PagerDuty, Inc.

Good afternoon, and thank you for joining us to discuss PagerDuty's first quarter fiscal year 2024 results. With me on today's call are Jennifer Tejada, PagerDuty's chairperson and chief executive officer, and Howard Wilson, chief financial officer. Before we begin, let me remind everyone that statements made on this call include forward-looking statements based on the environment as we currently see it. which involve known and unknown risks and uncertainties that may cause our actual results, performance, or achievements to be materially different from those expressed or implied by the forward-looking statements. These forward-looking statements include our growth prospects and future revenue, among others, and represent our management's belief and assumptions only as of the date such statements are made, and we undertake no obligation to update these. During today's call, we will discuss non-GAAP financial measures, which are in addition to and not a substitute for or superior to measures of financial performance prepared in accordance with GAAP. A reconciliation between GAAP and non-GAAP financial measures is available in our earnings release. For further information on these and other factors that would cause the company's financial results to differ materially are included in filings we make with the Securities and Exchange Commission, including our most recently filed Form 10-K, as well as our subsequent filings made with the SEC. With that, I'll turn the call over to Jennifer.

Good afternoon, and thank you for joining us on the call today. PagerDuty delivered solid 21% revenue growth in line with guidance and record non-gap operating margin well ahead of our range at 16%. Year-over-year operating margin expanded by more than 1,800 basis points as we balance growth with profitability in an increasingly challenging macro environment. Enterprise and mid-market customers exhibited resilience, contributing to our stable ARR turn rate of less than 5% and a 17% increase in accounts spending over $100,000 in ARR. Total customer count was up marginally year-over-year as we saw more pronounced headwinds in SMB acquisition and retention. From a pipeline perspective, total ARR and mix from new products improved meaningfully during the quarter, a positive demand signal, especially in a more conservative spending environment. We entered the first quarter with ramped capacity and pipeline value at their highest levels in several quarters. This combination generated strong transaction volume. However, customer spending was more centralized and rigorous, which lengthened sales cycles and put pressure on average deal sized, and conversion rates, especially for in-quarter created and closed business. At a high level, we saw stability in our enterprise and upper mid-market base, but more cost-constrained behavior and reduced budgets for new services while customers progress cloud and IT optimization efforts. S&B, which represents a high percentage of our customer mix, but only 20% of our ARR saw higher than historical churn, with customers primarily moving to homegrown or free solutions. Free accounts on our platform grew by 65% year over year. Platform usage grew in the quarter, demonstrating the essential nature of the operations cloud and criticality of incident response. The competitive environment remains stable as PagerDuty continues to widen the gap through innovation in AIOps and automation. We are adapting to our customers' evolving needs by ensuring full utilization and value realization from current deployments. In terms of demand creation, teams are enabled to cross-sell our newest AIOps solution while continuing to emphasize automation and the operations cloud as a means to achieving more with less. During the quarter, we continue to ship high impact innovation for our operations cloud platform. We released incident workflows for general availability, enabling teams with a no code workflow builder to customize their incident responses and expand the use of automation across departments. We added several new features to our cloud-based process automation SASH solution, which allows teams to leverage runbook automation in zero trust environments, critical given cybersecurity risk for enterprises. Our new AIOps solution includes global event orchestration specifically for IT and central infrastructure teams, complementing our existing developer-centric offering with flexible consumption-based pricing. AIOps is well-suited to address challenges our customers face in a more cost-constrained environment with value realized in days, not months. The solution complements our existing developer-focused offering to address the specific needs of centralized teams in network operations, site reliability engineering, and IT ops, which represent approximately 21 million global professionals. Adjusting to the market and aligning with the value of reducing incident noise, we now offer this SKU on a consumption basis. This pricing model gives customers scalability and flexibility while enabling PagerDuty to capture demand from a greater number of use cases quickly. AI has been a mainstay alongside automation in every part of our platform, and we continue to invest in it. PagerDuty was early in building a foundational data model to support our customers in moving from simply responding faster to issues to proactively preventing them from becoming major business and financial disruptions. This has been achieved by leveraging AI in incident response, AIOps, in process automation, and increasingly in customer service operations. The advent of generative AI represents a tremendous opportunity for PagerDuty and for our customers. The ease and elegance of engaging with generative AI, its fundamental intuitiveness through a natural language interface, creates a step function opportunity to unlock the full potential of the operations cloud. Generative AI brings a consumer-style simplicity to enterprise-grade automation and makes the realization of automation's potential a reality. With generative AI, the pace of software development will only accelerate, and more software means more complexity, which makes DevOps more important than ever. We see a vast number of use cases for generative AI across the operations cloud that will increase efficiency, improve team productivity, and delight users. Today, we announced early access for three use cases, including AI-generated status updates, incident postmortems, and process automation. We recognize from experience one of the challenges for AI in our space is that our customers expect a very high level of signal fidelity, accuracy of work orchestration, and automated actions. Trust is paramount during critical, time-sensitive crisis response, and the narrow margin for error means there is low tolerance for hallucination or false positives. the human in the loop of automated incident response will continue to play a critical expert oversight role. More broadly, the foundational data model that we've developed over a decade positions us well to continue to leverage AI and machine learning across the platform to automate solutions to big challenges where our customers are seeking productivity and efficiency. Ultimately, we see generative AI expanding our TAM because more software is generated faster, increasing the complexity and the volume of the software ecosystem, widening the digital operations chasm, and driving a greater need for PagerDuty's Operations Cloud. Our mission remains unchanged, to revolutionize operations and build customer trust by anticipating the unexpected in an unpredictable world. Protecting digital revenue remains a compelling value proposition for our customers and is increasingly relevant in the digital always-on world where most of our customers rely heavily or almost entirely on e-commerce for customer acquisition and revenue. During the first quarter, we secured a multi-year engagement with a premier online travel and hospitality brand. The multi-million dollar ARR contract includes three operations cloud products, Incident Response, AIOps, and process automation. Our projection of a 400% customer ROI equates to tens of millions of dollars in annual savings. Consistent with the purchasing rigor I mentioned earlier, alignments span multiple teams, ranging from developers to executive leadership. We continue to win in financial services during the quarter where the strength of our integrated operations cloud platform displaced point solutions for an enterprise in the midst of a multi-year cloud transformation. Standardization of pager duty at this customer increased ARR to over a million dollars. Our 700 plus integration ecosystem and several deep integrations were unique differentiator for closing this deal. Among the integrations required were Amazon CloudWatch, Datadog and ServiceNow. The automation of incident escalation across the customer's business has a projected return on investment of over 300% and a short three-month payback period. Championing our customers also means building an equitable company that reflects the global and diverse users, customers and communities we serve. This quarter, we released our FY23 impact report, detailing last year's progress on social impact and ESG. Our carbon footprint now includes a more comprehensive measurement of our value chain emissions in preparation for announcing our science-based climate targets. Our social impact continued in Q1 this year as well. During the quarter, we were recognized for our ongoing support of women at all levels. In Q1, 50-50 women on boards recognized PagerDuty for having a gender balance board, one of only 327 companies in the Russell 3000 to achieve this distinction. Our long-term strategy and value proposition are increasingly relevant as our customers struggle to cross the operations chasm and address technical debt while their customers demand perfection in every digital moment. Even as companies focus on cost containment and efficiency, we see event volume continuing to rise and very high utilization rates across our installed base of over 15,000 paid accounts. We expanded our value proposition during Q1 by delivering three significant product innovations, incident workflows, process automation, and AIOps. For enterprises seeking to optimize their potential through digital innovation, the PagerDuty Operations Cloud is a game-changing essential platform. We continue to execute well, unscaling efficiently, consistently and significantly improving our operating margins. Sustainably improving our cost structure supports our long-term strategy, our investments in innovation, and pipeline generation to drive growth in this environment. The customer stories I referenced earlier are indicative of the opportunities emerging for the operations cloud and underpin my conviction in our ability to deliver against the outlook provided today and in our long-term opportunity as a durable, profitable growth company. I would like to thank our customers for their continued trust and recognize our global teams for their resilience and dedication to our mission. With that, I'll turn the call over to Howard, and I look forward to your questions.

Thank you, Jen, and good day to everyone joining us on this afternoon's call. In Q1, we delivered solid revenue growth in line with guidance at 21% and record non-gap operating margin well ahead of our range at 16%. It was a quarter with significant operations cloud product innovation releases each month with general availability of flexible workflows in February, cloud-based process automation in March, and the next version of our AIOps solution in April, which provides complex support for both developers and centralized ITOps teams. Q1 also saw large enterprise customers continuing their operations cloud journey, embracing our more advanced product offerings with large expansion deals. In the quarter, we generated standout sales pipeline with a strong focus on multi-products. And we saw high levels of customer engagement reflected in a high volume of expansion transactions and high usage of our platform. In enterprise and mid-market new customer acquisition remains strong. The enterprise and mid-market segments continue to contribute to more than 80% of our annual recurring revenue. In some respects, Q1 proved to be a challenging quarter where we noted an increased focus by customers in cost containment, either making decisions to defer spend or looking for ways to reduce cost in the near term. Sales cycles continue to lengthen as deals required higher levels of justification and more approvals. This was particularly pronounced in the back half of the quarter where more deals were pushed, deal sizes decreased, and conversion rates came under pressure compared to our historical trends. We have made operational adjustments in response to the changes we're seeing in customer buying behavior, as well as revising some of our estimates for the rest of the year. Unless otherwise stated, all references to our expenses and operating results are on a non-GAAP basis and are reconciled to our GAAP results in the earnings release that was posted before the call. Revenue was 103 million in the first quarter, up 21% year over year. The contribution from international was 28% of total revenues, an increase from the 24% seen in Q1 of last year. We delivered dollar-based net retention in Q1 of 116% compared to 126% in the same period one year ago. DBNR came in just below the lower end of the full year range of 117 to 120%. Customers spending over $100,000 annual recurring revenue grew to 764, up 17% from a year ago. Total paid customers increased to 15,089 compared to 15,040 in the year-ago period. New customer acquisition for enterprise and mid-market were in line with our expectations, but we believe the macroeconomic climate had an outsized impact on our small business segment where slower acquisition and higher churn was evident. We think the 65% growth in free is indicative of the cost constraint SMB customers are under in particular. Free and paid companies on our platform grew to over 25,000, an increase of approximately 19% compared to Q1 of last year. Q1 gross margin of 87% above our target range of 84 to 86% was driven by infrastructure cost optimization and improved headcount utilization. Operating income improved over 1800 basis points up to $16 million or 16% of revenue compared to a loss of $2 million or negative 3% of revenue in the same quarter last year. The annual improvement was driven by additional efficiency within sales and marketing and scale across G&A. In terms of cash flow for the quarter, cash from operations was $22 million, or 21% of revenue, and free cash flow was $21 million, or 20% of revenue. Q2 is expected to be our lowest free cash flow quarter of the year, potentially negative, given the strong working capital performance in Q1 and the seasonality of our billings. And for the full year, we still expect free cash flow margin to be at least a couple of points better than our operating margin. Turning to the balance sheet, we ended the quarter with $495 million in cash, cash equivalents and investments. Total deferred revenue ended the quarter at $202 million, up 21% year over year. Quarterly calculated billings were $96 million, which was an increase of 16% year over year, below the guidance of approximately 20% provided during last quarter's call. Adjusting for multi-year billings, billings growth would also be approximately 16%. Given quarter to quarter fluctuations in billings, we report billings on a trailing 12 months basis, which were $423 million, an increase of 23% compared to a year ago. On last quarter's call, we provided an expectation of approximately 24%. As a reminder, the comparable period Q1 of FY23 included $3 million of benefit from early renewals and revenue from catalytic. In updating our guidance, we have factored in continued macroeconomic volatility manifested in constrained buying behavior, which leads to longer sales cycles and smaller than historical purchases. For the second quarter fiscal 2024, we expect revenue in the range of $103.5 to $105.5 million, representing a growth rate of 15% to 17%. and net income per diluted share attributable to PageDuty Inc in the range of 10 to 11 cents. This implies an operating margin of 7%. For the full fiscal year 2024, we now expect revenue in the range of 425 to $430 million, representing a growth rate of 15 to 16%. This compares to the range previously provided of 446 to $452 million. and net income per diluted share attributable to PagerDuty Inc. of 60 to 65 cents. This implies an operating margin of 11 to 12%. Our revised bottom line guidance is an improvement compared to prior guidance of 45 to 50 cents and 8 to 9% respectively. In line with this guidance, we're providing the following updates to our estimates. Given our revised expectation for pipeline conversion rates, we now expect DBNR to be at or above 110% for the remainder of this fiscal year. In anticipation of continued pressure on the SMB segment, we're revising our total paid customer growth expectations to low single digit growth by the end of the year. With respect to billings, we expect billings growth for Q2 to be in the range of 12 to 15%, with trading 12 months billings growth exiting the second quarter to be approximately 20%. In what continues to be an uncertain economic environment, I would like to thank our customers for their loyalty and continued partnership. Our expanding operations cloud offerings that help our customers transform critical work, our high retention rates, and demonstrated operational efficiency put us in a strong position for the long term. We are poised to manage ongoing volatility effectively, while also well positioned to respond quickly to any improvements in the macro, and we'll continue to expand our operating margin significantly this year. With that, I will open up the call for Q&A.