New Relic, Inc. (NEWR) CEO Bill Staples on Q1 2022 Results - Earnings Call Transcript

New Relic, Inc. (NYSE:NEWR) Q1 2022 Earnings Conference Call August 3, 2021 5:00 PM ET

Company Participants

Peter Goldmacher - Vice President of Investor Relations

Bill Staples - Chief Executive Officer

Mark Sachleben - Chief Financial Officer

Conference Call Participants

Kingsley Crane - Berenberg

Sanjit Singh - Morgan Stanley

Robert Oliver - Baird

Michael Turits - KeyBanc Capital

George Iwanyc - Oppenheimer

Yun Kim - Loop Capital Markets

Nick Altmann - Cowen & Company

Jack Andrews - Needham

Operator

Good day, and welcome to the New Relic First Quarter and Fiscal Year 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask question. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Peter Goldmacher, VP of Investor Relations. Please go ahead.

Peter Goldmacher

Hi, everyone, and thanks for joining our Q1 fiscal '22 earnings call. We published a letter on our Investor Relations website about an hour ago and hope you all have had a chance to read our letter together with today's earnings press release. Today's call will begin with prepared comments from Bill and Mark, and then we'll open up the line for your questions.

During this call, we will make forward-looking statements, including about our business outlook and strategies, which we based on our predictions and expectations as of today. Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors in our most recent 10-K and upcoming 10-Q to be filed with the SEC. Also, during this call, we will discuss certain non-GAAP financial measures. We have reconciled those to the most directly comparable GAAP financial measures in our earnings release. These non-GAAP measures are not intended to be a substitute for our GAAP results.

And finally, this call in its entirety is being webcast from our Investor Relations website, and an audio replay will be available there in a few hours.

And with that, I'd like to turn it over to Bill.

Bill Staples

Thanks, Peter, and thanks to everyone for joining our Q1 FY '22 earnings call.

We had a strong start in the first quarter of our fiscal year, delivering just over $180 million revenue, beating the $172 million to $174 million guidance that we provided last quarter and growing the business 11% year-over-year. Before we dive into the numbers and then answer your questions, I want to take this opportunity, my first earnings call in my new role as CEO, to step back and paint my view of the market, our strategy and our priorities going forward.

A year ago, last July 30, 2020, we introduced the New Relic One platform and consumption business model to the world. It was a bold but necessary move to serve our customers better and lay a new foundation of growth for the business. As you know, the past year of COVID has only accelerated the move to digital experiences. Nearly every company in the world, no matter the size or segment employs digital experiences to serve their customers, partners and employees. These digital experiences are built by highly skilled software developers and engineers, and there simply are not enough of them to satisfy the demand. The pressure on them to innovate faster is growing more intense and the complexity and toil the software systems they create and maintain continues to increase. They spend a disproportionate amount of time planning, architecting, building, fixing and deploying software only defined once it's in production and begins impacting customers, that's something somewhere went terribly wrong.

Observability vendors today use telemetry data to help production engineers reactively monitor and troubleshoot systems that are unhealthy. But that's too late, too reactive, too much focus on symptoms and not enough on the root cause and prevention. It doesn't help engineers spend more time doing what they really love, which is building cool stuff. Our vision is much broader, and we believe our potential much higher. At New Relic, we aspire to help millions of developers and engineers build more perfect software, by making observability a daily data-driven approach to engineering across the software life cycle. To get there, we are obsessed with helping our customers master telemetry data to get past the what and uncover the why. There are three fundamental things about our vision of observability that are unique and whose impact on the business, I believe, will grow overtime.

First, New Relic offers a purpose-built all-in-one telemetry data platform. Our customers are already ingesting petabytes of telemetry data from many sources, including our own agents, open standards, APIs or an ecosystem with hundreds of integrations thereby eliminating data silos and unlocking insights across their entire digital estate. Customers trust New Relic with their telemetry data because we've taken a strong regulatory posture in security, privacy and compliance with SOC2, GDPR, FedRAMP, and as of last week, we're now the industry's first HIPAA-compliant observability solution across all data types. We use advanced data science techniques, employing AI and ML throughout the platform to help our customers swift [ph] through the data and more easily finance signals from the noise, making AI Ops more accessible than ever. And we operate this telemetry platform at massive cloud scale actively ingesting, storing and analyzing in real-time many petabytes of metrics, events, logs and traces with blazing performance. This is fundamentally a different approach than most of our competitors and is foundational to our strategy, allowing us to provide a secure single source of truth for telemetry data for even the largest of enterprise customers with incredible economics.

Second, New Relic provides developers and engineers with integrated and powerful analysis tools on top of this data, the full platform experience in warm place and for one price. Competitors offer a bundle of SKUs, each with disparate user experiences, data stores and price points; all targeting those same production engineers focused on resolving incidents, and they call that observability. New Relic is thinking much more broadly about the users of observability, considering not just the needs of IT operations, site reliability engineers and cloud engineers by taking a developer first approach, and bringing the power of telemetry data into the flow of tools developers already use every day, ultimately reaching the estimated 28 million professional developers who build the software to begin with. Many of these potential users have yet to experience how observability can help them because they're focused on delighting customers through innovation and code, not troubleshooting production environments.

Third, New Relic offers all of this value with a unique consumption-based pricing model that is more predictable, affordable and scaled with value. Our platform is consumed in just two dimensions; data ingest and user access. First, our unified telemetry data platform allows customers to ingest, store and query the data for an unprecedented value at just $0.25 a gigabyte ingested. Competitors prices can be several multiples higher than this for data, forcing engineering teams to sample what the instrument in order to contain costs, which only leads to more blind spots and incidents. Second, we have integrated all of our tools and provide full platform access for one price per user, giving buyers incredibly consistent, predictable pricing that scales with usage and therefore, value received instead of infrastructure. This unique consumption model allows more users to observe more data in systems, all in one place, enhancing collaboration, and increasing productivity across the engineering organizations.

We are passionate and committed to this multi-year vision, and grateful for the ongoing focus and support of our Relics investors and stockholders as we work towards this audacious and achievable goal. You may wonder, with such an audacious long-term vision, how are we prioritizing the work and how can you measure our progress quarter-after-quarter? As our new CEO, I've identified five strategic priorities. The entire company is now aligned behind these objectives, and we've identified measurable success criteria for each to help us all gauge our progress. Each quarter I'll provide an update on how we're doing against each of these five.

Our top priority is to return our revenue to market growth rates. As a consumption business, this is the crowning metric which measures our ability to innovate value that customers are willing to pay for and deliver in an efficient manner. We measure our success with this priority through our quarterly revenue reports, and we aim to show revenue increases and year-over-year growth in the quarters ahead. We anticipate accelerating year-over-year revenue growth starting in Q3, and we've updated our guidance to help you gauge our progress. For eight quarters, revenue growth has decelerated while we've replatformed our products front-end and back-end, pivoted towards the new platform pricing model, and migrated existing customers' contracts to the consumption model as a foundation for the vision I described earlier. With that foundation laid, we are ready to bring that deceleration to an end, and we're focused on scaling the business starting in Q1.

As I mentioned at the beginning of the call, we're pleased to report just over $180 million in revenue, 11% year-over-year growth compared to the first quarter of our last fiscal year, and a significant increase over the $172 million to $174 million that we provided as guidance in our earnings press release last quarter.

Our second priority is to complete the migration of our business to the new business model. Our goal is to migrate more than 80% of our committed revenue by the end of this fiscal year. After three and a half quarters in market, we've already successfully migrated 71% of committed revenue as of the end of the fiscal quarter, up from 60% the prior quarter, another strong indication of our momentum. This is a high priority because we aspire to create a growth engine for this business that will be disciplined, systematic, repeatable and scalable; and by migrating the majority of our customers to our consumption model they will automatically benefit from the innovation and full value of the platform, which we believe will lead to growth of their consumption and our revenue will follow suit.

Our third priority is to grow the number of paying customers. The primary way in which we will deliver on this priority is through 100% self-service product-led growth funnel, starting with our New Relic One free tier. Since introducing the offer three and a half quarters ago, thousands of developers have signed up for New Relic One, and more than 3,300 PAYG [ph] accounts have entered credit cards through the end of the fiscal quarter, an increase of more than 1,300 since we reported last quarter. This priority is important for three reasons; first, we see our self-service funnel as strong validation of our product experience and product market fit. Without a great product, developers would simply not be willing to pay for the service. Second, as we grow the number of paying customers, we expand the pool we're able to nurture to higher and higher levels of service, including graduating them to sales-led accounts. And third, the self-service experience also signals experimentation and early adoption within our sales led accounts, further helping us identify new opportunities to nurture expansion.

Our fourth priority is to methodically deliver platform innovation and value to customers. We will showcase how we're achieving our unique vision each quarter through industry-leading innovation, customer success, analyst reports and rankings. This quarter was another hallmark of innovation from our product and marketing organizations. We held our annual FutureStack developer conference and enjoyed record attendance with many thousands more engineers viewing the sessions on-demand following the conference.

In this quarter, we were able to introduce the Pixi New Relic One integration, which unlocks what we believe is the world's best Kubernetes observability, enabling engineering teams to observe their environment and the services they deliver in indices with zero friction. Kubernetes is now mainstream, and adoption is widespread, so we see many engineers benefiting from this innovation. It's truly a magical experience that we see rivaling the early days of New Relic, which catapulted this company's success. We also introduced the New Relic Errors Inbox, another first that enables engineering teams to triage and resolve errors across their entire stack rather than firefighting them during incidents. Only New Relic provides this kind of platform-wide, proactive, aggregated errors experience included free for every full stack observability user. We were also excited to enhance our partnership with Kentik, pulling network context into New Relic One and helping DevOps teams and NetOps teams collaborate more closely in the New Relic One experience. These on top of AI Ops, logging [ph], New Relic Explorer and many other platform innovations over the past few quarters are delivering incredible value for customers, which we believe will fuel increased platform consumption for quarters to come, and that's just the start.

Our fifth and final priority is to improve our internal execution and costs. We realized that in order to reach our potential and achieve competitive growth rates, all areas of the business will need to move faster with less friction, more alignment and efficiency. We are systematizing our planning, prioritization and execution rhythms across functions and better stitching together internal data across product, marketing, sales and finance so that we can run the business in real-time and better serve our customers in their moments consuming the platform. Every executive on my team has clear objectives and accountability with accelerating the overall company's success as their overriding priority. We are driving reduction to our COGS and returning our gross margin to typical enterprise SaaS rates. And we're already getting traction on many of these fronts.

As I shared a few weeks ago, we hired Anita Lynch, our new Chief Data Officer and leader of our internal data systems. She's joining Christie Friedrich's team, our new Chief Operating Officer, responsible for systematizing our internal execution across functions. Manav Khurana, GM and product owner of our burgeoning self-service business was also promoted to Chief Growth Officer, bringing all aspects of that self-service product experience, together with the full marketing organization under his terrific leadership.

This is an incredibly exciting time to be at New Relic. I'm humbled to serve as CEO and grateful for all the contributions from Relics around the world, and especially for Lew Cirne, our Founder and Chairman. I've worked for some amazing companies and leaders, but there really is something special about New Relic, a special group of people with the vision and skill to make a profound impact on the world through our technology. And I'm honored to be part of this company and excited to help it grow.

With that, I'll turn it over to Mark Sachleben, our CFO, to walk us through the full set of financial results for the quarter.

Over to you, Mark.

Mark Sachleben

Thanks, Bill, and good afternoon and good evening to everyone on the call. I'd like to briefly recap our financial results and then spend some time helping everyone understand the most important moving parts of our financial model as we continue to transition to a consumption business.

For our first quarter of fiscal year '22, we reported revenue of $180.5 million, ahead of our guidance we set in Q4 for between $172 million to $174 million. GAAP loss from operations was $73.9 million and non-GAAP loss from operations was $16.2 million, ahead of the guidance we provided for a loss of between $24 million to $26 million. GAAP EPS was a loss of $1.24 and non-GAAP EPS was a loss of $0.25, ahead of our guidance for a loss of between $0.37 and $0.40. This top line beat was driven by increased variable consideration revenue of customers consuming an excess of their contract and better-than-expected churn. We are pleased with our results this quarter, and we continue to expect to return to accelerating year-over-year top line growth in the second half of this fiscal year.

As Bill mentioned, our number one priority is to get back to market growth rates, which we estimate to be at about 25% in the intermediate term, and Q1 was a positive step along that path. We are initiating second quarter revenue guidance of between $181 million to $183 million, and a non-GAAP operating loss of between $13 million to $15 million. We are also increasing full year revenue guidance from a range of between $709 million to $711 million to a range of between $730 million to $735 million, an increase of $22.5 million at the midpoint of the range.

For the full fiscal year, we are keeping our guidance for a non-GAAP operating loss of between $53 million and $55 million. This increase in top line guidance is driven by the current trends we are seeing in the business, including increases in consumption from customers and lower churn, which we believe are initial proof points that our product investments and strategy focused on customer success are paying off. We expect our non-GAAP operating loss to improve throughout the year. Since we introduced New Relic One and our new model last July, we've been talking to you about the many ways in which we have been transforming our business, both from an operational standpoint as well as the impact on our financial model.

Operationally, we took another big step in our transformation in Q1 as we rolled out a new comp plan, one which better aligns the interest of the sales force with the interest of our customers. In our new comp plan, sales reps are not made anything upon signing a deal, but rather are paid as the customer consumes more New Relic. Our sales force has embraced the change and is excited about it's potential. We're seeing early results as there is now less of a focus on large upfront contractual commitments and more of a focus on making sure the customer understands the value of the platform. In terms of the impact of our transformation on the financial model, I want to highlight a couple of things. The first is a reminder that we are no longer disclosing ARR or any ARR-related metrics as those are subscription-based metrics, whereas we are now a consumption-based company.

The second is that the move to a consumption model changes the dynamics of deferred revenue and RPO, and those metrics are less useful in understanding the momentum of the business as we continue our transition. Specifically, these changes stem from a number of factors, including: first, the aforementioned comp plan change means reps are driving consumption, not commitments; this means no early contract renewals or true-ups and less of a focus on large upgrades at renewal time or upon initial customer acquisition. Second, when we recognize variable consideration, we actually accelerate the drawdown of deferred revenue. Furthermore, incremental consumption in excess of commitment is built in arrears and thus generally doesn't hit deferred revenue. And finally, some of our largest customers for 1 reason or other, are opting for lower upfront commits in favor of a pay-as-you-consume structure.

There are a few other things that we'd like to highlight for the quarter. As of the end of our first fiscal quarter, we have converted over 70% of our business to the new model, and we are well on track to exceed our target of 80% on the new model by the end of the fiscal year. The majority of revenue that won't be on the new model entering fiscal '23, is multi-year site licenses that aren't renewing this year, not holdouts as legacy renewals are very rare. Churn in the quarter was down significantly sequentially and year-over-year. There are a number of factors that drove this result, including better products, better contracts and better customer service. We expect to continue to drive down churn, but it will take a while for this to get reflected in NRR, given NRRs as a backwards-looking metric.

I want to give you an update on our earliest conversions to the new model. The first cohort, August and September of last year of annual pool of funds renewals is small, but we believe they are on-track to finish around the original commitment level. This cohort signed on to the new APO [ph] model at a 15% uptick to their prior commitments; so we're encouraged to see their consumption track their commitment. The December cohort which is the largest cohort signed in calendar year 2020 is tracking well ahead of the September cohort at the same point in time. We still feel good about our customers consuming in excess of their commitments. The trend we see most consistently is that consumption shows modest acceleration through the year; this gives us confidence that each monthly cohort should finish the year with consumption in excess of commitment.

Lastly, COGS was flat sequentially, slightly ahead of the expectations we discussed with you all in the last earnings call. This was driven by the revenue beat and progress in implementing efficiencies in our cloud infrastructure which led to lower unit costs. As Bill mentioned, one of our priorities is to run an efficient business, and we continue to drive towards our goal of high 70% to 80% gross margins in the intermediate term.

With that, I'll turn it over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question will come from Kingsley Crane with Berenberg.

Kingsley Crane

Hi, thanks for talking my questions. So, we talked so often about the full stack vision. The benefits of this approach are becoming clear with the industry's first fully HIPAA-compliant solution. So, I would love to hear more about how this differs from existing solutions in the market? And then what this means for customers in the health care space?

Bill Staples

Thank you, Kingsley. Great question. As you mentioned, we announced HIPAA compliance last week, and we've already actually signed our first BAA in the first week. So that was encouraging news as well. To your question, the difference between what we announced and what other competitors offer really centers around the breadth of data and data types that are covered by our HIPAA compliance. One of the architectural and therefore, financial and security benefits of New Relic is this telemetry data platform as a service that we offer, which unifies all telemetry types, metrics, events, logs and traces, into one single source of truth is operating a massive class scale. And because it's one logical system, we're able to protect our customers' data and ensure that compliance across all data types. Many of our competitors who offer HIPAA compliance only do so for limited data type, like a logging monitoring system. And they're not able to offer the breadth of compliance that we are because of the investments we've made in that telemetry platform there [ph].

Kingsley Crane

Thanks. That's really helpful. One follow-up. On revenue, your top already returned to market growth rates around 25%, I mean that's a great goal. So how should we think about the growth algorithm to reach that figure? Do you think this is more of a 120% ARR model with 5% from new customers, maybe it's 10% with 15% of new customers? Just any more clarity there?

Mark Sachleben

Yes, this is Mark. We'll have to see. We expect new customers as defined by us is the first dollar they come in to spend. And so the vast majority of our new customer dollars come in at the pay-as-you-go level meaning the volume is high, but the actual per customer spend is quite low. So in any given quarter, even if we're successful getting big increases in getting big increases in the total loan of customers, the actual dollars that come in as new customer dollars, we expect to continue to be fairly low. And so the vast majority of our growth as we go forward and even when we're at the market levels, would be coming from existing customer expansion.

Kingsley Crane

Great. Okay. You made sure it makes sense. Thank you.

Operator

And the next question will come from - sorry, the next question is from Sanjeet Singh with Morgan Stanley.

Sanjit Singh

Thank you for taking the questions. And congrats on the progress with the transition to New Relic One, that 70% number is very impressive. Bill, I really appreciate the sort of walk down of the strategy and sort of the framework that we should be marking to market to over the next several quarters. There's one element that I would like to get a better understanding of which is sort of the go-to-market market segment part of this equation. So prior to when you became CEO, this was a big focus on the move upmarket into the enterprise, and we sort of looked at 100,000 customer adds and a mix of revenue from enterprise customers, but the focus for many years. As we think to getting back to those market rates of growth, what market segments do you think you're going to get most traction with initially? And then as you try and get to that better growth rates over time, which market segments do you think you'll be more effectively able to expand to with the current consumption-based model?

Bill Staples

Yes. I think Mark started to address that with the last question in that - you know, historically, we did look at the 100,000 plus customers and our large existing customers as the place for expansion; that continues to be true. Even in the consumption model, there's a large well of data and users there that we can continue to nurture to higher levels of value by driving platform adoption and increased consumption across the enterprise, taking advantage of all of the innovation that we're delivering more data types and more users engaging on that data. So we expect those medium and large enterprise customers to contribute - to continue to contribute the majority of our revenue and revenue growth. As I mentioned, though, one of the aspects of the New Relic One strategy that I laid out that is new as of last year, is this focus on self-service and really building next-generation cohort of customers that are looking for observability from the start and really starting in a self-service model that not only validates our platform and the product market fit. Because they wouldn't pay for it otherwise, but gives us a new cohort of users that we can continue to engage with both through the product experience and then once their spend levels reach a threshold with sales engagement to help them standardize on the entire platform by default.

As we shared in the investor letter, we're having quite a bit of success for that. I think we highlighted 1,300 new PayGo accounts this last quarter. We also highlighted nearly for of customers of the 25,000 and above annual run rate over last quarter, and four of those accounts that came in through the free tier are now spending more than $100,000. So increasingly, that part of the strategy will contribute not only to the number of paying accounts that we are serving. But increasingly, over time, the amount of revenue we're able to get from that segment. I hope that answers your question?

Sanjit Singh

Absolutely, Bill. That's super interesting. As my follow-up, I wanted to return to some of the comments on these early cohorts with the caveat that they're early, but with the - I guess, the August-September cohort tracking to their commitment of about 15% higher spend. If I remember correctly, December, I think it was more flattish, and we think they're going to exceed their contract spend from what you can tell in terms of their month-to-month consumption, is it just a function of time? Do they have to hit month 6 or 7 of the contract? Is it a certain amount of data that they get into the platform where that that fly [ph] starts to work in terms of accelerating the consumption? Any sort of early learnings, early guesses on the behavior patterns of these early cohorts.

Bill Staples

So Sanjit, we spend a lot of time looking at those numbers. And it's a little too early to make any definitive conclusions about that. But one of the things I would point out is when we look at the new customers versus customers that have transitioned from a previous an APM, typically an APM-only type arrangement to the full platform. And they've moved over to the consumption model, we do see significantly better growth rates in the new cohort versus the existing - the conversions. And I think one of the things that's going on is there's a legacy bias when a customer converts over, right? They come in, they hear about a new pricing plan, the market is skeptical, just of software channels and software companies in general, unfortunately. And so they have in their mind a certain level of value, and they'll try and manage around that level of spend. And I think it takes a while for them to realize, well, I used to be using on the APM. Now I have this full broad platform.

Over time, they start to see those benefits, and they've realized, wow, this is worth more. And we start to see consumption to exceed commitment levels. But I think that takes a little bit of time versus in come in and sign on directly to the consumption model, we see those numbers, those - that data and those user numbers grow pretty regularly right from the start.

Sanjit Singh

That makes quite of sense, Mark. And thank you for that early color. I appreciate it

Peter Goldmacher

Operator, next question?

Operator

And the next question will come from Rob Oliver with Baird. Please go ahead.

Robert Oliver

Great. Good evening. Thank you, guys, for taking my question. Bill, the vision that you've articulated is clearly a product-led growth vision and one that having spent time in future stack this quarter, I think with the extensive kind of free user base you guys have really invested in, really seems like you guys are really uniquely positioned to benefit from that. Just a couple of questions on that. I think Adobe is probably one of the original product like growth companies. And so you have a ton of experience there. What are some of the practical nuts and bolts things that you want to see happen or that need to happen internally at New Relic in order to create that sort of virtuous cycle where you get feedback on what your customers are doing and you're able to integrate that and apply that to new use cases? And then I know Mark talked about in response to Sanjit question, some of the early cohorts. And can you guys tell are those cohorts using the whole New Relic One platform? Or are they just primarily kind of sticking to APM for now?

Bill Staples

Yes. Thank you, Rob. You're right. Product lag growth is a really important part of our strategy because as you said, it's a strong signal and validation of the product experience and product market fit. It's something that other companies have done successfully and we've studied and learned from, and I have some experience with as well. And the techniques that we're employing as we go about it, is to really obsess about that self-service experience, really thinking about removing all of the friction from getting started with observability, building the nurturing and training in the product for how to take advantage of the features and master the capabilities. And it's the span of use cases, not just the things you might think of like ingesting your first data or analyzing the health of a particular system, but it includes things like adding users, reviewing your bill, adding your credit card. Every bit of friction that gets in the way of an engineer, getting value out of the product is the source of friction that we want to remove. And so the frac team has increasingly spent a lot of energy on removing those friction points.

And I'd point out that, that's valuable not only for growing new accounts and enabling customers to self-service about the platform. It's also extremely valuable to our large existing sales lead accounts because those same friction points annoy and get in their way of getting more value from the platform. As Mark described, the usage pattern of those large sales-led accounts that maybe have used us for APM. They go through this phase of kind of rightsizing and resetting their expectations on what they're getting from New Relic. And so removing the friction from engaging across the platform and getting all of the platform value is beneficial for them as well. It's why we're taking such a strong position on product-led growth. In terms of the usage patterns, yes, we are seeing those new self-service customers coming in, really with that expectation of adopting an observability platform from the start.

So, they often directly start monitoring not just their applications as you'd expect from a Newell customer with our world-class APM. But they're monitoring their infrastructure, they're ingesting logs they're making use of New Relic Explorer and the breadth of capabilities that we provide more quickly and more broadly than that existing customer base that has to go through the migration, the conversion and then the expansion. So their usage patterns, as Mark remarked, are markedly different and their growth as a result of that is also different.

I hope that answers your question?

Robert Oliver

It does. That's really helpful. Thanks a lot for all the color, Bill. I appreciate it.

Peter Goldmacher

Operator, next question?

Operator

The next question will come from Michael Turits with KeyBanc Capital. Please go ahead.

Michael Turits

Hey guys, very nice quarter in terms of a lot of upturns here. First, Mark, I wanted to start with you. I just want to make sure we clearly identify exactly what drove the revenue upside and acceleration in the quarter. I think you called out churn, but is it churn? And then is it also an uptick in the legacy customers that were converting over and then close in the consumption relative to expectations. I just want to make sure it's clear what drove that revenue upside.

Bill Staples

Sure. Michael, the primary drivers were in churn in terms of customers converting over. And so we did a better job with converting over customers than we had expected. In fact, the metric that we have disclosed in the past around the conversion ratio that I think you might remember was 15% in Q2 last year, 0 in Q3 and 4% in Q4. That number was actually negative 4% in Q1. And we feel that metric is declining in relevance to the point where we're not going to give it beyond this quarter because we migrated the majority of customers over. And I'll give you a little bit more color around that metric. Although that number was negative, our overall conversion rates in Q1 were better than expected. And by that, I mean, when we look at the total base of customers up for renewal at the beginning of the quarter. And we compare that to how many we were able to renew by the end of the quarter, we had a stronger-than-expected results. Specifically, customers who may have churned out in previous quarters instead migrated to a new consumption contract. And even though their commitment may have decreased, more of those customers remain and we can now focus on nurturing and growing them over the current year. So that was one source of the revenue upside.

The other was driven by variable consideration, which, as you know, is consumption in excess of commitment that we recognized in the period. And so that was one of the other drivers. In fact, we had about, I think, 5x as many customers that we recognized to have a consideration for in Q1 versus Q4. And the overall numbers are still relatively modest, but we look at that as a good sign in terms of customers consuming their commitment.

Michael Turits

And I guess, I'll actually go down and Bill, I'll hit you with the strategic question in other time got some that I think are interesting. But Mark, do we have a time frame for when we think that your new NRR metric as well as customers could start to increase?

Mark Sachleben

So for the customer count, we expect that to be increasing this year. As Bill mentioned, that's one of our key priorities. And we look at that - this quarter, it was relatively - it was flat. And we had a relatively high number of low-end customers convert to the free tier. And so that was offset by the new Pago customers. We're anniversarying that big - those migrations to the free tier because the free tier was introduced last August. So this quarter will have a fair number that I imagine, but then I think they'll decrease. And as we continue to grow the PayGo additions, we should start to see our total account numbers increase over the course of this fiscal year. In terms of the NRR, that is - I think that's a trailing metric. So the reality is I think we'll start to see - you'll see the revenue start to increase and start to reaccelerate in advance of the NRR ticking up.

Michael Turits

Okay. Thanks, Mark. Thanks, Bill.

Mark Sachleben

Operator, next question, please?

Operator

And the next question will come from George Iwanyc with Oppenheimer.

George Iwanyc

Thank you for taking my question. With the new sales comp plan now in place and kind of focused on platform consumption, Mark, can you give us a sense of - Have you seen any attrition? And are you able to bring in the type of people that you're comfortable with from a hiring perspective right now? And kind of where you are as far as staffing is concerned?

Mark Sachleben

Sure. The attrition in Q1 for an enterprise sale, a software company is always high relative to the rest of the year. We're no different. I think attrition throughout the industry, throughout every industry actually is obviously a hot topic right now. But - and we did a lot of education over the last couple of quarters the tail end of last year in Q4 and then coming into Q1, the trust us only go so far. But as we came into this quarter, Q1, we did, I think, a good job of educating the team and letting them know how they could do very well what was required. And in general, I would say it has been embraced, and people. I think we're starting to win over even the skeptics that were in the group from a Q1 - into Q1, I think attainment was strong and people are realizing, wow, this can be very attractive. So I think the internal team is buying in and bought in. And I think we're able to sell it to new folks, and we've had good success in attracting the kind of talent that we want.

Bill Staples

Maybe I'll just tag onto that a little bit of perspective. I have the opportunity with the CEO transition earlier in the quarter to really spend a lot of time with go-to-market function as well as other functions in the company that I haven't historically spent as much time with. And it was a great experience, getting no more relics and really understanding what's on their mind and what they would expect from me as CEO and from the company overall. And I can say with the go-to-market organization, it's a fantastic team that, as Mark said, really does seem to be embracing the model. And as you can imagine, with the results we were able to share this quarter, pretty excited as well with their own ability to attain quotas and drive consumption and get the rewards of that. In terms of attrition, that is an industry-wide challenge, as I've had a chance to also speak with other CEOs, who also facing a lot of attrition.

I think, I read Microsoft, LinkedIn, published a study at one point saying up to 40% of the workforce was considering changing jobs this calendar year no doubt, we've also seen our share of record attrition. But the good news is it's only decelerated. It's only gone down in the last couple of months. And so we feel like we've taken the steps to really address that and make New Relic a great company to work for, and we're going to continue to invest in our employees to make sure that their success in the company's success go hand-in-hand.

Mark Sachleben

Yes. I just want to follow on 1 comment about that. Bill mentioned steps we've taken one of the steps we took was to look at compensation and starting July 1, and we did a compensation adjustment for just about everyone in the company as a means of maybe - helping make sure that people are on board and engaged and fairly compensated. And you may have noticed that we kept our guidance - our operating income guidance for the year flat in spite of the big increase in the top line guidance. And a big reason for that was the compensation adjustment that we did effective July 1.

George Iwanyc

That's great. Thank you.

Mark Sachleben

Operator, next question, please?

Operator

The next question will come from Yun Kim with Loop Capital.

Yun Kim

Thank you. Congrats on a solid quarter. I think you guys are making a pretty good progress here. Just trying to understand - I know it's the consumption model, but just trying to understand the dynamics between the consumption and the seat count mix in your model. Is it fair to say that at least in the near term, the variability in your revenue or upside in your revenue will be more driven by consumption, whether then increasing the number of users? And just do you expect some seasonality around the consumption like strength in the December quarter?

Mark Sachleben

It is true. We are a consumption company. And as such, consumption for us is driven by more users and - or more data. And so that is what's driving our top line. That's what's driving growth. In terms of seasonality, we don't really expect too much of that the way we recognize revenue with variable consideration, It tends to smooth out any of those peaks. And over the customer base of many thousands of customers, inevitably, some might jump up in a certain month or a period and others are flatter, so we don't expect a lot of seasonality in our top line as we go forward.

Yun Kim

Okay, great. I just want to make sure, though, so in your contracts, it doesn't specify a number of users or whatever. It's just simply based on the fact that - if more users are using, they'll be increasing consumption. Is that how you guys are looking at it?

Mark Sachleben

Yes. So a customer commits to a certain amount of spend and then they can draw that spend down through adjusting data or through users, adding seats or employing seats. And it's incredibly attractive for customers because of the flexibility we offer - And I think that's something that perhaps isn't quite as well known yet, but it means that you don't have to worry about what you're doing in 1 month or if you have seasonal fluctuations, you just get a period of - a pool of funds that you can use for the year and you can consume that over that 12-month period at the rate which makes sense for your business. And if you go over that number, you just get charged at the same rate, it's not put ever something. You don't get charged excess instead of that. And so that's how you draw it down, it is either by ingesting data or easing seats.

Yun Kim

Got it. And then, just stepping back; can you talk about the progress that you have made in regard to using your pricing model you just described to attract new customers as you pointed out, it sounds like the new customers are ramping up or expanding faster than the traditional customers? Are you redirecting some of your efforts to attract these new customers rather than focusing on some of the older customers who may be always comparing to their whole pricing whenever they look at any kind of expansion opportunity?

Bill Staples

Yes. The way I think about go-to-market - this is Bill, the way I think about go-to-market, there's really three approaches and now that we have at New Relic, there's our sales-led approach, which for our top most highest contract - highest value contract customers. We have dedicated workforce around that nurtures their relationship, their consumption and adoption of the platform. We have a separate go-to-market motion around self-service. It's really product led. And that starts with the free tier. So 0 commitments, 0 credit card required, just begin using. And as soon as you hit the thresholds on users or data, you're then prompted to put in a credit card and continue to consume freely. And then the third is our partner-led approach. Our strategic partner, probably the biggest contributor to that revenue right now being AWS and the partnership we have there along with many other MSPs and resellers. And so all three of those we invest in with different parts of the company and with different tactics. The majority of revenue obviously continues to come from our large sales led customer base, but increasing in relevance in terms of the number of accounts, being our self-service go-to-market motion.

Yun Kim

Got you. I got one last question for Mark. When some of those customers with multiyear large renewals coming up, do you expect them to kind of renew under a shorter term, maybe 1-year annual contract link? Or do you expect them to kind of renew on a multi-year basis again?

Mark Sachleben

I would expect most of them to go on a 1-year basis. So our very large customers, we'll do what's right for the customer. And if that - it's multiyear is what they really require for their business, we would accommodate that. But by and large, our customers - we find our customers of all sizes realize that the 1-year annual pool of funds is a very attractive pricing model for them. It gives them great flexibility. A good combination of flexibility, but price certainty; and so I would expect most to go to that model.

Yun Kim

Okay, great. Thank you so much.

Mark Sachleben

Operator, next question, please?

Operator

The next question will come from Derrick Wood with Cowen.

Nick Altmann

This is actually Nick Altmann on for Derek. You guys have mentioned that you made some tweaks to how the sales force is incentivized and compensated with more compensation being derived from the consumption portion. But historically speaking, you guys have talked about how you're investing pretty heavily in the customer success organization. So can you maybe give us an update there. Because it seems like that would be pretty critical in sort of driving that consumption piece.

Bill Staples

Yes. Just to clarify, 100% of the new compensation model is derived from consumption. So - our - it's a complete pivot for our sales force, going from 100% really derived from that upfront commitment to now 100% driven from consumption. And it's a strategic change because we believe that when we invest in our customer success and helping them realize the value of the platform, they're going to be willing to spend more over time, consume more of the platform and spend more over time. And that rolled out at the beginning of the first quarter. And as Mark already shared, we believe is contributing to lower churn as well as the increased consumption and variable consideration revenue that we're able to report as part of our beating expectations on revenue this quarter. Mark, anything you'd add to that?

Mark Sachleben

Yes, I don't think so. I think you covered.

Nick Altmann

Got it. And then just maybe a higher - I was just going to ask maybe a higher-level question. Around a year ago, you guys talked about wanting to become interoperate, a little bit more with open source frameworks to help drive the consumption piece. So if you could just sort of give an update there as to how that's going, that would be great.

Bill Staples

Yes. Great question. Thank you. Yes, we announced last year we open sourced all of our existing proprietary agents. That has gone very well. We've taken many contributions from the community, from our customers and partners through those new open source, what were previously proprietary now open source agents. We've also committed to and put resources against open telemetry and the industry standard that many vendors and community members contribute to. And we also now supporting the platform. It's also open source. And then many open source systems like Prometheus, which is a metric system that's built into Kubernetes, Grafana, charting application that helps many operators often use to visualize their data we now natively support on the platform as well. And increasingly, we look for basically any telemetry data source. We treat as a first-class contributor to our platform and connect to ensure that our customers can ingest that data and really have one place as their authoritative source of truth for telemetry data.

That's so important for engineers because whenever they have to - in the middle of an incident, go between different tools and different data stores to try to reconcile the data they're seeing and troubleshoot, it just adds time and adds friction. In the middle of a crisis. That's not a good thing. So customers love being able to connect all of those data types, whether it's from our own from our own agents or from open source systems and see it all in one place. That's the core value proposition of our strata platform. And so far, it's going really well. We're seeing a lot more data coming in through those open source channels than we even expected. So it's one of the contributors to the large data growth year-over-year that we've reported on.

Operator

And the final question will come from Jack Andrews with Needham.

Jack Andrews

In the letter, you talked about laying the groundwork for a broader ecosystem outside of AWS. Could you just elaborate on who do you think you could be moving the needle for you in terms of really gaining incremental distribution?

Bill Staples

Yes. When we think about that partner channel that I was talking about earlier is a go-to-market channel for us, we think broadly across the set of partners that we have today as well as new partners that we want to nurture and grow. Starting with cloud providers, we obviously have a strategic partnership with AWS, but increasingly, our customers run in many clouds and want to see New Relic available and partner with the other major cloud providers as well. We see MSPs as an existing partner channel as well that works for us today, and we increasingly want to invest in to nurture more business going forward. And we did some business through other reseller channels and ISVs through technology partnerships. We have a team looking at that as well. And so when I think about partners, it's a third leg of the stool that I expect will continue to contribute to New Relic's growth in the quarters ahead.

Jack Andrews

Thanks very much.

Bill Staples

All right. Thank you so much for joining our call today. I look forward to meeting many of you in the coming weeks in calls and at investor conferences as the opportunity allows. Thank you for your interest in New Relic, and we'll see you again soon. Thanks.

Operator

The conference has now concluded. Thank you for attending today's presentation. And you may now disconnect.