A company doesn’t always know where popularity will take it, especially in the realm of cloud software.

PagerDuty (NYSE:PD), the 11-year-old San Francisco software maker, is really popular, with revenue growing 28% last year. Some of that is coming from areas such as security or customer support, where the company is learning about how the program is used by its customers.

“We often see people using us in other use cases that we couldn’t even have imagined,” said Howard Wilson, CFO, in an interview with Capital Market Labs following the company’s earnings report on March 17th.

An example, Wilson explains, was a large North American retail chain that used PagerDuty at their stores for a product recall, “to ensure that the right information is in the hands of the right people.”

“Now, we hadn’t thought of that purpose but it shows us the power of the platform,” said Wilson.

Those new use cases, sometimes surprising, are serving as a “tailwind” for the company’s revenue, especially as the pandemic has propelled digital transformation, said Wilson.

“We’ve always seen that things like digital transformation, cloud migration, and DevOps transformation have been key tailwinds,” he told CML.

“But I think the pandemic has shown us that as companies have increasingly come to rely for the — on their online business to drive their revenues, that’s become more important and those projects seem to be getting prioritized.”

While Wilson won’t commit to a time frame, “We’re really confident in the growth acceleration prospects for the company,” he said. “Our view is that the company has the potential to be growing above 30%” per annum.

Wilson also addressed areas of “leverage,” in expenses, saying that investing in the business to build out newer areas, as with last year’s acquisition of Rundeck, will be priorities.

To recap, PagerDuty’s revenue rose 29.1% in the January-ending fiscal Q4, to $59.28 million, yielding a net loss of 7 cents. That was better than the $57.5 million, and negative 11 cents per share, the Street had been expecting.

For the current quarter, the company sees revenue in a range of $61 million to $63 million, and a net loss of 9 cents to 10 cents a share. That compares to consensus for $60.7 million and negative 7 cents per share.

One-on-One with the CFO of PagerDuty

Capital Market Labs: Howard, are there any things, first of all, in the results and outlook that you particularly think investors should take away?

Howard Wilson (CFO PagerDuty): I look back at Q4, it was a record-breaking quarter for us on so many fronts.

We added $59 million, which represented 29% growth, which means we ended the year with $214 million, which represented a growth rate of 28%, that to us was a landmark of passing the $200 million mark.

We were also really pleased to see traction across a number of important areas for us.

One is the enterprise and mid-market business has continued to strengthen, and has been core to our growth in the year, and also our long-term growth, and that is represented in some of the metrics, such as our DBNR in total was at 121%, which was an acceleration from 119% in the prior quarter.

But our DBNR in the enterprise segment was above 125%, so that to us is really key because it indicates the momentum we have in that space.

When we have a look at how we were performing in terms of the efficiency of the business, we have gross [margins] that are industry-leading, and those, again, were above 85%. We typically target a range of 84% to 86%, so in terms of efficiency, from that perspective, we were above peer results.

In terms of our operation margin, we came in at an improvement of 8 points from where we were last year, from a negative 17 to negative 9, on a non-GAAP basis.

So those were results that we were pleased to see.

And we have a history of being very efficient from a capital perspective.

So, we have $550 million of cash on the balance sheet right now. But this was a very good year in terms of $10 million in terms of operating cash flow being positive cash flow, and $5 million of positive free cash flow.

Those were all really healthy sides of the business that, from top to bottom, indicated that we were lining up with our strategy.

CML: What else?

HW: Other things that were exciting for us are, when we look at the inroads that we make in the enterprise, we often look at how are we doing in terms of penetration in the Fortune 100 and the Fortune 500.

So, we are at over 60% of the Fortune 100 are using PagerDuty, and over 40% of Fortune 500 are using PagerDuty.

And what’s interesting there is even just the penetration that we have across a number of verticals. And particularly the financial services has been a place where we have seen a lot of really good expansion and growth, both in terms of just our earnings expansion in the sector, but also the growth in our customers within that segment.

And we did highlight when we did our earnings call a couple of deals that we think are really significant.

One is Morgan Stanley, large global investment bank, which added thousands of additional users of PagerDuty within that period, which represented the ongoing move to digital operations maturity.

And then we also referenced another bank that we didn’t name that similarly has made a commitment to PagerDuty where they expanded, again, adding thousands of users to as they continue to look to employing PagerDuty more broadly across the organization, to serve both their engineering team and associated groups, to essentially assure a good end-customer experience.

So that was a highlight for us when we see the progress that we’re making in the enterprise and mid-market space.

And I think some of the companies we have added this quarter, in terms of new customers, whether it was the likes of Jet Blue Airways or Sega Systems, or SK Telecom or Allied Financial — those all represent a really good mix of enterprise customers.

And if we look at our expansion, we’ve seen SAP, AutoDesk, Dropbox, Morgan Stanley, Netflix, all continue to expand with us.

Those for us — it’s good for us to see the predictability that we see in our customer base. Because about a third of our enterprise customers have routinely expanded with us ever quarter for the last eight quarters.

And that’s something that we are enormously proud of because we’ve had this land and expand model where customers are able to start using PagerDuty, and then there’s this growth that happens over time as more teams start using PagerDuty, more use cases are identified for PagerDuty to be deployed, and so we start getting greater coverage in the enterprise. And in doing so we deliver much greater value.

And we had IDC do a study for us last year, it was the second year that they did the study, and the interesting thing is that for large enterprises and companies, the investment that they make in PagerDuty, they see close to 800% return on investment over 3 years. That’s a payback period of just over 2 months, and the average enterprise can save in the region of $3.5 million in using PagerDuty, so, it’s good to see companies realizing that type of value.

The other thing that I would comment on as well is the momentum that we’ve seen in the international space.

Our international revenue grew by 34% in the quarter. A shining example of growth there is EMEA which grew above 40%. They’ve actually grown about 40% for 3 years in a row now.

That region has been significantly challenged by COVID.

They’ve seen some pretty harsh effects. And so, we found with good execution, we were solving some very real issues for customers who were COVID-affected, which I think was important.

That has led us to wanting to invest further in international and in Europe in particular.

And so, we were qute excited to announce the fact that we would be offering data residency or data hosting for European customers in the EU, via AWS, our cloud provider.

So that we think will open up further opportunities for expansion in Europe, and look forward to continuing to build on that momentum in the international space.

Likewise, we have seen good momentum in other regions like Asia-Pacific and Japan, and we expect we will continue to invest in those regions too, as they start to build to a critical level for us to have a base to accelerate growth in those regions.

CML: So, are those below company average?

HW: Those regions are still at or above the company’s level, but they represent growth of these smaller markets on a percentage basis.

So, it’s the case that we have significant opportunity — our efforts in Asia-Pacific and Japan have largely been in Australia and New Zealand to date. And we have some customers across the region. That’s one of the things that’s actually interesting about PagerDuty.

Because most of our land motion of finding new customers happens online. Customers will be searching for a solution, they find PagerDuty online, they start a trial with us, it’s a two-week trial period, they become a customer of ours.

So often when we go into a region, when I use the words go into a region, they have already started using the software, so often when we go into a region it is trying to amplify what is already happening there by putting some resources in-region, or running programs that are specific to that region, or adjusting our marketing programs to target that region.

So, that’s kind of an opportunity for expansion for us.

CML: EMEA is that funny ball of wax. When you use that term, are you talking mostly about Europe? Or do Middle East and Africa actually factor meaningfully?

HW: They don’t factor meaningfully, but we do have customers across the Middle East and Africa.

We have some notable customers in South Africa. But, you’re right, it is typically Europe, Europe is the bulk of that.

CML: Let’s drill into a few of these areas. Is security a vertical for you?

HW: Today, PagerDuty can be used across any industry.

So, when we look at our mix of customers, there isn’t a specific vertical from an industry perspective.

Obviously, we have high concentrations where companies are very reliant on the digital experience to drive their own revenues. That’s why we have a high presence in online retail, financial services, travel and hospitality before the pandemic hit.

If we think about media and entertainment, that’s another big area.

So, when we look at security, we often think about it in terms of a use case, in terms of where it could be used across the organization. That’s been a growing area for us, although our solution is not verticalized to cover that security use case, we find we are used increasingly in security operations teams.

So, Dev-Sec-Ops teams. We actually saw growth of over 56% just last year, in customers using us or applying us to that particular problem that they are solving.

So, it is giving us reason to think about how can we more specifically support folks within security. I think because for all of us, cyber-security is a concern of most boards and most companies.

Our opportunity to orchestrate work in that situation is really powerful.

Because if you think about any security incident, you have a lot of signals incoming that you have to detect.

And then you need to do a certain amount of triage on those signals, and then you need to mobilize the right people, and notify the right people. And that’s really at the heart of what the PagerDuty platform does.

And so be able to really support that security use-function quite effectively.

CML: So, what would it entail to support that more? Is that a product focus?

HW: Yes, today, the way that it works is that we support a number of integrations to the PagerDuty platform from other security products.

So, security products that do threat detection, vulnerability management and so forth.

So, the one natural vehicle for us would be to expand that ecosystem of signals coming into PagerDuty. And today, we do have an open API, so some customers just build it themselves. They are use our API to take it from their security product that they are using into PagerDuty. That may be the one way.

The other area for us will be to — we have always had the approach of thinking about the user. We are a product-lead company.

We originally were a product built by engineers for engineers.

We believe very strongly in understanding the persona of the security engineer or the security analyst. And so that’s an area where we haven’t yet invested resources into that.

And so that certainly represents opportunity for us, to understand exactly what their requirements are, and how they would maybe differ from how an engineer would be dealing with the critical incident, or with a complex situation, particularly when they are having to one, notify a large group of stake holders, and two, how they would mobilize teams.

So, we understand how you mobilize teams within development and IT really well, and our customers are using us in that security use case, but we haven’t spent a lot of time understanding what else would be of value to them.

CML: And so, when something like that increases by 56%, investors wonder, should we be watching that segment of the business as something that is a source of momentum going forward?

HW: Yeah, I think it’s one of the sources of momentum for us. Even at the time of the IPO, we identified sources of momentum, and one was new use cases.

So, our customers were already showing us that they were using us outside the dev and IT use cases.

We already had some users in security and some in customer success. So, we felt that as the business grew, that we would start investing more in those areas.

This past year we made announcements specifically around customer success — customer service, I should say. And so, we made some specific investments around supporting customer service applications of the PagerDuty product.

For folks who might be in a customer service role, where our product becomes useful. The same would be true of security. And in fact, we often see people using us in other use cases that we couldn’t even have imagined.

One recent case was a large North American retail chain is actually using PagerDuty across their grocery stores and outlets in order to be able to, in a product recall, to ensure that the right information is in the hands of the right people, around being able to respond quickly to that product recall notification.

And being able to acknowledge that they have received that and take the right action. Now, we hadn’t thought of that purpose but it shows us the power of the platform.

CML: A similar question, Howard, goes to entreprise since you spent a bunch of time nicely articulating that. Is it your expectation that enterprise growth is now a more meaningful contributor than maybe it had been?

HW: Yes, that’s right. So, we’ve seen a steady increase over the years around our progress in the enterprise.

So today the enterprise contributes to more than 50 percent of our revenues.

And if we put enterprise and mid-market together it’s around 80 percent of our revenues.

So, we get about 20 percent by revenues from the SMB or small medium business segment.

So, this has been a steady increase for us over the over the past few years. And it’s also reflected in the nature of the kind of contracts that we see today.

So, when PagerDuty started, out many years ago, we typically did month to month contracts where people could start and cancel at any time.

We then later-on introduced the concept of a term contract or an annual contract.

Now the majority of our revenue, 87 percent of our revenue is coming from customers who’ve committed to at least a year with us.

So that’s been a really good shift. And we also see that now, we’ve seen particularly in the enterprise, customers committing to longer-term agreements with us, wanting to sign up for multi-year agreements with us.

And in fact, this last quarter — or this last year, we did our first five-year contract which was a new thing for the company. And we also did our largest multi-year expansion within this last year, which was a multi-million dollar expansion this past year.

And that starts being reflected, and this is a very technical term, but, remaining performance obligation, which is effectively our backlog.

We saw a 59% in that, year over year, and that’s because of customers looking for longer term commitments.

They also feel, you know, they have the confidence in the PagerDuty platform. They see us as the leader, and they want the security of that relationship with us as well. So, we welcome that of course.

CML: That’s a really great point. People focused on ARR want to know what’s locked in, but RPO gives you another dimension by giving a sense of how contract length — effective contract length is extending outward on average.

HW: That is correct. Yeah. And it’s interesting: even for us as a business it’s something that we didn’t track previously.

But as part of our own evolution and growing as a business, we started tracking that because we see it as being reflective of our ongoing investment in us. And it’s particularly, again, it’s large organizations that tend to want to do that.

CML: And DBNER, dollar based net expansion rate, is also important here too, right? I think it was 125% for some of these larger entities?

HW: That’s correct. So, it’s 121 percent overall, but 125 percent, above 125%, in fact, in the enterprise.

So, for us that again is a very positive signal of how those companies continue to expand with us. And we’ve seen now, successive quarter after successive quarter, that our average revenue per customer continues to grow.

So, our customers are spending more money with us every quarter and getting more value out of PagerDuty.

CML: The outlook, the official forecast, I think, was 25% revenue growth at the midpoint this year, and it seems like your CEO was intimating a growth rate in the 30s was possible at some point, at an unspecified point.

So, should we think maybe growth accelerates after this year at some point? What’s the right way to think about?

HW: So, we’re really confident in the growth acceleration prospects for the company.

So, our view is that the company has the potential to be growing above 30%.

So, we haven’t provided a timeline of that. And part of that is because whilst we’ve seen real improvement and growth acceleration over the last couple of quarters, we recognize that we are living in what’s still an uncertain world.

And so, it’s very hard for us to really predict how things would unfold within this next year.

The things that are going really well for us is, one, our execution has improved significantly through the back half of this last year.

The second thing is, we’re seeing really strong momentum and good demand, particularly, again in the mid-market and the enterprise.

So, what we have noticed is that for many companies when the pandemic started some companies were you know were distressed almost instantly. Particularly in SMB, but a lot of the larger companies, like the enterprise companies, seemed to, you know, push the brakes, right?

So, they kind of just stopped a lot of their activity. And we saw some impact from that.

But we’ve noted particularly in the last few quarters that we seem to be getting back to some of the pre-COVID-type moment, where projects are being — are back on the table and moving forward.

In fact, projects that are about digitizing the organization are moving much faster than they ever had.

So, we believe that’s a tailwind for PagerDuty.

We’ve always seen that things like digital transformation, cloud migration, and DevOps transformation have been key tailwinds.

But I think the pandemic has shown us that as companies have increasingly come to rely for the — on their online business to drive their revenues, that’s become more important and those projects seem to be getting prioritized. And that’s acting as a tailwind for us.

Now, you know, using my crystal ball which I don’t have, you know, looking out over the next 12 months, things are certainly looking better than they did this time last year.

But it’s hard to know with any certainty.

CML: You got a lot of leverage this last year, I think you said 28% top-line growth for the year, and a lot of your expense growth, obviously, things like T&E, was helped unusually, but even in R&D, as well, you got a lot of leverage.

If this growth outlook for 25% at the midpoint is true for this year, do you get less leverage this year because it looks like some of these line items are kind-of in that 25% range?

HW: Yeah. So, I would I would say that when we look into this next year there are a couple of things.

Obviously, we did get some benefit this last year around, you know, reduced costs associated with in-person events, and travel, and expense coming down. We expect some of that to return this year, but not all of it.

And I think people’s paradigm around travel, and around events, has changed forever. Right?

So, I think those things we will see some return with respect to those items.

The other area, though, that I would say that as a company, we did an acquisition last year of Rundeck, which was to round out our automation solution, so that we can go from detection to self-remediation, that whole full lifecycle.

So, we’re continuing to invest in a number of areas including in Rundeck, and then also areas around AI ops, particularly the use cases that are important for the enterprise.

How do we make our workflow more supportive of the new ways in which people are doing things, which is what the page duty platform is really all about?

So, we have some incremental investment contemplated to drive our innovation forward this next year.

CML: It seems like that’s what you’re supposed to do if you’re a young growing company.

HW: Yeah, I mean, I think that’s often, you know, as a CFO, I try and think about how do I balance the interests of my various stakeholders.

And for me I always start off with thinking about, like, what’s going to create the most value for our customers, right?

So, if we can create value for our customers, that’s going to create value for all our other stakeholders, whether it’s our shareholders, or our employees. Because if that’s our focus, and if it right now, if what our customers need is product innovation to be able to help them use PagerDuty more effectively, then that’s a good area for us to focus on.

If our customers were looking for something else, then I would shift my mindset.

So, it’s about where do I kind-of allocate the capital that’s going to deliver the best outcomes for our customers, which in turn will deliver good outcomes for our investors.

And our investors — people who invest in PagerDuty often look at our growth as a really important indicator.

They recognize that it’s a very large TAM that we have.

We estimate that the TAM is a 25 billion dollar TAM. And it’s early in this market.

We’ve created a new category.

And so, investors expect us to continue to invest in innovation and invest in go-to-market to make sure that we are taking advantage of this opportunity that’s out there.

CML: That’s a good segue into an exit question. Do you think about the journey to a billion dollars in revenue annually from where you are now? What does that mean to you if anything?

HW: Yeah, so for us as a company, we definitely have our eyes set on being a billion dollars in revenues.

And we’ve you know we’ve mapped out what that looks like for us as a company. And how do we leverage both the market conditions, and also some of the levers that we have for growth. And I think for us there are four things that always come to mind in terms of how do we get there.

Certainly, continue to expand our presence in the enterprise and mid-market is key.

Secondly, geographic expansion.

You know, we would like international revenues to be a lot more than 24% of revenues.

So, there’s a real opportunity to grow there. Our new product revenues have become really pleasing. And we’ve seen really good uptake particularly in the last year with our Digital Operations Plan, which incorporates some of the most advanced technology that’s available in the market.

So, we see new products, our new automation product, as being a good driver. And those new use cases that we spoke about, like the shift into customer service and security operation — and it could be a whole raft of others — those will all put us on the path to that billion dollars in revenue.

CML: Thank you, this has been an excellent conversation, Howard. It’s a pleasure to meet you.

HW: Yeah, hopefully, that was helpful.

CML: Super helpful. I hope you can do this again in future.

HW: Yeah, I’d love to, so thank you. Cheers.

 

Conclusion

Thanks for reading, friends.

The author has no position in PagerDuty at the time of this writing. 

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