those databases were all design to work for a single tenant and therefore need to be individually managed and scaled in a way that was - didn’t anticipate the kind of scale that we need to deliver for our customers today.
It’s no secret that fiscal 2020 was a very challenging year for New Relic. Any time a company goes through the difficult but important work of preparing for the next 10 years investing for the future at the expense of doing more expedient things that could help us in the short-term. There are trade-offs involved and short-term pain is involved. And to be candid, it’s a lot of work to align the company around those tough trade-off calls.
So that was the natural course of what happened of going into fiscal 2020 and we didn’t make it any easier on ourselves, as I’ve said in previous calls. I think we could have executed better throughout most parts of the business as we went through that transitional year. To in that sense, I’m thankful that 2020 is behind us and we have made the transition to New Relic One and we are positioned now to establish ourselves for growth for the next years. I’m very confident in where we are today. But it all starts with our people and I’m very excited about the new talent we brought into our company.
We’ve got some remarkable new leaders that have joined New Relic in the recent couple quarters. Most of you have gotten opportunity if you were – came to our Investor Day to see Mike Christenson. Mike is a world class executive. He’s brought a great sense of clarity to business, he’s helped us align and simplify. How we think about our business. Align the company around clear goal that everyone could articulate and he’s driving a level of accountability and execution that is exactly what we need to drive the company forward.
We’ve also brought a great international leader, Dmitri Chen has come into APJ team and doing a great job, raising the game for that business. I’m very proud of the work he’s been doing. We just brought in a fantastic new Chief Strategy Officer, Wayne Kurbol [ph]. He actually was with a customer prior to joining to New Relic and I remember that from the moment I met, Wayne he was the kind of talent that I wanted to work closely with and we’re thankful to have him as Chief Strategy Officer at New Relic. And Bill Staples joined us – his impact has been immense as our Chief Product Officer. I’m very confident that Bill is going to move the needle for our company and help us redefine the industry and take the company forward to even greater heights.
On the product side, we’ve shifted some new incredible products. The first is New Relic AI. We’re very excited to have this in the market after a very successful Beta period. New Relic AI is we believe the most powerful, the most complete, AI offering in our space. Because we have the most telemetry data in our platform from all those metrics events, logs and traces and because so many customers today rely on New Relic alerts.
New Relic AI is the perfect complement for our larger customers to help them reduce the alert noise and do more proactive detection of anomalies and problems to predict production issues before they come outages. Some of our customers have seen 80% plus reduction in alert noise, thanks to New Relic AI. That direct hard dollar savings that are our customers can realize at a point in time where many companies are going to be looking at opportunities to save hard dollars.
The second thing we shift very recently is New Relic Edge with Infinite Tracing and I’m very excited about this capability. As some of you have asked in the past about how microservices and containers have impacted how people think about APM. One of the things that customers have been asking for is the ability to what we call in the industry do tail-based sampling. What it means is the ability to capture the slowest and the worst and the most and the erroneous transactions as they flow through a complex application environment. New Relic Edge does that. But we do it in a special way that very much differentiates us from the competition because our competitors require the customer to install a piece of software in their environment and aggregate and inspect all those traces and send the slow and erroneous ones back up to their cloud service, that’s a complex piece of single tenant software that the customer needs to manage and update and deal with.
Its 2020, our customers don’t want to be managing their management software. New Relic Edge delivers that capability in a multi-tenant service that we manage. We’ve deployed them in multiple cloud regions so that this logic sits close to where our customers run their software, but doesn’t need to be managed by our customers. We believe this unique in the industry. We believe it’s exactly what our customers want and it shows that nobody can beat New Relic in quote [indiscernible] APM.
We are hard at work, at a very exciting roadmap that I wish I could go into more detail for you right now. But I can tell you this I’ve never been more excited about New Relic’s roadmap, our opportunity and our position to do great things than I’m today. I truly mean that. Before I hand it off to Mike. I’d like to share a quote from the great Andy Grove. Andy said this, bad companies are destroyed by crisis, good companies survive them, great companies are improved by them. Now there’s no question that Andy Grove is one of the greatest CEO in the history of technology and Intel is truly one of the great companies in the history of technology. And so I think it would be premature for us to make that kind of declaration of New Relic. I’m biased, I’m a Founder. I believe we’re a great company.
But here’s how I want us to be judged by, did we do great things during the crisis of 2020 to improve ourselves? I believe, we will. Why do I believe that? It really starts with and ends with our people and our core values. We are bold, we’re passionate, we’re accountable, we’re authentic and we’re connected. And it’s during times like this that core values truly mattered. They’re not just things you say in an Annual kickoff, if you live them every day, then companies do great things crisis.
During challenging times, we ask our people to do incredible things, to deliver incredible results all still trying to be amazing parents and helping their kids with their [indiscernible] and dealing with the dog jump in the room when they’re meeting. This is happening to everybody, who’s working these days. And at times like this, great cultures do great things. I’m proud to be a Relic. I’m thankful for the great work that we all had done. I’m very excited about where we’re headed into the next year.
With that I’m going to hand it over to Mike.
Thanks Lew. Today I’d like to provide an update on four topics. These are topics that you heard us discuss at our Investor Day in December and at some conferences and investor events since December. But I’ll provide an update based on our results in 4Q. Those four topics are sales execution, selling the platform, portfolio management and hiring. And I’ll start with sales execution, as most of you know in 3Q that ended in December. We redefined some of our most important corporate objectives for the sales and customer success organization. Those objectives were new ARR, 100K customers and renewal yield. In addition, our simplified our customer segmentation, simplified our selling motion and we did a lot of training on the new product capabilities that we announced last fall. And then finally we did a reengineering of our renewal management system what we call portfolio management.
All of that was done in 3Q and it was very important for us to carry that work through into 4Q. In addition in 4Q, we ran a series of experiments in packaging our products, pricing and sales compensation. So it was a lot of change in two quarters, but the organization responded quite well to those changes. We felt very good in the beginning of our 4Q as we went through January and February. But clearly, we encountered a headwind as we moved through March. Stating the obvious, the quarter would clearly have been better, have we not had the pandemic and the beginning of a recession?
In some cases the impact of the pandemic and the recession were clear. We have customers in the airline industry, the hospitality industry and retail. These customers clearly have lower requirements for application monitoring, infrastructure monitoring and analyzing log data than they did before these events hit. Fortunately, these verticals in the aggregate are a small percentage of our business. But in other cases there was an impact that was less clear. Sales cycles were lengthening as people began working from home. Customers began imposing cost cutting programs and some were requesting extended and more flexible payment terms.
Having said that, the financial impact on our results is difficult to quantify. What we can say however is that the drivers of our business, the key drivers of our business digital transformation, cloud migration and operational resilience are as strong today as they were in 2019 and perhaps even stronger. And we do believe that our improved execution will continue in fiscal 2021 as we go through this year and beyond as we pursue our goal of getting to $1 billion of revenue, so that’s our sales execution.
So now let me talk about selling the platform. In fiscal 3Q and 4Q, we focused our sales team on selling our platform. The New Relic One Observability platform. We measure our success in selling the platform in a variety of ways. Platform customers typically use all three of our important on ramps. Application performance monitoring, infrastructure monitoring and log analytics. They also use the other essential capabilities of the platform. They send in data from third-party sources, they build their own custom applications on the platforms, it’s a programmable platform. And finally these customers have an agreement with New Relic that provide full and flexible access to all of the capabilities of the platform.
What I can tell you is that, our platform adoption, the platform maturity of our customers was quite strong in 4Q and we feel good about the direction in pace of platform adoption and we feel good about our sales teams ability to communicate to our customers, the value of New Relic One Observability Platform.
So next let me talk about portfolio management. At the end of 4Q, our aggregate ARR is $635 million. As we said we’re in the middle of a pandemic and an economic recession, so some of those customers the ones who pay us that $635 million a year are experiencing severe business stress. Some of them are likely to not need to renew their contracts at the same level in fiscal 2021 as they did in fiscal 2020. This fact shouldn’t surprise anyone and we’re not alone in having to deal with these challenges.
What we can tell you, is that we have built a portfolio management system that monitors customer usage of our products and customer health. It identifies any risk based on a set of variables and it helps us execute repeatable mitigation plans when we identify risk. So we work hard to improve that system every day monitor, identify and mitigate. And we will work with our customers to help them navigate any challenges that they’re experiencing when we can work with them to help them with their New Relic relationship.
Our number one priority when we’re dealing with these challenges is to keep our customers. Our new two priority, is to preserve long-term ARR. The impact of the pressure on renewal yields and the headwinds in the new ARR will undoubtedly put downward pressure on reported annualized dollar based net expansion rate and Mark will discuss that in his section.
So lastly, I would like to talk about hiring. Fortunately, our company is in a strong position financially. And our leadership team is very excited about our prospects at New Relic. So we’re in a strong position to attract exceptional talent in New Relic even in a challenging environment we’re still able to hire great people. In the last few weeks, Jay Snyder joined us as our Chief Customer Officer after a long and successful career at Dell and EMC and prior to that at Peoplesoft and Accenture.
In addition, Seema Kumar has joined our company has Chief Marketing Officer she comes from ServiceChannel, Salesforce and VMware with an extensive experience in a variety of roles including CMO, Product Management, Product Marketing and Corporate Marketing. And finally we’ve hired a new leader for our organization in EMEA; this person will be announced at the end of 1Q.
So I hope this commentary in our prospective is helpful to you and now I’ll pass it over to Mark to provide more of the financial details. Mark?
Thanks Mike. Let’s review the financials before I discuss our perspective on fiscal 2021. Revenue for the fourth quarter was $160 million up 21% year-over-year and above our guidance range of between $154 million to $156 million. ARR ending the fourth quarter was $636 million up 16.6% and in line with the guidance of $635 million in ARR in fiscal 2020, we meet you in December at our Investor Day.
Total deferred revenue in the quarter was $316 million up 33.5% and have date ahead of our guidance for low 30% growth sequentially. For the fourth quarter our non-GAAP operating income was $3.5 million or 2% of revenue compared to $3.8 million or 3% of revenue in the year ago quarter. Couple of dynamics to note, first we accrued $1.7 million in bad debt this quarter to all for the retention of customers would have hard time paying their bills. While we aren’t modeling those bills to eventually get paid. But there’s reason to expect some of them will.
Second and more important structurally, as challenging as the current environment is, we’re still investing in the business. We’re still very optimistic about the observability space and our ability to grow. So our focus remains on growth over profitability. Non-GAAP net income attributable to New Relic per diluted share was $0.14 compared to $0.13 in the fourth quarter of fiscal 2019.
Turning to cash flow, for Q4 cash provided by operating activities was $61.8 million. Free cash flow defined as cash used in operating activities minus CapEx and capitalized software development cost was $51.1 million. As of March 31, we had $805 million in cash, cash equivalents and short-term investments in our balance sheet up from $737 million last quarter.
For the full fiscal year revenue was $600 million up 25% from fiscal 2019. Non-GAAP gross margins were 84% down from 85% last year. Non-GAAP operating income was $25 million down from $30 million in fiscal 2019. Non-GAAP net income attributable to New Relic per diluted share was $0.66 same as $0.66 reported last year. Operating cash flow is $93.4 million compared to $116 million a year ago and free cash flow was $28.6 million compared to $67.1 million last year.
In Q4, we added 67 paid business accounts with over 100K in ARR to end the year with 993 paid business accounts up almost 16% compared to a year ago and up to 926 last quarter. This number represents a mix of new customers coming in at more than 100K as well as existing customers crossing that threshold. This quarter we generated 75% of our ARR from accounts spending more than 100K in ARR, that is up from 73% last quarter and 70% in the year ago quarter.
We previously shared a metric with you around percent of business coming from enterprise accounts. What we believe this new metric based on ARR from accounts that spend more than 100K is more indicative of a larger business opportunity as it measures customers based on their spend rather than their size. Our annualized dollar based net expansion rate in the quarter was 116% down from 131% from the year ago period. But up from 109% last quarter and our best expansion rate for the year.
I want to spend a minute or two discussing gross margin. Gross margin in the fourth quarter was relatively consistent 84%. However our expectation is that gross margin will come in for fiscal 2021 in the high 70s. This guidance represents the investment we’re making and moving to the public cloud as we sunset our data centers. This is a significant undertaking that will take about three years to fully execute. But when the move to the public cloud is complete, we’ll back to our near best in class gross margin in the low 80s range.
Mechanically even though gross margins will come down for a period of time. We expect migration project will have a positive impact on cash flow in fiscal 2021 as the savings and capital expenditures will more than offset the reduction in operating income. While we feel it is a good long-term financial decision. The move is primarily driven by strategic consideration as operating in a public cloud is more perfectly aligned with almost every element of our business strategy.
Turning to guidance, while the current environment is challenging, it is also temporary. We believe the opportunity in front of us is large is long-lived. So we’re going to take advantage of our large cash balance and continue to invest aggressively in the business. When the selling environment improves, we will be ready with the large and well trained sales force equipped some of the most compelling observability technology in the market.
In the near term however visibility is poor and what we can see isn’t very encouraging. We’re working through a challenging sales environment, compounded by the unfortunate reality that a portion of our installed based primarily smaller businesses cannot pay their bill. So is against this backdrop that we reluctantly rescind our ARR guidance for fiscal 2021 and we’ll only give guidance for one quarter at time until visibility improves.
Our guidance for the first quarter of fiscal 2021 is as follows. We’re forecasting revenue of $158 million to $160 million and a non-GAAP operating loss of between $3 million to breakeven. This will be to non-GAAP net loss attributable to New Relic per diluted share in the range of negative $0.01 to positive $0.04. In addition, we’re forecasting the first quarter end of period ARR to grow 13% to 14% year-over-year.
And with that, I’d like to turn it back to the operator for Q&A.
[Operator Instructions] our first question today is from Sanjit Singh of Morgan Stanley. Please go ahead.
Thank you for taking the questions and I hope everyone on team New Relic is doing well and the employees are doing well as well. So much to dive into, but I guess the first place to start is what you’re sort of seeing in the environment, Mark. If you could sort of walk us through the end of quarter March, do you see any sort of benefits from customers seeing a surge in usage of other digital properties? And then as we got through April and May what are the trends that you have seen since then, if you could maybe just start there?
As we entered the last couple of weeks of March, the end of our fiscal year obviously the two most critical weeks of the year for us, that’s when things really slow down really hit. And we did see an impact, I would say an adverse impact on customers who might have been looking at a large deal and decided to hold back and so we did see an impact there. We also saw an impact on customers very quickly looking to adapt their payment terms to go quarterly billing for the annual – just in cash preservation mode. So we did see that. And I think it was all pretty new going into the end of March.
As we entered April, I think those trends continue to a certain extent, some of our customers are seeing a spike which is it’s just great and we’re there to serve them. And then as we entered April. I think particularly on the small side, we saw initially in April from a cash collection standpoint April was very slow. I think a lot of that was as companies were getting used to work at home, just going to monthly bill run instead of weekly things like that. But we did see that come back pretty nicely in early May in terms of people paying their bills and things. So we’re comfortable in that regard. Overall though I would say, we continue to see customers that are cautious about their outlook going forward and that’s our cautious tone as we look out to our first quarter and first half.
Understood. As I follow-up and I guess it would be for Michael or for Lew, we’re all going to hopefully get out of this and the overall observability market it seems to doing continue to grow pretty fantastically well. And so, with the big improvements in the platform and all of the new product releases. I think what a lot of us are trying to understand is who’s going to be consolidating spend within 100K type plus and accounts and who isn’t. With the backup I think there was a report around this, 30 different monitoring tools at some large enterprise corporation. It seems to us that’s probably unsustainable over the long haul. So I was wondering if you could sort of walk us through the points on why New Relic could be a consolidated functionality and capability in this space as it may be due diligence [ph] for more conservative spend environment.
Sure, I’m happy to speak to that Sanjay, its Lew. I think we are in a naturally strong position to be that consolidator and it really starts with our platform. The data collection technology that we have which I think shared a fair bit about it at our Investor Day. Unlike any of our competitors we’ve custom built multi-tenant database to collect and ingest literally petabytes of telemetry data from some of our customers. So there is no scale that we really can’t handle in our customer base.
What we foresee for the digital business is up today in the future. And the fact that’s all going into one database regardless of whether it’s infrastructure data or logs or APM data. If you want to consolidate, you don’t want to consolidate to a vendor that has different data go into different places and usually going into databases that were designed to be running in a single-tenant architecture and so they run at a performance and a cost disadvantage. So we’re going to have more to share on this throughout the course of the year. But we believe we have an opportunity because of the nature of our data collection capabilities to be the most ubiquitous telemetry data platform for our customers because it can operate at the scale and because we can still cost effectively deliver that telemetry data capability.
Great. It sounds exciting and congrats on the strong Q4.
Our next question is from Sterling Auty of JP Morgan. Please go ahead.
So looking at your comments that you made in the guidance here for the June quarter. I want to make sure that I understand how you think it’s going to manifest itself in terms of the negative impact, in terms of the customers that are paying more than the 100K versus those spending less than the 100K. In other words the impact disproportionally represented in those smaller customers.
Sterling, its Mark. I think we’re seeing – we expect it in both at the low end smaller customers. I think their - business has been disrupted dramatically and they got to reduce their spend and so what we’re seeing is either they can’t pay much or business gone down and so they’ll reduce their spend with New Relic. And then on the high end, you have some situations where customers are reducing spend others where deals and projects are just going to take little bit longer time to manifest themselves. But I think we’re seeing it in both segments.
And the good news is that, we don’t see particularly in over 100K, we don’t see people going to zero. We don’t see people leaving the New Relic franchise but we’re working with them. We understand they’re going through challenges. We want to be good long-term partners and so we’ll work with them to adjust as their business needs and as Mike said in the prepared remarks. We’re focused on long-term ARR, long-term relationship with these customers and we want to make sure we protect those and so that’s the kind of North Star for us.
Okay and then one follow-up. So that’s kind of the next out retention [ph] what’s happening in the customer base. What are you seeing in terms of activity levels? In terms of being able to fill the top of the funnel on new sales leads? And in particular what’s that experience like on some of the newer solutions that you passed [ph] market over the last six to nine months?
I’ll give that a shot, Mark. I would say that again one of the advantages we do have is, we have 15,000 paying customers. So the vast majority of our ARR, new ARR comes from those existing customers. So top of funnel is great and we did have a lot of new logos, under 100K and above the 100K and we’re happy with that. But we’re really going to power through this period of time and through FY 2021 selling more to our existing customers.
In this quarter we saw terrific, what I described in my earlier remarks platform adoption where people are using all of the three core on ramps as we call them APM obviously. But good momentum in infrastructure and terrific momentum with logs. So they’re using all of the capabilities with the platform including the newer capabilities and looking at it as it as a true platform.
Got it. Thank you.
Our next question today is from George [indiscernible] from [indiscernible].
So to kind of digging in on the customer side? The year-over-year customer losses, can you give us a sense of how much that you feel that is competitive losses and then how much is just some distract within the customer base?
What I would say is, again we have 16,000 paying customers nearly a 1,000 over 100K and we want to grow our customer count across that entire range of customers. Obviously as you’ve heard we have a real focus on 100K. But smaller customers are still New Relic customers and we want them to get value and have a great experience and we’re making investments to improve the customer experience, make it easy to try, easy to buy and we do want to resume growth at the lower end of that customer size in terms of their spend.
What I will say is, although we had a – what I would describe is a slight decline in total customers. The aggregate ARR for that decline at the low end is less than $5 million. So although you had a bit of drift down, I would expect that to turnaround and it’s not a big dollar number in terms of ARR.
All right just one follow-up question. On the investing front. Mark, can you give us a sense of hiring plans, either near term for the next quarter and then for the full year and how would me say R&D oriented versus sales?
Sure. So we are investing for growth, we feel like we continuing have a very good long-term opportunity ahead of us. And we want to capitalize on that opportunity. So we’ll be investing. We’ll continue to hire. We’ve hired obviously everything has gone to virtual. But we’ve been able to do that and fairly seamlessly transition to that, the hiring environment has definitely gone in more in favor of companies like Arcelor [ph] are hiring. So we’re continuing to do that. We feel like we’ll be hiring fairly steadily throughout the year. It’s across the board certainly R&D as a percentage pull spend last year picked up a bit. I would like to continue to see that go up.
We have a lot of great plans and we want to be able to execute on those, on the sale side as well. We want to continue add capacity. These times will pass and so we want to be situated as things continue to improve over the latter half of the year. Hopefully. And on the G&A side, we’ve got to continue to improve our systems and things and so we’re investing there as well.
Thank you.
Our next question today is Raimo Lenschow of Barclays. Please go ahead.
Thanks for taking my question and the extra disclosure that was really helpful. One for Lew, one for Mark. Lew, can you talk a little bit about what you’re seeing in terms of understanding around observability and then we’re now talking APM and infrastructure and logs and how that will need to fit together versus like the old word of as doing everything separately. And then Mark on the ARR, growth number that you gave us thanks for that. It was really helpful. What’s the assumption? How do I have to think about kind of lower upsell versus extra higher gross churn like how do I kind of conceptually at least you kind of [indiscernible] think about that number? Thank you.
Sure. How we think about and our customers thinks about observability. One simplified way to think about it is, monitoring is the capability to tell you when you have a problem because it watches the same thing continually and then tells you when that thing changes or goes into a bad state. The difference is observability is telling you, why you have a problem by giving you the capability to ask questions you didn’t know you were going to need ask, it’s like because – in real-time you’re trying to solve a mystery where precious seconds count. So you need to have all the data at your disposal. Anything that can help you understand why there is a problem in order to prevent an outage or if you haven’t figured you have outage to get things back up and running as fast as possible. You need an immense amount of data and the ability to ask any question of it in real time, that data could be in logs or infrastructure or metrics. And so that’s why we, customers are kind of saying I don’t want to go between tools and so we and other companies are kind of advancing that the idea that all of these types of data should be provided by one vendor, where we take it a step further as we believe there’s not only one vendorship [ph] you literally use same database, with the same query language so that it’s a seamless transition to ask the next question and whether it be in logs or infrastructure data or application data. And we believe that’s unique and important to our customers.
Thank you.
Mark?
In terms of the question you had on upsell versus churn for Q1. We expect it to be a larger impact on the churn than on the upsell. And as I look at April and now, we’re midway through May looking through April and May. The new ARR that we’re seeing is probably in line what we saw a year ago. We came into the quarter with good pipeline, but as I said we’re expecting close rates to be impacted. So new is been fairly consistent with last year but on the churn, we’re seeing a pickup in churn as we think that will be the larger impact as we go through Q1.
Okay, perfect. Thank you.
Our next question today will come from Rob Oliver of Baird. Please go ahead.
Great, good afternoon guys. Thanks very much for taking my question. Appreciated and Peter, welcome to you. My first question is for Mike and then Mark, I had a quick follow-up for you. Mike at the Analyst Day last year you laid out really detailed plan and that focused on 100K ARR customers and 67 added this quarter was solid, it sounds like it would have been – better had it not been for those last few weeks of the quarter. I know you said your goal was get to a 100 at some point, kind of at a quarterly run rate.
Can you talk a little bit more about, you mentioned logs were strong? Can you talk a little bit more about some of the platform usage and where you saw particular strength this quarter? and you did mention in your prepared remarks that you had conducted some experiment in terms of packaging and pricing product and was wondering, if you could elaborate on that a little bit.
Sure. Obviously getting customers to spend more than 100K or getting net new customers to come in above 100K. We felt pretty good about that. The gross numbers were good. Logs was a big help. People are really beginning to look at as a complete platform. They’re exploring a full range of capabilities of that platform. They like the logs capabilities, so that was a help. In this environment we did have a few customers who are still customers who dipped below 100K. so that number that we report is a net and I would say that, had we not have a number of customers dipping below the 100K that might have actually gotten a lot closer to our 100 target. So I’m hoping that sometime over the course of FY 2021 as business regains momentum that we’ll be able to get that 100 per quarter, in terms of new 100K customers. I’m optimistic about that. The entire organization understands that as we have observed in working with our customers. There’s a fundamental difference when they get to that level of spend. They’re looking to you as a more important technology partner. They’re looking to you to provide a broader range of capabilities and we want to be able to answer that call.
Great. Thanks Mike and then Mark for you, just on the gross margin side. I know you guys aren’t guiding to the year. But you mentioned that trend down to high 70s. How should we think about that is that something that could happen kind of right away how do we think about that trajectory of that impact on the model? Thanks gentlemen.
I think it will trend down overtime, the gross margin will trend down overtime. This quarter we’re looking at probably about $2 million hit to gross margin and then drop to bottom line. But we expect to save more than that in CapEx reductions for the data center so that will be positive cash impact and I think that will kind of go down over as the year goes through Q4. And then, we expect high 70s margin in the next couple of years as well as we build out the data center. But thereto throughout the course of the project, we do see actual cash flow improvement over the life of the project as we’ll be saving more in CapEx than we’ll be spending in gross costs.
Thanks again.
Our next question is from Yun Kim of Rosenblatt Securities. Please go ahead.
Congrats on a solid Q4. Just following-up on the previous question. [Indiscernible] pipeline, do you see continued trends towards larger deals which should be to continue increase in average ARR for your 100K plus customers or do you see that metric kind of stabilize at current levels and then maybe the more of the growth will likely come from just simply higher number of 100K plus customers and just real quick on that. What are you seeing around the platform pricing model you introduced last year? Thanks.
I would say that we’re not expecting huge increases in average ARR per 100K customers. Where we are getting the most traction is getting the distribution across the 100Ks to be more uniform. So we have a lot to fill in around that average moving people up. I think that is from a math point of view more likely getting more 100K customers, moving the ones that we do have up a bit and our models are basically forecasting that we have more 100K customers but at roughly the same average ARR per 100K. In terms of – sorry the second half of your question?
Yes, question around platform pricing, what’s the pricing there?
We have been working on a number of tests I’ll call them to encourage our customers to explore the full range of capabilities of the platform and so we try to a few different models for that in terms of how we do business with our customers. What they pay us and how we give them flexibility to experiment and change their consumption of the different capabilities to that platform. I’m really happy as I said in my earlier remarks with how well that has been received by our customers and I think that over the rest of FY 2021 and beyond I expect to see many more of our customers and perhaps virtually all of our 100K customers having full platform access as they become more comfortable with the platform and its capabilities.
Thank you so much. Quick question for Mark on the expansion rate. Is there a noticeable difference between 100K plus customers and versus to the low and what kind of trend you expect going forward do you see higher churn rate or like a go down sales to be more material for 100K plus customers or churn rate to be more noticeable for those customers in the low 100K plus? Thanks.
Sure. Yes, we definitely see a distinction between the two under 100K that expansion rate tend to be quite a bit lower than over 100K. And so that’s, we expect that to continue that’s more of the reasons we really want to get the customer over 100K that threshold because their behavior really changes. They’re more committed and so lower downgrade numbers as well as better expansion opportunities and we expect that distinction to continue. But we’re trying to improve both numbers but obviously the one that’s really driving the ARR and driving a business is the number up to over 100K.
Great. Thank you so much.
Our next question today is from Jennifer Lowe with UBS. Please go ahead.
Maybe just to start, we talked quite a bit about the current demand environment and some of the challenges that ensue with that. But maybe even taking a back a step. I’m just curios what you’re hearing from your customers in terms of their willingness to try out new technologies like some of new things introduced with New Relic One. The types of projects that they’re working on, are they rolling out new apps, are they still going through digital transformation that potentially create opportunities for you to instrument those. Application shifting to the cloud, what’s sort of the bigger picture that you’re seeing out there and how that sort of trickles down to the demand for your product specifically?
This is Lew. There’s like a short-term and long-term way to think about this. Long-term, this is no – and unquestionably driving new habits for everyone in the world to do more digitally than they have done in the past. That could be in business learning that could be in video conferencing, it could be in shopping and so. And we have many of our customers seeing sudden spikes in usage and they’re thankful that New Relic is there to help them, handle that change in application behavior. But because of the macroeconomic environment it’s not necessarily turning into instant new business depending on the nature of that, that company might have more traffic but may not have corresponding more revenue in some of those cases. We believe that this just further makes our mission and category more important and more existing. But it doesn’t necessarily translate to short-term business benefits. But we think that it does set well for long-term successes as those companies move to cloud and move to digital.
And then just one for Mark. As we talk about customers who are looking to potentially downsize usage as they deal with the issue in their own businesses. How does that actually manifest? It is a scenario where they get kind of three-year, six-month grace period where they can reduce the usage but the expectation is that, that should scale back up as hopefully the world returns to normal or is it just a reset and it’s indefinite in time horizon, what are the mechanics there as customers come to you on those [indiscernible].
Sure, it can be any of those. From the spectrum of some customers just want to go from annual to quarterly billing, right that’s an easy one. Some people just want to go from net 30 to net 60 and those are pretty straight forward relatively easy to do. At the other end of the spectrum we have customers who literally can’t pay for six months and so we’ll say okay then you make up that payment once you go live and can pay or in the worst case, we say all right. You get these the product for free for six months and pay us when you can. When you start up again and then we’ll put some thresholds around that milestones and things around that. Obviously, that’s a huge impact to us and it’s not something we want to do lightly but it can be all across that spectrum and it’s really just to understanding a customer, understanding their needs, while at the same time being mindful, we’ve got a business to run as well.
Thank you.
Our next question will come from Rishi Jaluria of D.A. Davidson. Please go ahead.
Glad to hear you’re staying safe out there. I wanted to ask a little bit about going back to the churn question. You disclosed at the Analyst Day some of the metrics around your 100K customers and single, multi product, etc. adoption. Just to get a sense for what directionally be churn rate or you can expansion rates for that matter look like between single product customers and multi product customers etc. and maybe alongside that as Mark you were talking about customers looking for maybe concessions with their business. They’re struggling. At what point does it make sense to start adding kind of new products at discount for those types of customers to help increase [indiscernible]. Then I got a follow-up.
Sure, so when we look at it our best customers are customers that using our platform, that’s our goal. We’ve been making progress there. We now have the end of March, we had about 30% of our ARR that had access to our platform and RPP [ph] or some vehicle or another. That was – and another and about half our new ARR in Q4 came from customers who did have full platform asset. When we look at those customers, they adopt us more broadly, they get a lot more value, they have more users, their churn characteristics better, their expansion characteristics are better. We feel like that’s best for the customer and that’s best for New Relic.
So we want to drive as many customers to full platform. As we could do it, every one of our customers would have the full platform and so that’s our goal. We got to reduce the friction everything from product to the go-to-market and then to make sure that it’s easy for our customers to go from standstill to having never heard to New Relic too adopting a platform, so that’s what we’re working hard at doing now.
In terms of offering customers that that’s certainly part of the discussion when customers come to us and want to either downgrade or the issue is it’s sort of trying to get something else, trying to give them some help but if you think about it. A customer who is using a full platform is much less likely to come to you and say I want to reduce my number of host I have, it’s just APM. Obviously, they can use that spend on – they can use spend across all our products. They’re much more likely to be comfortable spending that as oppose to just taking a one-off reduction their spend because of a point solution. And so that’s why we’re driving these numbers and that’s why pushing this one of the key focus is as we go through this year.
All right, got it. That’s helpful. In the guidance you talked about ARR growth of 13% to 14%. I want to apologize if I missed this couldn’t find it [indiscernible]. But what was the ARR for Q1 fiscal year 2020 then and that based on the old definition of ARR that’s replacing 636 as it’s based on the new one that will put you in 642 [indiscernible] so what’s the picture. Thanks.
Okay, sure. So I will give you the ARR at the end of quarter – last year for fiscal 2020 based on the old definition be 636 comparable. And that was at the end of Q1 so end of June last year we were 563 at the end of September end of Q2, we were 585. At the end of Q3 we were at 601 and the end of Q4 as we just mentioned, we were at 636. So just on an apples-to-apples standpoint those are the ARR numbers for last year. We will be coming out full reconciliation of these numbers to the new definition of ARR in general that includes just some partner and support true [ph] ARR and it’s in the $6-ish million a quarter, but we’ll be coming out of that. But I wanted to give you those historical number for perspective.
That’s really helpful. Thank you so much.
Our next question is from Robert Majek of Raymond James. Please go ahead.
Just following up on the prior question, would be curios if you can just walk us through some of the conversations you’ve had with customers in this environment, as far as R&D goes, what are they asking for in terms of the product and functionality and how that may have changed down going forward?
Sure, so our customers and most recently it’s been in particular. Like how can I realize cost savings by standardizing on, reducing from the number of tools I use, standardizing on one platform that can replicate what I get from many vendors and many tools. So there’s certainly – there’s excitement that we have logs in the market and there are logs offering is very fast and scalable and that the logs are more valuable when they’re in the application context and when they’re in separate context is not application-aware. So that’s an example of – really at the end of the day as I think about how this market’s evolving. I think it has – you think about lessons like these its different products for mobile monitoring and browser monitoring and application monitoring and infrastructure monitoring. Is that we think observability is just like full stack monitoring all of those things and we want to serve every engineer, make sure they’ve got the tools they need to ensure that whatever they’re working on is bulletproof and delivers a great experience. So that’s how we think about where we want to take it as. We want every professional engineer to use the whole New Relic platform so that anybody who contributes code that can impact production has the tools that need to make sure that production works flawlessly.
That’s helpful. Thank you. And then just perhaps one more quick one more from me. You saw an uptick in our PO this quarter. Can you just give us some more color in terms of wins that are driving your pipeline here?
Sure. So our PO generally for us in Q4 does tick up. Our business is such that we do a lot of deals during the course of the year that are co-term side deals and so we’ll get a bump in ARR and maybe suppose some doesn’t upgrade in December. They’ll just commit for three months until their billing cycle in March. And then in March, when their annual renewal comes that’s when they’ll do the full 12 months. So from an IPO standpoint March deals is not in impact really on our revenue, on our ARR. But it does have an impact on our PO because of the 12-month gone from a three-month prepay basically to 12 months. And so that’s one of the [indiscernible] that drives the Q4 number up a bit relatively to other quarters.
Thanks a lot.
Our next question will come from Derrick Wood of Cowen and Company. Please go ahead.
Can you give us a sense for how much of your revenue comes from SMB and how much from so to speak distress verticals and I guess just on the flipside? Any verticals you’d call out that you’ve seen incremental strength from in terms of revenue in bookings since work from home? And then I have one follow-up.
I guess what I would say is, if you look across our 16,000 paying customers there are small businesses that spend huge amount on observability in the 100K and at the high end of the 100K customer segment. And there are very large companies that pay 25K to 50K per year, so you cannot look at our customer base and say the bottom end of the spend is SMB and the high end is big enterprise. Yes, it’s a little bit higher end – a little bit more big enterprise at the top. But there’s big companies through the entire customer base and small companies that spend a lot they spend a 100K or more with us. So it’s hard to make that distinction. That’s the way that I would describe it.
And on the distress?
On the distress. We look at heavily impact industries. It’s in the 10% to 15% range of our installed base and then when you look at verticals that are doing well. I would say, entertainment gaming are certainly two that stand out as you can imagine. I don’t think we’re alone in seeing that as people are sheltering in place.
Subscription, entertainment and gaming as supportive businesses have had some negative impact.
Right. And then so my second question, I guess more for you Mark or to anyone. I mean you guys had really nice upside on calculated billings. You had a big acceleration and do 100K customers. But your commentary certainly seems kind of more cautious than like a reported results which I see. You just touch on kind of delta between the tone and the results and maybe specifically on billings where there are some one-time factors on the deferred side that help you in the quarter.
I was wondering, who’s going to speak. In terms of the billing, we were helped, it was a strong quarter and we appreciate that. So that was good. I think after what we’ve been through last year. We went into the quarter with trying to set modest and achievable expectations, so that was certainly one factor. I don’t think there’s anything unusual. But as we’ve said in the past our billing quarter-to-quarter fluctuate quite a bit depending on durations and terms and things like that. So it was a good quarter and we’re pleased with that.
On the other hand, as we look out this year, we want to make sure we’re realistic about the headwinds that are out there. I think the economy is starting to open up on the other hand, is it going to be a V, U and L [indiscernible]. Pick your logo. There certainly uncertainty about that and we know we were making progress. We feel like we had good momentum as we came out of Q4. But there’s still work to do and we acknowledge that and we’re going to keep our heads down and go after. We still feel great about the long-term opportunity. But in the near term we still expect they’re going to be some bumps along the way.
Got it. Yes. Makes sense. Thank you.
Your next question will come from Keith Bachman of Bank of Montreal. Please go ahead.
Thank you and I’ll ask my questions concurrently. First Mark, I just wanted to get your feedback on how we should be thinking about reported net retention this year. It was up nicely in Q4, still down year-over-year. But as you balanced the economy versus an improving product set. Just wondering about how we should be thinking about that is it kind of – should we be thinking flat year-over-year, should be improving year-over-year, should be down year-over-year?
And Lew, I’ll just go ahead and ask my second question to you, is you talked about your improving AI capabilities at the outset of the call. I was just wondering if you could compare and contrast versus what’s out there today particularly against [indiscernible] and are there any other capability and should we think about that as opening up new accounts or is that additive being able to go ahead and sell to your existing accounts to be additive to your existing portfolio and that’s it from me. Thanks very much.
I’ll take the expansion rate question first. We think there’s going to be an impact in the first half on both the upsells as well as churn. And so we would point to first half decline in net expansion rate and then second half, we’ll see how things are going give up days later in the year about that.
Okay when you say decline margin, you mean from the 116, that right?
I would say from year-over-year.
Okay.
Our Q4 tends to be strong and somewhat seasonal.
And then on the AI product. We’re excited to have it in the market. Some of you may remember, this came out of the acquisition of great company called SignifAI that we bought about 18 months ago. So what we think is particularly differentiated about it, is it alert and noise reduction and the fact that we have many customers, that when something goes wrong, they don’t get one alert, they might get thousands. You can’t just assume they’re all the same thing and so you need to kind of use AI to sift through it all and reduce the noise and help you understand what really is going wrong.
We think that we’ve got the strongest capability in that particular area. We also have for many years, if you starting back with Radar, which I think I launched in 2015. Has technology to automate problem detection and resolution. I think we’ve under marketed it. We haven’t quite told that story as well as some other companies. But we do have great AI capabilities to surface what’s wrong and interesting and normal to our customers to help accelerate their ability to troubleshoot. And if you – and the way to kind of look at this like at the end of the day. Gartner did issue their Magic Quadrant and also the peer review and we ranked again I think third or fourth year in a row. It’s a number one peer reviewed product in our space as in the APM Magic Quadrant and that’s really important, that’s like the user saying, what is your favorite product and we get the highest marks, year-after-year on that. And a big part of that is, our AI capability such as they are and combination with our ease of use make it easier to solve these phony problem as rapidly as possible and so we’re proud of that accomplishment. But we have much more to do with AI and I’m very excited about the roadmap.
Okay, thank you. Congratulations.
Ladies and gentlemen at this time. We will conclude the question-and-answer session and also conclude the New Relic earnings conference call. We thank you all for attending today’s presentation and you may now disconnect your lines.