PagerDuty, Inc. (PD) Earnings Call Transcript & Summary

Good morning, everybody. Thank you for being here, and I have -- a great pleasure to have Jennifer, who's the CEO over at PagerDuty; and Howard, who's the CFO. My name is Bhavan Suri. I'm the analyst that covers PagerDuty at William Blair, and you can find all the appropriate disclosures on our website at www.williamblair.com. It's a great pleasure to have Jen and Howard with us and a compelling, compelling business here. But I'm going to have us walk through the business kind of metrics together. It's a fireside chat for about 30 minutes. And so guys, thank you for being here. I really appreciate you taking the time.

And Jennifer, maybe I'll start with you. Just an overview of what PagerDuty does and what Digital Operations Management means for investors that might be new to the story.

Sure. Well, thank you again, Bhavan, for having us. Really appreciate it. I think we've all really seen this, particularly given the environment with COVID in the backdrop, that the world is always on. We're truly living in this digital world. And every consumer experience that you engage in, from your children's education to how you purchase a pair of jeans or a shirt, I guess pants don't matter as much anymore because we're all just filming from the waist up, but all of those digital assets and mobile apps that you engage in, they're powered by complex technology. And that technology -- a lot of people think that as a technology stack. I actually think of it as a technology ecosystem because it's organic in the way it continues to grow, particularly as we've moved towards distributed architecture and microservices. So given that we're all reliant [Audio Gap] quickly yet it's proliferating in complexity at an unprecedented rate, it makes a lot of sense to expect that you need solutions to understand how that technology is operating, automatically use software signals to detect whether something is having a problem or not. And then getting those software signals turned into actionable work and routing that work to the right people in the right moment to solve a big problem at the right time is super important. And that's what PagerDuty does. What's interesting is the recent economic backdrop has sort of accelerated the digitization of many of our customers and prospects. So even very traditional industries that really saw the websites [Audio Gap] now having to rely on digital apps, whether they're web apps or mobile apps, for all of their revenue. We went to a 100% e-commerce environment over the last 3 months. And as every company becomes a digital company, that means every company also needs to be an operations company. And that's where digital operations comes in. We use machine learning and automation to detect those signals automatically. We orchestrate that work to the right people. And by right people, I often mean the expert, the person who's had experience with this incident in the past. And we then enable customers to not only manage incidents quickly but use events and predictive analytics to prevent event storms from becoming major incidents that can impact customers. We still have many new prospects who come to us and say the way they find out that they're involved in an incident right now is through Twitter or through their customer support chat, right? And that is a terrible feeling if you are a CEO responsible for your brand and your reputation. So PagerDuty has really come to the full to automatically enable customers to manage the technology that sits behind, keeping their business always on.

Yes. If I take that and you think about it, you were first mover kind of in the On-Call Management opportunity. And then, obviously, pretty first-mover in sort of the idea of Digital Operations Management and the whole category. When we talk to the investors, they always focus on the newer products. But when we talk to their customers or potential customers, they're all struggling just to get On-Call Management for DevOps right. So as you think about the level of penetration, a, within the base and then sort of broader speaking, I'd love to understand where you think we are in terms of that opportunity for PagerDuty.

Sure. Well, it's a phenomenal question. And I think it's because we are still very, very early in that TAM. We see the addressable incident management market at around $25 billion. We did a lot of work in the lead-up to the idea to assess that market on a per user basis to look at how many dev teams there were in the world, how many software developers there were, how teams are driving their IT operations, et cetera. And so just on the pure incident management or incident response use case, we think that's a $25 billion market. And to your point, one of the reasons that we believe that market is still early is because the vast majority of our new customer acquisitions are uncontested. These are companies that are either using legacy systems, they're using phone trees, e-mail distributions, [indiscernible] channels and human beings to identify a problem, to get people engaged. And the problem with that is, if you're a company with 10,000 people, you don't know who the expert is on job. You have no idea who the security expert is in the organization. And trying to go through active directory to find somebody makes no sense when seconds and minutes count. And I think this is a really important notion that -- our e-commerce retailers tell us they can lose anywhere between $250,000 and $500,000 a minute during a disruption, not an outage. Things aren't really down anymore. But if you're trying to transact and close the deal, so to speak, check out and get your groceries and somehow you get the spinner or that slows down and it takes too long, what do you do? You close down the app and you go to another one. So more than half of consumers will quit in the first minute if something is not working for them. So we really are talking about a space where seconds and minutes count, where automation is increasingly important. And what PagerDuty has done is taken DevOps methodology, really designed that into our workflow in a very opinionated way. So by nature of deploying PagerDuty's core products for incident management, you're really deploying best-in-class DevOps methodology, where people take responsibility for their services, where they're proactive in recognizing events before they become incidents. And what we learned in that process was over a decade of collecting data about responders, about events and about workflows, we actually know a lot about incidents themselves and how events storm to become incidents. And so the next natural step was to build Modern Incident Response, which starts to use machine learning to detect relationships between events and relationships between incidents, like, "Hey, Bhavan, this incident that's happening right now, it's actually happened 300x in the last quarter. Here's a person that you should be talking to, to get this solved." And now with Event Intelligence, which is our event management solution that correlates all of the events coming in ahead of recognizing an incident and starts to help you really reduce the noise, but also get people on important problems quickly, we're seeing our customers say that's reducing their events by 95% to more than 100%. It's reducing their time to respond by anywhere between 30% to 100%. And what's great about PagerDuty is there is a very quantifiable return on investment in terms of labor cost savings, projected revenue because you can look at -- if your downtime was 5% last year or 15% last year and this year, it's 10% or 2%, you can actually look at how much revenue you rescued in that process. And our customers see that. So they're increasingly doubling down, I think, on automation and starting to advance beyond On-Call, but it is a journey. And we look at our customers on what we think of as an operations maturity curve. Some customers are just trying to get their engineers on call. And they're just trying to change their culture and the behavior of, instead of throwing a problem over the wall to an ops team, you actually want to develop and deploy with production and perfection kind of in mind. You want to make sure this goes well. And that level of ownership is a cultural shift from the old way of doing things. Like something goes wrong, somebody raises a ticket. It -- that typically goes through a command-and-control process. 5 days later, their printer cartridge is replaced. And that's great. But in a world where we do everything virtually, and you don't want to wait for a printer cartridge. And in the world of getting revenue from your customers, you don't want to miss a second.

And I guess, maybe just to follow on, on Jen's thought, we looked at some information from a large retail bank in the U.K. that's got millions of customers and thousands of employees. And when they implemented PagerDuty, they saw an 85% reduction in the number of nonactionable alerts that were coming their way. And they were then able to improve their mean time to resolve from like 30 minutes to 5 minutes. So very dramatic change. And when they calculated with us what we sort of think that represented in savings for them, it represented like $3 million annually in terms of savings from work that would have been directed to work that now PagerDuty and our machine learning was actually getting done for them.

Yes. No, that's great. But the other thing I -- before we dive in sort of more nitty-gritty stuff, just you've highlighted seeing customers identify new use cases outside of incident response and DevOps by themselves, right, without the involvement of PagerDuty. And it totally validates kind of the horizontal nature, right? So we get all that. But I'd love to get a sense of what level of traction are you seeing across some of the emerging use cases, Security Ops, IoT, et cetera?

Yes. I mean one of my favorite use cases is Peloton. Recently, John and the team shared with us that, given the influx in demand for in-home fitness equipment, and I've been trying to get on the Peloton every now and then, although this job is not super Peloton-friendly, I'm finding, that they're using PagerDuty -- they're already using PagerDuty to manage their application development and their IT incidents. But they are starting to use PagerDuty to manage their customer shipments to ensure that those shipments are being delivered on time. And if they're not, they're getting notified and getting a team on the job of fixing the logistics issue before the customer knows that they're potentially going to receive that late because the delight of getting your bike or your treadmill on time is really an important part of their experience. And to your point, that organically happened. They were looking for ways to deal with an urgent unplanned issue that require orchestration of work across multiple functions that can be done in an easy-to-deploy way. And when you describe it that, generally, like that's PagerDuty. So we think about PagerDuty as fast becoming the platform for action, the platform for real-time operations across the company. And we do have a significant number of customers who have adopted us primarily in -- for the security use case, particularly as you see DevSecOps taking hold in organizations, and also customer service, where increasingly, the reason customers are engaging with companies, because they're having a difficult time, tends to be rooted in an issue with technology, the mobile app, the digital app, I can't finish this e-commerce transaction, I can't find the pricing that I thought I saw earlier, et cetera. And Howard, you might want to comment on the penetration question there.

Yes. Sure. So we continue to see good traction, particularly in the security and the customer support, customer service use cases, as Jen mentioned, especially since we introduced the upgraded integrations to Salesforce and to Zendesk last year. So security is another area where we see an increasing number of customers using us. And often that motion is one where they're using us in one part of the organization, and security becomes the natural extension. So we haven't been -- we've shared figures in the past, but we're not sharing every quarter what that looks like. But we are seeing good momentum, particularly across those 2 areas.

That's helpful. So let's touch on one of the things that has come up from a metrics perspective is the net dollar retention rate. So obviously, we've seen it when we talk to customers who do our checks about expansion and use cases, and we're seeing it go from IT to really sort of a business use case, which was always -- remember, we didn't actually have to do it because it was kind of the premise of this being much more business solution that e-commerce is a business problem, not a "did my microservice fail," which ultimately might have been the issue. But you did see that expansion rates decel from 140% plus in 2019 to sort of 122%. That was pretty quick. They will decel, obviously, with large numbers over time and all the rest of it, so we get that. But maybe just help us think through the sales execution issues, the new hires made early last year and ramping slower and sort of the change that's happening and where you feel we are in that progression of addressing that issue.

Sure. So Jen, do you want to go or should I go?

You go ahead and I'll jump in.

Yes. Sure. Yes. So as we mentioned previously, last year was an interesting year for us as a company. We saw there were a number of hires, but then there were some areas where we stubbed our toes. And I think when we looked at the sales execution issues that you referenced, one of the challenges we have that as a fast [Audio Gap] going. And in that hiring within the sales team, we essentially hired a larger number of people who we were not able to ramp as fast as we had historically. And that had some impact, both in terms of the existing team essentially trying to digest the folks that we had onboarded or were onboarding as well as then dealing with the transition of accounts. We started putting in place in Q3 last year a number of actions to address that. So we've revamped our enablement program. We put tools in the hands of our employees that help them to get to business value faster, particularly as the discussions now are very much focused around not just how you protect revenue but also how you generate real savings in an organization. So we've invested in that capability. And from a leadership perspective, having Dave Justice on board has been a very positive move for us. Dave has certainly brought new levels of operational rigor to the business. He certainly understands very well the motions that we have, both in terms of our inside sales capability as well as our field or enterprise sales capability. And he's building a very strong leadership team, like he has really stepped up the leadership team that we have across sales and has been building on the areas that we've been successful. Like EMEA has been a standout region for us, been very successful now for a number of years. But we did have pockets of sales teams that were struggling, and it's been great to see him come in and bring in a new leader for North America. We have a Chief Customer Officer, Manjula Talreja from Salesforce, who's joining us later this month. We have a new VP of Commercial Operations, who also has a very good track record in terms of both working at large companies like Salesforce and start-up environments. So we've certainly made good headway in terms of addressing those sales execution issues.

That's great. That's fantastic. And yes, I said that, I think, when you announced that David Justice [ is who you're going to hire ], so glad that's playing out.

Thank you.

Let's touch on competition. It comes up all the time, and you guys probably hear this a lot. But there's a couple of competitors out there that, certainly, if you take -- they've cut pricing, some very dramatically. There is a difference in functionality, but how do you view that competitive environment? And how do you think about your lead from a functionality perspective around that? So I want to understand -- and just, A, starting off with the better environment; and then B, sort of, obviously, as you think about functionality and the lead you have, how do you invest to keep that lead there?

Right. I suspect the community's getting really bored with this answer because they're very [indiscernible]. But so far, the market hasn't really changed for us. So the competitors that you mentioned have been competitors since they were start-ups. They followed us into this market many years ago. They've never really been able to scale as a result of our distant lead in the market and, frankly, our ability to continue to expand that lead through both product innovation but also customer retention and expansion. So if you look at our net retention -- or just our general retention rates, above 95% across all of our segments and even higher than that in enterprise, I think that really validates the fact that once PagerDuty is in, it actually becomes an essential component of your critical infra. And the more integrated it is, and we integrate to over 375 of the most popular, important applications and systems in the world, right, once it's integrated, you integrate it into 10 things, 100 things, it's not something you're going to go undo, right, and rip out in order to save 10% or 15% in OpEx, right? And what's also important is we are the only platform that scales to support enterprise in a resilient, highly secure way. And I say that with a lot of confidence because we support the most innovative customers like Netflix that drive a lot of traffic to the largest customers in the world, where they're 9 of the Fortune 10, but also customers who have tens of thousands of users using PagerDuty. And so there's a lot of proof points and validation to our ability to scale and be resilient. In 11 years, we've never had a maintenance window. We never proactively shut the platform down because we understand that our platform is the last line of defense. And if it's not working, people are blind and deaf to what's happening within their infrastructure and their application environment. So again, kind of super mission-critical. When I think about our investments going forward to continue to build that market leadership and expand the markets that we serve, a big part of our effort has been around the leverage of our proprietary data, which again is another moat because the other competitors you mentioned were not even capturing data for a period of time. And we've been retaining 100% of the data that transacts across our platform, again, in a very compliant way. We don't work with a lot of PII data. But in a way, such that we've been able to build machine learning models and start to really leverage that data and build products and services like Event Intelligence, like -- which serve the AIOps category very effectively by helping customers shift from reacting more effectively to being proactive, to preventing events from becoming incidents, to think -- understand the service environment that they're deploying into and become more proactive over time. And that's been, I think, super important. You should expect to continue to see us invest in new products in Modern Incident Response and improving the usability of PagerDuty because that's something else that always comes up because it's quite easy to use. It's quite easy to deploy. You can drop PagerDuty into a team and be up and running inside 10 minutes, right, because it integrates out of the box to the entire digital ecosystem. And the easier we make that, the more customers will continue to adopt this organically across organizations. And then the last thing that I would just mention is we've made a significant effort that has really paid off in moving to enterprise, right, in that, we really don't see any competition in enterprise per se. And because we integrate to every important platform that already exists in enterprise, we play very nicely with all of the technology that our customers are investing in, but in fact, help them see greater returns from that technology. So you should continue to expect us to focus on enterprise and mid-market, to focus on leveraging our data to apply machine learning and automation to other parts of the process from detecting or triage to the resolution learning itself. And this is an area where it's everything we do is built on the foundation of trust. And I just want to finish my comments on that. Our customers rely on us to be up when everything else is not, right? And so that trust, the trustful relationship that we've built over the years by not sending customers false positives, by not notifying them to things that aren't broken, also now is the platform that helps them ensure they can build a trustful relationship and maintain trust with their end customers. And so I think that becomes really important to us over time.

And I think the one thing I would add to those comments is that if we just look at the profile of the business in terms of our industry-leading gross margins, like this quarter, they were at 87%, we don't expect them to stay there. We normally target a range of 84% to 86%. But those gross margins, I think, are a good indicator of how we're dealing with the competitive environment. And they also create the platform for us to think about, are there ways in which we could maybe experiment around pricing and packaging so that we can be more competitive as this market continues to evolve?

No. It's helpful. It is easy to install, implement, deploy, like it's the prebuilt integrations. I remember the slides that -- where you guys were nervous system and you connect to everything. But if I look at it, you obviously then, a few weeks back, announced an expanded partner system. And I guess I'd love to understand sort of how you think that plays out because the system almost works without having to do massive customization, implementation, all the rest of it. And so is it just a soft process there? And sort of what are you seeing? I know it's early, but what are you seeing from a partner perspective?

Yes. I think partners are becoming increasingly important because even though our platform is easy to deploy, we have customers that are still trying to deploy a lot of cultural change and behavioral change around them. So this shift, for instance, from having a traditional centralized IT operations team that sits in a network operation center, eyes on multiple dashboards in glass, very inefficient, antiquated, manual way to manage digital operations when seconds count, right? But to move people from that, what you'll see in a lot of large customers is this transition from IT operations to SRE, site reliability engineering. But in some cases, these -- the individuals that we're calling SREs are ITOps people who haven't been developing apps or shipping code in a very long time. So the transition for them to really leverage and embrace DevOps and move faster and really to put agile behaviors into their entire DevOps life cycle takes some time. And so in some ways, we've got customers -- we've got partners that will help with that change management, that will help deploy PagerDuty as the facilitator of digital transformation and a bigger project, a bigger cloud adoption project or cloud migration project. Another example that we see, and this is where PagerDuty often becomes very sticky, is we're -- increasingly, customers are using the cloud to abstract some of their legacy infrastructure. We're not replacing their legacy infrastructure. And so you still have to integrate into that legacy environment, and we don't integrate into 19-year-old homegrown legacy systems. We build a really strong API environment to make that easy for engineers to do that. But sometimes, our customers will say, "Hey, we want some help with that." And so the more we can shift those types of professional services engagements to partners who do this all day long and 24/7, I think the more we can continue to support our strong margin profile in the business. And then the last thing I would say is, we've seen in our customers, particularly with the backdrop of COVID, an acceleration of digital transformation activities that would have taken them years being pulled forward and now being completed in months, likewise, this shift to -- an acceleration to cloud adoption and cloud migration. And we know that when PagerDuty is deployed with a cloud migration initiative or a cloud adoption initiative, that initiative goes faster, a factor faster than it's normally. And so we think that, that -- these are tailwinds that long term are going to continue to be very strong for PagerDuty. And the last tailwind I haven't mentioned but where we see a lot of partners engaging is around security, right? Sending everybody home, having a more distributed workforce really creates more exposure around your end points, more vulnerabilities. And as companies look to take stronger security stances and protect their data and their customers' value proposition, et cetera, PagerDuty as a part of the security response also becomes more important.

Yes. That's helpful. We haven't touched on COVID much. And obviously, you have reported recently. So there's not a ton of talk there. I'd just love to get -- for people who may have missed the call or not, just a quick update on how COVID has impacted business levels. How activity is trending to date? But it's been a week. So it's -- while the world feels like it's changing day-to-day, it's only been a week, right? And then the thought process and methodology around guidance, just love to get sort of all of those to [ coalesce ]. It doesn't have to be a long comment, but it's worth bringing out because, obviously, we are living in this pandemic times.

Well, I'll quickly address the first part of that. And Howard, you can jump in. From a COVID perspective, it's been a mixed bag. We had a really strong quarter in terms of new customer acquisition with our net new ARR growing at 55% year-on-year. And we also had a very strong quarter with our largest customers, with customers with ARR over $500,000, grew 46%. So we continue to see customers investing and new customers recognizing that now with the change in remote working, they actually need PagerDuty more than ever. On the flip side, we had customers that really had their hands full just in the transition. Customers that require a lot of physical engagement to do business found they were spending a lot of their IT and development time just supporting employees and working from home, getting laptops to people, addressing security environments as a result of all that and also potentially dealing with having to digitize overnight, build apps, build e-commerce environments to enable them just to serve their business continuity effort. So in those cases, we saw some deals delay, take longer. These deals didn't go away, but often, it was because we just don't have resources to even negotiate the services agreement, for instance. And we believe that as the market starts to recover, these tailwinds that I mentioned earlier, going digital overnight, cloud acceleration, e-commerce and security, all become really important tailwinds that drive momentum in the future. So we feel like we're very well positioned at this essential component of critical infrastructure going forward. The other thing that COVID has done for us is we have a lot of customers that saw phenomenal demand in surge for their products and services more so -- and as a result, saw between 2 or 11x the number of incidents they had seen pre-COVID. And in those environments, our customers responded and managed their incidents 20% faster. So in an environment where someone like Zoom, 11x the incidents they're used to seeing, scaling to educate our children essentially, so they became more efficient and more effective in that deluge of signals with PagerDuty. And I think that's really important, and it's really validated the value proposition of the platform.

Yes. And maybe I'll just quickly add to that, Bhavan. From a guidance perspective, we felt that it was important for us to take a balanced and prudent approach to guidance. We did extend our range slightly. And that was really a combination of the tailwinds that Jen has referred to, tend to be long term. Some of the headwinds that we've seen, for example, SMB, which represents 20% of our business, we have seen increasing rates of churn in that part of the business. So we just tried to balance those elements in terms of taking a view for the full year. But we're very confident about our prospects as a company, and we are confident in the guidance that we provided for the full year.

Yes. That was super. And again, no surprise, SMB churns a little more in this environment. None of that's a shocker, so I do appreciate the prudent approach. That's about it, guys. I think we're going to wrap up here. You've got a lot of one-on-ones in demand. I'll let you run to those fun conversations. But thanks again so much for doing this, Jen and Howard. It's great to see you guys actually in person, at least virtually. But hope all is well, hope all sales is well, and hope we see each other in person physically soon. Thank you again.

I do hope that. Thank you so much for having us. And really appreciative that you continued the conference, and we know it's a big effort to go virtual, so well done.

Thank you, guys.

Thank you very much. We're glad to be here.

Thanks, Howard.