New Relic, Inc. (NEWR) CEO Lew Cirne on Q1 2019 Results - Earnings Call Transcript

New Relic, Inc. (NYSE:NEWR) Q1 2019 Results Earnings Conference Call August 7, 2018 5:00 PM ET

Executives

Jon Parker - Head, IR

Lew Cirne - Founder and CEO

Mark Sachleben - CFO

Analysts

Robert Majek - Raymond James

Derrick Wood - Cowen & Company

Gray Powell - Deutsche Bank

Ugam Kamat - JP Morgan

Jennifer Lowe - UBS

Sanjit Singh - Morgan Stanley

Greg McDowell - JMP Securities

Kevin Kumar - Goldman Sachs

Steve Koenig - Wedbush

Jack Andrews - Needham and Company

Rishi Jaluria - D.A. Davidson

Operator

Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the New Relic First Quarter Fiscal Year 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Mr. Jon Parker, Head of Investor Relations, you may begin your conference.

Jon Parker

Thank you. Good afternoon, and welcome to New Relic’s first quarter fiscal year 2019 earnings conference call. Joining me today are New Relic’s Founder and CEO, Lew Cirne; and 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 projection 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 our earnings release issued today, as well as the risks described in our most recent Form 10-K 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. But 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 release issued today. At times, we may offer incremental metrics to provide greater insight into our business or results. This additional detail may be one-time in nature and we may or may not provide update in the future on these metrics.

I encourage you to visit the Investor Relations section of New Relic’s website to access our earnings release issued today, a presentation that accompanies our earnings release, periodic SEC reports, a webcast replay of today’s call or to learn more about New Relic.

And with that, let me turn the call over to Lew.

Lew Cirne

Thanks, Jon, and good afternoon to everyone joining today’s call to review New Relic’s first quarter fiscal 2019 financial results.

We had a strong start to the year with Q1 revenue of $108.2 million, up 35% year-over-year and non-GAAP operating income of $8.7 million, both of which exceeded our guidance ranges. My thanks to the 1,400 Relics who worked tirelessly to help deliver these solid results.

As we shared during our recent Investor and Analyst Day in June, our vision is to be the dominant DevOps platform that companies of all sizes use to monitor, manage and operate their digital applications and systems. Today, every organization needs to increase its pace of technical innovation, whether it’s by migrating to cloud, delivering compelling digital customer experiences or adopting DevOps methodologies. Our customers are all on a mission to move faster. By definition, this means increasing the rate at which they introduce change into their production environment, resulting in more organizational and technical complexity as well as higher levels of risk.

New Relic empowers forward-thinking organizations with the visibility and the data they need to overcome this complexity, reduce risk and increase their speed of innovation. This ultimately helps these companies improve business outcomes, including driving revenue, increasing productivity and building brand value.

We’re viewed to an integral part of the technology value chain for teams who are tasked with creating and releasing software into production without disruption. These developers, operations professionals and business executives are focused on three critical technology initiatives to drive their digital transformation. The first, cloud adoption to enable teams to have more autonomy in scaling their infrastructure; second DevOps to offer teams greater agility to deliver products to market; and third, delivering a flawless digital customer experience.

By aligning our go-to-market efforts with these foundational components to digital transformation cloud, DevOps and digital customer experience, we are driving larger deals with broader product adoption.

In Q1, the percentage of new ARR from non-APM products remained near the record levels from Q4, with New Relic Infrastructure contributing its strongest ever percentage of new business. Impressively, after just 18 months in the market, New Relic Infrastructure has already become our highest attaching product. In our view, this reflects the pent up demand for the unification of application and infrastructure performance data in a single pane of glass. Having said that, while the speed is incredibly encouraging, we still see our customers at earlier stages of adoption for this product and we have meaningful runway ahead.

Part of our confidence stems from the conversations I have with companies across the globe, who are increasingly focusing on how we can help them instrument a broader portion of their environment. As we have highlighted before, Gartner estimates that only 5% of application workloads are currently monitored by any APM products, but that this could grow to 20% by the year 2021. While we see our addressable market as much higher than just the APM portion, given the breadth of our platform, we do believe this helps underscore the immense opportunity we see in front of us.

From a go-to-market perspective, it was a solid start to the year as enterprise ARR grew to 55% of total ARR, while both our enterprise and SMB businesses have their best ever Q1s. Underscoring this momentum, in Q1, we signed our largest ever federal deal, as well as our largest ever SMB deal, both seven-figure ARR transactions.

One of the most exciting customer stories from the quarter was with Epic Games, developers of the smash-hit phenomenon Fortnite. I don’t know a single parent that I talk to that doesn’t have a child who is obsessed playing this game. It has truly taken the country and dare I say, the world by storm.

Now, if you have young adults in your household, I know I don’t have to tell you about Fortnite, it’s one of the most popular and fastest growing online games in the world today. It launched a year-ago and now has a stunning 125 million registered players. Hosted in Amazon Web Services, they’ve have had to scale quickly while maintaining reliability of a rapidly growing infrastructure. Epic Games relies on New Relic to support the global operations of Fortnite, utilizing New Relic APM to understand the health of their services. They are also focused on optimizing and enriching the user experience of their players, working closely with New Relic to achieve these outcomes.

Now, I bring up the story, because it exemplifies the challenges facing so many of our customers. Every company today needs to ensure that their digital systems can stand up to their busiest days, because that’s when your customers are counting on you the most. We believe that instrumenting that scale required by modern businesses can only be achieved in the cloud, in part because it would be cost prohibitive to stand-up and process this much data inside your own data center. I’m confident that if we can scale up to Fortnite’s needs, there isn’t an enterprise in the world that we can’t service, and we’re just getting started on this mission.

And speaking of happy customers, we’re thrilled that New Relic was recently recognized as a Gartner 2018 Peer Insights Customers’ Choice for Application Performance Monitoring Suites. Peer Insights is Gartner’s online platform of ratings and reviews of IT software and services that are written by IT professionals and technology decision-makers, designed to help IT leaders make more insightful purchase decisions. And as of last week, New Relic has received the highest score for this distinction in the market.

This recognition from our customers matters deeply to me. Since the founding of New Relic, my priority has always been on delivering a flawless end user experience for our customers, our end-users, the people who work every day to make sure their systems are running at peak performance. For too long, our industry was ripe with expensive and hard-to-use products that only a couple of people in enterprise could actually use. New Relic prides our self on our ubiquity throughout our customer base, meaning how widespread our software is adopted across the teams responsible for building and running modern software. Our most successful customers have hundreds and sometimes thousands of users who get value out of our platform. Our job is to make our category a joy to use.

To maintain the pace and high win rates needed to realize our win the cloud strategy, become the DevOps platform, we continue to deliver innovations across our product platform. Over the past few months, we’ve launched deep support for Kubernetes and mostly recently last week distributed tracing. We continue to be focused on making it an no brainer to deploying New Relic everywhere in modern environments. Our teams are hard at work and we expect to have some exciting announcements throughout the fall at our FutureStack event series.

Earlier this year, we celebrated our 10-year anniversary as a company. And while we’re still early in our journey, we continue to see strong demand for our unified platform from companies looking to modernize their digital business. We had a great start to fiscal ‘19 as evidenced by results I just shared.

And now, I’ll turn it over to Mark to run through additional numbers.

Mark Sachleben

Thanks, Lew.

As a reminder, during today’s call, our first quarter fiscal year 2019 financial results are presented under ASC 606, which we adopted using the modified retrospective method. To help aid with comparability versus the prior year’s results under ASC 605, we included a reconciliation table in the earnings press release and investor presentation accompanying today’s call, which is available on our investor relations website.

Now, turning to the financials. Revenue was $108.2 million for the first quarter, up 35% year-over-year. We ended Q1 with 748 paid business accounts paying more than $100,000 per year, up 35% compared to a year-ago and an increase of 45 from the prior quarter, our best ever Q1 performance. The growth of this figure represents both new logos and customers expanding beyond that threshold.

Overall, our total paid business accounts remained over 17,000, relatively flat form last quarter past. As we’ve discussed the past few quarters and in particular at our recent Analyst Day, we are programmatically focusing more of our resource, both up market and our expansion business given the significant opportunities we see here. We are pleased with the early results of this focus, which are reflected both on our 100K ARR paid account additions and continued paid account growth.

Our dollar based net expansion rate in Q1 was 118%, which increased 6 points from the year-ago figure and also reflects our current strategic efforts to focus more on our installed base. Given the expansion of our base over the past year and Q1 typically being the low seasonal point for this metric in the year, we are particularly pleased with this result. At the end of Q1, our enterprise business was approximately 55% of annualized recurring revenue, up from around 49% in the same period last year.

Turning to our geographic split. U.S. revenue of $74.1 million for the quarter was up 35% year-over-year while non-U.S. revenue for the quarter grew to $34.2 million, also up 35% year-over-year. Non-U.S. revenue represented 32% of revenue in the quarter. Before moving to profit and loss items, I would like to point out that unless otherwise specified, all the expense and profitability metrics I’ll be discussing going forward are non-GAAP and as reported under accounting standard ASC 606. A full reconciliation between historic GAAP and non-GAAP metrics can be found in our earnings release issued today and available on our Investor Relations website.

Our gross margin was a record 85%, an improvement from 83% in the year-ago. As we look at the full fiscal year, we do expect this to come back down towards 83% as the European region comes on line and we had additional domestic capacity.

With regard to operating expenses, sales and marketing costs were $52.3 million compared to $44.7 million in the same quarter last year. Sales and marketing costs included a roughly $1.7 million benefit compared to the comparable figure under the prior accounting standard, about 700,000 more than contemplated in our previous guidance due to slightly higher capitalization levels.

R&D expenses were $19 million compared to $15.2 million in the same quarter last year and reflected a particularly strong hiring quarter. G&A costs were $12.3 million compared to $11.9 million in the same quarter last year. Overall, we experienced our strongest-ever hiring quarter start the year. Looking ahead, we expect another particularly robust hiring quarter in Q2, reflecting our continued confidence in the market and investment opportunities.

On a non-GAAP basis, we achieved record operating results and profitability with operating income of $8.7 million or 8% of revenue compared to an operating loss of $5.4 million or negative 7% of revenue in the same quarter last year. Overall, our net income per diluted share was $0.15 compared to a net loss per basic share of $0.09 in the same quarter last year.

Turning to our balance sheet. We ended the first quarter with approximately $721 million of cash, cash equivalents and short-term investments, up from last quarter’s $248 million total. Much of the gain coming from our convertible debt offering which closed in May, as well as strong cash flow generation in the quarter. Elsewhere on the balance sheet, our total deferred revenue ended the quarter at $183 million, up 46% year-over-year and down 4% quarter-over-quarter, which compared favorably to our guidance for mid to high single digit decline from last quarter. As we look into Q2, we anticipate deferred revenue to decline low to mid single digits from Q1.

Turning to cash flow. Cash from operations was $50.4 million, driven by significant collection activity following our seasonally strong billing in Q4. Free cash flow defined as cash from operations minus capital expenditures and capitalized software was $41.5 million. For all of fiscal ‘19, we continue to expect cash from operations to be between $70 million and $80 million and free cash flow to be between $30 million and $40 million. We expect a pickup in physical CapEx beginning this quarter and our seasonally lighter quarters for operating cash flow in Q2 and Q3.

Now, I will turn to our outlook for the second quarter of fiscal 2019 and the full-year. For the second fiscal quarter ending September 30th, we expect revenue to range from $110.5 million to $112.5 million. We expect non-GAAP operating income of $4.5 million to $5.5 million. This would lead to non-GAAP net income per diluted share in the range of $0.11 to $0.12. For the full fiscal year 2019, we now expect revenue to range from $457.5 million to $462.5 million, an increase from our prior guidance of between $452 million to $458 million.

We expect non-GAAP operating income of $18 million to $22 million, an improvement from our prior guidance of between $15 million to $20 million. This would lead to non-GAAP net income per diluted share in the range of $0.39 to $0.46, an improvement from prior guidance of between $0.29 to $0.37.

This revised guidance also reflects expected interest income as a result of our convertible debt offering. Overall, as our guidance implies, we expect to reinvest a portion of our probable growth to investments that will continue to ramp in the second half which result in lower level of profitability in Q3 and Q4. We believe this will set us up for continued success as we enter fiscal ‘20.

And with that, I’d like to open the call for questions. Operator, please go ahead.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Michael Turits from Raymond James. Your line is open.

Robert Majek

Good afternoon. This is actually Robert Majek on for Michael. So, you recently rolled out support and integration for Kubernetes. Can you just talk about the importance of that initiative and what the customer response has been so far?

Lew Cirne

Certainly. I imagine that one’s going to be for Lew, not Mark.

Mark Sachleben

I’ll let you take it.

Lew Cirne

Yes. So, we’re excited about Kubernetes and what it does for our customers and enabling them to really adopt containers technology at scale, and to really reduce the cost and toil involved in these highly dynamic micro service environments. And so, it allows our customers orchestrate highly economic environment using largely open-source technology. But, it does involve new visibility requirements that our customers have been asking us for. And we’re delighted to deliver that visibility into the entire Kubernetes environment. Due to the breadth and strength of our platform, that was something we could add directly into New Relic integrated with all the other data we collect. So, our customers love that they can see the Kubernetes data right alongside application health data, and the other data that we provide out of our other products. So, responsive has been very strong. And we have a healthy roadmap of more than we want to do in Kubernetes. So, certainly, there’s more to be done but we’re getting great feedback from the market on what we’ve done in our first offering.

Robert Majek

Thanks. That’s really helpful. Maybe just one more for me. Just at the analyst day, one of your customers highlighted the fact how we have to use competing products for certain use cases when it comes to log monitoring. Do you plan to get more capability in that area?

Lew Cirne

We do see that log monitoring is a complementary source of data from the data that we collect, which is particularly coming directly out of the applications as they are running or from the infrastructure. And so, where we are today is that a complementary technology, and we have integrations with many of the leading logging providers. And that’s our strategy at this point in time. And so, we’ve got a lot of opportunity in market we serve today and we feel like that’s where we are focused on for now.

Operator

Your next question comes from the line of Derrick Wood from Cowen & Company. Your line is open.

Derrick Wood

Great. Thanks and nice job on the quarter. At the analyst day, you mentioned you’re starting to see more legacy APM displacements. And I just wanted to drill down on that. First, is the reason to rip out legacy generally due to a shift in cloud or are there other catalysts that you’re seeing? And then, second, when you do a legacy displacement, do they tend to be larger initial deals or is that a similar land and expand to a Greenfield environment?

Lew Cirne

Great question. And the things that will simulate a transaction where someone might leave a legacy on-premise monitoring vendor for New Relic are the three areas of focus for business that we highlighted in the prepared remarks, cloud adoption, DevOps and digital customer experience. And so, when any of those three initiatives become strategic for a company, they recognize that their previous generation on-premise tooling is not well-suited to help them be successful in migrating to cloud or developing a DevOps culture or in focusing on digital customer experience. And that’s when they turn to us. And then, -- and that’s often a land and expand strategy where we start -- where we have such a strong advantage in those core areas. And then, the customer prefers our ease-of-use and TCL, total cost of ownership, and then we have the opportunity to replace more and more pricing environment that might be the demand of a legacy vendor today.

Derrick Wood

And Mark, if I could squeeze one, you put in the earning slide deck a comparison of gross margin relative to peers, you guys are at the highest out of any one. I’m just curious what drives such cost efficiency relative to peers and what’s been the factor behind the move from 80% to 85% over the last couple of years.

Mark Sachleben

So, it’s -- I appreciate you noticing that. It’s always nice to be on the left hand side of that slide. So, a number of things. And it starts with the fact that when Lew started and Jim, and when we started we worked on efficiency from day one. And so, I think the attitude on our team was always that you don’t just worry about efficiency later and worry about gross margins later, because later never tends to come. So, from the get-go, we were very focused on an infrastructure that could support our customers and support large amounts of data in a very efficient manner. And so, that continues to pay dividends for us.

Another factor is just the ease-of-use of our product. When you look at our services costs, our support costs, even as we’ve expanded into the enterprise which generally has a higher support burden, we’ve been able to increase those gross margins because the product is very easy to install and deploy and has a quick time to value. So, those are a couple of the factors that have helped drive that. Also, just we’ve had a bit of a tailwind, as our business has migrated more toward the enterprise and larger transactions, even things like credit card fees, which in the old days when we were more SMB focused, tended to be more significant. Those are tending to be a lower number. And so, all those have helped drive the gross margins to the levels they are currently at. That said, as we mentioned, we do see -- we’ll see -- we do see pressure coming on that number and that migrating more toward an 83 or so percent level, as we go forward due to the investments that we continue to make in our infrastructure and additional capacity.

Operator

Your next question comes from the line of Gray Powell from Deutsche Bank. Your line is open.

Gray Powell

So, is there a rough way to quantify the percentage of deals, whether it’s landing a new customer or expanding with existing customer that are Greenfield versus replacement?

Mark Sachleben

The vast majority of our deals are Greenfield and that done in large part I think because of our land and expand strategy. Generally, we first get involved with a customer at what is for an enterprise by relatively modest number, $50,000 to $150,000 a year in ARR. And that will typically be on a new digital initiative or someone will be kind of dipping their toe in the water with the migration to the cloud, we will get involved there. And that’s how we enter the account. From there, we expand as that that grows, we’ll go to different -- they will bring more and more workloads to the clouds or environmental -- will expand, they’ll add new product, will expand in that direction. And then, as they see the -- as Lew mentioned, they see how easy it is to use, what kind of value they can get from New Relic will go into other parts of organization or other applications, but the typical land for us is in the Greenfield opportunity.

Gray Powell

And then, just one more if I may. I know you’ve already answered a couple of cost questions. But, you guys really did outperform pretty nicely on both the gross and operating margin lines, and in fact you flowed through more than 100% of the revenue beat on each metric. Was there any main particular driver there this quarter?

Mark Sachleben

We were helped from the bottom line, with revenue, obviously our performance, that helped. We’re seeing improvements. We’ve been investing in business for quite a while now. A number of years, we’re seeing operational efficiencies come from those investments. We also had, as mentioned in the script, better than expected benefit from the move to 606. I think it was about $700,000 of incremental expense improvement because of the capitalization of a higher percentage of our commissions than we had expected.

Operator

Your next question comes from the line of Sterling Auty from JP Morgan. Your line is open.

Ugam Kamat

Hi, guys. This is actually Ugam Kamat on for Sterling. So, Lew, in your prepared remarks, you mentioned about the record infrastructure quarter but -- and it is one of the highest attaching products. Just wanted to understand whether infrastructure is more off like an upsell product where you are seeing customers already owning APM or other solution go and buy infrastructure or is it that it just leads the way and helps you gain new business, or is it just like an upsell product?

Lew Cirne

It is predominantly the former scenario you described where, given our 10-year history as a leader in APM, obviously all of our customers are APM customers and virtually all of our prospects come to us with APM in mind as a minimum part of the problem they’re solving. And then, they love our infrastructure product and they love the idea of having one vendor provide all that in one place. And so, that’s why it attaches so well. But, we believe the application is the center of gravity. At the end of the day what people are spending all this money on cloud and on infrastructure for is to run application, to build and run applications. And so, with an application centric view and strategy, we believe we have a very important strategic role to play and that it’s a natural add-on for products like infrastructure to increase our value to our customers and help us with our business goals.

Ugam Kamat

Got you. And Mark, one for you. You mentioned about higher capitalization of sales and marketing expense to the tune of 700,000. Is it because of higher billings versus I would say amortizing over a larger customer life?

Mark Sachleben

Yes. It’s -- one of that’s driven by the commission numbers and just the assumptions we made and to what percentage of our commissions would be capitalized.

Jon Parker

This is Jon. Just to be clear, we’re not -- as we say in our filings, we don’t actually capitalize 100% of the commission. There are certain pieces that don’t get capitalized due to certain requirements. So, it just is related to certain assumptions we had made going into the year around what percentage of our total incurred commissions would actually be capitalized relative to what actually played out.

Operator

Your next question comes from the line of Jennifer Lowe from UBS. Your line is open.

Jennifer Lowe

I wanted to touch a little bit on the product innovation around distributed tracing, Kubernetes support, and then obviously a long train of innovation over the years. And as you roll out this functionality, do you see that as sort of benefiting adoption, driving uplift to higher price SKUs? How do you think about monetization opportunities attached to some of these innovations versus just being table stake to stay relevant in an evolving world?

Lew Cirne

Well, first of all, we think that we’re in an incredibly large and growing an exciting market. And the Gartner quote of 5% of applications under monitoring -- monitored by APM vendors today and that could grow to 20% by 2021. We’re in an abundant market to pursue. And so, distributed tracing, we’re very excited about, because as companies move to more and more micro service architecture, they want to see the health of an action, like say for example somebody logging in, that might touch 10, 20, 30 services, all running in concert in production. And so distributed tracing allows you to see the relationship as that transaction runs through all 30 of those services. And what’s cool about it is, if you’re only instrumenting a third of those services, then you’ve got a visibility gap that distributed tracing will stop short of, until you install New Relic on those other services. So, we believe it has the potential to perhaps provide more incentive for our customers to instrument more of their environment as it becomes more interconnected. And that will certainly drive growth for our business. So, our customers are subscribers and we have healthy dollar net expansion rate. And so we just believe by delighting them, we believe the business results will continue to be favorable.

Jennifer Lowe

And maybe just one more for me. On last call, one of the things you talked about was the opportunity to expand the role of technical sales as an added lever for growth. I’m just curious, sort of what the early feedback on that is? Are you are seeing the productivity out of the effort that you hold for? Just any color there would be great.

Mark Sachleben

Yes. So, we -- that’s been an emphasis for us. We’ve been doing that. As we mentioned, we had a record hiring quarter this last quarter. And we have been pushing out the folks who go out in the field, help our sales, our account executives, both before the sell or particularly after the sell to help with -- help customers learn, understand how to use New Relic. Our best customers are the ones that know us best, know the product best. And so, we’re seeing nice returns from those investments, so something we expect to continue to do. We’re constantly looking at the ratios of technical to account rep folks we have, tweaking those and at different levels, as you we get more toward the larger accounts, obviously higher ratios there tend to be more attractive. So, we are seeing good returns there and something we expect to continue to do as we go throughout the rest of the year.

Operator

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

Sanjit Singh

Lew, you opened your prepared remarks, you made a comment about how your opportunity extends well beyond the APM but that’s all an underpenetrated opportunity. I wanted to get your thoughts on what -- over the long-term, what the size of this customer base might be. And if you look at other infrastructure companies in the past whether it’s VMWare, Citrix, those guys have been able to get to 400,000, 500,000 type customers. I guess, my question is, to what extent do you see your products and your solutions as that ubiquitous in terms of the mass market for infrastructure software?

Lew Cirne

It has the potential to be that. We’re most focused at the moment on the largest enterprises in the world, particularly those enterprises that are most aggressively adopting cloud, DevOps, and digital. And we believe that while I love the idea of democratizing the category and that’s one of the reasons -- one of the strength of our product, how easy is to use, from a business perspective, we see the greatest growth opportunity on the high-end of the market. And so customer count may be long way to think about success, although we always love it when more people use our products.

The other way to think about it is ubiquity within an enterprise customer. So, you probably remember, I said this couple of times before. But, the sad history of this category before New Relic was that most APM customers had two or three specialists that knew how to use this, hard to use these hard-to-use arcane tools, one of them I created in a prior life. And so, but with New Relic, we want to make it easiest that hundreds or in some cases thousands of people use our product within these enterprises. And so, I like to think in terms not only of number of companies using our product, but number of number of people using our product. And that’s important way we think about changing our category.

Sanjit Singh

And maybe just a follow-up to sort of dovetail on your last comment. When Microsoft acquires GitHub and we start to think about the greater, strategic importance of the developer community. Can you talk to us about how New Relic tries to maintain its relevance and maintain its enthusiasm within the developer community? I think one way to look at is the strong non-enterprise growth that we’ve seen the last several quarters. But, can you talk to us about what you guys are specifically doing to drive that level of engagement with the development community? Thank you.

Lew Cirne

Sure. So, the big change really that we’re seeing and particularly on companies that are adopting DevOps is that the silo between building your software and operating your software is breaking down. So, as companies move from big monolithic architectures and teams to smaller teams that have responsibility for their service and their piece of the broader application, then, those teams have responsibility not only for building application but making the application delivers high availability. And that’s why you see this explosion in the number of people using our type of software. It’s because developers, primarily they’re writing code, but they’re also, if there’s a problem in production, they need to quickly be able to resolve it, so they can go back to writing code.

Now, in traditional IT operations organizations, there was a central operations team that tried to keep applications running. And when you have that organizational structure, the only way to manage risk was they said no to production change. And that’s why previous generation tools aren’t a fit for where the world is moving and why there is no to move faster. In order to move faster, you need developers to be more rapidly introducing change to production. And that means pushing out responsibility for the health of the system to those people. And that’s why we’re so relevant to that community.

Operator

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

Greg McDowell

Great. Thank you. One for you Lew and then one for Mark. Lew, I want to go back to infrastructure for a minute. You mentioned, it was the highest attaching product and the strongest ever percentage of new business. And I was just wondering, it you feels like we’ve hit an inflection point with this product. And I think you mentioned the words, pent up demand. And I was just hoping you can expand on whether that’s something you’ve made -- or changes you’ve made in the way you’re selling the product or additional functionality you’ve put in the product or whether or not the market has just finally come to you and some of the other players out there. So, I was just hoping you could expand a little bit on just what happened in the last three, four, five months with infrastructure. And one quick follow-up.

Lew Cirne

Yes. It’s a great question. And it’s really the combination. So, what we’ve been doing the product with things like the Kubernetes functionality and we continue to deliver more and more integrations and points of visibility in the infrastructure products. So, we’re -- our investments in the product are resonating well with the market. But, then, it’s also I think the market dynamics. It’s a well-known fact that most enterprise customers have dozens of tools to try to watch production and they are -- they didn’t like that. They don’t want to have the kind of the tab between a bunch of browsers and windows to try to have a complete picture of production. They certainly don’t want to have to switch between tools to figure out whether it’s the application or the infrastructure or both. And application help and infrastructure help are interrelated, and they belong in the same platform, and that’s an easy thing for our customers to understand and get behind. And they love our APM product. We’ve talked just earlier in this call about how the application really is the center of gravity for these things. And so, it’s a natural thing to add infrastructure visibility to that. So, it makes sense in the markets understanding that and that’s why we believe we’ve got this product platform play in front of us.

Greg McDowell

And Mark I’m just anticipating a question, we may be getting later today or tomorrow on the paid business accounts metric. I get the mix shift. I think most investors appreciate the mix shift to enterprise and the tremendous success you’ve seen in the enterprise. But, maybe just a little explanation on why company with this type of growth rate would have flat paid business accounts from quarter-to-quarter, that would be helpful.

Mark Sachleben

So, you nailed that in terms of where our investment focus has been. We’ve talked about -- this is number is fairly volatile and that our focus has been much more on the enterprise side and on the larger accounts. And we did have a record quarter, a record Q1 in terms of the number of over 100K accounts we added. We had a great quarter in terms of the number of enterprise accounts we added. And I think that’s where our energies are focused and we’re very pleased with the results we’re seeing there. On the low-end, there’s a lot of volatility and variability. Just as an example, half of the accounts that turned out last quarter, paid us less than $2,500 a year in ARR and nearly three quarters of those accounts paid us less than $5,000 a year in ARR. And so that segment is something that is not going to be driving top line back. But, it’s something that -- when we look at that segment over time, it’s something that we’re going to -- we’ve got to work on in terms of being superefficient at. But, it’s not really critical to driving top line economics.

Operator

And your next question comes from the line of Jesse Hulsing from Goldman Sachs. Your line is open.

Kevin Kumar

Hi. This is Kevin Kumar on for Jesse. Thanks for taking my question. Looking at your ARR mix, our math implies some acceleration in your midmarket business during the quarter. Can you talk about what’s driving that topline strength and what you think the sustainable growth profile for mid market is over the next couple of years?

Lew Cirne

Sure. I will take a stab at that. This is Lew. And then, Mark can provide some color. We’re really pleased with how our midmarket and SMB business is developing and how we are focusing on with this platform, strategy we’re pursuing of APM surrounded by these other product. The high-growth, high-potential companies that we focus on, tend to invest more with New Relic. And so, we mentioned that we had a nice seven-digit transaction in the quarter from our SMB commercial segment. And that’s just representative of doing well and delivering value in to that part of the business, and being efficient at operating there. So, the team has done excellent work. And I feel great about that part of our business. And so, it’s just a lot of hard work we’ve been doing over the last few years is really starting to show nice results.

Mark Sachleben

And I guess when we look at where we’ve been investing and the go-to-market engine for that side of our business, it has been more focus on the 100 to 1,000-person companies, sort of more mid-market as opposed to SMB. And I think over time, when you look at where we’ve migrated, you go back five, six years ago, we were focused just on getting accounts in. I think, now, we are focused on getting the right accounts in, the ones with the highest potential. And so, that could be some relatively small companies and then a lot of companies in that 100 to 1,000, where we look at the lifetime spend for them with New Relic and be meaningful. And we’ve been more targeted at approaching the market going after them. And I think those results have been -- we’ve been very pleased with the results we’ve been able to achieve.

Operator

Your next question comes from the line of Steve Koenig from Wedbush. Your line is open.

Steve Koenig

Hi, gentlemen, I’ll just ask one question for you today. I’m wondering, as you penetrate your enterprises with more and more projects, is it the sales motion and a market that can lend itself to a standardization decision where the enterprise says for the standard default assumption for any new application development is going to be the use of New Relic. Is that some place this market can go or are you going to continue to knock it off and expand really project by project, winning each decision at a time?

Lew Cirne

We’ve already gotten there with a few of our customers where we are the declared standard, not even de facto but declared standard from like the CTO level. I like how we get there typically by proving ourselves time and time again, proving the value we deliver, building a well spring of demand internally from the end-users to people that align our software to deliver great software within their enterprise. And often, it may be something your standard for anything running in the cloud. Well, we believe that’s virtually all future software from many companies. So, there may be some guardrails around that and say you’re not the standard running in an older environment or something like that. But we love earning that position with our most advanced customers. And we’d like to get better at doing that faster with our customers over time.

Operator

Your next question comes from the line of Jack Andrews from Needham and Company. Your line is open.

Jack Andrews

I just wanted to follow up maybe on Steve’s last question a little. You talked about this movement in terms of to trying to move customers from their initial deal sizes towards closer to this $1 million plus in revenue. And as you think about I guess the sales process around that, at what point do you need to engage with somebody higher up in the organization, just because of the sheer dollars involved here? Just what does that process look like? Does it help if you engage with perhaps the Chief Digital Officer early on in the process? Maybe just kind of shed some light on in terms of the dynamics of the budget dollars around purchasing your software?

Lew Cirne

Sure. So, if you look at what we’ve said in the past about our average customer spend in the enterprise segment, it’s about a 100,000 a year for enterprise customer. And those are subscriptions. So, total lifetime value of those customers will be attractive. But at that spend level that’s rarely at the C level for an enterprise. And that’s fine with us. That’s an average number too. So, there are many customers that are below that. So, we will often get in on the departmental level, a specific project, prove our value. And then, over time, we will often need to have our conversation and love to engage in conversation at senior level. Those senior level conversations are invariably around the three themes I talked about that in the prepared remarks. CTOs, they care about cloud adoption, they care about the becoming more agile and embracing DevOps and they care about their digital strategy. And so, whereas at the departmental level, they may ask about instrumentation and what are we doing for no Node.js or Kubernetes, right. That’s what our end users and departmental people care about and will have those conversations. When we get to the C level, we help them transform their organizations be successful with DevOps or by migrating to the cloud faster.

And so, our ability to have the right conversation at right level is a big part of why we’re seeing the nice improvement in large deal sizes.

Operator

And your next question comes from the line of Rishi Jaluria from D.A. Davidson. Your line is open.

Rishi Jaluria

Lew, in terms of the expansion with the new European headquarters. Can you give us a sense for what sort of investments you expect over the near and medium term in terms of really solidifying that expansion? And then alongside that maybe if there’s any different sort of sales motion that you need to consider in terms of that. And then, I have a follow-up for Mark.

Lew Cirne

Sure. And I may ask Mark to chime in on the European one. We are excited about our European opportunity, certainly by opening up a European hosted presence of New Relic that will -- there are many customers we believe we will be able to attract to New Relic who just feel more comfortable with their data being in Europe, rather than being in our U.S. data center. So, that’s being well received by parts of the market. And of course, we’re always investing on the go to market side in Europe and we’re excited with the team and the people and the talent we have on the ground there. I was just in our European office last week, and I was very impressed with the people there, the energy and how our products are resonating with that region.

Mark Sachleben

And I guess I would say that it’s a comparable go to market strategy that we’ve seen in the U.S. Our feeling is, prove something out in U.S., then bring it to the rest of the world. And we did that with our Dublin -- opening our Dublin inside sales team couple years after we started the U.S., the enterprise team in Europe is a couple years behind the U.S. But, it’s a similar strategy. We tweak here and there, certain markets will test different ratios and different things, but it is overall fairly similar to the U.S. And we take a fairly deliberate approach to Europe where we we’ll be entering countries at a measured pace once we see demand there and things. We don’t want to overspend too quickly. But, we see great opportunity there going forward.

Rishi Jaluria

Thanks. That’s helpful. And Mark, it was a strong cash flow quarter. I understand Q1 is a strong collections quarter. But, given how much you outperformed on cash flow and raised operating income guidance for the full-year. Can you maybe help us understand why you’re maintaining cash flow guidance on a full-year basis and not raising it? Thanks.

Mark Sachleben

Sure. So, if you look back historically, the patterns that evolved last couple of years, particularly last year, and you look into Q2 and Q3 where you tend to see cash flow dip down into negative territory, and we’ve got some investments coming up in some physical infrastructure that are going to be coming due in the next couple quarters. So, we do expect that to go negative in the next couple of quarters. And then, in Q4, we expect it to come back to the positive realm. But overall, we are looking at, as we mentioned in the remarks, looking at additional investment as we head out toward the second half of this year. We want to set ourselves up for success going forward in fiscal ‘20 and beyond. And so, we’re looking at some incremental investment in the next -- rest of Q3 and Q4.

Operator

There are no further questions at this time. I will turn the call back over to our presenters for some closing remarks.

Jon Parker

Thank you everyone for joining the call today. And look forward to talking to you all soon. Thanks.

Operator

This concludes today’s conference call. You may now disconnect.