Earnings Call Transcript - PD Q2 2022

Operator, Operator

Good afternoon, and thank you for joining us to discuss PagerDuty's Second Quarter and Fiscal 2022. With me on today's call are Jennifer Tejada, PagerDuty's Chairperson and Chief Executive Officer, and Howard Wilson, our Chief Financial Officer. Statements made on this call include forward-looking statements, 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. There are a number of limitations related to the use of these non-GAAP financial measures versus their closest GAAP equivalents. For example, other companies may calculate non-GAAP financial measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as

Jennifer Tejada, CEO

Thank you, Christine, and thanks to everyone for joining us today. Q2 was an outstanding quarter for PagerDuty, exceeding guidance and consensus for both top and bottom line results. We continue to benefit from strong demand in enterprise and mid-market, COVID tailwinds, a favorable competitive environment and a positive response to our product innovation in automation, AIOps and customer service. I'm so proud of the acceleration we've delivered and especially grateful to our customers, partners, and employees for their resilience and loyalty. For the second quarter of fiscal 2022, revenue growth accelerated to 33% year-over-year to $68 million, with trailing 12 months billings up 30%. Total dollar-based net retention accelerated to 126% and enterprise dollar-based net retention accelerated again to reach 130%. As the world's greatest enterprises transform into digital leaders, PagerDuty has become the operations cloud for the modern enterprise, demonstrating customer loyalty, durable growth and progress in building leadership share in a growing total addressable market. As our customers leverage PagerDuty across many new use cases, platform usage continues to accelerate with total year-on-year paid user growth up over 50%. Our solid top-line business was driven by accelerating demand for both our new automation offering and our comprehensive digital operations plan, especially in the enterprise and mid-market segments. To date, 15% of our mid-market and enterprise customers have attached digital ops, event intelligence or automation. Annual recurring revenue for our digital ops plan was up over 100% and now represents more than 20% of our total ARR. Customer spending more than $1 million with PagerDuty is up 63% year-over-year. The number of customers investing more than $500,000 in PagerDuty is up 34%; and those investing more than $100,000 are up 36%. Nearly 18,000 companies now run on PagerDuty, including over 65% of the Fortune 100 and over 45% of the Fortune 500. Within our largest customers, we still see significant room to grow both within and beyond engineering and IT. PagerDuty continues to focus on and influence the developer community in both large companies and startups. While many others have and will attempt to enter our market, our competitive differentiation is stronger today than it has ever been, and we continue to innovate and extend our leadership. For over a decade, we've innovated on behalf of developers and their interests while delivering unmatched resilience at scale for large enterprises. Our technology ecosystem, now over 600 integrations, is supported by recent investments in automation and 12 years of proprietary data driving our machine learning models. These are deep, durable competitive advantages that have established loyalty with our large and growing customer base. PagerDuty has strengthened its position as the leading choice for the most disruptive founders. Our start-up and small business segment performed exceptionally well after being impacted by COVID uncertainty last year. In Q2, SMB annual recurring revenue for both new business and expansion came in well above pre-COVID levels. While the pandemic continues to disrupt organizational plans, adaptability, flexibility and proactive operations have become core business imperatives. PagerDuty is essential infrastructure for managing increasing complexity in the service of customer experiences. And while nothing is certain, we expect post-pandemic benefits, including the builder economy and headcount growth to continue to fuel our momentum. Across our Annual Summit and Investor Day in June, we highlighted PagerDuty's original total addressable market, starting with the $25 billion TAM for on-call automation, incident management and DevOps. Our entrance into the broader automation market has expanded that TAM to $36 billion. This significant investment in automation capabilities has fueled our growth along with customer service, security operations and AIOps and enabled our customers to apply our platform to an even more diverse set of use cases. Q2 provided more evidence that the trends driving PagerDuty's success continue to accelerate. Companies are moving to a digital-first orientation to match the needs and expectations of their customers. This evolution is a multiyear effort for most large companies, even with the acceleration we saw during the pandemic. We measure this transition for our customers using an operational maturity framework. Simply put, operational maturity determines an organization's readiness and ability to shift from reactive mode to proactive and increasingly predictive operations. Most large organizations start on the far left with central IT op centers standing at the ready to react and to manually manage issues as they arise. The most innovative and operationally mature companies identify patterns through automation, predicting potential issues and then leveraging teams to prevent these issues from impacting their customers and business. The vast majority of enterprises are very early in this journey, creating a long runway for growth for PagerDuty. Our TAM now includes both upstream and downstream automation within and beyond incident management, allowing for an infinite number of critical work use cases. PagerDuty's automation solution performed exceptionally well this quarter, with new unique customer lands like Citigroup and Specsavers, and cross sales into existing PagerDuty customers, FedEx, Discovery, Netflix, Bose and one of the largest communication companies in the world. We added over 250 net new paying customers to our platform in the quarter. Our free offering has reduced friction for customers in low-value segments. And while this has impacted the total paid customer growth rate, it has expanded total companies on our platform by nearly 33% year-over-year. And also has enabled us to shift our paid customer acquisition focus to much higher value mid-market and enterprise segments. New customers include a Fortune 100 industrial company, Greyhelm bus lines and user testing, a late-stage private consumer insight start-up, which was also a win back from a competitor. During the quarter, thousands of our existing clients expanded their business with PagerDuty, including Anheuser-Busch, Carvana, FedEx, MasterCard, TripActions, Snowflake and a Fortune 200 fast food leader. One of the three largest communications companies in the world has leveraged PagerDuty for IT and engineering and this quarter added automation to improve customer service for over 200 million visitors to their web app. In the first rollout, PagerDuty automation reduced critical incident response from several hours to under an hour, which is projected to save the company millions in costs and revenue improvement. A Fortune 200 asset manager expanded during Q2 from a traditional incident response use case in engineering to implementation across data operations, site reliability engineering and their central command center. This customer now leverages PagerDuty to support 55,000 internal investment professionals. Regional expansion remains a terrific growth engine with significant upside for our team. International revenue grew 41% year-over-year, up from 38% last quarter and now accounts for about one-fourth of our total revenue. Magnitude Software in the Netherlands, New Zealand's KiwiRail, are now both part of our customer base. We also added Brazil's largest electronics and furniture retailer. International expansions included a Fortune 100 European-based multinational health care innovation company; Bunnings Group, Australia and New Zealand's leading retailer of home improvement and outdoor products; and one of Canada's largest banks, Scotiabank. In August, we appointed Jill Brennan to Vice President of PagerDuty's EMEA region. Jill previously led the $3 billion hybrid cloud software group for IBM across 26 countries and was most recently the SVP for EMEA sales at Metadata. Accelerating a journey to operational maturity for our customers is the objective of our four strategic product pillars, highlighted at Investor Day by our Chief Product Officer, Sean Scott. Each of these pillars deliver flexibility, connect everyone, connect everything, and automate everything. Delivering flexibility means effectively orchestrating critical work in real-time with a distributed workforce. The ability to assemble teams across DevOps, IT, SecOps and customer service is the only way to address critical issues that affect the customer experience. This quarter, one of the world's most well-known fast food companies implemented PagerDuty's digital operations plan to automate drive-through order taking, accelerate revenue and reduce customer wait times. Modern enterprises demand flexibility and connection. CloudFlare runs one of the world's largest networks to help make the Internet faster, safer and more reliable for millions of businesses. They are a long-time PagerDuty customer with their entire engineering organization on the platform. CloudFlare adopted PagerDuty for customer service, along with our Salesforce application, so now customer-facing teams can mobilize in real-time. PagerDuty for customer service connects service teams, those on the front lines of the customer experience with engineering teams in order to both address incidents quickly and communicate effectively to customers. This is just one more way PagerDuty supports CloudFlare's mission of helping to build a better Internet. During the quarter, we published new capabilities to empower full-service ownership. Dynamic Service Graph enables our users to instantly map, visualize and act on business and technical service dependencies across their entire digital environment. PagerDuty customers with Service Graph gain visibility into the health of their organizations, the ability to assess the impact of an incident and quickly identify probable causes, leveraging teams and data streams to derive insights that spur intelligent action. Connecting everything means layering traditional observability and monitoring functions from diverse data sources, prioritizing the real-time actions that matter the most. Our ecosystem of now over 600 active connectors is unmatched, enabling us to act as the central nervous system for our customers while making life easier for developers. The combination of our domain-agnostic approach to AIOps, our technology ecosystem, and upstream and downstream automation positions us to be the operations cloud for modern enterprises. We continually expand our relationships with leading technology partners like Cisco, who recently featured its partnership with PagerDuty in Times Square. Our Event Intelligence solution draws connections between the incidents that can interrupt business operations and their likely cause. Here, we focus on speeding mean time to resolution, reducing interruptions and delivering return on investments. An IDC study from earlier this year calculated PagerDuty's customers gain an average annual benefit of nearly $3.5 million per organization and almost 800% ROI with a payback period of 2 months. Our final product pillar is automate everything. We're reducing toil and further speeding response times by delivering intelligent automation that frees human experts to spend time innovating instead of responding. This quarter, the autonomous car unit of a Fortune 50 automobile manufacturer deployed PagerDuty automation. Previously, their small IT ops team supported more than 2,500 employees. The group spent the majority of their time on IT tickets and low-value activities. With PagerDuty, they're projecting improved mean time to resolution, additional flexibility to meet global scalability needs and projecting an average return on investment of more than $0.25 million in year one. We are very proud of our results for Q2, accelerating our growth to 33%, and we remain very confident in our momentum that it will continue as the market meets our leading product vision to be the operations cloud for modern enterprises. We also acknowledge many of the communities we work with still face the devastating impacts of COVID and more recently, those from fires and weather. In July, PagerDuty deployed $1 million in funding, product credits and volunteer technical assistance to support organizations working to equitably deliver COVID vaccines and vaccine education in underserved communities. We continue to build on our commitment to inclusion, diversity and equity as a business foundation for PagerDuty. Last week, we appointed our first Chief Diversity Officer to our leadership team, Roshan Kindred. In early October, we will release our second annual ID&E report, a transparent look at our employee composition, pay equity and diversity initiatives. In summary, Q2 was an inflection point for PagerDuty, with our acceleration illustrating the durability of our growth, the long-term potential for our platform and the legacy that we are building. PagerDuty is ushering in a new operating model for the modern enterprise, one focused on predicting and proactively managing issues as they arise; one that relies on automation versus people to detect and address critical work that drives business outcomes; one that requires a powerful combination of AIOps and automation on a digital operations platform that is easy to use, fast to deploy, delivers payback in weeks—it's weeks, not years—and delivers market-leading return on investment. We've spent over a decade earning the trust of our users and our customers, something we seek to earn every day by ensuring their success. Thank you to our incredibly talented Dutonians who work very hard to make these results look easy. Over to you, Howard.

Howard Wilson, CFO

Thank you, Jen. Financial results for Q2 demonstrate our success in building the operations cloud for modern enterprises. Once again, PagerDuty exceeded the high end of our guidance as top line growth accelerated. Our reliable execution in the face of the pandemic was bolstered by tailwinds, including cloud adoption, DevOps transformation and digital acceleration. And this gives us confidence in our plans to become a $1 billion SaaS company. Revenue of $68 million grew 33% year-over-year, driven by consistent execution in the enterprise and mid-market segments. New logos and familiar Fortune 500 names added users to the platform, including Abbott Laboratories, S&P Global, and Booking Holdings. We added a six-figure expansion deal with one of the world's largest airline carriers who are projecting higher developer productivity, accelerated migration to the cloud, and a six-month payback with a 449% ROI as a result of using our platform. PagerDuty drives value across all verticals but we continue to see strength within software and technology, financial services, and retail and wholesale. We also see continued new use case adoption across different teams with 12% of our paid customers using us for customer service and 20% using us for security use cases in addition to development or IT. International revenue, one of our four levers of growth, grew 41% year-over-year. International has grown from 23% of total revenue a year ago to nearly 25% this quarter. As the macro trends of digital transformation, DevOps adoption, and cloud migration accelerate globally, companies in the international markets are using PagerDuty to overhaul legacy and manual processes. Some highlights in the quarter include a new six-figure land in the EMEA region with a large media and broadcast company and a large six-figure multiyear deal in APJ transacted through our partner, AWS, with the Royal Automobile Club of Queensland, a 100-plus year motoring advocacy group in Australia. As we continue to gain share in enterprise and mid-market, we are seeing three underlying signals of strength. Firstly, durability in our revenues with customers on term arrangements representing 87% of our revenue versus 86% a year ago and 80% two years ago. Second, our remaining performance obligations, which grew 45% versus the same period a year ago, reflect momentum in multiyear deals. Third, we are seeing customers predictively increase their investment in PagerDuty. Customers spending over $100,000 a year and customers spending over $500,000 a year grew by 36% and 34%, respectively. And our average ARR per customer increased again for the 18th consecutive quarter. Our dollar-based net retention increased to 126%, up 10 percentage points year-over-year and 5 percentage points quarter-over-quarter, and our enterprise dollar-based net retention increased to 130%. For fiscal year 2022, we expect total dollar-based net retention to vary by quarter in the range of 118% to 124%. Trailing 12 months billings of $277 million grew 30% from a year ago and up 7 percentage points sequentially, making this the highest year-over-year growth since Q1 of FY '21. Quarterly billings increased 36% year-over-year. However, as a reminder, we focus on trailing 12 months billings to eliminate some of the noise associated with the variable timing of renewals and co-terms. We expect Q3 billings to grow between 25% and 35% and trailing 12-month billings exiting Q3 to be at or above 29%. The number of companies on the platform, both paid and free, grew by close to 33% from the same period a year ago. The conversion rates from free to paid continue to be better than expected, and the offering is creating a funnel for paid customer acquisition. A few recent examples of conversions are the Massachusetts Port Authority and OZ Minerals. They joined our platform through the freemium funnel and have converted to paying customers. I will now turn to the detailed non-GAAP financial results. Our EPS loss was $0.13 and our operating margin was negative 15%, both ahead of our Q2 guide and ahead of consensus. Gross margin remained best-in-class above 84% for the quarter, consistent with our target range of 84% to 86%. For the quarter, our operating expenses were $67 million compared to $48 million a year ago, primarily due to investments in sales and marketing and product development. Research and development expenses were $17 million or 25% of revenue compared to $13 million or 26% of revenue in the same period a year ago. We continue to invest in expanding our platform, including the areas of AIOps, automation, customer service, and our integration and workflow ecosystem. Sales and marketing expenses were $36 million or 53% of revenue compared to $25 million or 48% of revenue in the prior year. As we discussed on our last call, marketing expenses increased in the quarter, primarily due to our Annual PagerDuty Summit as well as the launch of our brand campaign. We expect sales and marketing as a percentage of revenue to be lower in the remainder of the fiscal year. General and administrative expenses were $15 million for the quarter or 22% of revenue compared to $10 million or 20% of revenue in the prior year. This increase was a result of a one-time non-recurring strategic consulting fee. We anticipate exiting the year with an expense to revenue ratio for G&A in the high teens. Our Q2 operating loss was $10 million compared to a loss of $3 million in the same quarter last year. Our operating margin was negative 15% compared to negative 6% in Q2 of fiscal 2021. Q2 net loss came in at $11 million, a net loss of $0.13 per share compared to a net loss of $3 million and a net loss of $0.04 per share in the second quarter of last year. Turning to the balance sheet, we ended the quarter with $547 million in cash, cash equivalents, and investments. Net cash used in operations was $12 million or negative 17% of revenue compared to net cash provided by operating activities of $2 million or 4% of revenue in the same quarter a year ago. Free cash flow was negative $13 million or negative 19% of revenue compared to $1 million or 3% of revenue in the second quarter of fiscal 2021. As a reminder, there were significant movements over Q2 last year, which we previewed. We brought forward our largest pipeline generating event, PagerDuty Summit from Q3 to Q2, made the semi-annual interest payment on our convertible debt and were impacted by the timing of some payments for standard operational items in Q2. Turning now to our guidance. For the third quarter fiscal 2022, we expect revenue in the range of $69 million to $71 million, which at the midpoint represents a 30% year-over-year growth rate. Non-GAAP net loss per share is expected in the range of $0.09 to $0.10 with basic shares outstanding of approximately 85 million. This implies a non-GAAP operating margin in the range of negative 9% to negative 11%. For the full fiscal year 2022, we expect revenue of $273 million to $276 million, which at the midpoint represents a 29% year-over-year growth rate. Non-GAAP net loss per share is expected to be in the range of $0.35 to $0.39 with basic shares out of approximately 84 million. This implies a non-GAAP operating margin of negative 10% to negative 11%. We look to Q3 and the rest of the year with confidence given our leadership position, the market demand and the demonstrable value we deliver to our customers, as shown in this quarter's results. With that, I will open up the call for Q&A.

Bhavan Suri, Analyst

Can you hear me okay?

Jennifer Tejada, CEO

Yes.

Bhavan Suri, Analyst

Perfect. Congrats and especially congrats on the net dollar retention rate and the enterprise; always fantastic. I guess I had a question around really the initiatives post-COVID, right? So we've gone through the pandemic, and now we look back, I'd love to understand how has PagerDuty changed, forget the addition of the head of sales, etc. But where do you go from here? How do you think the challenges of the past year have impacted the opportunity and your go-to-market vis-a-vis what we've seen through that process? I'd love to think through strategically what's happened and how you rebalanced, re-architected and how you think about going forward vis-a-vis the pandemic?

Jennifer Tejada, CEO

Sure. Well, as I've mentioned in past calls, I think the pandemic accelerated a number of tailwinds that were already in PagerDuty's favor. And we've talked about these digital transformation, DevOps, cloud migration, all important. As the pandemic evolves because, unfortunately, it's not over yet. I have a lot of empathy for people in many areas that are still unable to be vaccinated and dealing with the Delta virus. I think the world and our customers have settled into what I would call a new normal. And that new normal is distributed work, it's hybrid work, and it's a heavy focus on turning your business into a digital business, meeting consumers and customers wherever they are, right, whether that's in a physical location or on the curve where they're picking up goods and services or 100% online. And that kind of flexibility and need to adapt is another strong tailwind for PagerDuty. Because it means all these companies are now putting digital transformation and that customer experience, managing incidents very quickly, so they don't impact businesses at the top of their priority list. So we've seen a really strong buying signal to that extent. For our company, we were already 20% distributed when the pandemic hit. We're now nearly 50% distributed. And I think also has settled into, I think, what is a really good motion seeing our business accelerate by being able to execute as a distributed team. And so I think our culture has really lent itself towards helping our business become more efficient, helping our people become more effective and yet still managing the human needs of our employees. It's been a tough couple of years on everybody. Mental health is important. Physical health is important. In fact, my whole team and I are currently participating in a step challenge which is not going very well because I've been sitting in this chair all day. But net-net, I would say, as you look at how I think this pandemic will evolve, we're seeing the hottest talent market I've seen in my career. That means a lot of employee mobility and historically, employee mobility has been good for PagerDuty. When PagerDuty users leave one company and go to the next, they often drag our services with them. I also think headcount growth has historically been a tailwind for PagerDuty and could be good for us in the future. I talked a little bit about operational maturity. And I think the thing we haven't articulated as well in the past, the point I wanted to make today is even with the acceleration, it takes large companies a long time to move from being entirely reactive and just trying to react faster to a really proactive stance for their leveraging machine learning and analytics to get out in front of and automate issues within their digital ecosystem. And that's the role that we're now playing. And I see a lot of growth and upside and runway for PagerDuty as a result of that journey that we are working with customers on.

Bhavan Suri, Analyst

That's really helpful, and I appreciate the information. Another question that often arises is about competitive pricing. You have one competitor that maintains a low price, but there are others as well. Has there been any change in the competitive landscape? This topic comes up frequently, and you may have already addressed it. Has pricing affected your strategy? Are you considering any changes? I would love to hear your thoughts candidly. What feedback are you receiving from customers, especially in light of some competitors offering significantly lower prices? How do you perceive that opportunity or the current situation regarding win rates?

Jennifer Tejada, CEO

Thanks for the question, Bhavan. Candidly speaking, the market has been talking about competitors like some Kaisers popping up out of nowhere and killing PagerDuty, and our growth has accelerated. I will tell you that I have never been more confident in our competitive position, particularly as it relates to our product position, the success that we've had in enterprise, the loyalty of our enterprise customers, and the differentiation with which we go about helping customers not only modernize their IT but increasingly automate their IT and speed the ability for their companies to deliver on the brand experience and meet the needs of their customers. And we've done that by spending over a decade building deep trust and credibility with developers and SREs. And for developers, we are that superset platform that's essential, deeply integrated into their infrastructure across observability, monitoring, logging, orchestration, etc. And we're also very fast to deploy. Compared to platforms that take months and years to deploy and cost hundreds of thousands, if not millions of dollars to deploy, we're fast and easy to deploy across the business, which is why you see us virally growing into new use cases. And in the enterprise, because we are deeply integrated into those organizations, you're seeing our net dollar retention expand. So I'm very comfortable with our competitive position. You see we've been able to maintain best-in-class gross margins. And frankly, I see pricing for us as a future lever. But like that, that is just one of many growth engines that we have in the business, and I'm confident in the durability of our growth regardless of what's happening in the competitive landscape, which, to your point, has not changed dramatically.

Bhavan Suri, Analyst

No, I appreciate the candid. So I won't hold you to your saying you're going to increase prices. I'll let Howard deal with that.

Jennifer Tejada, CEO

You said that. I said it could...

Bhavan Suri, Analyst

Now, I know. Thank you. I really appreciate the candid. And congratulations, those are really good numbers.

Keith Weiss, Analyst

Excellent. Really nice quarter, really breaking out for PagerDuty from my perspective. I wanted to ask about the dollar-based net retention rate. And first half to Jennifer, second half to Howard. The solution portfolio has definitely expanded over the past year and further. What was it that caused that step function change in dollar-based net retention rate this quarter? Was it just the products got to a level of maturity, the sales process has got in place to really effectively bring that to market? Or are the customers just ready for this now? Can you help us understand kind of what that catalyst was? Because it was a really nice increase. And the question to Howard is why being such a Debbie Downer on the guidance? Like why can't we sustain this 125% further into FY '22?

Jennifer Tejada, CEO

Okay. Well, I'll start and I'll let Debbie Downer take the second question. But I have to give Howard a lot of credit. He is very disciplined and keeps me on a short leash. So when we talk about net dollar retention, I think the things that are driving PagerDuty's expansion are a combination of really seeing momentum in the cross-sell of our new products and services. We've talked about the growth of our digital operations platform being over 100% this quarter. We've seen really strong demand for automation and AIOps, which I'm excited about. And we just launched our customer service offering a few quarters ago and seeing a lot of interest there as well. So it's a combination of cross-sell, but also user expansion across new use cases. And not just use cases, we've built products more, but also use cases that our customers identify. And you can see that in our user growth, which was up over 50%. So we're starting to see that horizontal surface area growth across our customer base, which we've been talking about for many quarters and it's really just starting to manifest itself in the market. And the last thing I'll mention is our teams are executing really well. Like I am very proud of the way PagerDuty's employees have come together despite a difficult environment, one that's filled with surprises seemingly all the time in the macro, just keeping their heads down and focusing on the things that are important to our customers, on championing our customers. So I think execution is a big part of it, and I'm just really proud of the team.

Keith Weiss, Analyst

Excellent.

Howard Wilson, CFO

And Keith, my comment is, obviously, 130% for enterprise dollar-based net retention and 126% of total was a great result, and we're very proud of that. But as you know, we do live in a world where it's hard to predict exactly which cohort will expand on which timeline. So we feel very comfortable with the guidance that we've given, saying that range of 118% to 124%, obviously, high for enterprise.

Keith Weiss, Analyst

Got it. And just to be clear, are there any one-time items that occurred in Q2 that you think aren't repeatable on a go-forward basis? Or is it just more so conservatism on predicting the future?

Howard Wilson, CFO

It's really just a case of which cohorts will expand at which point in time. So there was no specific unique events in Q2.

Robert Oliver, Analyst

Great. Jennifer, I have a question for you and then a follow-up for you, Howard. Jen, I recall discussing around a year ago when some of your peers in the public market were already noticing that inflection while you all had not seen it yet. You mentioned something about companies needing to evaluate their situations before starting to invest. It seems that has indeed happened with the inflection you've pointed out. To follow up on Keith and Bhavan's questions, I wanted to delve deeper into that enterprise inflection. Looking at some of the data you shared, 20% of your customers are utilizing security features, and I believe 12% are engaged in customer service. Can you elaborate on where you’re observing the most cross-sell within organizations? Is it primarily due to the overall PagerDuty value proposition, where enterprises have significantly broadened their SaaS offerings and are now dealing with chaos and sprawl? Can you discuss the current key drivers in enterprise?

Jennifer Tejada, CEO

Let me share my view on the market and my interactions with customers. What I observe is that our customers are striving to provide exceptional experiences for their end consumers, who are becoming increasingly impatient. With numerous options available and many industries undergoing disruption, delivering a superior customer service brand experience is essential, especially in our current hybrid working environment. We've noticed metrics such as how quickly an issue is acknowledged and resolved are now reaching the CEO's office and Audit Committees, where they are scrutinizing the number of incidents and the resolution time. These factors have turned into key strategic priorities for businesses. Additionally, now that customers have adapted to this new normal, they are ready to engage in significant transformational initiatives. The way PagerDuty operates fundamentally enhances organizational functionality. Despite our product being easy to adopt and deploy, a cultural shift is necessary. Our solution is versatile and has shown strength across various major industries. For instance, we've seen solid performance in financial services this quarter, along with signs of recovery in retail and travel. It's also crucial for us to influence developers since they play a pivotal role within large organizations. Our emphasis on improving the developer experience contributes to our growing user base. Lastly, it's important to note that incident response and management, along with broader operations, are increasingly viewed as business issues rather than merely technology concerns. We are witnessing a rise in different leaders and personnel from across various business sectors joining our platform to actively engage in or observe incident management processes, which is further fueling user growth.

Howard Wilson, CFO

I think I would also just jump in there, Jen, just to comment. The one thing we've seen, Rob, not only the user expansion but also the attach of our new products. So our digital operations plan above 20% of our total ARR. We saw outstanding growth in our Event Intelligence offering. We're seeing excellent momentum with our automation offering. We're seeing now that of our enterprise mid-market customers like a 15% attach rate to that new product. So that's all I think testament to using PagerDuty as a platform where the full breadth of our offering delivers the highest value. And for enterprise and mid-market customers, they're solving big problems. They want the best most resilient solution and no one can compete with us.

Robert Oliver, Analyst

Great, that's helpful, Howard. Thank you, Jen. I think at the Analyst Day, you mentioned $200 million of the $1 billion target, and we were trying to understand that. It looks like you're making progress, Howard. My last question is about the variability in dollar-based net revenue retention. Is that because we're seeing, for example, the timing of renewals or certain customers adopting new products at different times, which creates a considerable range?

Howard Wilson, CFO

Yes. From a contextual standpoint, there is significant opportunity within our existing customer base. Our customers continue to grow with us, and approximately one-third of our enterprise customers expand their business with us each quarter. The challenge lies in accurately predicting the exact degree of this expansion and identifying which specific customers will increase their usage. This uncertainty is why we've provided a range and consistently maintained it. You may have noticed that we have steadily improved our dollar-based net retention every quarter since our low point, reaching a level we believe is among the best in the industry. We are among the top performers in this area. We are focused on this, understanding that enterprise performance will be the key driver, and we anticipate it will exceed the 118% to 124% range in net operating income.

Chad Bennett, Analyst

Can you hear me okay?

Jennifer Tejada, CEO

Yes. Hi, Chad.

Chad Bennett, Analyst

So, without taking away from the discussion on net expansion and net retention, Howard or Jennifer, is a significant part of the acceleration simply due to removing the last July quarter of 116% from the trailing data? I see that as a positive development, but isn't that a major factor?

Howard Wilson, CFO

I mean if you had the mechanics of looking at how a number changes or evolves, yes, certainly, if your baseline, your comparison is low, it certainly makes the compare easier. But if you look at the overall momentum in our business, which is showing up in the revenue and in the billings, you have to look at those things together, and that is why we are posting the strong dollar-based net retention. But also why when we look at this, we know that there is some variability that exists from quarter to quarter.

Chad Bennett, Analyst

I want to follow up on that because I see it as a positive development. I've pushed for an increase in the range for the year by a couple of hundred basis points, but that’s my personal perspective. I understand you’re experiencing strong cross-sell and upsell opportunities in various use cases like customer service and security, as well as in products related to automation and intelligence. You're also seeing an increase in penetration from a use case expansion standpoint. However, it seems early in tracking the actual impact on net expansion, whether it's 100 basis points or something else. Am I correct? Could we expect significant acceleration as these products start to have a bigger impact on revenue?

Howard Wilson, CFO

Yes. Jen, I don't know if you want to comment on that, and I can follow up. But yes, we are early.

Jennifer Tejada, CEO

We are very early in our journey with these nascent products. I view new products almost like small businesses and am pleased with the returns on the investments we're making to develop a stand-alone business. It’s exciting to see digital operations make up 20% of our total annual recurring revenue, and that achievement has helped us strengthen our ability to become a multiproduct platform. Transitioning from a single product to a multiproduct platform in a SaaS company is challenging, but we have discussed various themes, such as leveraging our 12 years of proprietary data across different use cases, maintaining a simple user experience, and ensuring easy onboarding, quick payback, and fast return on investment. We are successfully addressing complex challenges while delivering four nines of resiliency and reliability at scale, catering to the largest enterprises and most prominent brands. The process of making all of this happen is not easy, and I am truly pleased with how we are navigating this transformation, which is significantly contributing to our business momentum. I fully expect that the new use cases, along with the products and services that support them and our platform, will play an increasingly vital role in our business over time. Nevertheless, it's important to remember that the market for call automation and incident response is still in its infancy. Most of our engagements are in greenfield areas, and many of our customers are only reaching a small fraction of their workforce. Therefore, when I assess the expansion potential within our existing customer base, I am very optimistic about the opportunities ahead.

Chad Bennett, Analyst

So just one last thing. It seems like in the first half of the year, Jennifer, you were extremely enthusiastic about the pipeline and the developments, and you were aware of the roadmap and the introductions. You emphasized in multiple calls that we are aiming for consistent growth of over 30% on the top line. I assume you are maintaining that outlook moving forward.

Jennifer Tejada, CEO

We are a company that strives to deliver on our promises. Yes, I am. In the quarter, we made significant investments in marketing, especially by moving our summit conference to earlier in the year to generate pipeline growth. I'm very excited about the second half.

Matthew Hedberg, Analyst

Jen, you mentioned the significant expansion potential within your base, but I'm curious about the success you've achieved in security and customer service. How do you view other opportunities within the organization, such as in the finance or HR departments?

Jennifer Tejada, CEO

Yes. Absolutely, it is. And part of that is a brand challenge, right ?. So if you're watching CNBC, you'll be seeing PagerDuty's first televised commercial, and we're doubling down on digital branding to help employees across the organization learn about how PagerDuty can help them. It's not just about uptime, but you should expect to see us telling more stories about the different ways that PagerDuty can be leveraged. I'd also say that we have a lot of customers that use us in places like finance or legal or physical security, marketing, etc. And in fact, we have programs within PagerDuty to get every team to use PagerDuty for their business operations as opposed to just technical operations, SecOps or customer service ops. So the goal of the long-term mission is to become the operations cloud for the modern enterprise, and that's across the organization. And by the way, I love your T-shirt. For those of you who can't see Matt, his T-shirt says uneventful days are beautiful days and has a lovely PagerDuty logo on the back. That's one of my favorites.

Matthew Hedberg, Analyst

And I apologize if my video is a little bushy right now. And then, I guess, for Howard, gross margins at 84% are within the range, but they are a little bit lower than what we've seen historically. Anything to read into that just kind of being maybe the lower end of the historic range?

Howard Wilson, CFO

I would say, Matt, as we've spoken about previously, we were intentional about making investments, particularly around customer support and success to better serve our enterprise customers. So this has been a year where we have focused on how do we ensure that we can deliver the kind of experience that they need, which then supports our very high retention rate, very low churn, supports the high dollar-based net retention and also helps get rid of some of the noise that we get around renewals and timing, which is like trombones going off and you get all that noise. But certainly, it's been really about trying to ensure, 1, we can deliver the reliable service to our customers, but 2 that we're able to ensure that they're getting the best experience in using our product.

Rachit Agrawal, Analyst

This is Rachit on for Sterling. So I was wondering like can you give more colors on what's the uptake on the advanced modules?

Jennifer Tejada, CEO

Sorry, Rachit, I believe you asked about the uptake on our newer products. Is that correct?

Rachit Agrawal, Analyst

Yes. Yes. On the advanced modules, yes.

Howard Wilson, CFO

Sure. Our digital operations plan represents our most comprehensive offering, which includes our Event Intelligence, machine learning-based products, analytics, and various other features. We monitor this closely to assess how well we are gaining traction. Currently, this digital operations plan accounts for over 20% of our annual recurring revenue. Additionally, one of our stand-alone products, EI, which acts as an add-on for our customers, experienced growth of over 100% last quarter, nearing 200% in terms of adoption. Our automation product is also growing rapidly. These products enable customers to effectively manage their operations cloud environment, ensuring they can handle their digital operations efficiently. When combined, they allow for comprehensive issue detection and remediation, leveraging technology to handle most tasks while involving human intervention only when necessary.

Rachit Agrawal, Analyst

Yes. Makes sense. And then can you give the colors on like how your hiring plans are going for the year where you...

Jennifer Tejada, CEO

Yes, as I mentioned, the talent market is very competitive, and our recruiting team has been working diligently. We are currently following our hiring plan and are focused on ensuring that as we rapidly add to our headcount, we also attract the best candidates and maintain our diverse and inclusive culture. We are effectively utilizing remote work, so nearly all of our job positions are open in terms of location, and we are exploring additional locations globally to mitigate the competitive nature of the talent market. Additionally, the mobility we are observing among employees worldwide could benefit PagerDuty, as users take our platform with them when they move to new companies.

Kingsley Crane, Analyst

Can you hear me?

Jennifer Tejada, CEO

Hi, Kingsley.

Kingsley Crane, Analyst

So in the past, we've seen some competitors move off PD and when they've released their own incident management solutions. So it's especially encouraging to see Datadog expanding their usage this quarter. When you look across your customer base, are you seeing those two products competing or actually be deployed in tandem?

Jennifer Tejada, CEO

No, they're generally deployed in tandem where observability is part of a superset of incoming signal that we then manage and consolidate and use machine learning to deploy the right signal and orchestrate the right team on the problem in the moment, and Datadog has been a great partner.

Operator, Operator

Okay. Without any further questions, Jen and Howard, I would love to turn it over to you for any final comments.

Jennifer Tejada, CEO

Sure. Well, I just want to say one thank you to everybody for joining us today on the call. And a big thank you and appreciation for all of our customers and our partners, including our technology ecosystem who really are the reason that we're here and we're only successful when our customers are successful. And lots of warm wishes to all of those who are not having such an easy time with everything that's going on with the fires and the floods and the pandemic. To all of you, I wish you good health, and we look forward to seeing you next quarter. Thank you.