New Relic, Inc.
Q4 2016 Earnings Call Transcript

Published: 11 May 2016

[Operator:]

Good afternoon. My name is Andrew and I'll be your conference operator today. At this time, I'd like to welcome everyone to the New Relic Fourth Quarter Fiscal 2016 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 fourth quarter and full-year fiscal year 2016 earnings conference call. Today's call is to provide you with information regarding our fourth quarter fiscal 2016 performance, in addition to our financial outlook for the first 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, periodic SEC reports, a webcast replay of today's call, or to learn more about New Relic. Lastly, given it is our year-end call; we will be providing some additional one-time metrics today and publishing a supplemental earnings slide deck to our IR website shortly. With that, let me turn the call over to Lew.

[Lew Cirne:]

Thanks, Jon, and good afternoon to everyone joining us today to review New Relic’s fourth quarter fiscal 2016 financial results. Fiscal 2016 and Q4 in particular marked significant milestones for our enterprise strategy. I’m going to jump right in with some impressive highlights. In fiscal ‘16, we grew our new enterprise monthly recurring revenue over 90% and in Q4 added more enterprise new business than in SMB for the very first time. Coming into fiscal ‘16, we had four customers paying us over $1 million a year. And now, just a year later, we have 15, several of whom are paying well over $1 million a year and most are in multiyear commitments. In terms of the breadth, we now have over 350 customers paying us over $100,000 a year approximately 75% from 200 a year ago. All told, we now have over 1,500 total enterprise paid business accounts, and while we believe each of these can be a $1 million a year customer, only 1% are today, which could lead us to a $1.5 billion per year opportunity just in the existing installed base. And finally, as our Q4 dollar base net expansion rate hit a record 140% it was north of 170% in the enterprise. Overall this momentum helped us generate revenue of $181.3 million in fiscal ‘16, up 64% year-over-year. Yet even as we delivered this strong growth, we made tremendous progress with our operating models, once again delivering 1,000 basis points of non-GAAP operating margin improvement versus the prior fiscal year, well for the first time achieving positive cash from operations for the full-year. The progress we’re making is built on our focused vision and our execution against the key priorities that we share with all of you over the past year. Last quarter, we spoke about how our vision for New Relic is to be the first best place to look for companies to understand their digital businesses. Why is it so important to us? Because we’re seeing our customers going through a dramatic transformation, the world of IT operations professionals, software developers, and digital business leaders are becoming more complex and interdependent than ever. All of these constituents are trying to understand how their software that is their business is performing and to succeed, they need to collaborate in a way that has never been in the past. From the digital storefront, all the way back to the supply chain, businesses have a new way to assess their performance through all of the software and infrastructure that is at the heart of their operations. The result of this change is a demand for solutions that deliver well beyond what we think is possible from legacy, application performance management tools. We are removing the wall between developers, operators, and execs, to help our customers develop a shared understanding of their business. This results in hundreds of monthly active users as some of our largest customers which we believe provide these corporations unprecedented visibility into effectiveness of their digital experiences. That vision is defining our approach to the two priorities we stated coming into fiscal ‘16. One, continuing to execute on our multiproduct software analytics vision; and two, driving further success in the enterprise while extending our leadership position in SMB. We believe we succeeded on both fronts setting us up to gain further mind and wallet share in fiscal ‘17. From the perspective of developing our multiproduct software analytics platform we have seen very strong customer demand. I’m thrilled to be able to say that all five of our paid products had record quarters, as roughly 30% of new monthly recurring revenue added in the quarter came from non-APM products. Just two years ago, less than 5% of our new business came from outside of APM. Overall, over 25% of our customers now pay for more than one product. Importantly, even in transactions where a non-APM product is not part of the final purchase, we quite frequently see our non-APM product offerings as a deciding factor in that customer committing to a long-term partnership with New Relic. We often talk about New Relic insights in this regard and it has certainly been critical to our overall success this year and traction within the enterprise. We believe that with insights our customers can gain unparallel visibility into their own digital experience. I was recently speaking with a Fortune 20 IT Executive who expressed how Insights was a much-have tool for her, as she tried to understand why one of her largest customers is having trouble with one of their SaaS products. Whereas APM offerings report on application performance and help in aggregate to help diagnose technical problems, Insights helps our customers collect and report on everything that touches their software. It can uniquely surface and address individual customer problems in real time. We believe this capability has not only been a game changer for that Fortune 20 exec but also for all of our customers and prospects. I expect Insights as well as our other non-APM products to continue to play a major role in our growth in fiscal ‘17. But our work is not nearly finished, our customers have come to expect amazing innovation from us to help solve their most challenging problems and we will continue to be focused on meeting their expectations as we grow our product portfolio. As it relates to our second priority, the evolution of our platform is a key driver behind the markets increase in the number of large enterprises standardizing on New Relic. In fact, as I stated in the beginning, we grew new MRR from enterprise customers over 90% in fiscal ‘16 compared to the prior year and for the first time added more overall new business in the enterprise than in SMB in Q4. Overall, our enterprise businesses zoomed to more than 40% of our recurring revenue base as we’re seeing great success in our goals becoming enterprise standard at many of the largest companies across the globe. Companies like News Corp and GE and most recently Adobe which standardized on New Relic this past quarter. We increasingly see enterprises recognize the shortcomings of tools rooted in an on-premise or hosted approach including the inability to cost effectively scale a more limited depth of visibility into the customer experience and the lack of continuous innovation that a cloud solution like New Relic can deliver. As a 100% cloud-based multitenant solution, we are starting to see more companies choose New Relic not only for their forward thinking digital initiatives but also their core IT operations used cases throughout the rest of the enterprise. This recent trend substantially increases our opportunity and has led to larger deal sizes as we develop strategic relationships with CIOs. This was specifically the case in Q4 at a very large apparel manufacturer. We had previous won the standard to monitor this company’s billion dollar digital business but we were asked to compete for essential IT applications which help govern its mission critical payment processing systems. This IT environment is comprised of legacy framework and at the outset the IT team had non-premise bias for monitoring. Six to 12 months ago, we may have shied away from this opportunity given the greater focus on digital initiatives but we decided to pursue this opportunity to serve digital and IT together. This highly competitive evaluation we were able to quickly and deeply instrument their environment and demonstrate the value of our unique cloud architecture at scale. As a result, we won a seven figure deal in their corporate standard with more opportunities to pursue in the future. Hilarie and Mark will have more to say about our go-to-market financial priorities for fiscal ‘17 but from my perspective it comes back for a vision of being the first best place to look for companies to understand their digital businesses. This entails increasing our ubiquity in the market delivering even more innovation to our customers and becoming the trusted enterprise standard. Before turning it over to Hilarie, I want to also add how thrilled I’m to have announced last week that we added two highly experienced software veterans Sohaib Abbasi and James Tolonen to our board. These two bring rich experiences from Informatica, Business Objects, and Oracle, among other companies and I expect their leadership and expertise to be critical in helping us further scale the business. With that, I will turn it over to Hilarie.

[Hilarie Koplow-McAdams:]

Thanks, Lew. It was a really encouraging finish to the year with a number of first for the go-to-market organization, most notable was our enterprise new business outpacing SMB for the first time which I believe reaffirms that our investment in the enterprise segment is the right one. We saw over 90% growth in the number of six figure plus transactions for the year and we achieved a great milestone crossing through 1,500 enterprise paid business accounts. Overall, we now count over 40% of the Fortune 100 as customers and both our new and total enterprise business grew by more than 90% year-over-year in fiscal ‘16 increasingly driven by the type of standardizations that Lew mentioned earlier. We still see a huge opportunity ahead of us and given great returns we are seeing in our enterprise investments, we will continue adding meaningful capacity moving into fiscal ‘17. In the quarter, we saw new or add-on business with some fantastic enterprise companies including Cisco, Dunkin Brands, LinkedIn, Norwegian Cruise Line, Rakuten, and Unilever, clearly a diverse set of companies cutting across retail, leisure, tech, and CPG. Within SMB we had a great quarter in our mid-market business in particular once again breaking a record for our largest transaction to-date. In addition to this deal, we conducted business with great organizations like the non-profit Kiva, PointClickCare, and Xero among many others. Like past calls, we wanted to begin to a couple of examples for this quarter on how diverse companies are leveraging our platform. Lew mentioned a great standardization decision in Q4 of Adobe a customer we’ve mentioned on past earnings calls. Adobe is a poster child for migrating to the cloud going through a multiyear journey to read platform as a cloud first company. We were thrilled to expand our relationship with Adobe as it standardizes on New Relic to gain deeper visibility into the customer experience across its cloud offerings. Among the key differentiators we’ve heard from Adobe and other customers will benefit such as our true multitenant SaaS platform, breadth of platform coverage, and analytics first approach. Another customer we grow our partnership with in the quarter was Under Armour. Under Armour is a great example of a company committed to building innovative digital technologies to help drive its brand, mission, and growth. It wanted further insights and capacities beyond their home ground monitoring tool to scale with their speed of growth. As a result, they have turned to New Relic to help understand what was happening inside its e-commerce platform as well as its connected fitness applications recognizing our cutting edge language support and breadth of platform capabilities. Under Armour’s e-commerce unit is utilizing New Relic to help manage a rapid and complex migration from on-premise to a cloud-based infrastructure leveraging APM, Browser, and Synthetics, to help focus on creating and optimizing the ultimate customer experience for its engaged community of athletes. At Connected Fitness, New Relic is being used to help its engineering team rapidly innovate on new features and the end user experience and in the process satisfying current subscribers and driving new customer adoption. Lastly, I’m thrilled to talk about Concur another great win in the corner. Concur an SAP company joined the New Relic family this past quarter to gain better visibility into the business transactions of its private cloud-based services that make it simple to manage, travel, and spend. They’ve realized that their current solution would not suffice for the type and scale of data analytics that business required. Concur is now starting to leverage the entire New Relic software analytics cloud as its primary platform for optimizing top revenue generating applications and services like Concur travel and expense as well as trumpet. At the same time, they are gaining more visibility into end user experience by monitoring the entire stack from the customer to the supporting backend. We are so excited to be partnering with them. Last quarter, I spoke about a couple of our early priorities as we look into fiscal ’17. One of these was optimizing our current product offering to help expand our market opportunity. We introduced Essentials as a promotion in the middle of Q4 to help cost efficiently capture what our work had suggested is a more price sensitive Greenfield opportunity at the lower end of the market. We have been pleased by its initial traction and contribution towards bringing more customers into the New Relic franchise. As a result, we’re taking the promotional tag off as we begin fiscal ‘17. Looking ahead, we expect to continue various pricing pilots particularly as it relates to customers cloud-based environments where we recognize all hosts are not created equally. We believe there may be an opportunity for us to unlock an even greater TAM particularly in SMB through pricing that is better aligned to how companies run their applications in the cloud and which would be complementary to our existing host-based pricing. As it relates to other priorities in fiscal ‘17 within both SMB and enterprise we are starting to greatly increase our international presence but in a highly focused manner. We recently brought on a seasoned leader to run our European enterprise business and expect to significantly boost our capacity there this year as well as Australia where we just invested local headcount this year. We believe this added presence should help improve our coverage as we look to grow our existing relationships and bring new companies into our franchise. To support this growth, both domestically and abroad, we are continuing to evolve our marketing strategy and optimize our marketing investments. As an example for those fans of America's National Pastime, you might have recently seen our new agreement with Major League Baseball; I’m incredibly excited about this ground-breaking partnership with MLB which gives us the opportunity to share how MLBAM is leveraging New Relic on their mission to modernize the baseball experience for fans. Another meaningful initiative for us this year is deepening our partnership with Amazon Web Services. As we have said on past earnings calls, we believe the move to AWS and other public cloud vendors is a significant tailwind for our business. In FY ‘17, we will be working even more closely with Amazon, in fact, last month; we joined on to their AWS Global Summit Series which will visit more than a dozen cities around the world. We believe that New Relic is unique in delivering unparalleled visibility into on-premise and cloud-based workloads on AWS and customers are realizing how New Relic can make this transition seamless and provide multi-cloud and hybrid visibility in an increasingly heterogeneous IT world. To sum up, I’m thrilled with the progress, we made against our key initiatives in FY ’16. As we move into fiscal ’17, as Lew said, we remain focused on increasing our ubiquity in the market delivering more innovation to our customers and becoming the enterprise standard. With that, I’ll turn it over to Mark.

[Mark Sachleben:]

Thanks, Hilarie. I will start today by reviewing the results of our fourth fiscal quarter before offering guidance for our first quarter and fiscal ‘17. Turning to the financials, for our fourth fiscal quarter, revenue was $52.5 million, up 57% year-over-year, and up 10% sequentially. We ended the fourth fiscal quarter with 13,518 total paid business accounts. Of these, the total number of customers paying us more than 5,000 per year reached 5,887 up approximately 31% year-over-year. As such, our annualized revenue per average paid business account continued to grow, coming in over $15,700, up 37% year-over-year and 7% sequentially. As Lew stated, for the quarter we experienced a dollar based net expansion rate of roughly 140% the highest figure we’ve reported publicly to-date and which gives us confidence in a long-term payback of our investment in our go-to-market activities. While this continues to be an excellent indicator of strong customer satisfaction and the power of our model, we remain focused on improving the mix between new and existing customers and expect that rate to moderate back to normalized levels in Q1 fiscal ‘17. Having said that, we have over 1,500 enterprise customers and we do not believe any of them is fully penetrated. We continue to see success internationally in the quarter as our non-U.S. revenue grew to $17.1 million, up 53% year-over-year. Non-U.S. revenue again represents 33% of revenue in the quarter. Before moving to profit and loss items, I would like to point out that unless otherwise specified, all of the expense and profitability metrics I will be discussing going forward are non-GAAP results. A full reconciliation between historical GAAP and non-GAAP results can be found in our earnings press release issued today. Gross margin for the quarter was 81%, unchanged versus last year and last quarter. With regard to operating expenses, we continue to invest in our go-to-market teams across all segments of the business. Our sales and marketing costs were $33.8 million compared to $24.3 million for the year-ago period and $32.5 million in the third fiscal quarter of this year. R&D expenses were $12.5 million in the quarter compared to $6.5 million in the year-ago period and $10.5 million last quarter. R&D expenses were higher due to the expected timing of certain projects which impacted the balance of what gets capitalized versus expense in the quarter. G&A costs were $8.3 million in the quarter, up from $6.5 million in the year-ago period and $6.9 million last quarter. The sequential increase was largely attributable to office expansion related costs, the beginning of a new technology system implementation, and personnel related expenses. Overall our expenses in the quarter produced an operating loss of $12 million compared to a loss of $10.2 million for Q4 of last year and $10.7 million for Q3 of this year. This resulted in a negative operating margin of 23% in the quarter compared to negative 31% a year ago and negative 22% in the third quarter. Our net loss per share for Q4 was $0.24 based upon a weighted average share count of $49.6 million. This compares to a net loss per share of $0.22 based upon a pro forma weighted average share count of $47 million in Q4 of last year. Quickly running through our financials for the year, revenue was $181 million, up 64% over last year, gross margin was 81% unchanged versus fiscal 2015, operating margin was a loss of 23% versus a loss of 33% in fiscal ’15, and our net loss per share was $0.85 unchanged from a year ago. Turning to our balance sheet, we ended the fourth fiscal quarter with $191.3 million of cash, cash equivalents, and short-term investments unchanged from the end of the third fiscal quarter. Elsewhere on the balance sheet, our total deferred revenue grew to $74.7 million, up 156% year-over-year. As has been the case in past quarters, this growth was driven predominantly by the annual billing terms of our enterprise customers and also by some mid-market accounts changing from monthly to quarterly or even annual invoicing. As discussed previously, we continue to expect growth in our deferred revenue to meaningfully outpace revenue growth for the foreseeable future. However, while it is an indicator of the success we’re having in pursuing larger enterprise accounts, we do not currently view it as a key metric or a reliable indicator of our underlying business, due to the varying durations of our contracts and billing terms. In fact with our average invoice duration now at six months, up from 3.8 months a year ago, we expect that rate of change to begin to slow later this year, which could create some relative headwinds on our deferred revenue growth. Of note, our days sales outstanding adjusted for deferred revenue did increase rather meaningfully due to the timing of several larger deals and renewals closing in the quarter. We expect DSOs to return closer to historical levels in Q1, although given our traction in enterprise, we do expect DSOs to increase over time. Turning to cash flow, we generated roughly $1 million of cash from operations in the quarter, down as expected from the third quarter, but improvement from last year’s fourth quarter. Cash from operations for the year was a positive $4 million versus an outflow of $13.6 million in fiscal 2015. Now I will turn to our outlook for the first quarter of fiscal 2017 and for the fiscal year as a whole. We are initiating our outlook as follows

[Jon Parker:]

Thanks, Mark, and actually just before we start the Q&A a reminder for those of you who have joined the call late, we have a supplemental earnings deck available now on our IR website rehashing some of the key metrics from the prepared remarks since we did not go over a lot of them. So now we will turn it over to Q&A operator.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Sanjeet Singh with Morgan Stanley. Your line is open.

[Keith Weiss:]

Excellent, thank you guys for taking the questions, this is actually Keith Weiss sitting in for Sanjeet. Very nice quarter and very nice end to FY ‘16. When we look at the outlook for FY ‘17, I guess the opening question is how should we think about the balance between the initiatives to better target SMBs with some of the new pricing metrics and the ability to sort of reaccelerate customer base expansion versus the continued efforts to expand out sort of the size of the customers themselves. So I guess it’s like a price versus quantity equation. When we’re looking at what’s going to drive that growth in the top-line, how much of it comes from customer base expansion versus how much comes from improving the monetization per customer?

[Lew Cirne:]

Thanks for the question Keith, this is Lew. I will take that one; Mark may have his comments as well. First off, I think it’s great that we have a balanced business where we have got a healthy SMB business that we’ve had really since the company is founding and as evidenced by the metrics we shared our enterprise business is doing very well and growing very rapidly. So our SMB business is more mature now and we’re very pleased with where it’s at, it’s now profitable business for us and it’s continuing to grow nicely. And so we’re going to continue to develop that business. But as we look at the long-term unit economics we really like what we see in our enterprise business for example the dollar had expansion rate being so healthy in the enterprise segment. So that’s why we are investing the way we are in enterprise. So we want to see continued bounce in there, the SMB business is not only a healthy business for us but it also keeps a shelf in the product make sure it’s simple, I mean it keeps us kind of again just a view into where the rest of market might be going on SMBs offer or the first adopt technologies like cloud and other marketing standardizations.

[Keith Weiss:]

Got it. And if I could squeeze in a follow-up on that net expansion rate, you guys talked about 140% in that dollar expansion rate that's the highest that we've seen from the company. And it seems like part of the explanation is the shift with the enterprise business and these enterprises have a more wholesome net dollar expansion rate. So two kind of questions in that, one is that the primary driver why the net expansion rate is so high, and if so, why should it normalize back down if the business is shifting significantly towards enterprise or continue to shift towards enterprise?

[Mark Sachleben:]

Keith, this is Mark. The move to the enterprise is the primary reason the numbers gone up to 140 and that’s been driving that generally high over the last couple of quarters, and we’ve seen that shift. The enterprise is with our model the land and expand and standardize they come in and over time they love the product and they definitely expand and so we’re seeing great numbers there. I think coming into Q4 the end of our fiscal year, I think it’s a logical time to get a lot of expansion business in and then as we begin the beginning of the year and I think just the way with the -- with comp plans and the way we work as well, inevitably focus a little bit more on new customer acquisition in the first couple of quarters and then you crescendo towards the expansion deals toward the end of the year. So I think that has an impact on the numbers overall. And I just think, over time we do believe that number is going to we’re not going to continue accelerate the growth of that number like we have for the last couple of quarters.

[Keith Weiss:]

Got it. Excellent, it’s very helpful guys. Thank you.

[Operator:]

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

[Greg McDowell:]

Great, thank you very much. I want to ask about the impressive metrics around the non-APM products, could you just expand a little bit on whether or not you’re now able to lead with products like Insights even before APM and just talk a little bit about you mentioned a core of your customers are now paying for more than one product. As you think about FY ‘17 where that percentage of customers using more can -- where that number could potentially go. Thanks.

[Hilarie Koplow-McAdams:]

Greg, this is Hilarie, and I’m happy to take the first part of the question. What we see with customers is often they come to us with a question that falls squarely in the old APM space. And we quickly brought in the discussion with them to the performance of their user experience which is early our Browser offering or a Synthetics offering and then ultimately every time we get engaged with a customer, we talk about our Insights or analytics offering, and that’s really where we’re squarely winning these opportunities with customers because we can marry a performance experience through business outcome and that’s a big light bulb moment for our customers. So as it relates to why are we seeing the attach rate so high, I think they fully recognize and you hear in the stories that we’re telling about the standardization decision that we really have a platform that can make them more effective in their digital experience and so looking forward we expect that that rate will continue to grow, but every customer has sort of a season in which they progress across our platform. And so I can’t really predict if it’s going to accelerate. What I can tell you it’s resonating with the market as you can see from the very, very strong attach rates across each of the products.

[Greg McDowell:]

Great, thank you. And then one quick follow-up for Mark, I mean that your FY ‘17 guidance implies as you mentioned almost the third year in a row of 1,000 basis point improvement in operating margin, so obviously some clear leverage in the model. And I was just wondering as you think about the longer-term operating model of the business, if you’re thinking about potentially achieving that longer-term model faster than you originally anticipated when you went public. Thanks.

[Mark Sachleben:]

Sure. I originally I don’t think we’ve talked about when we a timeline to get to that model, but some checking a little bit. But we have aggressive targets out there, it will be the third year in a row which we have improved margin by 1,000 basis points and we continue to see good leverage in the model and so we’re going to continue to work toward that. We’ve talked about our cash flow and profitability outlooks for through fiscal ‘18 on the call. Beyond that, we’re not really going to talk much but we continue to be focused on growing the top-line, and at the same time, we continue to focus on improvements in efficiencies and improving the margin.

[Operator:]

Your next question comes from the line of Michael Turits with Raymond James. Your line is open. Michael Turits with Raymond James, your line is open.

[Michael Turits:]

Thanks, sorry, mute. Lew, especially I think talked about selling in the cloud and possibly some new price models there. So what do you think of the long-term economics of selling into the cloud. How are they different and how are you working through that with AWS?

[Lew Cirne:]

Well first of all we see AWS as an incredible tailwind for our business. Every time I meet with a Fortune CEO it’s a top of mind for them they are thinking about it strategically. And when they’re thinking about strategically at adopting cloud that forces them to reevaluate the tools that and the vendors they historically done business with have been geared towards on-premise world. So that’s great for us. And what we’re learning from our customers is that we should always be thinking about ways make it even easier to consume New Relic products and so Amazon is in particular has innovated a lot in that area and we’ve also seen Microsoft and Google present similar approaches to how they price. So we’re always thinking about ways to be easy and easier to consumer for our customers and the more friction we reduce in how you become a New Relic customer the better it is for our business over the long-term particularly for customers adopting a cloud where we really feel like we have a fundamental advantage.

[Michael Turits:]

Okay. And if I could get one other one in and sort of the other end of the spectrum, now I think this is among the pre-subs that you really spent a lot of time talking about I guess some of these word legacy displacement or core IT. What change there that you want to target that opportunity, what languages are you using that you’re monitoring and is Java and .NET and how are you getting in to that go-to-market and the economics any different?

[Lew Cirne:]

While it’s really exciting for us because it correlates with the larger deal sizes and certainly that’s evident in some of the numbers we have shared today. And how it comes about is over the last several quarters, we’ve been increasingly called into the standardization discussions. We’ve had so much success in digital initiatives often within the business units where we have hundreds of people using our product that we will get out that there is this great product called New Relic that they should consider for other workloads typically Java sometimes .NET and often in a hosted environment. And where we were a year ago was simply we were so early in developing our enterprise go-to-market force, we didn’t have the coverage to really fully address that opportunity and while we continue to go out that force, now we have enough coverage to say we’re going to pursue those opportunities particularly when we see the most standardization opportunities and we’re really pleased with our win rates. So by applying some focus and discipline where we’re tackling platforms like SAP or like IBM on the Java stack and having success doing that in concert with monitoring on other workloads that might be running in the cloud or on end servicing direct to consumer applications.

[Operator:]

Your next question comes from the line of Sterling Auty with JPMorgan. Your line is open.

[Sterling Auty:]

Thanks, hi guys. I also want to follow-up on the conversation you had about the win that included both digital and traditional IT. How much of that was multiproduct and the future functionality that you bring to bear versus was there any component that was really price sensitive and given your value proposition that that was key to the win.

[Lew Cirne:]

I wouldn't call price sensitivity, but I would call it compelling TCO advantage, I remember one standardization discussion where they had quickly concluded, they needed New Relic Insights and that big data approach and then when they did back with the math and how they might try it with an alternative solution became prohibitively expensive to deploy much less run and manage. So we do have a fundamental advantage with over that cloud approach. Insights plays a large part of it, but having the whole product portfolio is absolutely a key part of why we're winning in these standardization decisions. But is really what discounts many of the other players is just how far we are ahead in cloud environments, and which is increasingly critical to these customers and then they say well New Relic also did a great job with these on-premise and little bit older applications as well, so if they said nice sounds across the portfolio it's really resonating.

[Sterling Auty:]

Great. And you talked about --

[Hilarie Koplow-McAdams:]

If I could add a little bit --

[Sterling Auty:]

Sorry, go ahead.

[Hilarie Koplow-McAdams:]

Hello, I wanted to add a little bit of color to that. If you think about the digital experience where we were in a year ago that was where we were primarily playing as really a front office customer facing experience. What we've noticed is a lot of customers are savvy to the fact that their back office systems relate to that front office experience, and we really are the only providers that can marry those two systems. So when Lew if you think about these front office digital experiences you think about these back office systems, and then a shift to the cloud we’re really the only provider out there, that can provide full visibility to what is now the digital customer experience. And I think that's what gave us great advantage in these larger standardization pursuits and that's what the customer really recognize.

[Sterling Auty:]

Great, thanks. And I think just as a personal reference you talked about the profitability by segment SMB versus enterprise. Are you managing the two businesses along those structures and is that kind of dictating how you are allocating some of the sales resource obviously enterprise being core focus, but just curious if that's kind of mechanism you’re managing your sites.

[Hilarie Koplow-McAdams:]

Yes we've always thought about segment-based economics and really since I arrived at the company two years ago, and we saw the opportunity to look at the segment understanding there are different drivers, and different resource allocation models that play well. We've been really focused on our enterprise expansions of course the bulk of our resources, incremental resources have been focused there. But we also saw that we had some leverage points in SMB and we do manage them differently, we measure them differently, we think about lifetime value. But we have strong growth goals associated with each of these segments. Mark, anything to add?

[Mark Sachleben:]

No, I would say that certainly performs the way we invest and what we go after. Then we're -- we want to continue to grow both segments, we want to continue to grow the SMB segment in a profitable manner.

[Operator:]

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

[Greg Robinson:]

Great, thanks for taking my question. You have Greg Robinson on for Jesse Olson. To start I guess, you've talked a lot about Insights, but I’m thinking about what drove the sergeant up-sell activity in the quarter are there any other products that are doing better than others?

[Lew Cirne:]

What was great about the quarter from my perspective was that every product had a record quarter all five skews. And so, when we talk about the software and with this platform we were -- what we mean by that is the five products all built on a common platform database technology, all delivered by the cloud that work well together and leverage off each other. So if we don't think it makes sense to have one product to measure the customer experience of what's going on in the browser and then another product measuring it’s going on in the applications to tier in the backend, and then another product trying to make sense of it in real time in analytics. Like for example one of one of our customers is a travel company and they use Insights to look at ticketing activity second by second in real time seeing how many tickets are flowing through the site. And in the same dashboard they're showing how fast the page will burn how fast the server time is and they have proven beyond a shout of a doubt that for their business a slowdown in their application dramatically impacts their business in terms of ticket sales. So, the reason why all side products had a record quarter because these belong together on the same architecture and the same platform they belong from a cloud delivered SaaS architecture and that’s why we think we got such a strong advantage.

[Greg Robinson:]

Great and looking at the guidance for next year that 1,000 basis points of margin expansion. Sounds like you think that gross margins have stayed relatively flat and sounds like you also plan to continue to invest in R&D and sales and marketing but over the last two years sales and marketing revenues come down about a 1,000 basis points. Should we see the same kind of leverage in sales and marketing or you expecting most of the leverage be coming from G&A?

[Lew Cirne:]

I agree that the primary leverage will continued to be in the sales and marketing. So we want to continue to invest in R&D where we have been a product first company. We’ve talked about that a lot we expect to continue to be but we have some opportunities to improve in G&A but then primarily in sales and marketing.

[Operator:]

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

[Michael Turner:]

Hi, guys this is Michael Turner on for Brent today. Just to want to go back and talk a little bit about the sort of the customer ads I mean a lot of good metrics given on this call. We look at the -- we’ve talked a little bit about the deceleration and the customer ads as you add some more meaningful clients and focus on greater revenue generating opportunities. We look at the sort of the customer count remember greater than 5K you see a bit of a slow down there as well and may be 5,000 is not the right number now given the fact that the average revenue prepared now continues to go up. So just wonder if you can help talk through some of the puts and takes and what might be the right way to think about growth in customer ads and trajectory going forward.

[Lew Cirne:]

Well, first of all I really pleased with the customer ad number to quarter it was nice to see that number go up to 392 and it is nice that our customer is over 5K grew what is about 35% year-over-year. So those are all healthy metrics and you bring up a good point that our average -- our average spend per account is growing really, really fast. So this is just we pick the number 5,000 as a new metric entry as a while ago and quite frankly we were pleasantly surprised that how quickly average spend is eclipsing that. So who knows if it’s the right threshold in the long-term but that’s what we are reporting for the foreseeable future. I’d say we always need a healthy balance between cost effectively acquiring the right customers. The lighting them so that they acquire they continue to be customers and then increase our investment in New Relic while maintaining healthy gross margin those are the essential elements of building healthy business and we want to that in SMB and we want to do that in the enterprise. And so I think there is more work to be done there, I’m encouraged that that Essentials experiment we did last quarter certainly resonated with the low-end segment of the market that was a little more price sensitive, that’s not the last experiment we will run. So you can expect us continue to try new ways to reach more customers but its more on the lighting them after become customers that’s going to be the real key to our long-term success.

[Michael Turner:]

Great, thanks Lew, and then may be one from Mark. I appreciate the color on the deferred revenue I know that’s been the tough one for us to model. Just I wanted to sort of revisit you talked about potential for slowdown as we progress through the next year and just a little bit more if there is anything on that size of the customer base that remains on monthly billings and how much we might see of a transition there so.

[Mark Sachleben:]

Well we’ve talked in the script about our new business, earlier text about that going and its close little bit around six months now. So I think there is still room to go in terms of getting that up from six months and that will still have an impact on growing deferred but obviously the slowdown will continue or will continue to happen and we’re getting the point where we’re more mature our enterprise deals generally come in with an annual upfront payment term which is great. But in the low-end we still have a lot of customers that pay monthly and so there will still be quite a mix. We are migrating more towards the annuals but and as I said I think that six months is going to increase but certainly is not going to up another 2.5 months like I did in the last year.

[Operator:]

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

[Ryan Hutchinson:]

Okay great that actually was one of my questions on duration, so that makes sense. I guess shifting gears you spend a lot of time in your prepared remarks talking about doing more business in the enterprise versus SMB. Can you provide a little more color there in terms of how much more it was and then what the expectations are for the split between the two as we look out 12 to 24 months? And then I have a follow-up.

[Lew Cirne:]

We are very pleased with the investments we’re making in enterprise and paying off and as we talked about for the first quarter ever we had a greater incremental contribution in the quarter from enterprise than SMB. And enterprise has grown year or so is 34% to 35% range we mentioned that it was about 40% last quarter. So we expect that to continue to increase over time we think that's going to be more than half our business, but we're not putting an explicit timeframe on that.

[Ryan Hutchinson:]

Okay. And then may be just as a follow-up to that the 1,500 enterprise customers talking about them not being fully penetrated. What percent do you think could become fully penetrated in the timeframe there?

[Lew Cirne:]

Well the timeframe is really hard to predict, and if we could I don't know how much we disclosed today. But I think a million dollars here is a small price to pay to ensure your digital business initiatives are successful. I mean you think about what’s the competitive advantage of a modern bank today, is the quality of the mobile experience. Right? You want to measure everything about that and all your other software offerings. So I don't think of a million dollars a year of peaking out of an account and in fact our average spend for our top 15 customers that's been one million a year it’s well above million a year. So that's why I believe we've got, we've got work to do to make sure our customers understand that full value and we got deliver it, and we can't take that for granted it's just going to happen. But that opportunity is in front of us, and we're going to pursue it.

[Ryan Hutchinson:]

Okay. And a quick clarification the CapEx is going up quite a bit more than double year-over-year. Does that trend back to more normal levels in ‘18 just for modeling purposes and free cash flow?

[Mark Sachleben:]

Yes, we generally expect that will happen.

[Jon Parker:]

And this is Jon, one thing I did want to point out because we have got a couple questions that guidance for CapEx does exclude capitalized software cost, so the $32 million to$34 million is property and equipment does not include capitalized software, just to be clear.

[Operator:]

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

[Ben McFadden:]

Hi guys, thanks for taking my questions. I want to start with you mentioned on the call that you’re having success on sort of the backed IT systems. I want to kind of start with a question on a follow-up to a topic I was brought up at the Analyst Day, I think actually by Jim regarding a fourth of the users being from IT operations and a fourth of the users being business are executive users. Just kind of bigger picture as we look out a year, how much of new book do you think would potentially be coming from these two other categories?

[Lew Cirne:]

That's a good question. I don't think we’re prepared to give numerical guidance for that, but the key thing is all three of these constituents matter and they all need to be served by the same product. And what's different in our business today from say a year ago was how well our story is resonating with the IT ops team. And I think that what that correlates with how IT ops, is now recognizing cloud as an opportunity not a threat. And so now they're getting excited about how they can be more strategic for their company by really making their adoption quite successful. And so now they're -- they're interested in vendors and technologies that helps their cloud adoption strategy derisk it, make it more successful, make it work faster and better. And so that mindset change in our culture base is clearly with more focus in our end delight that constituent because they've got the hard job and a lot of hard work to do, and they also happen to have pretty healthy budget to allocate to being successful.

[Ben McFadden:]

Great. And then Mark, just a question on the model here, you’ve mentioned, you guided to positive operating cash flow for the year, but you said it could be volatile from quarter-to-quarter, just you had two straight quarters of positive operating cash flow, just kind of how should we think about linearity of cash flow throughout the year especially given the fact of the larger duration of kind of the deals that you’re entering into the bigger deals that you’re entering into.

[Mark Sachleben:]

Generally speaking I think the first half will be little bit more volatile than the second half. I think in general you can assume that it should be going out over the course of the year; I think the biggest volatility come in next quarter or so.

[Operator:]

Your next question comes from the line of Scott Zeller with Needham. Your line is open.

[Scott Zeller:]

Hi thanks, two questions. First is a housekeeping, I think you mentioned on this call that you ended the quarter with 350 customers paying over $100,000 per year, was there a number given last quarter for over $100,000 paying customers?

[Mark Sachleben:]

No, we’ve given that periodically but we did not give that last quarter.

[Scott Zeller:]

Okay.

[Mark Sachleben:]

It’s over 200 at the end of over at the end of last -- at the Analyst Day I think we said over 300.

[Scott Zeller:]

Okay. And the second question was regarding the -- there have been a few comments about going after sort of legacy on Prem type displacements. I guess the question is, is it inevitable that this happens because you’re moving upstream, you’re doing more enterprise work, it’s probably very hard to avoid that; is that correct?

[Lew Cirne:]

Well in respect of opportunity, we’re getting pulled into. So we feel like it lines up well with our products and our product strategy and it’s leveraging the great work we’ve done and it’s a nice adjacency. What was missing from our -- the missing piece of the puzzle really was coverage and focus in the field and when we saw these CIO driven opportunities coming into our pipeline, we decided to pursue these opportunities. So inevitable is the strong word but we’re excited about that opportunity and we think it’s another element of our growth opportunity.

[Operator:]

Your next question comes from the line of George Iwanyc with Oppenheimer. Your line is open.

[George Iwanyc:]

Thank you for taking my question. Just following up on the enterprise collections you’re seeing. Are -- can you give us an update on the competitive environment and whether you’re seeing more pushback from the traditional vendors there and any update on type of pricing you’re seeing?

[Lew Cirne:]

The composition of the competitive landscape is really unchanged as if the frequency with which we see a given competitor. As a reminder from what we’ve said in the past, 90% of the transactions we do, do not have a listed competitor. But as you can imagine the larger the deal size the more attractive that is to multiple vendors and so it’s an increasing portion of the large deals we see. And what I’m really encouraged by is the trajectory we’re seeing in our win rate and our confidence to compete for any deal really. And in the case that we cited with an IT operations team that came in with a bias for on-premise where we quickly demonstrated how much more powerful our SaaS delivery was and how no other provider whether they claim SaaS or didn’t, really could come close to doing what we did particularly on the analytics side. That’s an encouraging trend for us and so we like how we’re competing right now but we’re never done with that. We -- might -- the goal on bringing up to New Relic is we want market dominating product that we’re going to be delivering this year. So we have got a lot more work to do because you could never take anything for granted.

[Operator:]

There are no further questions at this time. Thanks again for joining us today and this concludes today’s conference call. You may now disconnect.