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

Welcome, everybody, to day 2 of the BofA Technology Conference. My name is Koji Ikeda. I am one of the software analysts here on the BofA tech franchise. I am super thrilled to have PagerDuty here for a fireside chat and CEO, Jennifer Tejada; and Howard, how do you do, the CFO. How are you guys doing?

He's like Madonna, he doesn't know the last name, Howard.

Yes, I'm just known as Howard.

So I guess to kick it off for maybe those in the room or on the webcast that are unfamiliar with PagerDuty. We'd love to hear what PagerDuty does? Kind of like a time line perspective, what was the original problem that you guys saw, what problems are you solving today? And really more importantly, what are the problems of the future that PagerDuty is going to be solving?

Sure. So today, PagerDuty is the most resilient and secure and scalable digital operations platform available to large enterprises and highly innovative new technology companies. We started out in the developer community, providing on-call automation that enabled developers to go from a very manual process of identifying problems in the tech stack or the tech ecosystem to a very automated process, where instead of people or customers letting you know that there's a problem with your technology stack. We use -- we have over 700 integrations in an ecosystem around a first-class API that automatically identifies, challenges, can prioritize and triage them and can automatically orchestrate them to the right people or increasingly the right agents or machines to then triage, diagnose and resolve issues before they cause business impact. And I think general business people have begun to really understand that major incidents, not unlike cybersecurity breaches can cause tremendous business impact because almost every company now runs on a modern technology stack. And that's becoming even more true with the advent of using both generative and Agentic AI. In fact, operating your AI investments and your AI operations has become 1 of PagerDuty's newest use cases. Both where we're seeing more success in landing what I would call native AI companies. Like we -- this last quarter, we talked about Anthropic, Anduril and Scale AI, but also helping large enterprises manage the quality, the reliability, the resilience and the security of their AI investments in production. And it's very early days as far as AI usage is concerned, in my view because I think we're just tip of the iceberg in terms of understanding the potential productivity gains, but there's a huge opportunity. So over the course of the almost 9 years that I've been in the business and the 16 years that the business has been around, we've gone from this single simple, but very reliable and easy-to-use solution around on call to a modern automated incident management platform to then covering more and more use cases across the modern operations of the company. Including AIOps, automation across different real-time unstructured, but mission-critical and high-value type of operational problems to increasingly prevention and supporting, bringing together the islands of automation inside of a company where you might find out about a problem through your customer service team, but that customer service team is on a different tech stack than the developer or the IT team that could actually address that issue. And so it's about bringing those islands of automation together so that the customer -- the end customer experiences a seamless execution of the transaction that they're trying to complete. And that impacts revenue and operating expenses. So what we're helping our customers do ultimately is increase their pace of innovation themselves, enable them to develop and deliver more products and services through their technology. We're enabling them to protect and grow their revenue, particularly from an e-commerce standpoint and enable them to reduce their operating cost because with automation, you need less and less human beings involved, then you have less risk to mitigate when you can prevent major incidents from happening.

Got it. Got it. You mentioned a couple of pretty big logos right there, Anthropic, Anduril, Scale AI. And one of the questions or debate that I often get within infrastructure software as a whole as why can't AI just do what you do? And here, you're helping 2 pretty big AI companies out there right now. And so tell me a little bit about why AI can't displace you tomorrow?

Part of it is the data. So we have 15 years of proprietary data that includes both infrastructure, application, UI level events that stream in and help us understand how systems work and how systems are related. Where dependencies live, but also where fragility lives and also helps us to understand patterns. Like why certain combinations of technology issues lead to major incidents or why certain dependencies lead to more fragility or cost. We also have a lot of information around workflows, why some workflows solve major incidents faster than others, why some teams are more successful and efficient than others, why some machines are more reliable and resilient than others. And when you take all of that together, it enables us to quickly surface automatically in seconds, what is the most important problem that needs to be dealt with? What are potential solutions to that problem, recommendations on how to address it. And then it captures all the information on how you address it. So that the next time a similar incident comes up, it recognizes that's the similarity in that problem, and it can start to auto remediate that issue. So you go from orchestrating events and problems and people to eventually getting to what we call event to code, identifying event in flight and dispatching the code automatically to prevent it from becoming a major incident. And as like I said, general business people, not only CTOs and CIOs sort of understand the cost of not preventing these things from happening, that investment becomes important to them. It's also our customers get the benefit of our learning from other events. Our root cause analysis across the industry, across their vertical, not just their own customer data and yet we're able to manage how we use data very effectively. The last thing that I would say is scalability, security and resilience are incredibly important, and customers are often having a failure in the platform that they would be using to detect failure in their environment. So you actually need a third-party platform on top of your own business to monitor, measure and manage incidents when your own environment is down. So there is actually a first principal need to have a third party involved in securing and stabilizing the resilience of your operations, particularly as more and more of your operations rely on technology. And it's hard for them to prioritize how they burn that tech debt down to prevent fragility in their operations and our AIOps solutions, but also understand where that risk in fragility is so that they have a higher level of awareness or better triage systems to support those dependencies and that fragility. And sort of like when you go into a hospital, not every part of the hospital and all the equipment in the hospital is brand spanking new. There are things that have been around for a very long time that still need to work to keep that hospital working, including like their HVAC system or the electricity feed or WiFi, right? And you might not think about it, but you may need WiFi to operate a surgical robot. If the WiFi goes down, that's maybe older tech debt, it may be an older installation, but it's going to impact the end patient in that surgery. We see the same thing inside corporations. The last thing I would say about our native AI customers is incident management is not their core competency and nor do they want to be distracted by having to invest in or build that. And while you can leverage AI to do certain things, you still have to manage how that AI operates, and you have to continue to build upon it, learn from it and iterate it. And it can be a very big distraction and require a lot of resource investment.

That makes a lot of sense. Yes. You guys reported results last week. And so maybe from a high level, what were the recaps from the call, high-level big takeaways. And I got a bunch of other questions to kind of level takeaway.

Sure. So revenue grew 8%, came in at the top of our guide, and we beat on both EPS and earnings, I think, 800 basis points...

We were 500...

500 basis points. Sorry. He's the -- it's quarter in 8 quarters for new customer logos and in particular some decline in dollar-based net retention. We don't believe that is a systemic problem. And in fact, we think it was really oriented around our own execution. We are undertaking quite a significant amount of transition in our enterprise business. We announced last quarter that we have a search running for a new CRO. And Howard and I have been making some pretty significant changes in terms of the profile of the type of reps that we bring into the company, how quickly we ramp them, what we're enabling them to do. And so on one hand, we were disappointed with our execution around enterprise retention in the quarter. But on the other hand, by the end of this quarter, more than 60% of that new profile of rep that really is truly an enterprise sales executive, understands how to sell top-down platforms. Has a relationship to understand how to sell top-down platforms and being more ramped into the back half. So we're encouraged by that half, so we're encouraged by that. We also know that we continue to see success with very large platform and platform and all products in the Operations Cloud, including services. And we have a number of very successful reps that are demonstrating the ability to routinely deliver these kinds of services, but we have to scale that through the rest of the sales organization. And if you're not familiar with PagerDuty, it's worth noting that we came from and grew up in a bottoms-up developer land and expand motion that successfully got us into enterprise. The majority of our ARR does come from enterprise today, but that motion of small patient growth from the bottoms up no longer really supports the way enterprise businesses are buying now. There's much more scrutiny and effort on behalf of strategic sourcing or procurement, CIOs and CTOs, CFOs are signing a lot of even small contracts at this point. So we really had to transition from what had been a successful land and expand model at the same time that the market has been in some transition. The other thing that I'd say is we've been evolving our pricing. So our pricing historically was 100% seat-based. And in a world where our customers are looking to automate more and more of what they do, but where the value of preventing business impact from major incidents is getting higher and higher. Seat-based licensing is not as well aligned to value as it could be. So all of our new products, AIOps, customer service, automation and PagerDuty Advance, our AI solution, they're all consumption based. And so we've been providing more and more flexibility for our customers around how they get to an effective price such that the number of people using the product matters less and less to them and reduces friction in terms of expanding across teams. But also how they have flexibility to move between products and services. And you should expect to hear us continue to update and iterate our pricing in service of making it more flexible and easier to use and more aligned to the value we're creating for customers. In the last quarter, we announced that we were offering AI and advanced features in every package. We currently have a good, better, best sort of pricing offering, across all of our products. And we think that has led to some of the success that we had in new logo acquisition this quarter because we're just deploying and enabling discoverability in even the lowest cost offering.

Got it.

And maybe, Koji, just from the financial side, Jen focused a fair amount there on what's happening with from a customer and from some of the transition. But we delivered non-GAAP operating margins of 20%, which was higher than the guide that we provided. But we've also, in this last earnings call, pointed to, not only did we raise our guide in terms of operating margin for the full year to 20% to 21%, but we also have a clear path to GAAP profitability and in the next fiscal year. And our view on that has really been around a very concerted effort to manage both dilution and stock-based compensation. So improving the profile of the business. We delivered free cash flow margins of 24% in Q1 and continue to generate healthy cash flow.

Let's stick with you, Howard, for a second. You're in control of the guidance. So you did take down the guide a bit. I think there's some considerations for enterprise and commercial, which we'll touch upon in a second. But as you construct the guidance methodology, how much more conservative or not is the guidance from a overall leverage perspective when you did it this quarter versus 90 days ago?

Yes. So we certainly looked at it in the light of the Q1 performance. So being a subscription business, obviously, incremental bookings that we do within Q1 has a flow on revenue effect through the rest of the year. So in contemplating that and the transition that we were going through, I felt it was prudent to take look at the year and anticipate that the economic environment is the economic environment will continue to do what it's doing. We have execution opportunities that are within our control, particularly within the enterprise that we see that transition, looking at ways in which we can accelerate that. So applying a similar level, if you like, of conservatism on the full year, but taking into account that this transition that we're going through has taken a little longer than we had anticipated.

Okay. Okay.

Yes. I'd also add that we expect the macro to continue to be uncertain. So as we've moved into landing and expanding larger enterprise deals, our quarters, which historically been pretty even from month 1 to month 3 have become more back-end loaded, where the third month of the quarter sees a lot of your bookings come in. And Liberation Day was right at the beginning of that third month. So it was weird. That's the only way I can describe it. You have customers who will use uncertainty against you in some cases, they use it as a reason to negotiate more. They use it as a reason to delay things, et cetera. And we just expect, given what's going on with the tariff war, environment, the geopolitical environment, currency, et cetera, for the market to continue to be uncertain, whereas months ago, I think people were more optimistic about what this year was going to look like.

And I think just to add, Jen mentioned the fact that by the end of this quarter Q2, we'll have 60% of our quota-carrying reps who've been with us for a year or more. What we have seen by doing the analysis is that once reps have been with us for 12 months, their yield improves. So that's given us a basis for confidence in seeing improvements in incremental ARR through Q3 and Q4.

I'm going to try and get it out of you. You said April weird, May, still weird or less weird?

It's funny because like I think you get that like first weirdness and then you just sort of acclimate to it. So I think it's the same. It's just this like uncertainty is the name of the game. And I was talking to a customer the other day, and he said, I just wake up in the morning, and I just don't want to turn on the TV anymore. I just don't want to hear what's going on because I just need to get s*** done at work. And I think there's some volatility fatigue in the market, right? But at the same time, what's really unique about the market that we're in is while there's this uncertainty, there's also one of the most transformative technology opportunities we will see in our lifetimes. And so people are experiencing this sort of interesting emotional mix of uncertainty around the macro and like what am I going to have to deal with next that wasn't built into my original plan. But at the same time, like this is just such an incredible opportunity and when it catches on, I mean, we've even seen in our own internal organization. The vast majority of our engineers are using code assistance and more than one, all of our employees have access to a secure proxy environment where they can use generative AI tools to do their work. And it sort of catches on like wildfire. And then they get really excited about it and you just start to see these new use cases and new capacity, and that is contributing to our efficiency gains as a company, and we're seeing that with customers. So it's kind of this weird juxtaposition of the externalities are uncertain, but internally, you have so much opportunity, both from a product and from an internal use of AI that it's inspiring. And so there's probably a lot of mood swings going on in the marketplace.

On the enterprise segment, you did mention some downsells happening. What does it take to get these customers that have downsold back up to par? And maybe expand from...

Yes, it's purely engagement, like some of them shouldn't happen in the first phase. So one of the things that we did in the quarter in some cases, intentionally, in other cases, unintentionally was we transitioned a lot of reps. We took some low performers out of the business. We moved reps that had a profile more suitable to mid-market into different roles, and we are ramping new kind of more traditional enterprise sales reps into our bigger territories. And at the same time, at the beginning of the year, you often have a territory reallocation exercise that you go through. In doing so, while also transitioning, ramping a new Chief Customer Officer, we created some unintentional coverage gaps. And that's not the right thing to do for the customer. It's not the right thing to do from an execution. It's not the right thing to do for investors. And we're on top of that, but those coverage gaps led to some surprises in downwards that I think could have been avoided. And so it's about, one, making sure that our customers are using the product that they've paid for effectively that they're well deployed. But also importantly, that they understand the value they've realized from that product. So oftentimes, the CIO doesn't realize that the use of the platform reduced the number of major incidents that they had in the quarter or in the period because nobody wants to tell them how many bad incidents they had before, like they don't want that information getting to the bosses. So you have to be really intentional about making sure that both the product and your post sale team helps customers understand their value realization. The second thing is we have to be more programmatic. So we're maturing our post-sale deployment capability, our professional services capability, our work with customers and our customer success for large complex enterprise deployments. And what I would say is our product is not meaningfully complex and our product is still relatively easy to deploy, but our customers are more and more complex. The change management required, the way they work across regions, across departments, the increasing number of use cases that they're using us for require a more mature kind of typical enterprise professional services and deliver your implementation motion, which we didn't require in the past when we were primarily a single instant management offering with just a small handful of use cases.

So it sounds like within the enterprise, a lot of CIOs, CTOs, head of dev and second ops are underappreciating the ROI that you guys are giving them.

Yes. I mean it's really interesting, like the ones who are on top of it are like unsolicitedly like raving fans. It's -- but the other thing I would say is if you look across large enterprise, there are sort of 2 kinds of technical leaders right now. They are deep technologists, in the top technology role. And then there's sort of more the business consultant style of program management leader, and they are playing catch up, trying to figure out how AI is going to work in their environment, how they should be managing their budget across organizations. So we tend to see that more technical leader because they do come out of a developer or a software engineering background. They actually understand and appreciate our ROI, the low cost of ownership, the quick time to value, more readily than maybe the more traditional CIO persona that is used to big ERP platforms. Big ITSM solutions want to go to them and say, it's only going to cost you this, but it's going to deliver this, and it's going to do it in 5 quarters, they're like, what? Because they don't come from that software engineering background. So we have to do a better job of starting there and having that conversation and our newer profile of reps that do that, that's where you're seeing large lands that we've talked about, like the financial market infrastructure company or the health care company, we talked about a couple of quarters ago, the semiconductor company that we've spoken about that is a 7-figure deal that's continued to expand over time. And that semiconductor business, for instance, is 1 where we're getting tailwinds from both the way they're using our automation for different use cases well beyond incident management, but also because they are investing heavily behind their AI investments and using us to operate all of their AI investments. So we get kind of 2 tailwinds in an example like that. And we're starting to see more and more of that, but we need our reps to recognize that opportunity and convert it.

Yes. Yes. Another segment of the business where you saw elevated churn in commercial. So maybe a few minutes there on what happened in commercial? How do you define commercial, all these software businesses define enterprise commercial differently. So maybe a definition there. And then why or why not? Or why wouldn't the elevated churn in commercial continue in the future?

Yes. We see sort of the tale of 2 cities in commercial and commercial is customers with revenue under $500 million. And -- thank you, Howard. And 1 of the things we see is sort of 2 segments of that commercial space, which is really small and the lower end of the mid-market business for us. Traditional startups. And for us, this business has almost always been tech, e-commerce, online travel, your kind of traditional digital first small growing companies. There is 1 cohort of that business that our start-ups that has sort of fallen or falling away. They were overvalued in the 2018, '19, '20 -- through 2022. And when the valuation multiples start to come down in the private market. They just aren't able to grow into their valuation and they don't have the cash to support that growth. So we've just been seeing that cohort, their head count is contracting. Their businesses are contracting and they're going -- they're still going out of business at a much higher rate than they were 5 years ago. So that cohort is really the have and the have nots. You've got companies that have been able to pivot and get to cash flow positivity and continue to get investment from their insiders and companies that are just sort of disappearing. And we go through and we look at bad debt in that segment, and we'll lock customers who are not paying and things like that. So every now and then, you'll see a burst of elevated churn in that segment. On the flip side, which I don't think is systemic. On the flip side, we're seeing increased growth and interest from the generative AI segment where those customers are very well funded. They're growing fast. Some of them are getting very big, very fast and the biggest names in that sector are choosing PagerDuty as essential infrastructure, much in the way startups in the past have chosen us as part of the start-up toolkit, but their requirements for security, for resilience and for scalability are very different than the traditional small startups we used to start with. Because they're growing so fast, they're serving such large cohorts and the quality and reliability and resiliency of the actual product outcome, whether it's their LLM, their AI infrastructure, apps or agents is very important to them because when customers experience hallucination or rogue agent behavior, they get very nervous about expanding the use of those solutions. So we help them identify those issues early, moving them very quickly, but most important, learn from them and get -- remove that problem from their systemic offering before it becomes a big problem. And in AI, those problems can spread faster than they could in kind of the traditional world. So that part of the business is where we're seeing -- that cohort is where we're seeing new logo growth at a faster rate, and we think that cohort has the ability, the potential to grow faster and more profitably than what we used to see in software start-ups. And then on the flip side, we think the other part of that cohort, the long tail will continue to moderate over time. But we were pleased to see in the last few quarters, the commercial business growing again, returning to growth. The other thing I would say is that our focus on new logo lands is in upper mid-market and enterprise. So we do not have new logo targets that are as high as they were 4 or 5 years ago when commercial was a bigger part of our business because most of our new logo lands are in enterprise and they're -- they grow faster and more profitably.

Got it. Maybe a capital allocation question for Howard. I know you guys got a share buyback in place, maybe a quick reminder of how much is left. And then maybe going beyond share buybacks, how do you think about capital allocation and investments for growth?

Sure. So we recently announced the authorization for a share repurchase. This is our second share repurchase. This 1 is 450 million. And that share repurchase program will be in effect this quarter. So with this -- we feel capital allocation decisions need to be taken, looking at what's in the best interest of our -- the company and our shareholders, all the stakeholders. And so together with our Board when we reviewed this, we saw this as a good opportunity for us to be able to return capital. We obviously take a view looking at what the opportunities are for us as a company. We want to continue to grow. We see ourselves as a long-term profitable growth company. So we're making the investments that will secure that future.

Yes. And I think it's worth mentioning that we've demonstrated pretty consistent improvement in operating margin. Last quarter, we shared a long-term operating margin target of 30%. In this quarter, we mentioned that we see a clear path to GAAP profitability and that requires us to continue to produce healthy cash flow, but also for us to focus on reducing dilution and stock-based comp. And we've put in programmatic systems in place to just make sure that we can manage that more and more effectively each quarter.

Got it. I think 1 of the big themes is sales rejiggering of the organization -- a little bit of...

Rejiggering, I think my teams would tell you they can feel the rejiggering.

You have a CRO that you're still looking for? Maybe just last question is, what kind of qualities are you looking for this CRO?

Yes. I mean no one is more motivated to find the new CRO than me because I'm the current CRO. I do have enterprise sales experience, so I guess that's a good thing. But we are looking for someone who has a global enterprise sales experience in large platform selling. Someone who has experienced standing up a partner channel and someone who likes to win but hates to lose. Someone who is a competitor. As we've expanded the products and expanded our platform, we've expanded our TAM and therefore, have a higher number of competitors, which can be noisy. And I want somebody that's used to winning in a more competitive market environment and stealing share of wallet from other people. And we have this kind of nice Canadian culture and we were sort of alone in our market that we created for a long time. So it's a cultural shift for our company to go top down, to be selling, starting with the platform and value-driven vision. And to be really looking to be one of a handful of strategic players alongside of our -- alongside the, I think, the most valuable software platforms in the world. But I'd also say that we're not waiting for that new CRO to step in, already with the new Chief Customer Officer, who's now ramped, Allison Corley, myself really driving a cultural change and an operational change, a higher set of standards and expectations, higher levels of inspection and higher engagement. I mean I have 5 C-level customer appointments this afternoon. So there's a lot of context switching going on, but there's just a different level of activity and a different pace and a different level of inspection already in place which we expect to drive both leading indicators in this quarter on lagging indicators in the back half.

Yes. Got it. Makes sense. We're all out of time.

Well, thank you for having us.

Jennifer, Howard, thank you so much for doing this. Appreciate it. Thank you so much.

Thank you.

Thanks for coming.