Earnings Call Transcript - PD Q2 2025

Operator, Operator

Good afternoon, folks. Sorry for the delay. We've had some technical difficulties with Zoom, but we're going to get going here in just 2 seconds. Go ahead, Tony.

Tony Righetti, Moderator

All right. So apologies again for the delay. We will start with the safe harbor right about now. Good afternoon, and thank you for joining us to discuss PagerDuty's Second Quarter Fiscal Year 2025 Results. With me on today's call are Jennifer Tejada, PagerDuty's Chairperson and Chief Executive Officer; and Howard Wilson, our 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-A, as well as our subsequent filings made with the SEC. With that, I will turn the call over to Jennifer.

Jennifer Tejada, CEO

Good afternoon. Thanks for your patience, and thanks for joining us today. PagerDuty delivered a solid second quarter with revenue growth within our guidance range at 8% and non-GAAP operating margin 4 points above the range at 17%. This was our eighth consecutive record quarter of non-GAAP profitability. We increased annual recurring revenue by approximately $11 million to $474 million. We have stabilized ARR growth at 10% year-on-year for a third consecutive quarter, as well as dollar-based net retention at 106% quarter-over-quarter. Both results were supported by improving new and expansion bookings, especially in our Enterprise segment. As we've shared in recent quarters, PagerDuty is scaling by addressing the critical operations needs of the Enterprise segment with our operations cloud, a multi-product platform helping the largest companies in the world improve resilience and modernize their digital operations. I'm encouraged by the signals in both the market and the business that validate our strategy. In fact, the value segment of accounts with ARR greater than $500,000 grew more than 20% as we executed a more effective cross-selling and upselling strategy. During the quarter, we signed a record number of multi-year agreements representing nearly a third of renewal ARR despite the volatile macro environment. While we still experienced increased scrutiny and multiple approval levels when selling into the Enterprise segment, which can lengthen sales cycles, our focus is paying off. Our Enterprise segment's first half dollar-based net retention ended 10 points above that of our SMB segment. Many of the Global 2000 companies suffered the negative effects of major incidents in the past quarter. When these incidents occur, global innovation and customer service get disrupted as IT teams and development teams around the world work day and night to diagnose and recover impacted systems, costing billions in lost labor and lost time. For our customers and the broader market, recent major technology failures are a wake-up call, a reminder that suffering negative business impacts from widespread incidents is not a question of if, but when. Nearly two-thirds of enterprise leaders we surveyed this year saw customer-facing incidents rise 43% year-over-year. The systematic fragility that triggers these events exposes an existential threat we see across industries where aging infrastructure, growing technical debt, and manual processes persist. This challenge is compounded by the increasing proliferation of complexity, as CI/CD distributed architecture and generative AI co-development all become mainstream. With recent global outages and technology disruptions, these recent global outages and technology disruptions underscore the pivotal role our platform plays. When the world is down, customers rely on PagerDuty to identify issues, orchestrate, and increasingly automate the best possible response to quickly contain and reduce business impact. The July 19th outage tested our platform on a massive scale. The operations cloud rose to the occasion. We saw an over 1,400% increase in incident workflows initiated on that day alone, and we maintained high availability, speed, and fidelity without incurring significant cost surges. Our reliability is the result of our history of investment in innovation, and it's why companies trust us to deliver operational resilience in their most vulnerable moments. Improving operational resilience to protect customer experience and revenues while mitigating risk and the cost of major incidents has upleveled incident management to a CEO imperative, similar to that of what we saw with cybersecurity in the past. PagerDuty's operations cloud scales resiliently to address each of these challenges for enterprise companies. Anecdotally, many of our customers have communicated a renewed preference for choosing a best-in-breed incident management offering and an increased sense of urgency to be better prepared for major incidents. It's early, though we expect to see some benefit in demand over time. Our customers across verticals and regions are also increasingly subject to heightened regulation requiring automation and controls to mitigate risk and support compliance. From DORA in the EU to diverse data and privacy oversight demands worldwide, regulation has become a long-term demand driver for the operations cloud. The financial services vertical exemplified this trend in Q2, with several six and seven-figure strategic expansions and overall ARR growth above 20%. For example, a global banking institution based in North America strengthened their operations cloud journey by expanding usage of incident management, AIOps, and automation in Q2. At over $4 million of ARR, they are targeting a 30% reduction in incident duration through automated customizable workflows by partnering with PagerDuty. The ROI over three years is estimated to exceed 500%. Strategic platform agreements like this demonstrate the progress of our product to platform transition and the power of AI, underpinning our platform. During the quarter, new products including AIOps, automation, CSOps, or customer service Ops, and premium support contributed 65% of net new ARR. Two additional financial services customers signed strategic six and seven-figure expansions in Q2, based in Europe and Australia, respectively. These financial leaders optimized for resilience at scale and chose the operations cloud to grow and protect their revenue. We also closed a high six-figure expansion, including AIOps and customer service operations with a large workforce management software provider to help the company accelerate their operations modernization efforts. On the hardware side, a computer drive manufacturer and data storage company expanded the size and scope of their relationship by nearly doubling their incident management coverage and adding AIOps. With these products, the customer is targeting an ROI of over 300% in the next three years. The expanded feature set addresses the real-time operations challenges presented by complex modern environments, like machine learning, flexible data ingestion, and end-to-end event-driven automation, environments that are common within our million-dollar ARR cohort of customers. During the quarter, we also hosted five global customer events to build awareness and educate enterprise leaders and practitioners on both the technical and financial benefits of the operations cloud. One of the highlights of this series was the positive response to PagerDuty Advance, a suite of generative AI capabilities embedded in the PagerDuty operations cloud platform, which we made generally available at the end of July. These GenAI offerings can save enterprise teams hundreds of hours, equating to millions of dollars in annual savings. For example, instead of wasting precious time updating leaders and responders as they join an in-progress incident response, those coming in late can use simple prompts for summarization of key incident information, and we offer tight integration with both Slack and Teams to efficiently keep work where it happens. PagerDuty Advance can also anticipate diagnostic questions and suggest troubleshooting steps for responders, automating work and minimizing the financial impact at a time when the average incident costs an enterprise approximately $800,000 per incident. Generative AI postmortems and AI-generated runbooks are progressing well in early access. Together, they further equip enterprise companies to accelerate digital transformation while automating time-consuming tasks and recommended actions at every step of the incident lifecycle. We also released new integrated capabilities across the operations cloud, like the combination of dynamic escalation policies connected to incident workflows. Using our proprietary data model, this solves the common challenge of not being able to match a problem to the most knowledgeable, well-equipped responder instantly. This requires deep knowledge and correlation on events, past incidents, and people, and as such delivers a differentiated more complete incident lifecycle offering. From a social impact perspective, we announced our third impact accelerator cohort focused on crisis response services through pagerduty.org. These nonprofits provide emergency response services to support people in urgent crises, and they leverage PagerDuty to ensure availability of critical online services to their communities. These are an ideal and important PagerDuty use case. Overall, we're encouraged by the gains we have made to scale our enterprise business. This progress moderates the effects of lower growth and higher volatility in SMB. These positive trends validate our strategy and reinforce our optimism in PagerDuty's long-term market opportunity. As we progress through the back half of the year, we remain confident that we can increase dollar-based net retention and professional services attach rates. From an ARR perspective, the elevated awareness of our value proposition following recent IT outages, along with quarterly highs in multi-product and multi-year agreements, culminated in a strong close in the first half. This reinforces my confidence in our ability to exceed 10% ARR growth in FY ‘25. I would like to express my gratitude to our shareholders for their ongoing support, our customers for their trust, and our dedicated employees and partners for their commitment to revolutionizing operations. With that, I'll turn the call over to Howard and look forward to your questions.

Howard Wilson, CFO

Thank you, Jenn, and good day to everyone joining us on this afternoon's call. 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. In the second quarter, we continued to solidify our progress in the enterprise, consistent with the last quarter closing six and seven-figure multi-product, multi-year contracts with large companies across our U.S. and international regions. Customers remain focused on value when negotiating both new business and renewals. Our Enterprise business is strengthening and expanding with our strategic deal focus, whereas SMB remains a headwind to growth with high levels of churn and downgrade. As our business becomes increasingly enterprise-focused, we continue to make adjustments to the typical rhythms and seasonality of the sales motion. The momentum in the enterprise and the strength of our back half pipeline gives me confidence in a reacceleration of ARR growth by the end of the year. Revenue for the quarter was $116 million, up 8% year-over-year. Despite unfavorable net new ARR linearity and phasing of one-time service engagements, we remained within our guidance range. The contribution from international was 27% of total revenues similar to the year-ago period. Annual recurring revenue exiting Q2 grew 10% year-over-year to $474 million. We delivered 106% dollar-based net retention in line with our Q2 expectation. Our DBNR expectation for Q3 is to be at least 106% and 107% by year-end. Customers spending over $100,000 in annual recurring revenue grew to 820, up 6% from a year ago. In addition, our cohort of logos with greater than $500,000 in ARR grew in the low-20s, up from the high teens in the first quarter. Total paid customers decreased to 15,044 compared to 15,146 in the year-ago period. The bulk of the decrease came from customer departures in our SMB segment. Free and paid companies on our platform grew to over 29,000, an increase of approximately 12% compared to Q2 of last year. Q2 gross margin was 86% at the high end of our 84% to 86% target range. We continue to expect services to grow modestly this year, but our current view is that gross margin will remain at the high end of our range until moving closer to the mid-point in FY ‘26. Operating income was $20 million, or 17% of revenue compared to $14 million, or 13% of revenue in the same quarter last year. The outperformance compared to our guidance was primarily due to headcount shifting to the second half, lower commissions, and marketing expenses shifting from Q2 to Q3. In terms of cash flow for the quarter, cash from operations was $36 million, or 31% of revenue and free cash flow was $33 million, or 29% of revenue. The benefit we received from working capital during the second quarter will even out during Q3, with free cash flow being near breakeven for the quarter. We expect free cash flow for the full year to be a couple of points above our operating margin. Turning to the balance sheet. We ended the quarter with $599 million in cash, cash equivalents, and investments. In Q2, we repurchased 1.3 million shares from our $100 million repurchase plan. We have $72 million remaining through May 2026. On a trailing 12 months basis, billings were $468 million, an increase of 8% compared to a year ago. With respect to Q3, we anticipate trailing 12 months billings growth to be approximately 10%. At the end of Q2, total RPO was approximately $403 million. Of this amount, approximately $280 million, or 70% is expected to be recognized over the next 12 months. As a reminder, our remaining performance obligations disclosure includes contracts with an original term of less than 12 months as of FY ‘25. Applying the current definition to the year-ago period, total RPO for Q2 FY ‘24 would have been $294 million. Turning to our guidance. For the third quarter fiscal 2025, we expect revenue in the range of $115.5 million to $117.5 million, representing a growth rate of 6% to 8%, and net income per diluted share attributable to PagerDuty Inc., in the range of $0.16 to $0.17. This implies an operating margin of 13%. For the full fiscal year 2025, we now expect revenue in the range of $463 million to $467 million, representing a growth rate of 7% to 8%. This compares to the range previously provided of $471 million to $477 million. And net income per diluted share attributable to PagerDuty Inc., of $0.67 to $0.72. This implies an operating margin of 14%. This compares to our prior guide of $0.66 to $0.71 and 13% to 14%, respectively. As we look to the back half of the year, we remain confident in accelerating ARR growth, exiting the year above our current 10% rate, along with improvement in our dollar-based net retention. The success we're having in multi-product, multi-year strategic contracts with enterprise customers and a strong growing multi-quarter pipeline positions us well for growth while we remain committed to continuing to expand operating margins over time. With that, I will open up the call for Q&A.

Tony Righetti, Moderator

All right. Thank you, panelists. Our first question will come from Sanjit Singh of Morgan Stanley. Please go ahead, Sanjit.

Sanjit Singh, Analyst

Thank you for taking the question. So I guess the theme of this call, it sounds like the underlying fundamentals of business seem to be improving on the enterprise side, yet at the same time, guidance had come down by just under $10 million. So I was wondering, Howard or Jenn, if you want to take it, can you sort of bridge us between the cut to the revenue and it seems like on the ARR side, more stability and your confidence in sort of exiting the year with acceleration.

Jennifer Tejada, CEO

It's a good question. Thank you, Sanjit, and I appreciate everyone’s patience as we address a technical issue at the start of the call. First off, I dislike lowering guidance and I’m not pleased about it; it primarily stems from timing. Let me explain. The larger, multi-year, multi-product strategic deals we're pursuing are less predictable than our previous transactional business and exhibit increased seasonality compared to the past. We noticed some of this in Q1, which we thought was an exception, but Q2 turned out to be heavily back-loaded, and we anticipate more of the same in Q3 and Q4. This has resulted in a delay in associated professional services as well. So, it's mainly a timing issue regarding revenue. However, I want to reiterate that our ARR guidance remains the same. We still anticipate ARR to accelerate in the second half of the year, including in the SMB sector, even though that market is improving, it hasn’t fully stabilized yet. A significant portion of this is related to tech startups, and we know that funding for these startups continues to be challenging. As a precaution due to the timing concerns, we are mitigating some of the risk. Nevertheless, we expect ARR growth to get better as the year progresses, as will DBNR. We predict ARR growth over 10% for the entire year and DBNR at around 107% for the full year.

Sanjit Singh, Analyst

Got it. And when you talk…

Howard Wilson, CFO

Sorry, I would probably just add to that, Sanjit, that in many respects, as we focus more on the enterprise, the linearity and the seasonality that we're seeing starts to reflect more like other enterprise companies.

Sanjit Singh, Analyst

Understood. Jenn, when you discuss the underlying backdrop or the increased incidents and their rising costs, how does that ultimately translate to better growth for PagerDuty? Will this lead to more inbound opportunities for you, or how do you plan to leverage this opportunity in the current environment?

Jennifer Tejada, CEO

Anecdotally, there's already a heightened discussion at the CEO level, within the audit committee, and on the Board about budgeting for these issues, similar to how cybersecurity budgets have been prioritized. When business leaders recognize the financial repercussions of significant outages, they are compelled to consider what precautions to take, what infrastructure investments are necessary, and how to manage their technical debt. During the incident in July, many senior leaders sought our best practices and support, not only for response but also for future guidance. We noticed a clear distinction between customers who have adopted the operations cloud and enhanced their operations, identifying problems early and being back online by dawn, compared to those who were manually tackling issues that took days to resolve. This resulted in substantial revenue losses, as well as wasted time and increased operational expenses. I anticipate that more strategic deals will emerge in the pipeline, and we should see greater investment protection for PagerDuty. While it's still early to see a tangible impact in the pipeline, these discussions are already occurring with customers.

Sanjit Singh, Analyst

Understood. Thank you.

Jennifer Tejada, CEO

Thank you.

Tony Righetti, Moderator

Yeah. Next question, we'll go to Bank of America. Koji, please go ahead.

Koji Ikeda, Analyst

Sure, I appreciate your insights. I'd like to hear your thoughts on fiscal '26. Considering the slower billings growth this quarter, the guidance suggests an acceleration in the latter half of the year and shows confidence in the annual recurring revenue. Jennifer, you also mentioned a bit about seasonality versus linearity. How should we understand the exit rate from the fiscal fourth quarter this year into next year, and will those seasonal trends persist?

Jennifer Tejada, CEO

Yeah. Well, the good news is some of that seasonality is driven by the fact that we're doing more multi-year, multi-product deals that require different levels of approval and scrutiny from the customer base. And so we're seeing, as a result, we saw a record number of large multi-product, multi-year deals this quarter and we also renewed 30% of our ARR available renewed in multi-year, which takes pressure off of retention in the future, enables us to focus on growth. So I think fundamentally that puts us in a better place. But I'll let Howard comment on 2026.

Howard Wilson, CFO

Yeah, Koji. So we haven't provided any specific guidance yet on FY ‘26, but our expectation is that, that ARR growth rate will be above the 10% mark. If we look at where we think trailing 12 months billing will be, that does actually pick up to approximately 10%. If you're looking at the billings number for Q3, we look at it on a trailing 12 months basis. And the way that I would think about it is, to Jenn's point we’re from a retention perspective, the efforts that we've made around doing multi-year arrangements with customers who moved some of the downgrade and churn risk out of the successive year, which creates a really strong platform for future growth. So we would expect that as we go into next year, we're in a better position from a fundamental perspective, but also that the seasonality that we've started to see emerge as we focus on the enterprise that's likely going to remain, and that will mean that, that the third month of every quarter is going to be more heavily weighted, and it would mean that as we progress through the year, like other companies, probably your fourth quarter ends up being the biggest quarter.

Koji Ikeda, Analyst

Got it. Thank you so much for taking the questions. Appreciate it.

Jennifer Tejada, CEO

Thanks, Koji.

Tony Righetti, Moderator

Next up, let's go to William Blair, Jake Roberge, perfect. Thanks. Jake, please go ahead.

Jake Roberge, Analyst

Thanks for taking the questions. Just from an expectations perspective, is there anything different about the guidance you're putting out today versus last quarter as it relates to kind of when those large deals start to close or some of the SMB churn that you're seeing? Just trying to understand if there's kind of different puts and takes that you've put into the guidance plan to account for some of these issues.

Howard Wilson, CFO

Yeah. I can break it down a little bit, Jake. I'd say the one element that has led to a change in the guidance is this lag that we're seeing in professional services attached, which is now happening later. As these deals with longer sales cycles are happening, it means that our ability to deliver that revenue gets delayed, and that's taking a couple of million dollars out this year. When we look at some of the phasing that we had even within the first half of this year, some of that linearity change led to less revenue being recognized in Q1 and Q2. And so we've taken that out of the full year, but then when we look at the back half, we're expecting that Q3 is probably going to have a similar complexion in terms of net new ARR as we saw in Q2, and that there will be, again, more of a weighting to the third month in Q3, and we expect that for Q4, it'll be a bigger quarter, not enormously so, but certainly a bigger quarter than Q3, but again, with that weighting towards the back half.

Jennifer Tejada, CEO

Yeah. And I just add to that, Jake. We do have very good visibility to the pipeline in place to deliver the back half. I think our visibility is improving as we've got used to these sales cycles with larger or more strategic deals in them. We also, as you know, have been evolving our go-to-market organization over many quarters, and we're really starting to see the execution behind all of the enablement we've done around top-down, outbound, land and expand, the multi-product, multi-year platform versus the bottoms-up, start with incident response, expand surface area, and then start adding new products. The success there has led to a very strong quarter for AIOps, growing over 20%, or about 20% year-on-year, and customer service ops growing over 50% year-on-year. So we're seeing that evolution in addition to now having new leaders in place in some of our largest markets where they're hitting the ground running and driving both improvements in churn and more productivity around some of these renewals, and that's in EMEA, North American enterprise, and in federal. So just feeling like we're coming from a stronger foundation as we look toward the back half of the year with like I said, quite a bit of confidence in the pipeline. But also, seeing that cadence of large deals, our growth in the customer value segment, spending over 500k was more than 20%. So continuing to see that momentum there in enterprise and over time SMB represents less and less of the total ARR.

Jake Roberge, Analyst

Okay. That's very helpful. The comment about the 1,400% increase in incidents during the quarter is interesting. It seems there's been some positive top-of-funnel activity since the CrowdStrike outage. Given that it's still early days, when do you anticipate that early pipeline will start contributing to the business? Are you thinking it will be in the first half of next year or the latter half? I would like to understand your perspective on that traction.

Jennifer Tejada, CEO

We're not including new pipeline based on what we observed last quarter regarding major incidents. Initially, I expect this to be reflected in our discussions, followed by approval processes and the variety of purchases made by customers. A trend we’ve noticed is that when a customer truly grasps the cost of a major incident, averaging $800,000, realizing a 50% reduction in incident duration to $400,000 represents significant real financial value. The sooner leadership comprehends this, the quicker our advocates can push for multi-product, multi-deal agreements. The most significant advantage we notice is increased awareness among CEOs and CFOs who now realize that cutting corners on infrastructure and platforms to effectively detect, orchestrate, and automate responses to major incidents can lead to substantial costs later on. This short-term thinking is likely to evolve into a long-term investment perspective. Following our observations in sales cycles, I anticipate we'll also see this reflected in advertisements, although I cannot precisely predict the timeline for this to occur. Some customers react very swiftly after an issue like this, while others may take more time to adjust their internal mindset regarding recovering from major incidents, which has always been a key use case for PagerDuty.

Jake Roberge, Analyst

Thanks for taking the questions.

Tony Righetti, Moderator

All right. The next question will come from TD Cowen. Andrew, please go ahead.

Andrew Sherman, Analyst

Great. Thanks, Tony. Hey, guys. We'd love to hear how the flexible enterprise pricing is tracking? What is feedback from customers? Has this helped drive any expansions in the quarter? What are you expecting from this in the second half to help with those deals?

Jennifer Tejada, CEO

Feedback has been very positive and it's really enabled some of the big deals that we shared in prepared remarks, and I know it took some people some time to get into the call, so we talked about a North American global bank that was already a seven-figure customer, that's expanded beyond that had AIOps as well as customer service ops. We've talked about the global nature of the financial services industry that's under heightened regulation around customer service incident response regulation like, DORA in the EU, and increasingly diverse regulation around data and privacy. That means the genesis of incidents is emerging or is evolving and changing, and that is leading to leadership coming to us and saying, look, we now kind of understand the value of doing this. How do we expand with you? And it's less about, it's just this many users and this price tag for those users, our AIOps business, which, like I said, grew about 20% this quarter, that's consumption-based pricing. So we're getting, I think, a warm reception to that, but also flexibility in terms of thinking about how customers are going to grow their adoption across products and services. Howard, anything that you want to add there?

Howard Wilson, CFO

I think you've covered it, Jenn.

Andrew Sherman, Analyst

Thanks. Howard, we understand that you're more focused on Q4 now, but how have you considered that these deals are larger and taking longer to close? Have you adjusted your assumptions regarding close rates for Q4? Also, how have renewals performed compared to your expectations?

Howard Wilson, CFO

Sure. We adjusted our guidance based on our recent experiences with deal closures and their timing. We anticipate that some deals might take longer than expected, which we've factored in. Our sales team is motivated to close these deals within this year, and we've implemented sales disciplines over the past year to enhance scrutiny and improve deal quality, boosting our confidence. We have clear visibility on the deals active in Q3, Q4, and into next year. Regarding renewals, we initiated our effort roughly a year ago to transition customers to multi-year arrangements at renewal time, not just with new deals. This has shown positive results, as the renewal volume available for Q4 this year is significantly less than it was in Q4 of last year, allowing us to manage potential retention risks more effectively.

Andrew Sherman, Analyst

Great. Thank you very much.

Tony Righetti, Moderator

All right. Next up, Craig Hallum, please. We will go to Jeff Van Rhee.

Jeff Van Rhee, Analyst

Great. Thanks, Tony. Hi, guys. A couple of questions for me. I just want to read this back to make sure I understand that the guide at the midpoint is reduced by $9 million. I think, Howard, you mentioned if I caught it, that you think PS is a couple of million. You mentioned seasonality and a bunch of other factors, but just simply put, we're seeing longer cycles in years back and more back-end loaded. But you're going to get to the same ARR, just going to happen later in the year, is that a fair read back?

Howard Wilson, CFO

That is correct. With the exception of the revenue that's specifically professional services related, our expectation is that in terms of what we would expect to book in terms of net new ARR will still get us to above the 10% growth rate by the end of the year.

Sanjit Singh, Analyst

Multiple Speakers

Jeff Van Rhee, Analyst

Yeah. Got it. Okay. And then from a competitive win rate, when you look at deals that are just incident management, I realize you're going with a much broader proposition. Jennifer, you talked about the attach rate to some of the incremental products, but when you're in just an incident management deal, what do win rates look like now versus a year ago?

Jennifer Tejada, CEO

We haven't shared our win rates, but that segment of the market hasn't changed significantly. Customers appear to be more price sensitive, especially in the lower end of the market, particularly within small to medium-sized businesses, as well as to some degree in the mid-market. We're also not seeing the same level of headcount growth in these segments compared to previous years, which is putting some pressure on both growth and renewals. However, from a competitive perspective, this isn't a zero-sum market. The major outage that occurred on July 19th demonstrated that many large companies still rely on manual processes with minimal automation in detection and have numerous observability tools that aren't correlating information effectively. They need a robust platform to enhance their response capabilities. Additionally, our incident management platform is built on an AI-based foundation that utilizes a unique proprietary data set unlike anything else available. We have insights into incoming events, incident workflows, and increasing automation around responses, including generative AI features I mentioned earlier. Notably, during the July incident, we experienced a 1,400% surge in incident workflows on our platform without any disruptions or cost increases, which is something no other competitor in incident management or observability can claim during a significant global outage. This reinforces both our resilience at scale and the security of our platform during extreme events. Furthermore, we've taken steps to assist small and mid-market customers who are more price-sensitive, including offering free options and making some adjustments to our pricing. Despite the tough macroeconomic environment, I believe we're managing what we can control and remain optimistic that the tech industry will rebound, and we will eventually see more venture funding return to the SMB sector. However, I'm not incorporating that expectation into our current outlook, as we anticipate that the present conditions will persist for the time being.

Howard Wilson, CFO

Sorry, Jenn, I'm going to have to do my CFO thing and say it was 1,400%, not 14,000%.

Jennifer Tejada, CEO

Sorry, good point. I added an extra zero.

Jeff Van Rhee, Analyst

One last for me, if I could sneak it in on the SMB side. Just two clarifications, Howard, on the numbers, on the customer count number, I know there are some pretty different trends within enterprise versus SMB. The overall customer count was down, but can you give a little more granularity of SMB versus enterprise? And then, just to be clear, on the SMB side, it feels to me, maybe I'm splitting here that there's a little more of a message of stability prior quarter, and a bottom was in on SMB, and it feels slightly more pessimistic, if I'm reading it correctly. But you tell me if I'm wrong there.

Howard Wilson, CFO

Yeah. So, SMB has remained, we've had elevated churn and downgrade there now for four quarters in a row. In fact, it's the fourth consecutive quarter of that contracting year-over-year. And so it's been a real headwind to growth. What I would say is that from a stabilization perspective, we see like elements or signs of some level of stabilization from one quarter to the next, but then that can reverse fairly quickly in terms of movement. Now, from a customer count perspective, our customer count went down year-over-year. Again, the bulk of that churn is actually in SMB, by far the number of accounts that are outside of SMB, the churn is actually relatively small. So this is part of us also focusing more on the enterprise, where landing enterprise and mid-market logos is more important, and so given the volatility, if you like, within the SMB market in general, not specifically for us, that means that we do expect to see higher levels of churn.

Jeff Van Rhee, Analyst

Yeah. Okay. I'll leave it there. Thank you.

Tony Righetti, Moderator

All right. Next, we'll go to Canaccord Genuity, Kingsley.

Kingsley Crane, Analyst

Hi. Thanks for taking the question. So I just want to return a little bit to competition. We've seen some of your smaller competitors combine and some larger competitors reintroduce their products with a couple of new bells and whistles. So just want to hear more about how the competitive environment has evolved. And then more specifically, how you think about that affecting relative enterprise strength versus relative SMB softness.

Jennifer Tejada, CEO

I would say most of the competition we see is in the mid-market or below in small and medium-sized businesses. This is because the competitive offerings available don't scale effectively into enterprise solutions and are primarily focused on price rather than features. What we've observed in the last quarter with global outages highlights that performance is crucial, and this will likely drive our competitive advantage moving forward. Other players have much less functionality, minimal AI integration across their platforms, and lack proven enterprise solutions, which is clearly our focus. I feel confident that we will continue to outpace the competition in research and development and in delivering our operations cloud platform. This includes not just incident detection but also the intelligent correlation of those events and their orchestration to the appropriate teams and increasingly the right agents. As AI continues to advance, we expect to see more automation in troubleshooting and diagnosis through both traditional and generative AI, leading to faster resolutions for the large enterprise-grade incidents we are witnessing on a global scale.

Kingsley Crane, Analyst

Great. Really helpful. And then one for Howard, you've really made strides in expense efficiency over the past year. You're close to your long-term model. The business has changed a lot since that was put out. And I would say that your 85% plus gross margin profile suggests you could have an attractive terminal margin. So just any more thoughts on more efficiencies you could find from here would be helpful. Thank you.

Howard Wilson, CFO

Yes. Thanks for the question, Kingsley. As you know, we've always taken a structural and programmatic approach to how we think about improving our productivity and our efficiency as a company. And we've laid really good foundations for that in terms of both our location strategy, our use of technology, our internal use of AI, all of these things contribute to this. So I think you'd expect what you can expect to see more of the same. So leveraging on those areas that we've already made those investments. And on the sales and marketing side, we continue to look at how can we more efficiently raise our brand and how we can more efficiently drive demand gen and at the same time drive efficiency into our sales team. So I think the areas where for the longer term, where we still have the most obvious opportunity is around G&A and then sales and marketing, and then obviously from an R&D perspective, our goal is to try and maintain high levels of investment in R&D to support our innovation strategy.

Kingsley Crane, Analyst

Okay. Helpful. Thank you.

Tony Righetti, Moderator

And our final question comes from Scotiabank. John, please go ahead.

John Gomez, Analyst

Hi. This is John Gomez for Nick Altmann. Thanks for taking the question. So when you talk about deals taking longer, there can be a lot in there that's driving it, larger deals, the macro focused on enterprise customers, so what has been the biggest driver here and how are you guys feeling about the overall sales cycles relative to prior quarters?

Jennifer Tejada, CEO

I feel positive about the sales cycles. I'm not concerned that the deals are taking a bit longer because they involve larger average deal sizes, multi-product offerings, and more flexible pricing. This approach fosters stronger long-term partnerships with our customers. It's a solid investment in our foundational growth and business strength. Our change in guidance mainly relates to timing, as this small shift to revenue is taking a little longer due to less linearity and increased seasonality. However, over the long term, this is beneficial because we are seeing an increase in referenceable customers entering multi-year deals. The guidance adjustment is primarily about minimizing risk for the full year and demonstrating some caution. Nevertheless, we are confident in our ability to accelerate ARR in the latter half of the year, aiming to achieve a base net retention of $107. As our focus continues to shift towards enterprise customers, I believe this is advantageous for both customers and shareholders in the long run. I hope this clarifies things.

John Gomez, Analyst

Super helpful. And obviously, the SMB has been challenged, but when we look at the second half for ARR, can you talk about the underlying assumptions for ARR from SMB? Should we expect that to continue to downtick or should that stabilize? Just any color on the anticipated ARR mix would be super helpful.

Jennifer Tejada, CEO

Howard, you're on mute.

Howard Wilson, CFO

We're anticipating that most of our growth will come from the enterprise and mid-market segments. The trends we've observed for small and medium businesses are negative, although we expect some stabilization. However, we still consider this to be a bit of a challenge even in the latter half of the year.

Tony Righetti, Moderator

Okay. Let's turn it back over to management for closing comments. Please go ahead, Jenn.

Jennifer Tejada, CEO

Well, first of all, thank you for your patience as we got off to a little bit of a late start with some technical glitches, a proof that these incidents happen all the time and everywhere, and thank you to my team for a terrific incident response. I appreciate it. Thank you all for joining us today. The increased recognition in our value proposition following the recent high-profile IT outages, coupled with the record numbers of multi-product and multi-year agreements really underpins my confidence in our ability to surpass 10% ARR growth for the fiscal year. As Howard said, we're going to continue to work on improving efficiency and most of all continue to focus on building trust and long-term relationships with our customers. So thank you very much for your time and have a great rest of your day.

Tony Righetti, Moderator

With that, our call concludes. Thank you very much.