PagerDuty Inc

NYSE:PD

Earnings Call Analysis

PagerDuty’s Strategic Shifts Lead to Steady Growth

PagerDuty reported an 8% revenue increase to $116 million for Q2 FY 2025, with a non-GAAP operating margin of 17%. The company grew annual recurring revenue (ARR) to $474 million, achieving a 10% year-over-year rate for the third consecutive quarter. CEO Jennifer Tejada highlighted progress in the enterprise segment, including a record number of multiyear agreements. However, guidance adjusted slightly down to a full-year revenue range of $463-467 million, with expected ARR growth exceeding 10% by year-end, amidst some sales cycle lengthening.

Solid Performance Amid Challenges

In the second quarter of fiscal year 2025, PagerDuty reported revenue of $116 million, marking an 8% increase year-over-year. The company also achieved a non-GAAP operating margin of 17%, outperforming expectations by 4 percentage points. This reflects PagerDuty's ability to stabilize its annual recurring revenue (ARR) growth at 10% year-on-year, amounting to approximately $474 million. The company registered its eighth consecutive quarter of non-GAAP profitability, highlighting strong operational performance even amid a challenging economic landscape.

Enterprise Focus and Strategic Growth

PagerDuty's strategy to enhance its enterprise segment is yielding positive results. The dollar-based net retention (DBNR) stood at 106%, with expectations to maintain this level into the next quarter. Encouragingly, enterprise accounts generating over $500,000 in ARR grew by more than 20%. The increasing awareness of the operational challenges posed by recent IT outages has intensified demand for PagerDuty's services, solidifying its role in helping enterprises manage digital disruptions efficiently.

Customer Dynamics and Market Trends

While there has been a notable decrease in total paid customers—from 15,146 last year to 15,044—this decline primarily stemmed from the Small and Medium Business (SMB) segment, which experienced higher churn rates. On a positive note, the total number of customers using PagerDuty's platform increased by approximately 12%, reaching over 29,000. This suggests ongoing interest and engagement within the use of PagerDuty's products, especially among larger enterprise clients.

Profitability and Cash Flow Performance

Throughout the quarter, PagerDuty generated $36 million in cash from operations (31% of revenue) and recorded a free cash flow of $33 million (29% of revenue). The company ended the quarter with $599 million in cash, cash equivalents, and investments, which provides a strong buffer for future investments and strategic initiatives. With share repurchases amounting to 1.3 million shares, PagerDuty is focused on optimizing shareholder value while retaining ample liquidity.

Guidance and Future Expectations

Looking ahead, PagerDuty has revised its guidance for the third quarter, anticipating revenue in the range of $115.5 million to $117.5 million (growth rate of 6% to 8%) with net income expectations of $0.16 to $0.17 per diluted share. For the entire fiscal year 2025, revenue expectations are between $463 million and $467 million (growth rate of 7% to 8%), a downward adjustment from the previous guidance of $471 million to $477 million. However, the full-year DBNR is expected to reach at least 107%, indicating a positive outlook for customer retention and growth despite short-term challenges.

Market Positioning and Competitive Landscape

As PagerDuty pivot towards a more enterprise-focused approach, the company is increasingly distinguishing itself from competitors, particularly in the SMB segment where most competitors cannot effectively scale. The July outages underscored the advantages of PagerDuty’s Operations Cloud, validating the need for robust incident management solutions among enterprises. The performance during crises has fostered conversations with higher-level decision-makers, improving the likelihood of securing larger contracts and driving long-term growth.

Long-term Growth Potential and Strategic Vision

Customers are increasingly recognizing the critical nature of incident management and operational resilience, particularly after experiencing significant service disruptions. PagerDuty aims to transition a growing number of customers towards multiproduct, multiyear contracts that reduce the overall risk of churn. As the company successfully navigates this transition, it anticipates that its ARR growth rate will exceed 10% by the end of fiscal year 2025, positioning itself well for future fiscal years as well.

Earnings Call Transcript 2025-Q2

[Tony Righetti, executive]

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, would 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, executive]

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 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 multiproduct platform, helping the largest companies in the world in 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 multiyear agreements, representing nearly 1/3 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 team and development teams around the world work day and night to diagnose and recovery 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 incidence is not a question of if, but when. Nearly 2/3 of Enterprise leaders we serve 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 19 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 and innovation and it's why companies trust us to deliver operational resilience in their most vulnerable moments. Improving operational resilience for protect customer experience and revenues, while mitigating risk and the cost of major incidents has up-leveled 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, but 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 6- and 7-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 PagerDuty. The ROI over 3 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, our Customer Service Ops and premium support contributed 65% of net new ARR.

Two additional financial services customers signed strategic 6- and 7-figure expansions in Q2. Based in Europe and Australia, respectively, the financial leaders optimized for resilience of scale and chose the Operations Cloud to grow and protect their revenue.

We also closed a high 6-figure expansion, including AIOps and customer service operations with a large workforce management software provider to help the company accelerate their operations modernizations 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 instant management coverage and adding AIOps. With these products, the customer is targeting an ROI of over 300% in the next 3 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 $1 million ARR cohort of customers.

During the quarter, we also hosted 5 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've joined 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 forward 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 generator run books 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 life cycle.

We also released new integrated capabilities across the Operations Cloud, like the combination of dynamic isolation 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 life cycle 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 prices, 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 multiproduct and multiyear 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, executive]

Thank you, Jen, 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 6- and 7-figure multiproduct multiyear 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 the 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 onetime 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 expectations. 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 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 midpoint 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 up 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-month basis, billings were $468 million, an increase of 8% compared to a year ago. With respect to Q3, we anticipate trading 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 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.

Our 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% 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 multiproduct, multiyear strategic contracts with enterprise customers and a strong growing multi-core 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, executive]

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

[Sanjit Singh, analyst]

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

[Jennifer Tejada, executive]

It's a great question. Thanks, Sanjit. And thanks, everybody, for your patience has worked through a technical issue at the beginning of the call. So first of all, I hate taking down guidance, I'm not happy about it, and it's largely a timing issue. I want to walk you through this. So the larger multiyear -- multi products, strategic deals that we're doing are driving less linearity than we had seen in our land and expand transactional business and increased seasonality more so than the past. We saw a little bit of that in Q1, but I thought it was an anomaly, but Q2 was quite back-end loaded, and we're expecting more of that in Q3 and Q4. And that also results in a lag in professional services attached. So it's really just timing from a revenue perspective.

Having said that, just to reconfirm, our ARR guidance is unchanged. We still expect ARR to accelerate in the back half. Even with SMB, while we're seeing improving trends that market is yet to stabilize. And I'll remind you, that's mostly tech startups for us. And we know that funding in tech start-up land continues to be under pressure. So we're taking some of the risk out given this timing issue, but ARR growth is expected to improve through the year as is DBNR. So ARR growth above 10% for the full year and DBNR above -- or at 107% for the full year.

[Sanjit Singh, analyst]

Got it. And...

[Howard Wilson, executive]

And I think -- 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 SaaS companies.

[Sanjit Singh, analyst]

Understood. Jen, when you talk about the underlying backdrop or just more incidents and these getting more costly. Is that just sort of -- how that translate ultimately to better growth for PagerDuty? Is that something that would turn into better inbound for you? Or how do you go sort of prosecute the opportunity in this sort of current environment?

[Jennifer Tejada, executive]

Yes. Anecdotally, it's already driving a higher level of conversation at the CEO level, at the Audit Committee level in the Board, which I think, over time, will improve our ability to get to budget and ensure that budget is set aside for this much in the way we've seen cybersecurity budget be prioritized because when business leaders realize the financial impact of a major third-party or worldwide outage, they're forced to think through what precautions am I taking. What infrastructure investments do we need to make, how do I prioritize my tech debt burn down. And what we saw during the incident that took place in July, was a log senior leaders reaching out to us for best practices, for support, not just in the response, but for advice on where to go from here.

We also saw the differences between customers that have adopted the operations Cloud and matured their operations who found -- who discovered the issue very early and were entirely back online by the time the Sun rose. And customers who are manually processing secondary and tertiary incidents that took days to get back full in full operations, which has a huge cost of revenue, not to mention lost time and excess OpEx in terms of labor. And so I expect that we'll continue to see more and more of these strategic deals show up in the pipeline. And I expect that we will see more protection around investment and the budget for PagerDuty. That's where we're anecdotally seeing. Too early to see it really show up in pipeline, but it's already showing up in customer conversations.

[Tony Righetti, executive]

Next question will go to Bank of America. Koji, please go ahead.

[Koji Ikeda, analyst]

I wanted to ask -- maybe some thought process into fiscal '26 from a very, very high level. Just thinking about the billings growth decelerating this quarter, but the guidance implying acceleration in the second half and confidence in the ARR. But then Jennifer also you mentioned a little bit more of seasonality versus linearity. How should we think about kind of the exit rate of calendar -- I'm sorry, fiscal fourth quarter this year, into next year? And do those seasonality type trends continue?

[Jennifer Tejada, executive]

Yes. Well, the good news is some of that seasonality is driven by the fact that we're doing more multiyear, multiproduct deals that require a different level of approval and scrutiny from the customer base. And so we're seeing -- as a result, we saw a record number of large multiproduct multiyear deals this quarter, and we also renewed 30% of our ARR available to renewed in multiyear, 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, executive]

Yes, 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 trading 12 months billings 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-month basis. And the way that I would think about it is were -- to Jen's point, we're, from a retention perspective, the efforts that we've made around doing multiyear arrangements with customers move some of the downgrades 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 the third month of every quarter is going to be more heavy 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.

[Tony Righetti, executive]

Next up, let's go to William Blair, JP.

[Jacob Roberge, analyst]

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 put into the guidance plan to kind of account for some of these issues?

[Howard Wilson, executive]

Yes, I can break it down a little bit, Jake. I'd say the one element that is 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 in our ability to deliver that 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 tuned 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 will 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, executive]

Yes. And I'd 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 gotten used to these sales cycles with larger, 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 multiproduct, multiyear platform versus a bottoms-up start with incident response, expand the 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 are hitting the ground running and driving both improvements in churn and more productivity around some of these renewals. And that's in EMEA in North American enterprise and in federal. So just feeling like we're coming from a stronger foundation as look towards 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 $50,000 was more than 20%. So continue to see that momentum there in enterprise. And over time, SMB represents less and less of the total ARR.

[Jacob Roberge, analyst]

Okay. Yes, very helpful. And then just a really interesting comment about the 1,400% increase in incidents during the quarter. It sounds like there's been some good top of funnel activity since the crowd straight outage, but just given it's still kind of early days. When would you expect those -- that early pipeline to start actually layering into the business? Is that kind of a -- and first half of next year, back half of next year, I just would love to kind of understand how you're thinking about that traction?

[Jennifer Tejada, executive]

We're not modeling in new pipeline as a result of what we've seen in the last quarter in terms of major incidents. What I would anticipate is first, we'll see it in conversations, then we will see it in approval processes and just the breadth of what customers are buying. And one of the trends we've already seen is that when a customer really understands the cost of a major incident on average, $800,000 an incident. If you can compress the incident duration by half, and that becomes $400,000, like that is real financial business and customer -- end customer value. So the faster leadership understands that, the faster our champions can often move to get a multiproduct multi-deal done. So the biggest, I think, tailwind that we've already seen is just awareness. Just now CEOs and CFOs really understanding that if you infrastructure and on having platforms to really detect orchestrate and automate the response when these major incidents happen because they will, you're going to pay for it in spades later. And so that sort of -- I think that short-term thinking is going to manifest to more long-term investment and long-term investment mindset. And then I expect that after we see it in terms of sales cycles, we'll start to see it in ads. But I can't predict how long that's going to take to manifest. Some of our customers move really quickly on the back of an issue like this. Coming -- recovering from a major incident has long been a primary use case for PagerDuty, and some of our customers take longer to transform their thinking internally.

[Tony Righetti, executive]

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

[Andrew Sherman, analyst]

We'd love to hear 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, executive]

Feedback has been very positive, and it's really enabled some of the big deals that we shared in prepared remarks. I know some people some time to get into the call. So we talked about a North American global bank that was already a 7-figure customer that's expanded beyond that 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 incidence 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 consumption-based pricing. So we're getting, I think, a warm reception to that, 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, executive]

I think you've covered it, Jen.

[Andrew Sherman, analyst]

Okay. And then Howard, I get the -- I think we all understand that you're more Q4 weighted now. But how have you factored in the fact that these deals are larger and taking longer to close? And anything you've changed as far as your assumption on close rates for Q4? And then how have the renewals tracked as well versus your expectation?

[Howard Wilson, executive]

Yes, sure. So from a guidance perspective, part of the reason why we made the adjustment to our guidance was because we took into account the our most recent history in terms of seeing how these deals are closing and their timing. And also anticipating that some of these deals may end up taking longer. So that's been accounted for. That being said, the approach that we're taking in terms of how we're managing our pipeline is certainly around our sales team being incented to get these deals closed within the timing and within this year. And a lot of the sales disciplines that we put in place over the past year have really been about improving the level of scrutiny and the quality of those deals. So that's improving our level of confidence as we think about it. So we have good visibility into the deals that are in play, both in Q3 and Q4 and into next year.

Fundamentally, like from a renewals perspective, we started the initiative about a year ago in earnest it was actually Q4 of last year, it was in earnest to get customers onto multiyear arrangements at renewal, not just when we did a new deal. And that's starting to bear results in that when we look at what's available to renew within Q4 this year, it's a lot less than what it was in Q4 of last year. So that means that we're in a position to manage any potential risk on the retention side more effectively.

[Tony Righetti, executive]

Next up, Craig-Hallum, please. We will go to Jeffrey Van Rhee.

[Jeff Van Rhee, analyst]

A couple of questions for me. I just want to read this back to make sure 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 and years back and more back-end loaded. But you're going to get to the same just going to happen later in the year. Is that a fair read back?

[Howard Wilson, executive]

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.

[Jeff Van Rhee, analyst]

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, what do rates look like now versus a year ago?

[Jennifer Tejada, executive]

We haven't published our win rates, obviously. But that part of the market hasn't changed meaningfully. I think that customers are more price sensitive in some in the lower end of the market, particularly SMB, but also to some extent, mid-market. And they also is like we aren't seeing the level of headcount growth. that we've seen in those segments compared to the past. So that puts some pressure on both growth and renewals. But from a competitive standpoint, like it's not a zero-sum market. And I think what you saw with a major outage like what happened on July 19, one thing that works in our favor even in incident management as a stand-alone offering is, there are still a lot of large companies out there that have manual processes that use very little automation and detection that have more than 10 observability players that are not correlating that information, right, and need the support of a platform just even get to responding more effectively.

And then I would also say that even our incident management platform is built on an AI based foundation on a proprietary data set that is distinctly different to anything else that's out there and that we have data on the events coming in, the incident workflows themselves and then also more and more automation around the response, including the generative AI-based features that I mentioned in prepared remarks. One of the things that is -- that I think was really interesting about the July event is we saw, like I said, a 14,000% increase of incident workflows running on the platform and suffered no disruption and no cost surge. And there isn't another player, incident management notifications alerting observability that can, I think, attest to that kind of pressure live when the rest of the world and the largest companies in the world are suffering a major outage.

So I think that reinforces our resilience at scale and the security of our platform, even under a significant global outage -- to a worldwide outage. The last thing that I would say is we have taken steps to try and support SMB and mid-market customers that are more price sensitive, free is one of those. We've made some changes to pricing. But at the end of the day, even in this tough macro, I think we're controlling the controllables. And getting there -- and I am somewhat of an optimist like the tech industry will come back. We will start to see venture funding back in SMB at some point in time. I'm just not calling that in our expectations. Like we expect that to continue for the current conditions to continue.

[Howard Wilson, executive]

Sorry, Jen, I'm going to have to do my CFO, thing and said it was 1,400%, not a 14,000% [indiscernible]

14,000 sounds fantastic. It is pretty impressive.

[Jennifer Tejada, executive]

Let's use the appropriate number. Thank you.

[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's 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 just longer there's a little more of a message of stability prior quarter and the 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, executive]

Yes. So SMB has remained. We've had elevated churn and downgrade there now for 4 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, right, 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 that churn is actually relatively small. So this is part of us also focusing more on the enterprise where landing enterprise and mid-market goes 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.

[Tony Righetti, executive]

Next, we'll go to Canaccord Genuity, and Kingsley.

[William Kingsley Crane, analyst]

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

[Jennifer Tejada, executive]

Yes. I would say most of the -- again, not a zero-sum market. Most of the competition that we see is in the mid-market or below in SMB. And that is because the competitive offerings that are out there don't scale effectively into enterprise or purely price-led versus feature led. And I think if anything, what we've seen in the last quarter with worldwide outages is that this is an area where our performance does matter. And I think that will serve as a competitive driver for us in the future. The other players that are out there have much less functionality, very little AI supported throughout their platforms and are not proven in enterprise, which is very clearly our focus. And so I think we're -- I feel confident and believe that we are going to continue to outpace the other players from an R&D perspective. And in terms of just delivering the Operations Cloud platform, not just in detection of incidents, but also the intelligent correlation of those events and orchestration of them to the rate teams and increasingly, the right agents as AI starts to take more and more hold, more automation of the actual troubleshooting and diagnostic with the help of both traditional AI and generative AI and faster resolution that compresses these large enterprise grade incidents that we're seeing on a global basis.

[William 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 Europe would be helpful.

[Howard Wilson, executive]

Yes. So 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 have 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.

[Tony Righetti, executive]

And our final question comes from Scotiabank, John

[Unknown Analyst]

This is John Gomes on for Nick Altmann. So when you talk about deals taking longer, there can be a lot in there that's driving larger deals, the macro focus 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, executive]

I actually feel good about the sales cycles. I don't actually mind that the deals are taking a little bit longer because they represent much larger average deal size, multiproduct, which is stickier, more flexible pricing, which also, I think, in genders like a long-term partnership and relationship with the customers. So it's a very good investment in the long-term foundational growth and strength in the business. And as I said, like our change in guidance is really about the timing of this kind of small transition to revenue taking a little longer because of the less linearity and more seasonality. But at the end of the day, long term, it's a tailwind because we are seeing more and more highly referenceable customers doing multiyear deals. So the guidance change is really about derisking the full year and articulating some conservatism, but also we are very confident in the ability to accelerate ARR through the back half of the year and end the year at $107 base net retention. And as more and more of our business shifts to that focus on enterprise, I think that's good for customers and good for shareholders long term. So I hope that's helpful.

[Unknown 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 AR mix would be super helpful.

[Jennifer Tejada, executive]

Howard, you're

[Howard Wilson, executive]

We're expecting the bulk of our growth to be coming from the enterprise and mid-market segments. We have -- the trends that we've seen around SMB being negative, whilst we expect to see some stabilization. We still see that as being a bit of a headwind even in the back half.

[Tony Righetti, executive]

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

[Jennifer Tejada, executive]

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. It 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 of our value proposition following the recent high-profile IT outages coupled with the record numbers of multiproduct and multiyear 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, executive]

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