PagerDuty, Inc.

Good afternoon, and thank you for joining us to discuss PagerDuty's third 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, future revenue, operating margins, net income, cash balance, and total addressable market, 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. Further information on these and other factors that could 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 other subsequent filings made with the SEC. With that, I will turn the call over to Jennifer.

Good afternoon and thank you for joining us today. PagerDuty delivered solid Q3 top and bottom line results above the high end of our guidance ranges with 15% revenue growth and a non-GAAP operating margin of 14%. Year-over-year operating margin expanded by over 1,000 basis points as we continue to demonstrate our commitment to profitable growth. Long-term demand remains strong as all enterprises seek to address similar high-priority challenges. First, their customers are digital and expect real-time modern experiences and services, but their operations are antiquated, command and control, and manual. Crossing this operations chasm is critical to protect and grow revenue in an increasingly digital on-demand marketplace. Second, all businesses seek to do more with less in the face of an ongoing skill shortage. This has led to an increased appetite for automation and demand for generative AI in order to reduce costs and achieve operational efficiency at scale. And third, tech debt and complexity continue to rise creating material risk of operational and business failures, driving demand for automated and intelligent incident management solutions. Solving these priorities is critical for technology and business leaders, especially in enterprise, and has increased the demand for the PagerDuty Operations Cloud. New customer acquisition in enterprise and mid-market and strengthened strategic customer expansions were the highlight of the quarter, surpassing results from Q1 and Q2 of this fiscal year. Among the contributions to strengthen new business was a record setting win with a longstanding enterprise software customer. This operations cloud expansion included all four products, incident management, AI ops, automation, and customer service ops. Two at over $1 million of ARR each and showcases PagerDuty's platform value proposition to increase productivity, protect revenue, and reduce risk by advancing operational maturity and resilience for enterprises. Enterprise, our strongest performing segment during the corner, remains our strategic focus. Notwithstanding a few unusual but sizable renewal issues in Q3, enterprise dollar-based net retention was more than 500 basis points above that of SMB. Customer retention and growth in enterprise have also been more resilient over the past 12 months. These key metrics reinforce our prioritization of resources and our confidence in our global enterprise strategy, product development and go-to-market efforts. Macro volatility and uncertainty continues to pressure budgets and slow customer decision-making. While our customers remained highly engaged with nearly a third of enterprise and mid-market customers expanding with us in the quarter, they continue to apply conservatism to expansions and seek ways to reduce overall IT spend while protecting investments for critical functionality and operations. In the past, we've seen similar behaviors. We were rewarded by focusing on long-term relationships rather than short-term gains, and that will continue to be our approach. New and expansion ARR was the strongest of the fiscal year, reinforcing that even in a challenging operating environment, the operations cloud value proposition resonates. That said, turn and downgrade dollars were unfavorable to our target and created a headwind to total business generated during the quarter. We are addressing the higher risk of downgrades in churn by first systematically identifying risk and engaging with customers earlier in the renewal lifecycle. Second, by providing flexible multi-year pricing solutions for customers who demonstrate need. And third, working with customers to optimize their use of the operations cloud to maximize business value. As centralized decision-making has become the norm for our customers, we continue to evolve our enterprise motion. This has included increased focus on C-suite buyers with centralized purchasing authority, positioning centered around the financial value proposition of the operations cloud, and enterprise pricing to support scaled expansion across all products. This account management approach complements our high velocity land and expand motion that focuses on technical champions and practitioners and has enabled us to methodically improve the quality and quantity of enterprise wins. The focus on enterprise leadership with our persistent pace of innovation underpins an increasingly efficient enterprise go-to-market practice. During the third quarter, our generative AI program continued to advance. We now have four intuitive features in early access, including AI-generated runbook automation, status updates, postmortems, and a new Slack-based chat interface to make it even easier to engage with our capabilities. These capabilities are the first of the family of generative AI use cases we're calling PagerDuty Copilot and make it possible for PagerDuty customers to use generative AI across the operations cloud from event ingest to resolution. Our strategy is to take a platform approach to leveraging generative AI across all products, instantiating it as a core primitive developers and employees can build upon with a common secure gateway and customer opt-in interface packaged as PagerDuty Co-Pilot. Our current primary goal is customer engagement and input available through our early access program. To date, the feedback on design and usage have been very positive. Also in Q3, we expanded our customer service operations solution to include private status pages and ServiceNow CSM case automation. These enhancements immediately connect customer service agents to PagerDuty in product enabling customer facing teams to more quickly close customer cases without context switching. This level of visibility and engagement into live incident management is a workflow requested by our largest, most complex customers. In AIOps, we rolled out several significant enhancements specifically for central IT teams, including network operation centers and site reliability engineering teams. These additions enable teams to improve operational resilience using automation to analyze and action vast volumes of data immediately with measurable results. During the quarter, these went into early access and are oversubscribed. And finally, on the product development front, we closed the acquisition of Jelly earlier this month. And I want to welcome Nora Jones and the team to PagerDuty. Incorporating Jelly's talented team and technology will further differentiate the operations cloud as a system of action, going beyond instant response to drive quantifiable improvements in productivity and resilience. Jelly turns every incident into a learning opportunity. by completing the lifecycle of incident management, particularly for service reliability management in IT, with deep, actionable analysis, enriched learning, and proactive improvement. Customer reaction to this combination has been incredibly positive, and we look forward to expanding our incident management offering rapidly as a result. Incorporating product innovation into our enterprise go-to-market produces enduring customer commitments to the operations cloud. Recall that in Q2, a global semiconductor supplier identified our no-code workflow automation as the unique solution to reduce manual work and human error in pursuit of eliminating tens of millions of dollars in non-value-added annual costs. Our focus on enterprise continued to scale in Q3, resulting in a multi-year, eight-figure record-setting win, as well as an additional seven-figure operations cloud expansion. In both cases, strong executive alignment, combined with a proven track record in serving technical champions, proved instrumental in navigating their centralized decision-making processes. With a large enterprise software customer, we tightly aligned across multiple business units on their service ownership journey to save tens of millions of dollars in operational costs and provide a best in class customer experience for their end users. Our team identified high priority business problems in collaboration with executives to anchor PagerDuty as a strategic partner to scale across technology and customer service teams. We estimate 25 million in annual savings through operational efficiency, reduction in manual work, and revenue protection from churn. A rapidly growing global cybersecurity leader also partnered with PagerDuty to reduce the strain on its teams by increasing productivity through automation. This aligned with the CEO's objectives to improve customer service and reduce manual processes throughout the organization. These examples are representative of a growing number of strategic wins. Our competitive differentiators, including our functional advantage, resilience at scale, short time to value, and low total cost of ownership, provide an ROI that we believe outpaces the narrow set of use cases served by homegrown, low cost, and platform competitors. We've begun piloting new bundling and pricing strategies to support more seamless user adoption and expand the surface area of the operations cloud within our customers. In some cases, this has reduced sales cycle time, generated pipeline, and reduced retention risk. We plan to scale several initiatives over the next two quarters. Earlier this week at AWS reInvent, PagerDuty was recognized as the AWS Marketplace Partner of the Year for North America. This honor recognized us as a partner whose business model embraces specialization, innovation, and cooperation over the past year. This recognition validates the strategic nature of the operations cloud in modernizing operations. We plan to refine and deepen our technical and consulting partner relationships across the globe to unlock more value as we scale partnerships in FY25. During Q3, we also welcomed Eric Johnson as our new CIO. Eric comes to us from SurveyMonkey and is focused on leading PagerDuty's critical IT infrastructure, data management, enterprise systems, and evangelism with fellow CIOs. Prior to this, he had served as the CIO and Senior Vice President at both DocuSign and Talent. We were honored to be recognized by Fortune in three Best Places to Work categories this quarter, including best workplaces in technology, best medium workplaces, and PagerDuty's employees ranked us as a great place to work. Additionally, PagerDuty was named one of the top 10 companies to work for in Portugal. Finally, we were named the definitive leader in GigaOhm's incident response radar. To summarize, while the environment remains tough, we've significantly advanced the operations cloud in enterprise and saw momentum in expansion ARR. While it's too early to call a market recovery, we do see several green shoots, including enterprise and mid-market stabilization and demand for strategic operations cloud engagements. We are proud of our operating margin improvement and intend to continue to drive further margin expansion, but make no mistake, we are focused on growth. We expect the initiatives we have in place to position us well for growth reacceleration during the next fiscal year. We've made great progress on our mission to revolutionize operations, and I want to thank our teams for their commitment and our customers who trust PagerDuty to manage and automate their most critical work. 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 Q3, we delivered solid results above the guidance ranges we provided for both the top and the bottom line. We continue to adjust effectively to the economic environment with improvement in new business, in enterprise and mid-market, both in terms of new acquisition and expansion. Cautious spending by customers continue to impact SMB and cause increased negotiation around renewals. However, several large six and seven figure transactions this quarter are providing evidence of PageDuty's key role in enabling our customers to mature and modernize their technology environments. Our multi-year initiatives focused on profitable growth continue to deliver operating margin improvements with over a thousand basis points improvements this quarter. 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 $109 million in the third quarter, up 15% year over year. The contribution from international was 27% of total revenues, an increase from the 23% seen in Q3 of last year. Annual recurring revenue exiting Q3 grew 13% year over year to $439 million. We delivered 110% dollar-based net retention in Q3 compared to 123% in the same period one year ago. Our DB&R expectation for Q4 is approximately 106%. Customers spending over $100,000 in annual recurring revenue grew to 778, up 10% from a year ago. Total customer count of 15,049 declined year over year by 1% as demand among SMB and VSB accounts remain uneven. Free and paid customers on our platform, however, grew to over 27,000, an increase of approximately 18% compared to Q3 of last year. Q3 gross margin was 85% and within our 84 to 86% target range. Operating income improved by over a thousand basis points to $15 million or 14% of revenue. This compares to $3 million or 3% of revenue in the same quarter last year. Revenue upside along with a one quarter delay in realizing approximately $2 million of non-recurring expenses contributed positively to the operating income result. In terms of cashflow for the quarter, cash from operations was $17 million or 16% of revenue and free cashflow was $15 million or 14% of revenue. Turning to the balance sheet, we ended the quarter with $575 million in cash, cash equivalents and investments. Total deferred revenue ended the quarter at $196 million, up 9% year-over-year. Quarterly calculated billings were $109 million, an increase of 4% year-over-year and below the range of 8-10% provided during last quarter's call. On a training 12-months basis, billings were $437 million, an increase of 14% compared to a year ago and in line with our estimates. With respect to Q4, we expect 12-months billings growth to be approximately 10%. Turning to our guidance, for the fourth quarter of fiscal 2024, We expect revenue in the range of $109.5 to $111.5 million, representing a growth rate of 8% to 10%. And net income per diluted share attributable to PagerDuty Inc. in the range of $0.14 to $0.15. This implies an operating margin of 8% to 9%. For the full fiscal year 2024, we're increasing our revenue expectation to a range of $429 to $431 million, representing a growth rate of 16%. This compares to the range previously provided of $426 to $430 million. And net income per diluted share attributed bill to PagerDuty Inc remains between 72 and 73 cents. This implies an operating margin of 13%. The changes we have made adjusting to the macroeconomic environment over the past two quarters are yielding results. We are driving a new level of engagement with our customers outside of the renewal cycle to ensure they are successful and support their business priorities. In enterprise and mid-market, our investments enablement are leading to improve new customer acquisition, stronger expansion metrics, increase in larger multi-year commitments, and strategic operations cloud multi-product transactions. Our long-term view of the business has us focused on continuing to deliver profitable growth as we revolutionize operations with our customers. With that, I will open the call for Q&A.