New Relic, Inc.
Q2 2017 Earnings Call Transcript

Published: 8 Nov 2016

[Operator:]

Good afternoon. My name is Christine and I'll be your conference operator today. At this time, I would like to welcome everyone to the New Relic Second Quarter Fiscal 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Jon Parker, Senior Director of Strategic Finance and Investor Relations, you may begin your conference.

[Jon Parker:]

Thank you. Good afternoon and welcome to New Relic's second quarter fiscal year 2017 earnings conference call. Today's call is to provide you with information regarding our second quarter fiscal 2017 performance, in addition to our financial outlook for the third quarter and full fiscal year 2017. Joining me today are New Relic's Founder and CEO, Lew Cirne; our President, Hilarie Koplow-McAdams; and our Chief Financial Officer, 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. For more information about factors that may cause actual results to differ materially from forward-looking statements, please refer to the press release we issued today, as well as the risks described in our most recent Form 10-Q filed with the SEC, particularly in the section titled Risk Factors. 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 and evaluate ongoing operating results and trends. But note that these measures should not be considered in isolation from, or as a substitute, for financial information prepared in accordance with GAAP. Reconciliation between GAAP and non-GAAP metrics for our reported results can be found in our earnings press release issued today, a copy of which can be found on our website. At times in our prepared comments or in responses your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business or our quarterly results. Please be advised that 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 our Investor Relations website at ir.newrelic.com to access our earnings press release issued today, a presentation that accompanies 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.

[Lew Cirne:]

Thanks John. We are pleased to deliver another quarter in which both revenue and profitability exceeded our expectations. Revenue of $63.4 million was up 48% year-on-year, led again by our enterprise business, which remains our fastest growing area. We also continue to generate significant operating leverage, highlighted by over 1,200 basis points of year-over-year improvement in our GAAP and non-GAAP operating margin, resulting in our smallest loss to date as a public company. As a result of our strong second quarter performance and positive view on the remainder of the year, we are again increasing our fiscal 2017 outlook. Beyond the excellent financial performance, we have made great progress against key objectives for the year. These included establishing New Relic as the trusted enterprise standard, increasing our ubiquity in the market, and continuing to extend our innovation leadership position. Let me provide a highlight in each of these areas. I'll do this starting with the enterprise business, which is trending to become the largest part of our overall business. We continue to build momentum in Q2 by winning many fantastic new enterprise logos, while at the same time deepening existing relationships. In Q2, we saw our second highest ever number of six-figure transaction and now count more than 400 customers spending more than $100,000 per year, almost triple, where we were at the closing our IPO less than two years ago. Additionally, we saw several more customers cross through the million dollars per year spent threshold and now count over 20 in total. This is up not well over 100% year-over-year in comparison to the two that we had at the time of the IPO. While these $20 million plus relationships helped symbolize the critical role we are playing in helping our customers run their digital business, it is important to stress that none of these are close to being fully penetrated. In aggregate, we have well over 1,500 other enterprise customers and many other SMB -- in the SMB portion of our business who we believe can also reach the $1 million annual spent threshold over time. In the second quarter and in the first half of 2017, we also made great progress against our second priority, which is increasing our ubiquity in the market. The key enablers to achieving this goal are our cloud-only DNA and powerful yet easy-to-use platform. New Relic can help monitor, measure, and analyze the company's digital business in ways that are simply not possible with traditional on premise or hosted solutions and in a much more cost-effective manner. These are critical factors when considering the exponential growth in the scale of digital business initiatives. For example, in Q2, our customers use New Relic to collect approximately 25 trillion events, up more than 14% quarter-over-quarter and despite this incredible data volume being processed by our cloud-based platform, this past quarter, we were still able to deliver our strongest non-GAAP gross margin as a public company, nearly 83%, which we believe to be one of the three strongest level across all public pure play SaaS companies. To become truly ubiquitous in the market, we believe it is imperative to be a true cloud-only company, built for the cloud from inception. Our cloud-based platform enables us to address the needs of companies of any size in all sectors across the world from startup digital to the largest enterprises in the world in the midst of digital transformations. While we continue to see impressive wins this past quarter in verticals like technology with Cisco, as well as retail with BabyCenter, The Gap, and VF Corp., home of great brands like Nautica, North Face, and Timberland. We also saw growing demand from other industries that historically have been slower to adopt cloud-based solutions. For instance, in financial services, we did business with Barclays, Liberty Mutual and Northwestern Mutual and we are -- and in the transportation vertical, we also did business with new logo Nissan, as well as, the Swiss Federal Railway and TrueCar. As companies are launching digital businesses or adopting the public cloud as a core component of their technology strategy, there are more and more often turning to New Relic. As developers, IT operations professional, and line of business owners increasingly collaborate and try to join success of their company's digital initiatives, the breadth of our platform is helping to change the game by driving hundreds and sometimes thousands of users in a single company to connect and interact with our analytics platform. As more people connect with New Relic, it generates a scalable and data rich feedback mechanism that can help improve our value proposition and optimizer our customers' digital experiences. This is a significant sustainable competitive advantage that we had versus traditional on premises vendors who are blind and in a silo unable to processor or share these connections. Next week you'll hear us talk about this and how we are uniquely positioned to leverage machine learning and the trillions of offense our users collect using New Relic each month to drive even more powerful customer experience. I wanted to finish my prepared remarks discussing the progress of our innovation efforts, which is been a major factor in New Relic's momentum in the enterprise market as well as the broader market. Our customers see the power of our differentiated cloud-based Digital Intelligence Platform and more expansive vision for the future compared to alternatives. We are particularly excited about the upcoming launch of our newest product, New Relic Infrastructure, which we designed to provide real-time visibility in a critical configuration changes that affect the company's cloud infrastructure and intelligently alert users so they can troubleshoot problems and reduce downtime. Customer demand to participate in the beta program we announced three months ago was frankly overwhelming with over 1,500 of our customers requesting access. Today I'm thrilled to announce that New Relic Infrastructure will be generally available ahead of schedule next week at FutureStack. We believe New Relic Infrastructure meaningfully expands our total addressable market. It makes our rebranded Digital Intelligence Platform, which can now analyze massive quantities of both software and infrastructure data increasingly relevant to core IT use cases over and above our support for digital business initiatives. In addition we believe New Relic Infrastructure has the long-term potential to become a second initial entry point for new customers on top of being an excellent opportunity to further expand existing customer relationships. Today, we also made another exciting announcement New Relic Infrastructure Professional Edition will offer expand the date of monitoring for the 12 most popular Amazon Web Services components, including CloudFront, DynamoDB, EBS, ElasticCache and many more. These additional services will be available immediately within the New Relic Infrastructure Professional Edition and added as an ongoing basis, In closing, we've made a tremendous amount of progress against our strategic growth initiatives in the first half of the year, which we believe sets us up well for the back half and for fiscal 2018. My enthusiasm about our position and the opportunity ahead of us has never been greater. With that, I'll turn it over to Hilarie.

[Hilarie Koplow-McAdams:]

Thanks Lew. From my perspective, our second quarter and first half performance provides strong evidence of several important trends. First, companies of all sizes are increasingly using software as a primary way to differentiate their business and drive growth initiatives. Second, the world is moving to the cloud. This trend is already well underway and we believe it will continue to gain momentum in the years ahead. And third, New Relic having been born in the cloud and not migrated there is well-established as a visionary leader in the market and we're becoming viewed as an increasingly strategic partner to our customers. In line with the trends we pointed to in Q1, we continue to see great technical design wins including several of the ones Lew mentioned. We'll talk about this in more detail next week at Investor Day, but we believe these new customers are critical in helping fuel future growth and should help drive much of the expansion activities we've previously spoken about for the second half of the year. Going into the second half, our pipeline feels very healthy. Enterprise wins in the second quarter were broad-based. One particular area we highlighted on prior calls was our international investment. We've started to see some great returns. I was pleased in Q2 that several of our top deals came from EMEA; this includes Barclays, leading online retailer, Ocado, and News Corp. UK. In APAC, we're super excited to add Pokémon to the New Relic family, helping them respond to the incredible demand for their blockbuster Pokémon Go app. In India, we are also now helping Ola Cabs, the country's leading on-demand transportation provider scale through its growth. We believe that we have just scratched the surface of the international opportunity and it's an area where we will be continuing to add resources. While we talk a lot about our enterprise business, we continue to profitably grow our SMB business and in the second quarter, three of our top 10 deals actually came from this area. The recognition of the need for a cloud-based Digital Intelligence Platform to support transformative business initiatives cuts across all types and sizes of companies and we're pleased to see continued success in our SMB business. Among other companies, we were pleased to expand our relationships with HubSpot We Work and Casper Sleep. Next week at Investor Day, we'll host a customer panel where you will have a great opportunity to talk to some of our customers. So, we're going to skip over my usual customer stories and finish up by quickly commenting on the cloud pricing option we introduced last quarter as well as New Relic Infrastructure. You'll recall that our new cloud pricing option enables customers to adopt New Relic in a manner that is more aligned with how they consume the underlying cloud infrastructure. In just two months of availability with fairly restrained promotion, we've had hundreds of customers adopt our cloud-based pricing option, some of whom were previously light customers. We also saw the new pricing resonate with some existing customers as well. In fact, we leverage cloud pricing to close our largest deal of the quarter, a seven-figure per year commitment. With the growing adoption of public cloud infrastructure, we believe our supplemental pricing option helps extend our addressable market advance New Relic ubiquitous status and is accretive to the business. We believe another important factor that will contribute to our ongoing momentum is the continued expansion of our Digital Intelligence Platform. We're very excited to bring New Relic Infrastructure to market faster than previously announced. Market indication suggest that there will be strong interest for this offering as it provides real-time visibility to the health of servers, a must in agile continuous deployment cloud and hybrid environments. We believe in the new world of DevOps, New Relic Infrastructure is a must-have solution. That said, market adoption of all new products takes time to ramp and given our subscription model, we expect a more material impact from New Relic Infrastructure in fiscal year 2018. From a longer term perspective, we also expect New Relic Infrastructure could represent a new entry point for our platform. With that, I will turn it over to Mark.

[Mark Sachleben:]

Thanks Hilarie. Turning to the financials, second quarter revenue was $63.4 million, up 48% year-over-year and up 8% sequentially. We ended the quarter with 14,538 total paid business accounts, up almost 500 from Q1. Of these, the total number of customers paying us more than $5,000 per year reached 6,229. Our annualized revenue per average paid business account continue to grow, reaching proximally $70,750, up 31% year-over-year and 4% sequentially. As we mentioned last quarter, we continue to expect a growth rate of our annualized revenue per average paid business account to moderate over the next few quarters, as both essentials and our cloud pricing options start at lower prices. It would stand to reason that these new options could account for a large portion of net new paid business accounts. As Hilarie mentioned, we saw great adoption of our cloud pricing option. Last quarter we discussed our expectation for this new pricing to be accretive to our overall business. While it is still early, anecdotal feedback for customers and actual closed deals support this business. In fact, existing customers who adopted cloud pricing in Q2, expanded their commitment by over 40% in aggregate net of churn and still by over 20% when excluding seven figure deal that Hilarie mentioned. Our dollar-based net expansion rate the quarter was 116%, roughly in line with Q1. To reiterate from last quarter, as our enterprise business becomes a greater percentage of our install base, we're starting to see more meaningful seasonality in the past as we are being brought into discussions for larger, more strategic standardizations that tend to close later in budget cycles, so later in our fiscal year. Additionally, we have been putting increased emphasis behind the bringing in new customers to the franchise given the attractive long-term economics we'll talk more about next week at our Investor Day. And we're pleased that the percentage of our bookings coming from new customers increased for the second consecutive quarter. Turning to our geographic split, U.S. revenue of $42.9 million for the quarter was up 49% year-over-year, while non-U.S. revenue for the quarter grew to $20.5 million, up 45% year-over-year. Non-U.S. revenue represented 32% of revenue in the quarter. Before moving to profit and loss items, I would like to point out that unless otherwise specified, all the expense and profitability metrics I will be discussing going forward are non-GAAP results. A full reconciliation between historical GAAP non-GAAP results can be found in our earnings press release issued today and available on our website. Our gross margin was 83%, the highest figure we've reported as public company. This is up from 81% in both the year ago and last quarter. We did have some timing benefits including a couple significant data center purchases that will be more back end loaded in the fiscal year than previously expected, but we do now expect gross margin to be between 81% and 82% for fiscal year 2017, up from our previous outlook of around 80%. With regard to operating expenses, sales and marketing costs were $36.8 million compared to $35.9 million last quarter and $27 million in the same quarter last year. As discussed of prior calls, the sequential increase was actually a bit higher than in the past two years given our new local FutureStack event held in Q2. We continue to meaningful invest across our go-to-market organization and see improving operating leverage. R&D expenses were $12.1 million compared to $13.3 million last quarter and $9 million in the same quarter last year. The sequential decline was largely attributable to several seasonal events within the product organization in the first few months of the year. G&A costs were $8.6 million compared to $8.3 million last quarter and $7 million in the same period last year. Overall our expenses in the quarter produced an operating loss of $4.9 million, a 50% reduction compared to loss of $9.8 million last quarter and down meaningful -- meaningfully $8.4 million in the same quarter last year. This resulted in a negative operating margin of 8% in the quarter compared to negative 17% last quarter and negative 20% in the same quarter last year. Our operating loss benefited in the quarter both from the aforementioned timing movement in some of our data center activities as well as a much higher proportion of spent tied to a major system implementation that we now expect to occur later this fiscal year. Our net loss per share was $0.09, which compared to $0.20 last quarter and $0.17 in the same quarter last year. Turn to our balance sheet, we ended the second quarter with $197.3 million of cash, cash equivalents and short-term investments, $1 million increase from the end of Q1. Elsewhere on the balance sheet, our total deferred revenue ended the quarter at $80.4 million, up 77% year-over-year. As mentioned last quarter and consistent again this quarter, the growth in our installed base invoicing duration has meaningfully slowed in the first half as we anniversary significant gains from over the past year in turn creating relative headwinds on our deferred revenue growth this year. And as a reminder, we have built more than $3 million of long-term deferred revenue in the year ago period and did not have any long-term billing this quarter. As we have stressed since going public, we do not view deferred revenue as a reliable indicator of our underlying business trends due to the varying durations of our contracts and billing terms and the frequency with which customers expand their commitments. Turning to cash flow, we generated modestly positive cash from operations in the quarter, our fourth consecutive positive quarter. Free cash flow defined as cash from operations minus capital expenditures minus capitalized software return to an outflow of $7.6 million as our office buildout started to ramp. We continue to expect to generate positive cash from operations for the full year, but negative free cash flow unchanged from prior guidance. As it relates to Q3, we would note that we have several significant cash items expected to hit which could cause cash from operations to be closed breakeven in the quarter as we recently made some significant multiyear upfront commitments with our cloud infrastructure that should drive long-term savings. As it relates to physical CapEx, we expect continued increases in Q3 before declining in Q4. Although we now expect CapEx to be towards the lower end of our prior outlook of $32 million to $34 million. Note that this is separate from capitalized software, which we expect to be fairly comparable in the second half of the fiscal year to the second half of last fiscal year. Now, I will turn to our outlook for the third quarter of fiscal 2017 and the fiscal year as a whole. We are initiating our outlook as follows

[Operator:]

[Operator Instructions] Your first question comes from the line of Sterling Auty from J.P. Morgan. Your line is open.

[Sterling Auty:]

Yes. Thanks. Hi guys. I want to start with Infrastructure, you talked about its systemic spending in the new entry point into customers, is it also a different buyer your that you need to focus on? So, what's going to be the sales strategy to execute on gaining traction?

[Lew Cirne:]

Hi, Sterling, it's Lew. Great question and I'm glad you asked it. Actually we see very high overlap between existing New Relic users and the people who would be the likely users and buyers of Infrastructure monitoring. We have that through data on how our customers use our product today, and also through feedback from our beta program. So, one of the reasons why I'm so excited about Infrastructure is I believe that it has the potential attached very well without us needing to establish relationship with the new buyer.

[Sterling Auty:]

Okay. And then just one follow-up, Mark, on the deferred revenue, can you go into a little bit more color, I know it's been a point of confusion and noise even since the IPO, but anything that you can quantify in terms of what the duration impacts were? Or just another layer of detail in terms of the outcome in terms of deferred revenue this quarter?

[Mark Sachleben:]

Sure. I know it has been confusing. We have been seeing a slowdown in the rate of change of the duration of the contract. And if you look back a couple quarters ago, last Q3 and Q4, we were seeing a lot of enterprise customers who were shifting from monthly or short-term durations to longer term duration, so we're getting a significant advantage of that in the back half of last year. As we come into this year, we're seeing that duration change really slow down and actually it's been fairly flat the last couple of quarters, so that has been providing a headwind against our deferred revenue growth. When we look at the renewal base, the second half of the year, it's meaningfully larger than the first half of the year. So, as we look out into Q3, we should expect to see deferred revenue continue to grow in Q3.

[Sterling Auty:]

All right. Thank you.

[Operator:]

Your next question comes from the line of Greg McDowell from JMP Securities. Your line is open.

[Greg McDowell:]

Great. Thank you very much. I want to ask about cloud pricing, based on the commentary, it sounds like you're doing more and more deals -- big the deals using the new cloud pricing option and some conversions from like customers. So, I was just wondering if you could just give us an update on sort of the uptake on cloud pricings from both the existing install base or converting the cloud pricing and maybe what does that new customers are choosing to adopt from a pricing model perspective? Thanks.

[Hilarie Koplow-McAdams:]

Why not I handle, Greg, the qualitative, this is Hilarie, and then maybe Mark can speak to the client [ph]. If you remember when we rolled out the cloud pricing option, really three months ago, we had the goal of creating a drop dead simple price point that customers could easily translate for their cloud-based platform that they were using, namely AWS, Azure, Google, et cetera, and we found that to be really successful. We wanted to roll it out somewhat cautiously to understand how easy it was to translate that pricing to the -- both the base and to new customers and we were really pleased with what we saw in the quarter. As you mentioned, we saw a seven figure deal. We saw a lot of customers, existing customers opt to use cloud pricing. They did what we wanted which was they expanded their footprint significantly with New Relic and then we saw new customer say this is a wonderfully simple way for us to understand our pricing and think about using New Relic more broadly. So, we think it was a big success. I think as you see us roll into our Annual User Group Meeting next week and go out to market in our second half, which is always a big half for us, you'll see us promoting this even more aggressively because we know we've trained the sales force.

[Greg McDowell:]

Great. Thanks Hilarie. And one follow-up for you, Mark, regarding the gross margin. I mean as you guys highlight, you guys already have best-in-class gross margins by getting to 83% and even above sort of your long-term gross margin operating profile. So, I guess as we think ahead and I know there were some -- maybe some catch-up items, but as we think ahead of maybe levers you have on a gross margin line, how we should think about that number going forward? And maybe if you could just remind us the levers you had to get 83%. Thanks.

[Mark Sachleben:]

Fortunately when Lew found New Relic, we've always been focused on efficiency and so that's allowed us to keep the gross margin -- as you said, best-in-class. This quarter we did benefit, as we mentioned in the prepared remarks, from some timing issues -- timing purchases of some capital. But what we are seeing is we've been able to add new products, we've been able to dramatically grow the customer base. Lew talked about the number of metrics we're collecting in the quarter and the increase, we've been able to do that and still maintain this great efficiency. So, we're optimistic we'll be able to continue to do that focus on it and maintain a great margin. Long-term we've mentioned this year, we've upped the guidance to a little bit in the call and long-term, we continue to be confident in the 71% to -- 78% to 82% long-term margins.

[Operator:]

Your next question comes from the line of Ben McFadden from Pacific Crest Securities. Your line is open. Excuse me Mr. McFadden, your line is open. Your next question comes from the line of Ittai Kidron from Oppenheimer. Your line is open.

[Ittai Kidron:]

Thanks. It's Ittai, can you her me?

[Lew Cirne:]

Yes.

[Mark Sachleben:]

Yes.

[Ittai Kidron:]

Okay it works. Mark, I want to dig-in again into the deferred comments, you talked about how the duration of the contract has been expanding, it has been the driver for all deferred revenue increase in the past and now that's not happening. I guess a question what is the risk that it flips actually upside down, meaning now that you've moved to this cloud price, you bill per month whereas before in the old APM pricing, you had both monthly and annual, is there a risk would that more customers move into monthly and then they first start declining. How do I get my hands around that?

[Mark Sachleben:]

Well, I guess I should clarify that under our cloud pricing, we still generally charge customers annually. So at the low end, our customer base is -- there will be monthly customer -- monthly paying customers, in the SMB business, they are cash sensitive, so many of those customers will come in and require that we pay -- they pay monthly. But at the enterprise level, our larger customers, they generally pay annually. And whether there are cloud pricing or traditional host-based pricing, they continue to -- they will pay annually up front or have semiannually. You just also would want to remind folks that what is in the prepared remarks, our quarterly mantra about not reading too much into the deferred in the billings number. If you look the last couple quarters you, will look at our revenue growth in Q1, Q2 and what we've guided to and Q3, you can see that was quite a bit higher than our billings growth over that. So, that's why we want to we want to guard against reading too much into billings as an indicator of business momentum.

[Ittai Kidron:]

Got it. Okay. And then for Lew and Hilarie, Hilarie first of all can you talk about productivity, how do you feel about the progression over there and going after enterprise deals? And then Lew, with regards to the Infrastructure, is this -- while you say Infrastructure is just serve host monitoring at this point, or there's a broader set of Infrastructure elements that being monitored as well?

[Hilarie Koplow-McAdams:]

So, let me start with productivity, we're really pleased with the productivity of our enterprise team, and you know substantiation of this is the type of logos that we mentioned earlier in the call. We're seeing strong adoption among insurance companies, retailers, media companies. Tomorrow night during the election, we will have people in the war rooms of every media company around the globe and we've got a really committed enterprise sales force that's doing a great job of bringing new customers into the franchise, but also expanding our footprint. One of the statistics that Mark shared earlier in the call was the growth we're seeing in deals over $100,000. We think that's a driver of productivity and we're still in that first half of the year that we characterize as being around new logo acquisitions and then moving into the second half, we will see more expansion. One of the places that we think we'll get expansion, I'll give Lew sort of tee-up is around the Infrastructure offering. We're so excited to be releasing our Infrastructure product. If you think about where we were, we had an APM offering, we went customer experience. And that IT ops fire that we're embracing and spending a lot of time with and the enterprise has asked us to provide them the visibility that they need to what the state of their servers is and we now have a solution for that. And next week, we launch it at our User Group Meeting and we're super excited about what this means for the company. And that's what's unique about this particular offering is we're calling them the same buyer that we've been calling on historically. But we've a much more complete offering for them.

[Lew Cirne:]

Yes. And to your question about what it does and what makes is special, the nature of the problems change dramatically over last few years as the clients have moved to cloud and what has been a challenge of putting visibility into the tens or hundreds of servers might be now putting visibility into thousands of virtualized servers or containers and a large percentage of that may come and go as a normal course of operations. So, traditional -- altering traditional visibility tools that assume a small number of servers, kind of stay in place aren’t well-suited to the needs of today's enterprise customer. But what's an even bigger point differentiation for New Relic Infrastructure is tracking in real-time the state and configuration across all those servers. Imagine as many of our customers do if a very security flow was exposed by an open source package, New Relic Infrastructure will allow our customers to search across tens of thousands servers and instantly see where that faulty piece of software might be installed. We also track changes in real-time. And what we found out from our customers is that the number one risk to production availability is a change, a change that might be benign by intent, but actually cause a production problem. So, we feel like this is an absolute must-have product that fits hand-in-glove with our other products and we think it has great potential in the market.

[Ittai Kidron:]

Very good. Good luck guys.

[Operator:]

Your next question comes from the line of Ben McFadden from Pacific Crest Securities. Your line is open.

[Ben McFadden:]

Hey everyone. Thanks for taking my call. Sorry, about the technical difficulties earlier. I wanted to start with the stat that was given around customers with cloud pricing have expanded by 40%. I think it was you, Mark, that said it, but just any color you can kind of provide on maybe what type applications that they are expanding with this cloud-based pricing and are these applications that they just would not consider adding New Relic to under previous pricing dynamics. Any more color there would be great.

[Lew Cirne:]

Well, I'm going to take it from Mark and then Mark can correct me as the numbers expert, but the reason why we're seeing that expansion is because I think there are certain types of applications that typically run on lots of smaller instances in cloud environment. So, what our competitors in the rest of market has done, and we originally did, was price a fixed-price for every server you run on, whether that be a server with a lot of CPUs and RAM or smaller server. And a lot of people, especially, if we move to Amazon Web Services and other clouds, they deploy on smaller instant sizes and our cloud pricing made it a no-brainer to put on those instances too, because we're right-sizing our pricing to the size of the server. And so it's less about the nature of the application, more about what kind of infrastructure it runs on that makes it an easier win for us with this new pricing model.

[Ben McFadden:]

Okay, great. And then Mark, to hit on this point again, but I wanted to touch on the deferred revenue. I think the part about the deferred revenue that's confusing investors is the fact that it was down -- the short-term deferred revenue was down sequentially, so I mean just any additional color you can provide that kind of gets us there? I mean I know you're going to -- not getting the same duration tailwind that you've seen in the past, but does the cloud-based pricing potentially hurts the relative amount that's booked up front or just any additional commentary that might get us comfortable with the fact that that number was down sequentially, which we just haven’t seen before?

[Mark Sachleben:]

Yes. No, I will say the current billings were down in Q2 last year as well. So, I would point that out. And the -- we feel good about the momentum of the business, but we are seeing more seasonality. And we talked in Q1 about the nature of our business shifting more to the enterprise and what we're seeing is the larger standardization deals are more likely to happen in Q3 -- our Q3 in the December quarter and our Q4 in the March -- our last quarter of the year. And to get into a little bit in the details, I understand because we're -- it's been the third time it's been asked, we see customers repeat purchases throughout the year and if someone's got a year-end purchase -- a renewal date, say in December, if they do a deal in Q -- in July or August, they're very likely to purchase just for four months even though they may well be on an annual contract. That way their initial purchase of that expansion deal will be a rather short duration and then we get the full benefit of that deferred hit when they get their renewal date in December. So, there's a lot going on and what we have said is -- what I said -- mentioned earlier is that sequentially quarter-to-quarter Q2 to Q3, given the renewal base we see in the second half of the year, we do see deferred revenue growing Q2 to Q3 this year.

[Jon Parker:]

And this Jon, I do wanted to be clear about one thing, we did get some questions on, we talk about invoicing duration being flat, we are talking about our installed base duration. So, we're talking about what happens quarter-to-quarter, which to Mark's point about the coterminous activity can impact it in any given quarter. So, that comment is reflective of our installed base only and not what happens quarter-to-quarter to be perfectly clear.

[Ben McFadden:]

Okay. That's very helpful. Thank you.

[Operator:]

Your next question comes from the line of Sanjit Singh from Morgan Stanley. Your line is open.

[Sanjit Singh:]

Hi guys. Thank you for taking my question. If we get back to some of the seasonality trends and your view of the enterprise going forward, I think you rightly pointed out that Q1 and Q2 are typically "land quarters", but we've seen a number of companies in the space -- high good SaaS space, start to hit some challenge in terms of expanding to the enterprise. So, I just want to do a gut check in terms of your view on enterprise spending in your customer base as we looked at Q3 and Q4, are you seeing any sort of enterprise spending slowdowns or some sort of resistance to signing deals, which may impact your overall bookings growth going forward?

[Hilarie Koplow-McAdams:]

Yes, I think that's a great question. We really aren't seeing anything. If anything we're seeing enterprises, even traditional industries get very savvy to the need to move fast around these digital initiatives. I wish you were all with me for a week on the road, calling on customers when they describe what their future state looks like from a digital experience perspective, because it's really exciting as everybody tries to digitize a brand engagement experience and we're a partner in that. What I will say is as they go into these new initiatives, it takes time to line up all the resources within the account, which is why we see it is a land and expand strategy, because we partner with them, we give them a lot of advice. We're actually really excited right now for a lot of our customers that are rolling into their peak season as the holidays approach and it started with the World Series last week, I think you all know MLABM is a customer of ours, we've got people as I mentioned in all the election war rooms around the globe, we've got Cyber Monday and Black Friday coming up, we have healthcare enrollment periods, both public and private. So, it's kind of our season to work with customers and we haven't felt any sort of negative sentiment in the market. If anything we felt their need to get our advice on how they go faster. And that's why I think when you look at the completeness of the platform that really I think we'll underscore next week and I hope you all join us for our User Group Meeting, you'll see us explain in more detail why it's so important to look at customer experience, application, performance, and infrastructure monitoring as one experience for a company versus the alternative today, which is a bunch of fragmented solutions that they sort of have to piece together.

[Sanjit Singh:]

On the competitive question with the Infrastructure coming out in the next couple of weeks, you had some partners previously in that space and what do you see as sort of the competitive dynamics that some of those Infrastructure partners maybe try and compete with you and APM. How does that -- how do you think that potentially plays out to your customer base with maybe more alternatives for both Infrastructure and application monitoring?

[Lew Cirne:]

Great question Sanjit, this is Lew. As we continue broaden our product offerings, we're going to bump into new competitors. And as we move into Infrastructure, we see some legacy systems management providers in the space. We see some people struggling with open source products, which our -- they are struggling to actually make that work well for their needs, and then there are some niche players in the space as well. So, we feel like having the customer experience telemetry in the application telemetry and Infrastructure telemetry all in one place and in particular, our uniquely ability to configuration of the Infrastructure in real-time that gives us a lot of differentiation. So, we feel great about our competitive position. And now we got a large number of our customers that we can sell directly into, so with nearly 15,000 paid customers, we've got a healthy customer base to take this product to and many of them are already trying the beta.

[Sanjit Singh:]

Great. Thank you, Lew.

[Operator:]

Your next question comes from the line of Michael Turits - Raymond James. Your line is open.

[Michael Turits:]

Hey, Michael Turits, thanks a lot guys. Good revenue numbers and guide. Question on the backup seasonality. One, I don't know if you commented on this, but should we start to see that net expansion rate head up logically at that time if you sign some of those larger deals? And I guess I would assume what you're saying is the duration should be -- continue to be flat in the back half and if that is the case, should we start to see billings growth more closely in line with revenue growth?

[Mark Sachleben:]

We don't specifically guide toward the net expansion rate or durations, but when we look the last two quarters, we've been pleased as we mentioned that the percentage of our business that's come from new customers has increased twice in a row and going to the back half of year as Hilarie mentioned that is more of the expansion season. So, I think it stands to reason that we'll see good result from dollar-based net expansion rate. But that's also being affected by the well large numbers as the numbers go up, that the percentage is challenging to keep high. But we feel good about where we are from a business standpoint heading into the second half. When we look at our pipelines, when we look at the business that we have coming forward, the business cycle, the year-end budgeting cycles in our Q4, we feel good about where we are.

[Michael Turits:]

Okay. Thanks very much Mark.

[Operator:]

Your next question comes from the line of Ryan Hutchinson from Guggenheim. Your line is open.

[Ryan Hutchinson:]

Okay, great. Most of my question have been answered, but maybe just on the operating expense line, just on R&D and in prepared remarks you talked about several seasonal events and so one, maybe just flush out what those were? And two, the starting point for this upcoming quarter should be based off of the first quarter or off the most recent quarter with respect to R&D?

[Mark Sachleben:]

So, in the first half of the year, the first quarter has got some events such as our kickoff that we do. We do a kickoff at a company, an R&D kickoff and so that tends to boost the R&D spending in the first quarter a bit. Through the rest of the year, we expect it to be fairly consistent with the second quarter growing from there. There's always a little bit timing of when you get new hires and things, hiring tends to slow down as you can imagine in the -- sort of the holiday period toward the end of Q3 and then pick back up again in January. But we expect it to be basically fairly consistent an increase from the Q2 level.

[Ryan Hutchinson:]

Okay, great. That's all I got. Thank you.

[Operator:]

Your next question comes from the line of Jesse Olson from Goldman Sachs. Your line is open.

[Jesse Olson:]

Yes. Thank you. A couple of questions. First, I guess for Hilarie, this is the second quarter or third quarter in a row where you've seen customers over 5K, the net ads kind of trend down and I'm wondering if you could give us a sense of -- is that because there's more big customers and less of a focus at the low end? Is that seasonality, what's driving that?

[Mark Sachleben:]

Jesse, this is Mark. I will take that one. What we're focused on is the quality of customer we get and that -- I don't want to say that 5K line is arbitrary, but we -- what we look at is we look at the quality of customers and we look at all sorts of threshold, not only 5K, we look at the customers paying us more than 10K, 50 K, 100K et cetera. And what we're seeing is we're seeing nice healthy growth across all those thresholds. I think we talked about the number of customers now paying us more than 100K. That's gone up almost by a factor of three in under two years that would -- since we've been public. So, we're seeing great growth in the higher regions, we're also -- we're pleased to see the nice increase year-over-year in the total net ads close to 500 and so -- I think any individual threshold for a period or two, you might see some events that may stick out or little discontinuous. But when we look at the customer base across all those thresholds, we feel like the business momentum continues to be strong.

[Jesse Olson:]

Got it. And then back to the billings, I'm wondering if you could -- because investors are going to look at billings as a proxy for bookings and I'm wondering if you could give us a sense if there was a meaningful difference in the growth rate of your bookings versus your billings because of the duration dynamic?

[Mark Sachleben:]

We're not going to give guidance on that or talk about those specifics, but we -- as I mentioned, we look at our billings -- our current billings did go down Q2 last year and then resumed its increases for the rest of the year. And I don't I want to get into the details of specific billings or bookings metrics.

[Jesse Olson:]

Understood. Thank you.

[Operator:]

Your next question comes from the line of Steve Ashley from Robert W. Baird. Your line is open.

[Steve Ashley:]

Well, if the risk of being -- I'm going to ask it for the ninth time and just to try to say this as plain [ph] as I can, were the bookings in the quarter consistent with what you had expected?

[Mark Sachleben:]

Folks don't give up.

[Steve Ashley:]

No, we just keep coming.

[Mark Sachleben:]

We -- I'm not sure how else to say it, but when going to the year, we talk about -- we put a plan out -- the team puts a plan out about how we expect to see the growth coming from new accounts and expansion of our business, we don't forecast billings or bookings, we don't comp our sales team on billings or bookings. But what I can say is that we're very pleased that for the seventh quarter in a row, every quarter since we've been public, we've been able to beat our guidance and we've raised our guidance for the year. And so I think that speak for self in terms of how we're doing.

[Steve Ashley:]

Well, thank you. And thank you for your patience; I'm just doing that again. And then obviously for Lew, I think I ask standardization question. You land and account I'm assuming they have a legacy application performance management vendor somewhere else in the organization. You start to grow your presence legacy vendors there. What are the benefits of standardizing on a single vendor across the company and how much pressure is there on organizations to make that decision?

[Lew Cirne:]

Well, so my perspective on it is we typically are brought in on new customer facing digital initiatives that require not just traditional application performance management, which is an important product, but also visibility is the customer experience and now with New Relic Infrastructure, we believe it will -- they will want to see the Infrastructure all in one place. These businesses are under tremendous pressure, their lives are changing dramatically. So, the Infrastructure is changing. They are moving from hosted to cloud, the technology sector changing. They're going from monolithic applications to service at oriented applications and the timeframes are shrinking. They have to do more with less and they have to do it would typically often with fixed or shrinking budgets. And so why on earth would you try to put visibilities that kind of environment or standardize on something on premise. They don't want to be in business of managing their management systems. So, we feel like it’s a straight forward conversation to have with our customers. They have had success with us in digital. A typical customer will have success with us in digital and they will say why are we overspending on this on premise stuff that hasn’t kept up with where our company is going. And so the pace at which customers come to us with that conversation varies depending on the nature of the company and their vertical. If you're in media, that's been happening very rapidly, because media has to move to digital and is becoming the business strategy. Other verticals are coming along actually more recently, like we're seeing insurance companies come to us starting off with small projects, but moving to standardization decisions. So, we think that the trend certainly favors us. But by vertical it may come fast or slowed within a single account.

[Steve Ashley:]

Okay. Thank you.

[Operator:]

Your next question comes from the line of Brent Thill from UBS. Your line is open.

[Brent Thill:]

Good afternoon. Mark I just want to understand -- just reconcile a few comments here. Lew mentioned your -- the enterprise business is turning to be the largest portion of the business. And I realize maybe it's not quite there yet, but when you talked about contract durations, we typically see as you get more enterprise contract duration tends to go a little longer in most the companies that we've all covered. So, I think we're just trying to reconcile why that move upstream you're seeing contract durations not really moving? I think you maybe said that they were contracting a little; can you just give us a sense of what is the duration right now? I would assume you would see that lengthen as you get more enterprise level relationships or am I not thinking about this the correct way?

[Mark Sachleben:]

Well, Lew did make that comment and hat comment is accurate in terms of our business is more toward the enterprise. Q4 last year, I believe, for the first time, our enterprise business exceeded our -- incremental business in the quarter, enterprise exceeded SMB and that has continued for the past couple of quarters. We think that trend will continue. On the other hand, when you look at the install base we have and when enterprise is going to be half or -- it takes a long time for the enterprise percentage of our installed base to increase in spite of the fact that every quarter, it might be exceeding SMB. I think the last time we talked about this was at the end of Q4 and we said enterprise was about 40% of our business. That's going up, but it's going to take some period of time, a year or two before enterprise gets to 50/50 and then goes -- migrates more from there. So, the impact takes time given the install base that Jon talked about. The duration that we give is the duration of all the contracts and all the customers in our install base, not just the ones we build in that quarter. And so, I think if we look at the quarterly number, those numbers are much more viable in any given quarter, the durations could go up or go down fairly meaningfully, but it takes time for the duration to change and what we are seeing is we do see enterprises with generally speaking longer durations and they will generally spend annual upfront when they commit to a new deal. So, they come into as a new customer, still commit to an annual upfront deal. But as I talked about when they do an expansion deal, if that expansion deal happens, you have in done the quarter which does not align with their renewal date, they will often just bill -- or you just -- it will invoice for just the period that gets them to that renewal date. So, if you think about all the expansion business we do in a certain quarter, much of that is quite a bit less than a 12-month duration because they're just doing the stub [ph] period to get to their renewal date and then at their renewal date, they will align and that will be invoiced with the rest of the their purchase. So, that's the real point at which that business will become or that expansion business will become a 12-month duration contract.

[Brent Thill:]

Okay. I think we're just all trying to reconcile on subscription recurring model deferred being down sequentially is something we don't usually see. So, I think we're all just trying to figure out how that plays in. One other quick one for Lew and Hilarie just on the new cloud pricing model, do you anticipate this to be the primary way that you go to market him on pricing? And Lew does that tie in how -- I was unclear how you're going to place Infrastructure, is that also going to be priced on that methodology as well?

[Lew Cirne:]

Yes, we will price Infrastructure on cloud pricing or traditional host pricing. Some customers still like host pricing. It's just how they are used to doing business with us. And they want to stick with us. So, I think it's fair to say we will pursue both. But that -- everything we've seen our strength and taking infrastructure market has met or exceeded our hopes and expectations. And so we feel like we need to be more aggressive with positioning in front of customers, because we think it will turn to more consumption when -- especially when the customer is in a cloud environment.

[Brent Thill:]

Thank you.

[Operator:]

This wraps-up our Q&A session for today. Mr. Jonathan Parker, I turn the call back over to you.

[Jon Parker:]

Thanks again for everyone joining us today. Just I want to quickly remind everyone that we'll be hosting FutureStack next week in San Francisco and as Hilarie mentioned earlier, we're also hosting our Annual Analyst and Investor Day on Wednesday afternoon. If you're interested in attending, please reach out to us at ir.newrelic.com and we'd love to see you there. So, thanks everyone and we'll talk to you soon.

[Operator:]

Thank you ladies and gentlemen. This concludes today's conference call. You may now disconnect.