mekong22 –
I sold out of NEWR after last Q’s report, but was paying close attention to this one as it was on my watch list. My sell thesis at the time was:
“I had no problem with revenue growth holding at 35% last Q. My issue was slippage in all of the following areas:
* gross profit growth
* operating expenses
* operating expenses as a % of revenues
* operating margins
* free cash flow margin
* expansion rate
* their prior EPS momentum/growth
In addition:
* their overall customer count remained flat for the 2nd Q in a row (potential growth issue)
* they spent a decent amount of time on their call outlining a move upmarket, suggesting a little more work to generate business (potential operating leverage issue)
Considered individually none of those blips was big enough to scare me off. However, when I put them all together I decided NEWR might have some headwinds I didn’t see in other names I was tracking.”
So after taking a look at their release and listening to the call, how did they do in addressing my concerns? (Please note that there might be some ASC 606 vs 605 consideration in the exact comparisons, but I think the gist is right.)
As you noted, their major point of emphasis this quarter was the release of their new New Relic One plaform. Unless I’m reading it wrong, they view this as a revamp of their core product offering. According to the CEO, “we’ve designed it to be the basis of the next 10 years of innovation for New Relic.” So they’ve got quite a few things going on. There’s nothing wrong with that as all companies need to innovate especially in the tech sector. The question becomes whether we believe this innovation will lead to more business success down the road. Here’s how I’m thinking through it:
Revenues %YoY
Q1 Q2 Q3 Q4 YR Q1 Q2 Q3 Q4 YR
2017 $63.44 $68.10 $73.34 $263.48 2017 0
2018 $80.10 $84.69 $91.83 $98.45 $355.06 2018 #DIV/0! 33.5% 34.8% 34.2% 34.8%
2019 $108.22 $114.90 $124.01 $132.10 $479.23 2019 35.1% 35.7% 35.0% 34.2% 35.0%
Take: Holding steady and no issues here. I’m not crazy about the 29% guide for Q1 or 27% for FY20, but as we’ve seen before guides are made to be beaten.
Operating Expenses %YoY
Q1 Q2 Q3 Q4 YR Q1 Q2 Q3 Q4 YR
2017 $64.99 $65.96 $69.41 $74.47 $274.83 2017 0
2018 $81.57 $83.83 $84.14 $89.60 $339.14 2018 25.5% 27.1% 21.2% 20.3% 23.4%
2019 $94.80 $101.98 $112.35 $125.80 $434.93 2019 16.2% 21.7% 33.5% 40.4% 28.2%
Operating Expenses % Revenues
Q1 Q2 Q3 Q4 YR
2017 104.0% 101.9% 101.5% 104.3%
2018 101.8% 99.0% 91.6% 91.0% 95.5%
2019 87.6% 88.8% 90.6% 95.2% 90.8%
2020 0.0% 0.0%
Take: Hmmm. Trending the wrong way the last couple of Q’s. They mentioned record hiring in both S&M and R&D as the main driver here. They stated on the call they believe this hiring and a couple acquisitions have pulled their R&D model forward about 2 years, so that’s a positive. However, there will also be some carrying costs as they will need to support both their old and new platforms while transitioning customers over. That could be a drag for a while. However, these increases are perfectly reasonable if they lead to avenues for future growth.
Are there any signs of that future growth? They obviously believe their new platform will be an avenue. I don’t have any reason to doubt them on that point. However, they’ve also referenced “upmarket opportunities with greater expansion potential” for a couple of quarters now. What’s that look like?
Pros:
- 2300 Enterprise accounts vs 2100 last year (+9.5%). Not great growth, but it is an increasing base.
- 61% of ARR from Enterprise accounts this quarter vs 54% last year. Good.
- Average ARR from Enterprise accounts $140K vs $100K (+40%). Very good.
Cons:
- Total paid accounts dropped to 16,900 vs 17,000 (-5.8% YoY). From flat to a decrease in 3 Q’s. That’s fewer small customers to hopefully convert into bigger customers.
- Their expansion rate has declined from 141% to 131%. They are selling less to their existing customer base, although that’s not unusual if you’re getting bigger lands from Enterprise clients. This admittedly might not be a con, but I can’t consider it much more than a push at best.
- And…
Customer Accounts >$100K %YoY
Q1 Q2 Q3 Q4 YR Q1 Q2 Q3 Q4 YR
2017 517 2017 0
2018 555 586 629 703 2018 36.0%
2019 748 786 816 858 2019 34.8% 34.1% 29.7% 22.0%
- As we see above, growth in their lowest reported tier of upmarket customers appears to be declining rather holding or accelerating. Uh oh. We have other companies at similar run rates showing much better growth at the $100K level.
Take: I view the cons outweighing the pros here, at least in the short term. This doesn’t look like a company organically moving upstream to take advantage of bigger business already coming its way. It looks more like a company trying to monetize bigger clients because the easy money is drying up. They suggested on the call the time to ramp up new sales hires was roughly one year. I see more slog than smooth transition here.
Final Take:
As a prior holding for me and a company I was pretty familiar with, NEWR had a strong spot on my watch list. However, I can’t say this quarter impressed. A lot of companies organically release new products or features as a natural expansion of their business model. This smells more to me like a company who is reactively adjusting its business in an attempt to reignite growth. NEWR does have an advantage in that it is already profitable as it tries to make this adjustment. However, my assessment of this quarter suggests NEWR is likely to drift for a while until it finds its new footing. I’d be curious to hear if Bear sees things differently as he’s a little more adept with the numbers than I am and clearly knows New Relic better than just about anyone.