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

Okay. Welcome, everyone. We are down to our last session. We're going to save the best for last. We're super thrilled to have the PagerDuty management team, CEO, Jennifer Tejada; CFO, Howard Wilson on from PagerDuty. You're going to have, hopefully, a thoughtful discussion on how they sort of look at app dev and DevOps and what some of the initiatives they are driving towards. We have Keith Weiss joining us again, Head of our U.S. software coverage. I deal with infrastructure analytics for the software team. Before we get started, let me quickly get through the disclosures. Please note that this webcast is for Morgan Stanley clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. Former important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. So with that, Jen, welcome to the Future of App Dev Conference. We're really thrilled to have you.

Thank you so much for having me as well. It's great to see you, and I hope everybody is well.

Great. And you, too, Howard, thank you for joining us from way out in Australia. We really appreciate it, to have you.

Thank you, Sanjit.

Maybe to kick off the conversation is just a quick review of last quarter, a lot of exciting things. And I guess, I think one of the -- my lead bullet in my note is I sort of copied it from your guidance press release. Like lead indicators turned positive, right? And if you could just sort of walk us through, Jen, what sort of got better in Q3 for you as you look sort of across the customer base and the demand environment?

Well, thanks for that, Sanjit. Look, we saw a lot of momentum in Q3. We started very strong in the quarter with a large deal from a large mortgage provider. We really see it as an inflection point as our customers really started to find their new normal, following having to respond quickly to the pandemic and remote work and just a different way that everybody is living digitally online. And that has really created, I think, the acceleration of some of the long-term tailwinds we have talked about in the past. And for us, these are digital acceleration. The fact that now most revenue goes through a digital front end as opposed to just a portion of the revenue means digital operations are a huge priority for our customers. Cloud adoption is another tailwind that was really important for us. And you've seen customers moving faster to adopt the cloud. But I would also tell you, it's still very early for a lot of our enterprise customers, and many of them still have to meet the challenges of managing a hybrid operating environment where they still have a lot of physical assets and physical infrastructure and also trying to get the benefit of building apps quickly in the cloud. And then the third area is DevOps transformation. And with DevOps transformation, post pandemic, what we found was customers are having to figure out how to work remotely with distributed teams more effectively. And so that led to more strategic discussions with customers who I think now have a better handle on their budgets and are looking to manage this really interesting, contradicting challenge of having to innovate faster and shift their business to digital at the same time that they're trying to reduce cost. And that just is such a perfect opportunity for PagerDuty because we help customers automate the process of identifying mission-critical, time-critical issues with their digital environments and respond to them really effectively, resolve them quickly before customers feel a pain. In doing that, there's a lot of automation. We've been focused on automation over the last several quarters, and that reduces costs, it reduces labor, it reduces the time that people are taking away from meaningful customer-facing work, and it improves the customer experience and the ability to generate revenue and drive transactions and close those transactions with customers.

Great. And so the theme of this conference, Jennifer, is kind of the future of app dev. And certainly, we're talking about the development teams, the operations teams, frankly, the security and customer support teams as well. Can you give us a sense of what you see as their challenges today, particularly in the sort of pandemic that we've been dealing with? And what are the things they need to get more productive to drive that faster pace of innovation going forward? And what's PagerDuty's role in helping to solve some of those problems?

Sure. Well, the cloud is very powerful. It can create a shortcut to innovation and give customers a lot of capacity to build better digital experiences, whether that's apps or websites or even services like curbside pickup, which became really big, or home food delivery. I mean we've all been watching the DoorDash IPO. And I think that personally in one of their top revenue providers potentially. But in doing that, you actually -- the sort of patience that an end customer has for something to not work right is minimal, if at all. And customers will move to a competitive application and consumers will if things don't work the way they're supposed to. Sitting behind that is technology that's increasing in its complexity because we're leveraging things like distributed systems and containerization, which means there's actually more data and information and signal coming at humans than there ever has been before, which means there are more events that cause problems, there are more incidents that shut the digital business down. And I think that proliferation is going to continue for the foreseeable future, which means that customers need a central connected environment that will capture those events, enable them to get proactive and predictive. And this is what PagerDuty does. We sit at the center of the digital ecosystem. We integrate to over 500 of the most popular applications, monitoring environments, security and threat management systems, ticketing systems, like you name it, and we can consolidate all that signal and correlate it such that we can tell you that these 100 events that you're seeing right now, they're not 100 separate incidents, 70 of them are related to one particular issue. There's massive time savings in that. So in the quarter, we talked about MSCI, which is a financial services company, and they shared with us that they had reduced the tickets that their employees were faced with by 50% by capturing that signal early and helping to automate the process of where the real work and real issues were, getting the right people on those issues and resolving them much more quickly, which improves the customer outcomes and customer experience there. I think this is going to get harder, not easier. And a lot of the products and services that are available in the marketplace prior were built for sequential command-and-control workflows that take time. And these are the ticketing systems, the analytics systems of the past that allow you to either look at something's history and try and make changes for the future that's not a real-time solution or you create a human that has to detect the issue as opposed to using software and instrumentation to do it, a human that has to run a process through an approval cycle, a sequential cycle, to actually get that work done. That's a minutes, hours, days challenge when our customers are faced with milliseconds and seconds issues. And I say that because a minute in e-commerce can cost the company more than $0.5 million. And we think that number has gone up significantly post COVID because so much revenue has shifted online.

Makes tons of sense. One of the things that Keith and I have been trying to better understand, and we've been asking a number of companies who have -- who are so thrilled to have joined us at this conference, is kind of where we are in some of the big forces that are shaping the market. And particularly, when it comes to DevOps and site reliability engineering, I've always sort of viewed PagerDuty as kind of the technology enablers to drive that culture shift. But can you give us a sense of where you think we are in terms of 2 things, DevOps adoption, but then also penetration across the application footprint? Where do we stand today on DevOps and SRE?

Yes. Well, I think, to some extent, it's a little bit of a tale of 2 cities. So if you're a start-up today, you're so lucky because of the democratization of cloud and all of the amazing SaaS tools out there, and PagerDuty is kind of part of the start-up toolkit where customers build things -- build everything they do on the cloud. They leverage a lot of available SaaS applications, so they don't have to build them themselves. And developers, increasingly, in a high growth, progressive organization are expected to code something, ship it and then take full ownership for it. You don't toss it over the wall to somebody else to manage it. And that has huge benefits in that the culture of accountability in DevOps enables better code, better reliable services and production, et cetera. And so we see a lot more progressive DevOps kind of originating and being part of the way a new company would run. On the flip side, if you look at the largest companies in the world where the majority of our revenue comes from, what we see is this pretty significant transformation in front of these companies where the vast majority of their technology and their businesses run on physical infrastructure, data centers, legacy built or in-home built solutions and technology that's really important, like transaction systems in the financial services industry or logistics systems in the transport industry, even billing systems. There's a lot of -- there's more homemade billing systems than you could shake a stick at. And all of these systems are running in physical environments. As those companies start to adopt the cloud, they actually create more complexity for themselves even though they get some big benefits from it, and that's harder and harder to manage. So you end up with kind of this hybrid siloed environment. We've got centralized IT teams working in what we call network operation centers where, historically, they would manually identify issues, looking at a lot of different dashboards. They would manually try and escalate those issues by e-mailing people or creating tickets or calling people, et cetera. Well, they're not together in a NOC anymore, so that process has been disrupted. And that process wasn't very fast or efficient anyway. We also see change in change management being a really important part of the DevOps life cycle. So if you can identify an issue early before it has an impact on your employees or your customers or your business, you can also take that learning and push that directly into the next deploy. Likewise, if you're trying to troubleshoot and diagnose an issue, PagerDuty has integrated change into our systems, you can actually see the last deploy, and you can figure out very quickly that, that issue actually came from change. These kind of features are very powerful because, again, they're automating what humans had to do in a very time-consuming way. And the other issue with manual work or traditional ticketing systems is the company doesn't learn from them. You don't build institutional knowledge that helps you solve the next incident, right, whereas PagerDuty has been using a decade of data on responders, on events and on workflows to increasingly identify patterns and recognize them, learn incidents that are taking place, making recommendations and suggestions for immediate fixes. And with the acquisition of Rundeck, now even automating the resolution through what we call safe -- self-healing, runbook automation and some of the great feature sets that Rundeck has. So where I see the DevOps market and, frankly, software going is more and more of the toil has to be automated in order to enable developers and citizen developers, for that matter, to keep up with the pace of innovation that they need to deliver to meet the needs of the consumers. And that's not just in the B2C world where we've always been demanding consumers who want more, more, more and we want it now and who want it to be easy and perfect and inexpensive. But enterprise users, employees now expect the same consumer-grade experience and immediate time to value that they get in their consumer apps, or they'll switch, right? And I think one of the things that is special about PagerDuty that attracted me to PagerDuty is the whole experience is designed for the user to be able to get in, go quickly, integrate to the environment they're working in and get value immediately, right? There's no 6-month integration and value comes over 18 months. You can be up and running inside 10 minutes and receiving value very quickly. And the ROI for PagerDuty is super quantifiable. We did some research with IDC recently. And I mean, it's kind of astounding. It's a 2-month payback period, over 800% return on investment and for enterprise customers, an average of $3 million saved annually. And what I love about that is that all comes through automation in service of the people, right? We're not trying to get rid of their jobs. We're trying to help them do the highest order work, innovating, disrupting, changing their businesses without having to deal with some of this toil and get more proactive, predict that these certain issues will become major incidents and stop them in their tracks, learn from them at the same time.

Jen, can I jump -- this is Keith Weiss. I wanted to jump in -- another theme that Sanjit and I have been talking about in a lot of these discussions is whether the DevOps tool chain, that's pretty fragmented and there's a ton of different vendors used in the entire kind of application life cycle, whether that needs to be consolidated and/or from like a PagerDuty perspective, like, you guys have, I think, over 370 integrations. Does it make sense for sort of the architecture to be one of kind of loosely coupled, that you have PagerDuty and then you have all these dozens of integrations that go into PagerDuty? Or does the necessity to create more automation, does that mean it makes sense to consolidate some of this and you could sort of get more back and forth, more of an integrated functionality, more of an automated functionality, if you consolidate more of that tool chain yourself?

Well, I think you want to be looking for, first, technology partners that really leverage strong API capabilities because the reality is there's so much innovation hitting the market, and our customers are experimenting with lots of different things to manage these complex environments, customers are never going to use one observability provider or one monitoring provider. They're going to use all the different types of instrumentation they need in order to have very good bridge. And there's so much best-in-breed technology out there that that's why we've chosen to sort of take this neutral position where we integrate everything. And that integration is really easy. Like you don't feel it, you just see PagerDuty pop up in Slack or you disabled the leverage PagerDuty inside of ServiceNow, et cetera. And actually, if you're building that interoperability effectively and you have a strong operating process around API development that allows other developers to leverage your APIs to build different integrations, then that becomes very seamless. And I would argue that even if you consolidate some of the DevOps tool chain, you're still going to see this ongoing onslaught of new products and services coming to the market. So it's really important to build for this idea of not just connectivity of data moving around, but integration of the workflows. And that's where PagerDuty, I think, has really been visionary, frankly, because that's where we started early on. And I see that when I see just an increase in the velocity of developers building on top of PagerDuty or developers building their own integrations, and then we publish those that become very popular. So I think the modern sort of easy to connect, easy to use, bringing those best-in-breed solutions together, like Slack, like PagerDuty, like Okta, for instance, is really important. And at the same time, where we think we can consolidate different feature sets or different parts of the DevOps tool chain in a seamless way that creates much faster time to value and more ROI, we'll do that. And so automation and AIOps is an area where we've made some investments. But we really look at it through the lens of our users. So if you're a DevOps user, what are your biggest challenges, right? Like, what stops you from innovating faster, from driving more stickiness to the products and services that you build? If you're a person in security, like, what are the issues that are keeping you up at night? And one of the biggest challenges in security is speed. Like, you recognize a threat, but how fast you move is what makes the biggest difference. And that's why most security teams use PagerDuty because it's not only the work they have to do, it's the coordination of that effort across multiple teams, right, whether that's risk management or IT or dev or communications, et cetera. So where speed matters, those workflows have to be tightly integrated. And I think also, ease of use is really important and not something we don't talk enough about in tech and in SaaS. Increasingly, customers are moving to lower code or node environments, but developers still want the ability to customize and build on the things that you create. So our technology ecosystem, our app ecosystem becomes more important, but at the same time, usability and making sure that the more complex our solution gets, the easier it is for users to use. And we see users coming from nontechnical parts of the organization. That's why I call them citizen developers, like customer service agents using PagerDuty to resolve system faster. So while I think there are parts of the market that will continue to consolidate because people don't need 3 of the same thing, I also think that there's going to continue to be great new technology coming to the market that you want to be able to operate with effectively and integrate to and connect to in a way that makes that whole ecosystem work really well for a user simply and easily.

Got it. When I think about the space, like, one of my frameworks, as I look at my coverage is, where does a particular company sit in the architecture? What type of technology, real estate, how attractive is that technology real estate that they occupy? And you sort of alluded to it in an answer to an earlier question. But I was wondering if you could sort of describe where PagerDuty sits in the sort of modern architecture. And what license does that give you to do more on behalf of your customers because of that real estate? The position that you occupy today, when is that going to give you credible expansion opportunities as you think about areas like security and customer support?

So one thing I would say beyond the technology is partnership, long-term strategic partnership and reliance on a platform starts with trust. In PagerDuty, that's one of our most important value propositions for our customers because if you're going to work as an entire team in the middle of the night over an emergency, there better be a lot of fidelity about that emergency or you'll start to very quickly have all these false positives, and people will stop paying attention to the information that's coming to them. Secondly, you need to be giving people rich data and insight like what to do, not just what's going on. And as a result, our customers have become very reliant on the insight that we give them in the first moment that we let them know something is happening. And you have to know who does what and how -- who you need to solve a problem. And active directory is not going to help you there. So the data that we've built over many years enables our system to automate where it routes work and how it distributes work through an organization. And again, that's created a lot of trust because there's a lot of fidelity in that. The last thing I would mention with regard to trust is reliability. So one of the things we noticed through the pandemic is there's been a significant increase in the velocity of incidents, the volume of incidents and the amount of event traffic transiting our platform, 130% in the last quarter and yet, we've actually increased the reliability of the platform, delivering [ 4 9s ], not just for availability but for events moving across the platform. And I think that's super important when we're the platform helping -- giving your operations team the ability to do work when everything else has gone down. So trust is kind of what -- and that gives us, I think, a lot of opportunity and the right on behalf of customers to do more for them. And frequently, customers will say to us, you do this so well, could you tackle this other thing, and that's kind of how our path in the journey to automation started. Whereas a lot of customers who were saying, guys, you're already doing these things, what about runbook automation. The second thing I would say is because of the way we integrate and are so tightly stitched into so many services within a company, we become central infrastructure, right, an essential infrastructure, frankly. And so I was talking to a large retail and e-commerce customer a little under a year ago, and she was CTO, and one of the things she told me was they had a major incident right before back-to-school that they basically shut down over $1 billion of revenue, and it was the one service PagerDuty wasn't integrated to. And it was related to other services, but none of the other services went down because they were integrated to PagerDuty and teams were on it very quickly. They, of course, immediately made that integration work and move forward, but that kind of gives you an idea. I recently was on the phone with some customers the other day. And I think another reason we've kind of earned the right to do more is because we're quite popular, that sounds like a silly term, but we're quite popular with users because we make users' lives easier. Like, you don't have to -- you don't ship your product or your service into production and then sit and worry. You know that PagerDuty is going to engage you if something is not going right, and you know you're going to get an early warning because you're going to know, hopefully, before your boss knows, before the public knows, before your customers know. And one of our customers in Europe was saying the big problem I have is I need to get more budget from my management for more licenses because so many people are asking for them because it makes their work easier and better, allows them to focus on the things that matter. So I look at the adjacencies and some of the areas where we're investing, obviously, AIOps and automation. Customer service is a really exciting one because there's so much overlap and interconnectivity between what's happening in the digital environment and with digital technology and how customers are experiencing that. And yet, historically, customer service agents and devs and IT personnel were all working on different platforms and very disconnected in trying to respond. So that integration, I think, is going to make life a lot easier for our customer service agents but also improve outcomes for end customers. And then you've seen us investing in a lot of machine learning, analytics insights, ease of use. So PagerDuty is the only incident management or incident response platform out there where you can run an incident entirely on a smart device, on a mobile device, without having to use a web front end. And that's really meaningful in terms of unleashing people from their laptops when they're trying to go to a -- they're trying to watch a Netflix movie at home. I was going to say go to a wedding, but nobody does that right now.

Right. Like, your answer has sort of hit on another theme that Keith and I have been trying to better understand all week with all the attendees at the conference. And it's sort of another take on consolidation. But if we look at some of these workflows, it seems like it's sort of between security teams, operation teams, developer teams, et cetera. A lot of these workflows are very, very similar, right? The challenge is, like, on the go-to-market motion, sales side that, that -- there's different buying criteria, different ways these purchase decision-makers look at how they want to build these capabilities. So as you look to execute on unifying these teams together, what, from a go-to-market sales standpoint, are you going to have to change to bring that vision together?

Sure. I mean one of the things that we have to change and improve is our brand awareness and the ability to get some of these different personas into the product as users because that -- the way we've grown over the years is through users championing the benefit of the product to their leadership and the leadership understanding the benefits in partnership with our direct sales force or our partners to do more strategic deals. And historically, our only land motion has really been with dev or SecOps or, in some cases, IT. So making that land motion easier by creating more awareness around what we do and how we do it, I think, is important and then ensuring that the land into things like freemium, which gives people access to our products and services in really easy, frictionless way, our trials and some of the more -- the simple pricing around our platforming, I think, will just improve the process of the acquisition over time. The second thing is I'm seeing a consolidation in leadership responsibility in businesses. So historically, in large enterprise, what we saw were CIOs who tend to have kind of program management backgrounds. A lot of them come out of big consulting organizations, and they often don't -- aren't responsible for application development or the apps that are customer-facing. They're responsible for infrastructure and employee-facing apps. And increasingly, we're seeing more technically experienced leaders in those roles that may also own app development and engineering. And likewise, we're seeing chief digital officers, CTOs and even heads of businesses and products that own application development and also own application operations and really care about how those applications affect their consumer outcomes, their end consumer outcomes and the business. And when that happens, they're actually very tuned in to the shortcomings of their operations organization because everybody who runs the business and is responsible for a brand or product knows you're only as good as your worst minute, your worst second out there in the market, and that's never been true with everything shifting to kind of a digital default. So we're actually seeing some sort of nice confluence happening with leadership. Security is on the mind of every technology leader, whether you're a CIO or a CTO or a CDO. And a lot of customers are really focused on building more secure apps in the first place. And PagerDuty helps with that because you get educated as you solve more incidents. I once was sharing this analogy that being part of an incident response team is a little bit like being a general practitioner who does ER rotations, right? You learn fast in the ER. You get to see different cases. You have to work under time pressure. There's a different level of criticality with -- you hone and sharpen your skills. And so there's a lot of employees that learn a lot from being part of that incident response process. And I think that bodes well. The last thing I would say about buying is, again, we don't necessarily require support from the economic buyer to grow into a customer. Almost 90 -- more than 90% of our customers land through our e-commerce motion without sales touch. And so our relationship starts on the ground in every function that we're in. And then you'll find champions in the business that start to take across to customer service or to IT or to Dev, Sec or SecOps.

And maybe just to wrap up and close the loop on the conversation. You talked about where PagerDuty is positioned, where we stand on DevOps. We just talked a little bit about go-to-market strategy. I think the toughest nut to crack for many people in this space is around getting pricing right and finding that balance between supporting attractive long-term growth opportunities, but then also making -- like sort of incent through that adoption within your [ country ] and making that as frictionless as possible. So what is sort of the right approach to pricing, in your view? You recently sort of optimized pricing coming off on the back of your user conference. What do you think that'll hold -- what do you think you hope that'll achieve in terms of driving that easier expansion path to your customers?

I'll make a quick comment there, and then I'm going to turn it over to Howard because he is our pricing guru. But what I would say is providing a freemium offer for us was all about extending our reach and making it easier for users to engage and try PagerDuty and use PagerDuty for projects so that they kind of get the hang of it and see the benefit. And then we're lucky that with the benefit of our best-in-class gross margins, which I think we're up around 87% this last quarter, that gave us a little room to simplify some of the pricing and packaging across the rest of our product suite, making it easier for our customers to migrate and trade up and expand across the organizations, but with predictability about what this is going to spend. We've noticed that consumption-based pricing for some of our peers, while it's been a boon when people are pulling forward resources during the pandemic, it also scares [ economic buyers ] and budget owners because you can't see how much you're going to consume in the future, and those costs can spiral. Whereas with PagerDuty, like, you have a lot of predictability in how you're going to spend. Howard, do you have anything to add there?

Yes. I think just the one thing I would add is that we do engage our customers in terms of understanding what's important for them. And definitely, there's been a good response to our user base metrics for the reasons that Jen outlined, and it gives them a very good handle on how they can expect to grow. But we are experimenting with our pricing, and we have been doing so to try and understand, particularly as we bring new products to market, what is the most sensible way of licensing some of those new products. And I think even just the philosophy that we have is, the early in this market, it's a large market, we would -- our goal is to gain as much market share as we can, get as many companies using PagerDuty now because that's the way in which they're going to really unlock the value.

Makes total sense, Howard. With that, we're all out of time. Jennifer and Howard, thank you for joining us. It's always a very insightful conversation. I think I've learned a lot. And it's great to see PagerDuty have a really strong quarter going into, hopefully, a better year for everybody in calendar '21. So thank you so much for joining us. With that, this conference comes to an end. It's been a great 3 days. Hopefully, you guys have learned a thing or two. I certainly have. And I'm going to hand it back to Keith Weiss for some closing comments on the conference.

Excellent. Thank you, Sanjit, for all your work on this conference. And thank you to Jennifer and Howard for participating, this has been great, and to all the investors who have been dialing in. I, for one, learned a lot over the course of this week. I would say a couple of the key conclusions from my perspective is, one, it's still very early days in terms of the adoption of DevOps methodologies and technology, particularly when you think about it in terms of the access penetration on and how much of the sort of app workflow is being done with those methodologies, even more so on the Dev, Sec side of the equation versus DevOps, number one. Number two, a rapid, rapid pace of innovation going on in this overall market, both in terms of how we're architecturing these applications but also in terms of the tools and technologies necessary to keep that DevOps tool chain flowing smoothly and flowing efficiently. And then three, and this probably ties into PagerDuty as well, it seems like consolidation overall is unlikely. There's just too much innovation, too much movement. But where we do seem to see consistency is in the control planes. For all these moving pieces of that DevOps tool chain, for all these various piece parts, you need coordination amongst all the various elements. And there's workflow parts of the automation, the collaboration and communication parts of that control plane. It seems like PagerDuty, with the incident response perspective that [indiscernible] the equation is part of that kind of control plane and helping to sort of bridge the players, to bridge the participants as they move through these various parts of the equation. So I think that's a pretty interesting perspective on kind of what could be more durable in this marketplace on a go-forward basis. I'm sure as we sit down and comb through our notes, we'll come up with some more key conclusions out of the day. So take -- keep a lookout for -- I'm sure we'll come out with a report summarizing some of these conclusions. But again, thank you to everyone for joining us over the course of 3 days. This had been a great event. Looking forward to doing it again next year. And everyone, have a great evening and a great weekend.

Happy holidays.

Happy holidays.