Good afternoon. My name is Camille, and I'll be your conference operator today. At this time, I would like to welcome everyone to the PagerDuty Second Quarter 2020 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. [Operator Instructions] Thank you.

I will now turn the conference over to Stacey Finerman. Please go ahead..

Good afternoon, and thank you for joining us on today's conference call to discuss PagerDuty's second quarter financial results. With me on today's call are Jennifer Tejada, PagerDuty's Chairperson and Chief Executive Officer; and Howard Wilson, the company's Chief Financial Officer. Statements made on this call include forward-looking statements.

Forward-looking statements 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.

Forward-looking statements represent our management's beliefs and assumptions only as of the date such statements are made, and we undertake no obligation to update these forward-looking statements. In addition, during today's call, we will discuss non-GAAP financial measures.

These non-GAAP financial measures 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 tools for comparison. A reconciliation between GAAP and non-GAAP financial measures is available in our earnings release.

Further information on these and other factors that could affect the company's financial results are included in filings we make with the Securities and Exchange Commission from time to time, including the section titled Risk Factors and the company's most recent quarterly Form 10-Q previously filed with the SEC.

Now I'd like to turn the call over to our CEO, Jennifer Tejada.

Jennifer?.

energy and natural resources, financial services and transportation. This quarter, IHS Markit replaced a point solution that did not scale effectively with PagerDuty platform. The company is deploying our platform and Modern Incident Response across nearly 1,000 users.

It's also important that companies can determine the business impact of unplanned work and customer-impacting incidents on their bottom line. According to our survey, the cost of unplanned work is increasing, and 86% states that this results in less time to innovate.

Team states burnout, lost productivity and less development time which, in turn, impact competitiveness and creates brand risk. Other companies cannot understand the real-time business impact of incidents. Our Visibility product translates the immediate impact of incidents like outages and disruptions into business outcomes.

No other product in the market consolidates a real-time holistic view of operation and correlates people, technology, services and business impact in the moments that matter.

PagerDuty analytics provides operational scorecards and customizable dashboards so companies can apply a proactive approach to managing digital operations based on how teams have historically responded to major issues.

The scorecards provide a curated approach to improve team health, technology service health and business outcomes like total cost of incidents, response cost to the business and predictive people metrics to detect response of the team. This is an industry-first and a significant differentiator for PagerDuty.

We are excited by the broad visibility of PagerDuty's platform. This quarter, we discovered a number of new use cases where our customers have applied our platform. A late-stage, hydro fintech company that facilitates digital payments for millions of businesses worldwide uses PagerDuty across many of its teams.

Having started with developers, they then expanded their users to legal, security and payment operations teams. The payment operations team use PagerDuty to coordinate with global banking partners in real time, ensuring successful transaction. Physical security teams are on PagerDuty for real-time response to physical security issues.

The legal teams manage time-sensitive requests from law enforcement, and SecOps teams are on PagerDuty to monitor security risk and ensure compliance. A global recognized leader in GPS navigation and wireless devices uses PagerDuty to monitor its emergency communication devices where complete reliability is a life or death matter.

The company previously used a basic monitoring service and switched to PagerDuty due to reliability concerns. After recognizing improved reliability, scale and value PagerDuty provides, the company has now expanded its use of PagerDuty to its digital transformation initiatives.

Another notable new use case led by our PagerDuty.org initiative was Code for America, a nonprofit that focuses on reforming government services to make them simple, easy to use and accessible to all Americans.

They are currently using PagerDuty to support their GetCalFresh program, which improves access to the Supplemental Nutrition Assistance Program, or SNAP, more commonly known as food stamps.

GetCalFresh has digitized and streamlined the process for applying for SNAP, reducing the application time from 82% from 45 minutes to 8 minutes and has helped over 1 million Californians gain access to food stamps.

From a product perspective, this quarter, we launched a number of new capabilities that help our customers more quickly and accurately respond to issues and opportunities that impact revenue brands and customer experience.

In July, we launched Business Response, which advances traditional status page capabilities so responders can seamlessly update business stakeholders on business service impacts and real-time recovery progress in an intuitive, fully automated way.

This allows responders to drive faster evolution and enable stakeholders to proactively manage customers' needs.

Similarly, in Q2, we enhanced our search capability to provide improved contacts for IT and DevOps team so they can more easily navigate large organizations to find the right subject matter experts team and escalation policies during incidents and respond faster in the moments that matter.

To further build on our market leadership, we continue to deepen our leadership bench. During the quarter, we appointed a new CMO, Julie Herendeen.

Julie comes to PagerDuty having led large marketing teams at companies, including Uber, Dropbox, Yahoo! and Lookout, and now leads our efforts to scale our brands and continue to build our demand generation and growth markets. As we expand our business, we will continue to invest proactively in leadership to support our growth.

In the coming quarters, we anticipate adding a Chief People Officer and a Chief Revenue Officer. Overall, we had another strong quarter, and I'm proud of what our team has accomplished to benefit our users, customers and partners. We are encouraged by our continued strength in enterprise and rapid adoption of add-on products.

We continue to see growth in expansion, geographies, new use cases and new products aided by our self-serve and high-velocity sales motion. Finally, I'd like to highlight our fourth annual user conference summit, which takes place on September 23 through the 25th where we will be hosting over 1,000 developers and technology executives.

We are excited to host industry leaders, including Jeff Lawson from Twilio, Eric Yuan of Zoom, Cynthia Stoddard of Adobe and investor Andre Iguodala as well as breakout sessions led by leaders and practitioners innovating with the PagerDuty platform.

We look forward to an action-packed week with our community, including new product innovation and best practices we can all learn from. With that, I'd now like to turn the call over to our CFO, Howard, who'll walk through the financial results.

Howard?.

clinical work. They're a digital neuroscience company developing validated software technologies to enhance research into brain health and mental well-being.

In addition to using PagerDuty to monitor the health and status of its IT infrastructure, the company utilizes PagerDuty to help monitor suicidal ideation, immediately notifying clinicians and sponsors to take action to prevent self-harm in patients. The need to acknowledge the call and using escalation policies ensures that the message is actioned.

With that, I will turn to the detailed financial results. I'm providing these results on a non-GAAP basis. Our GAAP financial results, along with the reconciliation between GAAP and non-GAAP results, can be found in our earnings release. In Q2, non-GAAP gross margin was 85.7% and was in line with the second quarter of last year.

Our cloud native architecture, DevOps approach to production and programmatic approach to customer support and success drives our efficient operating model. Our strong gross margins create operating leverage and allow us to make investments in the long-term growth of our business.

We have run our business on gross margins between 84% and 86%, and we expect gross margins to stay within this range for the remainder of the fiscal year. Turning now to operating expenses. While we remain focused on scaling the operation to improve our leverage, we anticipate continuing to make investments for growth.

Over the long term, we anticipate that our revenue will grow at a faster rate than our total operating expenses, which will improve operating margins over time. Operating expenses this quarter reflected anticipated investments in expanding our sales force and go-to-market programs.

Second quarter non-GAAP operating expenses were $41.7 million compared to $28.1 million a year ago. This 48% increase year-over-year was driven by investments made in line with our go-to-market strategy, continued product innovation and infrastructure to support being a public company.

Non-GAAP research and development expenses for Q2 were $10.2 million compared to $7.4 million in the same year ago period, representing an increase of 38% year-over-year. Innovation has been and will continue to be a top priority for us as we continue to move up the value chain in real-time operations.

We expect R&D to increase for the remainder of the year but remain roughly the same as a percentage of revenue. Non-GAAP sales and marketing expenses for Q2 were $21.5 million and grew by 49% compared to Q2 of fiscal 2019. As we discussed on our Q1 earnings call, we made early investments in the first half of the year to increase our sales capacity.

We expect to expand our sales force more modestly for the remainder of the year. And over time, we would expect to see improved operating leverage as our subscription revenue grows. From a marketing perspective, we will host our annual industry conference, PagerDuty summit, in September, which is a significant investment in the quarter.

We will be making additional investments in Q3 program spend to promote our brand, which includes above-the-line advertising, and this will continue into Q4. Non-GAAP general and administrative expenses for Q2 were $10.1 million for the quarter ended -- and increased 60% year-over-year.

As I mentioned in our Q1 earnings call, the year-over-year growth in G&A was driven by investments in head count and systems that we made in anticipation of becoming a public company. G&A expenses in Q2 was sequentially flat relative to Q1 and decreased as a percentage of revenue.

We expect G&A expenses to increase slightly over the remainder of the year but to continue to decrease as a percentage of revenue. Our non-GAAP operating loss in the quarter was $7.1 million compared to a loss of $4.2 million in the same quarter last year.

Our non-GAAP operating margin was negative 17.7% in Q2 and negative 15.2% in the same period of last year. The decrease in operating margin is largely due to investments in G&A to support becoming a public company. Over the longer term, we expect improvement in operating margin.

Non-GAAP net loss for the second quarter was $5.3 million or a net loss of $0.07 per basic share compared to a non-GAAP net loss of $3.8 million or a loss of $0.18 per share in the second quarter of last year. Turning to the balance sheet.

We ended the quarter with $341 million in cash, cash equivalents and investments, up $213 million from the end of the fiscal year 2019. This was primarily driven by proceeds raised in our initial public offering, slightly offset by our year-to-date operating losses.

We generated $2.2 million in operating cash flow in Q2 compared to having used $4.7 million in the prior year primarily due to timing in working capital changes. Free cash flow was $1.3 million in Q2 compared to negative $5 million last year. Free cash flow margin was positive 3.3% compared to negative 18.1% in Q2 last year.

In the second half of the year, we are planning a number of capital expenditures related to our office build-out. And in the short term, we don't expect positive operating cash flow or positive free cash flow.

While we expect to make continued progress towards sustainable free cash flow in the long term, it may not be in a linear trajectory given period-to-period fluctuations in billings and working capital and capital expenditure as we expand our U.S. and international offices.

Moving on to guidance for the third quarter of fiscal 2020 and the full fiscal year 2020. Revenue is expected to be in the range of $41.5 million to $42.5 million for the third fiscal quarter and would see our full year fiscal 2020 end in the range of $162 million to $164 million.

Non-GAAP net loss per share is expected to be in the range of $0.09 to $0.10 for the third fiscal quarter and in the range of $0.36 to $0.37 for the full fiscal year 2020. Bottom line forecast include the impact of the cost of our user conference in Q3 and program spend for above-the-line advertising.

Basic shares outstanding for Q3 and the full year fiscal 2020 are expected to be 76 million and 65 million, respectively. With that, Jennifer and I are happy to take any of your questions.

Operator?.

[Operator Instructions] And our first question comes from Sterling Auty with JPMorgan..

Hi, guys. So guys, net retention rate kind of came down. I know it does fluctuate, vary per quarter, but trying to see if pricing is kind of becoming an issue with the competition and how the level of expansion deals look in the quarter versus the last couple of quarters. Thanks..

Yes. So in terms of dollar-based net retention rate, the 132 number is -- 132% is a strong number for our industry and for our company. And we do expect to see that fluctuate from quarter-to-quarter. A couple of points to note though with respect to Q2, we did see a couple of our primary competitors churn or downgrade within the quarter.

And I think one other characteristic is that this was a quarter for us of intense hiring. In fact, we -- from a sales team perspective, we have our highest proportion of our sales force ramping in this quarter compared to prior years as we front loaded our hiring in H1..

Got it. Thanks for taking the question. I appreciate it..

And our next question comes from Matt Hedberg with RBC Capital Markets..

Hey, guys. Thanks for taking my question. Jen, on the top of the new product attach, you launched a number of products over the past year. You talked about another one in this call, a couple examples.

I am curious, when you look at these family of products, was there one that we should be keeping an eye on more in terms of attach or just sort of overall demand from an add-on perspective?.

Hi, Matt. Good to hear from you. We were really encouraged by the new product adoption that we're seeing.

Event Intelligence and Modern Incident Response in particular are products that are sort of the natural next step for a customer that has already automated their on-call environment, is looking to use beyond simply improving their response to becoming more proactive and more predictive by leveraging machine learning on automation.

And we also see that some of our products suit the more senior personas whereas other products suit sort of all of the developer and operating community. So there are sort of bigger horses for different courses. But the next sort of logical step, I think, for our customers as they add on product is Modern Incident Response and Event Intelligence..

That's great. And then, Howard, one for you. I know you talked - we talked a lot about trailing 12 month billings as probably the best indicator. But technically, the billings still, I think, it accelerated sequentially. It looked like deferred revenue is pretty strong this quarter.

Can you remind us again how we should think about calculated billings given your monthly contracts and the fact that a lot of your customers co-term deals?.

Yes. Well, thanks, Matt. Obviously, we're pleased when we see some acceleration when it comes to billings [ph]. To your point, we do have a few items that do create some fluctuation in that which includes the fact that we do have 20% of our revenue coming from monthly customers who are on a month-to-month arrangement with us.

And then because of the nature in which we contract, those annual customers initially do then will co-term and so end up with shorter period billings associated with those. So we do tend to look at it in terms of on a trailing basis to get some sort of view because that helps balance out those fluctuations.

But again, it's one of those things that does move around because of these factors that I mentioned including the seasonality of our renewals..

Great. Thanks a lot guys..

And our next question comes from Rob Owens with KeyBanc Capital Markets..

Yeah, good afternoon. Just want to drill down a little bit again into the net renewal rates. I did hear you say churn or downgrade during the quarter with a couple of customers. Would love a little more clarity on that and where you are seeing success with the expansion.

Can you help us understand how much of that is seat-based versus maybe product-based at this point?.

I might take that question, Rob. It's nice to hear from you. So I just want to clarify what Howard alluded to was we had a couple of competitors that churned off of our platform in Q2. Yes, which is - and in a business like ours, you're always seeing some customers come and go. But our churn number still remains best-in-class.

And we're particularly proud of the expansion that we've seen in enterprise where this quarter in particular, we added 32 customers spending over $100,000 with us. I think I'd also would just point out that we're seeing -- we continue to see strong expansion, user expansion, across teams and use cases. And that drives the majority of our growth.

But we're excited about the new product adoption that we've seen. I would just underscore what we said last quarter, which is those new products are still early. We don't guide on a revenue breakdown by those new products or share that information.

But we are seeing customers very interested and excited about taking their operations maturity to the next level, starting to use machine learning and automation to their advantage to reduce the cost and time and risk associated with what we think of as modern incident response..

Great. Thanks for the clarification there on the competitor churn.

Number two, with the success you're seeing internationally, can you talk about go-to-market overseas? And is there any unique localized competition or anything different from a competitive landscape?.

I think go-to-market is a lot like it is in North America. Most of the accounts we engage with are greenfields, and that's the case across our customer base.

While we do see some competition from time to time, I'd emphasize that we still really see it as a large and nascent market, and a lot of customers are really just phasing through how to improve the time it takes for them to respond to demanding customer requirements when their technologies are getting more complicated.

We're really proud of the growth that we're seeing with very new teams in both EMEA and APJ. Those teams have only been in market for about 2 years. And some of the most interesting use cases are coming out of those markets.

Again, I would also just reflect that in international, very similar to North America, the adoption of our platform is very horizontal. We see it across just about every single vertical and across different kinds of teams..

Great. Thanks, Jennifer..

[Operator Instructions] And our next question comes from Sanjit Singh with Morgan Stanley..

I just had a higher, I guess, a strategic question, Jennifer, if you will. So we see a lot of -- call it in the IT operation management space, a lot of consolidation, I suppose made a couple of acquisitions in the performance monitoring side, on application performance monitoring side. A lot of these guys are your partners.

But in terms of the longer-term strategy, is the partnership strategy with the performance monitoring vendors and other parts of the ecosystem, is that the right way to go? Or do you just start to bring in more and more and consume more of that functionality into the PagerDuty platform as you try and pursue a platform play in the enterprise? Just want to get your like sort of higher-level thoughts there..

Thanks for the question, Sanjit.

What I would say is that as we see consolidation in that particular part of the market, it really strengthens our position because it becomes increasingly important to our customers to have a central, independent, third-party correlating events from all the different points and monitoring environments within the ecosystem.

And that's not limited to APN. It includes security, ticketing, physical environment, et cetera. And so you're correct that we do partner with the APN providers. And in fact, most of them like Datadog, New Relic, AppD, Cisco are our customers as well. So there's a very strong complement.

And the way to think about it is as we consume those signals long term, we're not just leveraging what's happening right now in the moment, we're leveraging 10 years of data in the platform that helps us to really correlate and make sense of what's happening regardless of how complex or how distributed the environment is.

The second thing that I would say, which is very different from the approach of the APN providers or traditional monitoring and log providers, is that we're really focused on automating and intelligently orchestrating the people and the work itself.

So every time an issue or an opportunity runs on the platform, the platform is learning from it and then providing more proactive, predictive capabilities to the teams the next time around.

And that continues to be, I think, a really important part of our long-term strategy, the fact that our focus is actually on the people and helping them orchestrate and engage effectively even though their organizations and the ecosystem is getting more complex.

So we continue to see ourselves as being central in that ecosystem as opposed to a bias towards one particular type of capability or a subsegment or an ops..

Understood.

And maybe just sticking with that, those sort of longer-term themes, as customers kind of move more and more to these container-based, micro services-based, Kubernetes standard type application architectures, how does that impact PagerDuty from a growth and positioning standpoint in your view?.

So containerization so far has been great for PagerDuty because it actually creates another layer of complexity to monitor, but it doesn't replace some of the legacy environments that our customers have to contend with on a day in and day out basis.

And I would say even with some of our younger disruptive customers, because of the pace at which technology and architecture has changed, they all have to deal with some kind of hybrid mix of native, new cloud-centric technology, on-prem, traditional legacy technology and the complexity and the change that accelerates as you have people doing 10, 20, hundreds of deploys a day, make it impossible for you to manage.

So containerization's actually been a good tailwind for us alongside of cloud and the broader sort of umbrella of digital transformation where you're trying to do more, you're trying to shift your investment to innovation and application development, and yet the complex technology sitting behind it isn't getting any easier to manage.

There's just a kind of different set of challenges, I would say, that come with this containerization and the distribution in architecture..

Great. Appreciate the thoughts Jennifer..

And our next question will come from Bhavan Suri with William Blair..

Hey, guys. Thanks for taking my questions. And a nice job there on the quarter. I guess I wanted to chat a little bit on the penetration opportunity of the core product.

If I think about the core On-Call Management product and you think when you look the seat count perspective within average customers, I'd love to sort of get an idea how you think about sort of the remaining runway for additional seats within larger customers.

You got some customers deployed more than 20,000 seats and you think about sort of that spreading. I'd love to sort of think about how you guys think about attacking that opportunity and what the size of that opportunity within the existing base might be..

Yes, the way we think about that is, I think the traditional starting point for most of our customers is in developer ops and IT teams. And then you see this natural expansion, organic expansion, into related organizations like customer support or security operations, et cetera. We don't have a single customer that is sold out.

All of our customers still have employees that have real time responsibilities that deal with complexity in their day-to-day operations that are not on PagerDuty. So we think the opportunity continues to be significant within our existing base on our core products as well as the opportunity to acquire new customers and expand through add-on products.

What I would say is we continue to work very hard at making our products simple and easy to use that you don't have to be a developer who can script to kind of understand how it works.

That includes things like removing jargon from ELI and also articulating the value and how our products can be leveraged and applied to different use cases than sort of what's typical as opposed to sort of allowing customers have to figure it out for themselves..

Got it. Got it. That's helpful. And then I know someone asked about competitors, there's a little bit of consolidation.

But I want to touch on some of the AI Ops entrants, right? So you think some of the monitoring guys are coming in, so guys like Dynatrace have opened up their platform to work with more third-party systems and data sources and addressing sort of the AI Ops opportunity.

I guess are you seeing it in customers at all? Do you see any of these new AI Ops kind of entrants in that space? Are you seeing monitoring entrants on deals? Or is that sort of still pretty much the traditional guys or guys that have been acquired and consolidated like VictorOps or whatever..

So first of all, most of our deals are uncontested. There are still a lot of greenfields where we're replacing PhoneTree and want that channel. Second of all, I would say that we're not seeing AI Ops as a competitive way at all.

And in fact, all those people that you mentioned use PagerDuty and are beginning to leverage PagerDuty for things like event management or event intelligence. So I don't see them coming that way. And I think what's important is there's quite a technology effort to not just consume a signal but then correlate that signal.

And you need a very strong data set to work from in order to make sense out of a very complicated set of events that in a traditional APN environment will each look like their own separate incidents and would be pushed to a single silo team whereas with PagerDuty Event Intelligence and Modern Incident Response, as those events come together through our platform, they're consolidated into a single related event and then orchestrated to maybe a handful of people instead of hundreds of people across 5 or 6 teams working on it.

So the workflow is different, and then our ability to orchestrate people -- orchestrate team and intelligently route insights and actions direct to the right teams and right subject matter experts is very differentiated. The last thing I'd mention is Visibility where we talked about helping people in the moment.

We understand the context of what's happening in business, for instance, changes in transaction volume or changes with shopping cart abandonment at the same time they're experiencing a complicated technology incident, which helps responders prioritize immediately, spontaneously, the things that are the most important for the business in that moment.

And that, again, is quite different relative to the AI Ops part of the world..

That was super helpful. Thank you, guys and nice job there. Thanks for taking my questions..

And our next question comes from Rishi Jaluria with D.A. Davidson..

Hey, guys. Thanks for taking my questions. I wanted to start by drilling down on the $100,000 adds, now 32 and getting to 74 in the quarter.

Maybe help us understand, was that just a result of better execution in terms of sales and go-to-market or any other contributors there? And then maybe directionally help us understand, was that mostly existing PagerDuty customers that just expanded with both products and seats? Or were some of those net new customers that weren't PagerDuty customers before?.

Thank you. I'll answer your second part of your question first because it's easier to remember. The customers over $100,000 is a mix of existing customers and net new customers, but the majority are existing customers that are expanding within their dev teams or to new teams or new use cases or new products within their relationship with us.

And if I think about what's driving the strength in that segment, I think one of it is just market demand from enterprise and mid-market and the fact that there are not other scalable, resilient, secure platforms available to them. Some of those customers have tried point solutions or internal solutions and have not been successful.

The other thing I would say is some of the macro trends that we're seeing, which is most of these large companies and even large, disruptive, mid-market players are trying to move very fast. They're investing heavily in digital transformation, which we facilitate readily. A lot of them are involved in cloud adoption or cloud migration.

And those tend to be tailwinds that really support that kind of expansion. And then last, I would say I think we are building credibility because we are proven in more than half of the Fortune 100 and over a third of the Fortune 500 as delivering the enterprise scale and enterprise grade offering.

We've also had feedback from a lot of these customers around how excited they are about the road map and the fact that as their operational maturity advances, there is somewhere for them to go..

Got it. That's really helpful.

And then just in thinking about some of the early positive reception you've had with Event Intelligence, Incident Response, some of the other ancillary products, I mean have you given thought to at some point -- I know, Jennifer, you said not disclosing revenue breakdown or anything like that but maybe even something like attach rates or attach rates for even just $100,000 customers, even be that once a year or at the Analyst Day or something, just I think what gets people really excited is when the platform part of the story really starts to take off, and clearly the pieces are in place, but any kind of early signs on that I think would be helpful but just wanted to get your perspective on that..

Thanks, I appreciate your feedback there. At this point in time, we don't have an intention to share that data. Again, I think these products are early. We've released Event Intelligence into the market last summer, so it's been out in the market in just a year, and the other products have all followed.

And just earlier this quarter, we've released Business Response, which allows customers to not just manage their technology incidents and issues and opportunities but helps business leaders drive the corporate response that they need to engage go-to-market to get ahead of challenges with their customers or legal or PR.

And so it's a pretty diversified offering, and I think from where we are right now, we don't intend to share attachment data..

Okay, got it. Understood. Thank you so much..

And there are no final questions at this time. I will now turn the conference back over to management for closing remarks..

Thank you, everybody, for taking the time to join our call. And thank you for the entire PagerDuty customer and user community and the team for another solid quarter. We look forward to seeing many of you at our upcoming summit later this month. Thanks very much, and have a great night..

And that concludes today's conference call. You may now disconnect..