New Relic Inc (NEWR) 2017 Q2 法說會逐字稿

Good afternoon. My name is Christine, and I will be your conference operator today. At this time, I would like to welcome everyone to the New Relic second-quarter FY17 earnings conference call.

(Operator Instructions)

Thank you. Jonathan Parker, Senior Director, Strategic Finance and Investor Relations, you may begin your conference.

Thank you.

Good afternoon and welcome to New Relic's second-quarter FY17 earnings conference call. Today's call is to provide you with information regarding our second-quarter FY17 performance in addition to our financial outlook for the third quarter and full FY17.

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 in evaluating ongoing operating results and trends. Note that these measures should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP.

Reconciliations between GAAP and non-GAAP metrics for our reported 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 to 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 www.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.

Thanks, Jon.

We are pleased to deliver another quarter in which both revenue and profitability exceeded our expectations. Revenue, at $63.4 million, was up 48% year on year, led again by our enterprise business, which remains our fastest-growing area.

We also continued 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 FY17 outlook.

Beyond the actual and 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 the highlights 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've continued 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 transactions and now count more than 400 customers spending more than $100,000 per year, almost triple where we were at the closing of our IPO less than two years ago. Additionally, we saw several more customers cross through the $1 million per year spend threshold and now count over 20 in total. This is up well over 100% year on year and compares to the two that we had at the time of the IPO.

While these 20-plus $1 million relationships help 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 others in the SMB portion of our Business, who we believe can also reach the $1 million annual spend 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 a 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 used 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 levels across all public peer place 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 startups born digital to the largest enterprises in the world in the midst of digital transformations.

While we continued 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, The North Face, and Timberland, we also saw a 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. 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, they are more and more often turning to New Relic. As developers, IT operations professionals, and line of business owners increasingly collaborate to drive the joint success of their companies' 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 optimize our customers' digital experiences. This is a significant, sustainable, competitive advantage that we have versus traditional on premise vendors, who are blind and in a silo, unable to process or share these connections. Next week you will hear us talk about this, and how we are uniquely positioned to leverage machine learning and the trillions of events our users collect using New Relic each month to drive an even more powerful customer experience.

I wanted to finish my prepared remarks discussing the progress of our innovation efforts, which has 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 a 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 1500 of our customers requesting access.

Today I am 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 expanded data monitoring for the 12 most popular Amazon Web Services components including CloudFront, DynamoDB, EBS, Elastic Cash, 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 FY18. My enthusiasm about our position and the opportunity ahead of us has never been greater.

With that, I will turn it over to Hilarie.

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. Third, New Relic, having been born in the cloud and not migrated there, is well established as a visionary leader in the market. We are 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 will talk about this in more detail next week at Investor Day. We believe these new customers are critical in helping fuel future growth and should help drive much of the expansion activities we have 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 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 were super excited to add Pokemon to the New Relic family, helping them respond to the incredible demand for their blockbuster Pokemon GO app. In India, we're 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've talked a lot about our enterprise business, we continue to profitably grow our SMB business. 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 initiative cuts across all types and sizes of companies, and we are pleased to see continued success in our SMB business. Among other companies, we were pleased to expand our relationships with HubSpot, WeWork, and Casper Sleep.

Next week at Investor Day, we will host a customer panel where you will have a great opportunity to talk to some of our customers. So we are 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 will 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 leveraged 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 expand our addressable market, advance New Relic's 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 are very excited to bring New Relic Infrastructure to market faster than previously announced. Market indications 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. Given our subscription model, we expect a more material impact from New Relic Infrastructure in FY18. 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.

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 in 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 continued to grow, reaching approximately $17,750, up 31% year over year and 4% sequentially. As we mentioned last quarter, we continue to expect the 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 from our customers and actual closed deals support this thesis.

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 the seven-figure deal that Hilarie mentioned. Our dollar-based net expansion rate in 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 than 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've been putting increased emphasis behind bringing in new customers to the franchise, given the attractive long-term economics we will talk more about next week at our Investor Day. We are pleased that the percentage of our bookings coming from new customers increased for the second consecutive quarter.

Turning to our geographic split, US revenue of $42.9 million for the quarter was up 49% year over year, while non-US revenue for the quarter grew to $20.5 million, up 45% year over year. Non-US revenue represent 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 and 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 reported as a public Company. This is up from 81% in both the year-ago period and last quarter. We did have some timing benefits, including a couple significant data center purchases that will be more backend loaded in the fiscal year than previously expected. We do now expect gross margin to be between 81% and 82% for FY17, 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 year and $27 million in the same quarter last year. As discussed on prior calls, the sequential increase was actually a bit higher than in the past two years, given our new, local, FutureStack events held in Q2. We continue to meaningfully 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 a loss of $9.8 million last quarter and down meaningfully from $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 spend 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.

Turning to our balance sheet, we ended the second quarter with $197.3 million in cash and cash equivalents and short-term investments, a $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 install 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. 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 use 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, returned to an outflow of $7.6 million as our office buildouts started to ramp. We continue to expect to generate positive cash from operations for the full year, but negative free cash flow unchanged from our 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 close to breakeven in this quarter, as we recently made some significant multi-year 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 FY17 and the fiscal year as a whole. We are initiating our outlook as follows.

For the third fiscal quarter ending December 31, we expect revenue to range from $65.5 million to $66.5 million, or a growth of 37% to 39% year over year. We expect a non-GAAP operating loss of $7.2 million to $8.2 million. This would lead to non-GAAP net loss per share in the range of $0.14 to $0.16 based upon a weighted average share count of 52.4 million for the quarter.

For the full FY17, we now expect revenue to range from $255 million to $258 million, a growth of 41% to 42% year over year. We expect a non-GAAP operating loss of $30.5 million to $32.5 million. This would lead to a non-GAAP net loss per share in the range of $0.58 to $0.62, based upon a weighted average share count of 52.2 million. We remain confident in our ability to achieve non-GAAP operating income of breakeven and sustainably positive free cash flow no later than the March 2018 quarter.

With that, we're happy to turn it over to your questions.

(Operator Instructions)

Sterling Auty from JPMorgan.

Yes, thanks. Hi, guys. Want to start with Infrastructure. You talked about it [Tam] expanding and the new entry point into customers. Is it also a different buyer that you need to focus on? What's going to be the sales strategy to execute on gaining traction?

Hi Sterling, it is 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 products today, and also through feedback from our beta program. So, one of the reasons why I am so excited about Infrastructure is I believe that it has the potential to attach very well without us needing to establish a relationship with the new buyer.

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 at this quarter?

Sure. I know it has been confusing. We have been seeing a slowdown in the rate of change of the duration of the contracts. 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 shorter-term durations to longer-term durations, so we were getting a significant advantage of that in the back half of last year.

As we've come into this year, we're seeing that duration change, really slow down, and actually it's been fairly flat the last couple quarters, so that has been providing a headwind against our deferred revenue growth. When we look at the renewal base in 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.

All right, thank you.

Greg McDowell from JMP Securities.

Great, thank you very much. I wanted to ask about cloud pricing based on the commentary. It sounds like you are doing more and more deals, big deals, using the new cloud pricing option and some conversions from light customers. I was just wondering -- if you could just give us an update on the uptake on cloud pricing from both the existing install base who are converting to cloud pricing and maybe what net new customers are choosing to adopt from a pricing model perspective? Thanks.

Why don't I handle, Greg, the qualitative. This is Hilarie, and then maybe Mark can speak to the (inaudible). If you remember when we rolled out the cloud pricing option really three months ago, we had this goal of creating a drop dead simple price point that customers could easily translate for their cloud-based platforms that they were using, namely AWS, Azure, Google, etc. 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 on 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 customers 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 have trained the sales force.

Great. Thanks, Hilarie. And one follow-up for you Mark regarding the gross margin. As you guys highlight, you guys already have best in class gross margins by getting the 83%. It's even above sort of your long-term gross margin operating profile.

I guess as we think ahead, and I know there were maybe some catch up items -- but as we think ahead of other 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 to 83%? Thanks.

Fortunately, when Lew founded 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 have been able to add new products, we've been able to dramatically grow the customer base. Lew talked about the number of metrics we are collecting [in the] quarter and the increase. We have been able to do that and still maintain this great efficiency, so we're optimistic we'll be able to continue to do that to focus on it, and maintain a great margin. Long-term, we 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% -- 78% to 82% long-term margins.

Ittai Kidron from Oppenheimer.

Mark, I wanted to dig in again into the differed comments. You talked about how the duration of the contracts has been expanding, and that's been the driver for deferred revenue increase in the past, and now that's not happening.

I guess the question -- what is the risk that it flips actually upside down, meaning now that you've moved to this cloud pricing you billed per month, whereas before in the old [APM] pricing you had both monthly and annual. Is there a risk that more customers move into monthly and then deferreds start declining? How do I get my hands around that?

I should clarify that under our cloud pricing we still generally charge customers annually. At the low-end our customer base is -- they'll be monthly paying customers. The SMB business, they're cash sensitive, so many of those customers will come in and require that they pay monthly.

But at the enterprise level, our larger customers, they generally pay annually. And whether they are at cloud pricing or traditional host-based pricing, they continue to -- they will pay annually up front or perhaps semi-annually.

I just also would want to remind folks that what I said in the prepared remarks, our quarterly mantra about not reading too much into the deferred and the billings number, if you look at the last couple quarters, you look at our revenue growth in Q1, Q2 and what we've guided to in Q3, you can see that was quite a bit higher than our billings growth over that period, and so that's why we want to guard against reading too much into billings as an indicator of our business momentum.

Got it. 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 -- when you say infrastructure is this just server host monitoring at this point, or there is a broader set of infrastructure elements that are being monitored as well?

Let me start with productivity. We are really pleased with the productivity of our enterprise team, and 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 are still in that first half of the year that we characterize as being around new logo acquisition, and then moving into the second half where we will see more expansion. One of the places that we think we'll get expansion -- I will give Lew this sort of tee up -- is around the Infrastructure offering.

We are so excited to be releasing our Infrastructure product. If you think about where we were, we had an APM offering, we went to customer experience, and that IP [ops fire] that we are embracing and spending a lot of time with in 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 are super excited about what this means for the Company. And that is what is unique about this particular offering is we are calling on the same buyer that we have been calling on historically, but we have a much more complete offering for them.

And to your question about what it does and what makes it special, the nature of the problem has changed dramatically over the last few years. As deployments have moved to cloud and what has been a challenge of putting visibility into tens or hundreds of servers might be now putting visibility into thousands of virtualized servers or containers, and a large percentage of them may come and go as the normal course of operations.

So traditional alerting, traditional visibility tools that assume a small number of servers stay in place aren't well-suited to the needs of today's enterprise customer. But what's an even bigger point of differentiation for New Relic Infrastructure is tracking in real time to stay in configuration across all those servers.

Imagine, as many of our customers do, if a serious security flaw was exposed by an open-source package, New Relic Infrastructure will allow our customers to search across tens of thousands of 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.

Very good. Good luck, guys.

Ben McFadden from Pacific Crest Securities.

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 has expanded by 40%. I think it was you, Mark, that said it.

But just any color you can provide on maybe what type of 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.

I'm going to take it for Mark and then Mark can correct me as the numbers expert, but the reason why we are 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 with what our competitors and the rest of the 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 a smaller server.

And a lot of people, especially as they 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 rightsizing 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.

Okay great. And then, Mark, hate to hit on this point again, but I wanted to touch on the deferred revenue. I think the part about the deferred revenue that is confusing investors is the fact that it was down -- or the short-term deferred revenue was down sequentially. So just any additional color you can provide that gets us there?

I know you are going through -- you're not getting the same duration tailwind that you have seen in the past, but does the cloud-based pricing potentially hurt the relative amount that is 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.

Yes, no. I will say the current billings were down in Q2 last year as well. So I would point that out. And 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 are seeing is the larger -- the 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.

To get into a little bit of the details I understand because it's been -- the third time it's been asked, we see customers repeat purchases throughout the year. And if someone has got a year-end purchase, a renewal date say in December, if they do a deal in July or August, they are 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 hit the renewal date in December.

So there is a lot going on, and what we have said is -- what I 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.

This is Jon. I do want to be clear about one thing we do get some questions on. When we talk about invoicing duration being flat we are talking about our installed base duration. So we are not talking about what happens quarter to quarter, which to Mark's point about the [co-terminus] 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.

That is very helpful. Thank you.

Sanjit Singh from Morgan Stanley.

Hi guys, thank you for taking my question. If we get back to some of the seasonality trends and your view on the enterprise going forward, I think Hilarie rightly pointed out that Q1 and Q2 are typically, quote-unquote, land quarters. But we have seen a number of companies in the space and high growth status space start to hit some challenge in terms of expanding to the enterprise.

So I just wanted to do a gut check in terms of your view on enterprise spending in your customer base as we look to 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?

Yes, I think that's a great question. We really aren't seeing anything. If anything, we are 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 are 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 as a land and expand strategy because we partner with them, we give them a lot of advice.

We are 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 (inaudible) is a customer of ours. We've got people, as I mentioned, in all the election war rooms across the globe. We've got Cyber Monday and Black Friday coming up, we have healthcare enrollment periods both public and private.

So it's our season to work with customers, and we haven't felt any sort of negative sentiment in the market. If anything, we have 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, it really I think will 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 is so important to look at customer experience application performance and infrastructure monitoring as one experience for a company versus the alternatives today which is a bunch of fragmented solutions that they have to piece together.

On the competitive question with Infrastructure coming out in the next couple of weeks, you had some partners previously in that space and what do you see as 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 in your customer base with maybe more alternatives for both Infrastructure and application monitoring?

Great question, Sanjit. This is Lew. As we continue to broaden our product offerings, we are 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 are -- they struggle 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 and the application telemetry and infrastructure telemetry all in one place, and in particular our unique visibility 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've got a large number of 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.

Great. Thank you, Lew.

Michael Turits from Raymond James.

Great, Michael Turits. Thanks a lot guys. Good revenue numbers in guide. Question on the back half 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 do sign some of those larger deals? And I guess I would assume what you are saying is that duration should be continued to be flat in the back half, and if that is the case, should we start to see billings growth more closely aligned with revenue growth?

We don't specifically guide toward the net expansion rate or our durations. But when we look the last two quarters, we have been pleased as we've mentioned that the percentage of our business that has come from new customers has increased twice in a row. And going to the back half of the year as Hilarie mentioned, that is more of the expansion season.

I think it stands to reason that we will see a good result from a dollar base and that expansion rate. But that's also being affected by the law of large numbers. As the numbers go up that percentage is challenging to keep high.

We feel good about where we are from a business standpoint heading into the second half when we look at our pipelines and 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.

Okay, thanks very much, Mark.

Ryan Hutchinson from Guggenheim.

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

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 for the 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 of timing when you get new hires in and things. Hiring tends to slow down as you can imagine in the holiday period towards the end of Q3 and then pick back up again in January. But we expect it to be basically -- fairly consistent in increase from the Q2 level.

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

Jesse Hulsing from Goldman Sachs.

Yes, thank you. A couple questions. First, I guess for Hilarie. This is the second quarter or third quarter in a row where you have seen customers over $5000, then net adds kind of trend down.

I'm wondering if you could give us a sense of is that because there is more big customers and less of a focus at the low end? Is that seasonality? What is driving that?

Hey Jesse, this is Mark. I will take that one. What we are focused on is the quality of customer we get. And I don't want to say that $5000 line is arbitrary, but what we look at is we look at the quality of customers and we look at all sorts of threshold.

Not only $5000, we look at the customers paying us more than $10,000, $50,000, $100,000, etc, and what we are seeing is we're seeing nice, healthy growth across all those thresholds. And I think we talked about the number of customers now paying us more than $100,000, and that's gone up almost by a factor of three in under two years since we've been public. So we are seeing great growth in the high -- higher regions.

We're also pleased to see the nice increase year-over-year in the total net adds. It's close to 500. And so at any individual threshold for a period or two you might see some events that may stick out, or a little discontinuous, but when we look at the customer base across in all those thresholds, we feel like the business [momentum] continues to be strong.

Got it. And then back to the billings. I am wondering if you could -- because if that's where they're 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?

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

Understood. Thank you.

Steve Ashley from Robert W. Baird.

At the risk of beating a dead horse I'm going to ask it for the ninth time and just try to say it as plainly as I can. Mark, were the bookings in the quarter consistent with what you had expected?

Wow, folks don't give up.

No, it just keeps coming.

I'm not sure how else to say it, but when coming into 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 to billings or bookings. We don't comp our sales team on billings or bookings.

But what I can say is that we are very pleased that for the seventh quarter in a row, every quarter since we have been public, we've been able to beat our guidance and we have raised our guidance for the year. And so I think that speaks for itself in terms of how we are doing.

Thank you. And thank you for your patience with us doing that again.

And for Lew, I'd like to ask a standardization question. You land an account, I am assuming they have a legacy application performance management vendor somewhere else in the organization -- you start to grow your presence [with] that 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?

From 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 visibly is the customer experience, and now with New Relic Infrastructure we believe it'll also -- 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're moving from hosted to cloud. The technology [stacks] are changing. They're going from monolithic applications to service oriented applications, and the time frames are shrinking. They have to do more with less, and they have to do it with typically -- often with fixed or shrinking budgets.

And so why on earth would you try to put visibility into that kind of environment or standardize on something on premise? They don't want to be in the business of managing their management systems. So we feel like it is straightforward conversation to have with our customers.

They've had success with us in digital -- a typical customer will have success with us in digital, and they will say why are we over-spending 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 are in media that has been happening very rapidly because media has to move to digital is becoming the whole business strategy. Other verticals are coming along more recently, like we are 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 faster or slower within a single account.

Thank you.

Brent Thill from UBS.

Good afternoon. Mark, I just want to understand -- just reconcile a few comments here. Lew mentioned the enterprise business is turning to be the largest portion of the business. And I realize maybe it is not quite there yet, but when you talked about contract durations we typically see as you get more enterprise contracts and (inaudible) duration tends to go little bit longer in most of the companies that we have all covered. So I think we are 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 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?

Lew did make that comment, and that comment is accurate in terms of our businesses moving more towards 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 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 install 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 is about 40% of our business. That is 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 north 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 you looked at the -- if we look at the quarterly number, those numbers are much more variable. 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 up front when they commit to a new deal. So they come into -- as a new customer they will commit to an annual up front deal. But as I talked about when they do an expansion deal, if that expansion deal happens to get done in a quarter, which does not align with their renewal date, they will often just bill or will invoice for just the period that gets them to that renewal day.

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 are just doing the sub-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 their purchase. So that is the real point at which that business will become -- or that expansion business will become a 12 month duration contract.

Okay, I think we are all just trying to reconcile on the subscription recurring model; deferred being down sequentially is something we don't usually see. I think we're all just tried 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 on pricing? And Lew, does that tie into how -- I was unclear how you are going to price Infrastructure. Is that also going to be priced on that methodology as well?

Yes, we will price Infrastructure on cloud pricing or traditional host pricing. Some customers still like host pricing. It is just how they are used to doing business with us and they want to stick with us.

I think it's fair to say we will pursue both. But everything we've seen in our experience in taking Infrastructure market has met or exceeded our hopes and expectations, and so we feel like we need to be more aggressive with positioning it in front of our customers because we think it will turn to more consumption when -- especially when the customer is in a cloud environment.

Thank you.

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

Thanks again for everyone joining us today. Just wanted to quickly remind everyone that we will be hosting FutureStack next week in San Francisco. As Hilarie mentioned earlier, we are also hosting our annual Analyst and Investor Day on that Wednesday afternoon.

If you're interested in attending, please reach out to us at ir.newrelic.com and we would love to see you there. Thanks everyone and we will talk to you soon.

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