Pagerduty Inc

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PagerDuty (PD) : The freemium model is proving itself, says CFO





Date Published:
Author: Tiernan Ray

 

 

The so-called freemium model, giving some stuff away and charging for others, is a debatable approach to business: does it actually lead to new business?

According to Howard Wilson, chief financial officer of PagerDuty (NSE:PD), it has absolutely produced new business, as the “viral” quality of the way the product spreads by word of mouth benefits as more people spontaneously take up the product.

“Even around free, we're seeing enterprise and mid-market accounts of companies increase,” said Wilson, in an interview with Capital Market Labs following PagerDuty’s June 3rd earnings report.

“And that allows us to be very targeted on driving conversion to get those to be customers who will then sustain the kind of growth that we see for the future.”

Part of the secret of using free offerings, explained Wilson, is then tailoring the paid product so that it has meaningful feature expansion to match a company’s growth.

“As people develop and they need more functionality, they can move to our professional plan, and then they can move to our business plan,” explained Wilson. “And then our digital operations plan. So, we were very mindful when we redesigned our pricing and packaging about ensuring that we could deliver real value for each plan.”

It helps that Wilson personally has a feel for the kinds of technology that PagerDuty brings. He ran a customer support team years earlier at Oracle.

Among other topics, Wilson reflected on the growth of the company’s business overseas, which he characterized as “really strong.” Whole industries such as automotive manufacturers are becoming a vertical market turning to PagerDuty.

“We still see that as a large opportunity at 25 per cent of revenue,” he said. “It's left plenty of room to grow, as we grow as a company.”

 

Capital Market Labs: As we did last time when we spoke, I would throw it open to you. What things about yesterday's report and outlook do you think are especially important for investors to take away?

 

Howard Wilson (CFO PagerDuty): So, I guess, you know, when I look back at Q1, it was a really solid quarter for us.

We were pleased that we, that our revenue grew at 28%, year over year, and we were above our guidance and above consensus. So, we felt good about that.

In terms of EPS, our EPS also came in above our guidance, and above consensus. So that is positive to us in terms of the external metrics.

I think the things, though, that speak to some of the momentum and the underlying health of the business that are important from my perspective, are, first of all, the growth in companies using the platform.

So, we have sixteen thousand eight hundred companies, that's free and paid customers, using the platform today.

That's nearly a 30% increase on where we were a year ago. And that speaks to the fact that we made a strategic decision in the September quarter, kind-of the fall timeframe last year, to take what had been an experiment around free as part of our response to COVID, and to make it part of our lineup.

And what was important about that is, it just created a whole lot more access to the platform.

So, we see, you know, single developers joining PagerDuty, and starting to use the platform. But more importantly, we’re seeing companies.

And that number of sixteen thousand eight hundred companies, we don't include, you know, single, random developers who are using the platform, but really where we can identify that this is a company.

And so, this has created access, particularly for SMB companies, but also for enterprise and mid-market. And what that does for us is, it creates a really good funnel for us in terms of opportunity in the near term, but also in the longer term, because we think some of those SMB companies, when I go through the list, a lot of them as startups.

And so, they could be the next Zoom. Or the next Twilio. Or the next Okta. So, the fact that we had them on PagerDuty today is really like a competitive moat for the future.

And then what it allows us to do is when I look at our mid-market and enterprise, which represents — mid-market and enterprise, those two segments — represent 80% of our revenue.

And that's an area that's really a growth engine for us. And so, with this program that we have, even around free, we're seeing enterprise and mid-market accounts of companies increase.

And that allows us to be very targeted on driving conversion to get those to be customers who will then sustain the kind of growth that we see for the future.

And that's why, when I looked at the quarter, as well, it was great to see our dollar base net retention at one hundred twenty one per cent. And in fact, above 125% in the Enterprise segment.

That, again, speaks to the fact that we have this very strong land and expand model, and that we truly are becoming more and more an enterprise business that is able to meet the needs of organizations who see what PagerDuty does as really critical infrastructure.

One of the reports that we saw most recently was from IDC. And they actually spoke about the fact that they did a survey. And in that survey of CEOs, they actually came up with a finding of seven in 10 I.T. decision makers named digital infrastructure resiliency as their top priority. And that's really where PagerDuty is today.

We're all about digital infrastructure resiliency because, you know, uptime is money for people. And so, the role that we play is really important.

So, when I look at the quarter, I really feel pleased about those characteristics.

The other thing for us is that the traction that we're seeing in international is really strong. So, it was another strong quarter of growth in international.

International revenue grew thirty-eight per cent. It now represents 25% of our revenue. And particularly in Europe, we're seeing, you know, making good strides.

And one of our initiatives that we started more than a year ago around getting ourselves set up for European data residency, we've now started a pilot program for customers, and will start launching it more broadly in the summer.

And we see that it's going to create an opportunity for customers in Europe who previously because, although we've been GDPR-compliant since the regulation came out, these customers have felt that they want their data in Europe.

It doesn't matter if you’re GDPR-compliant, it’s, is the data residing in Europe.

So, with that opportunity to provide that, we think it's going to open up opportunity for us in Europe.

And some of the cases that we spoke about on our earnings call, we spoke about a large car manufacturer, connected car manufacturer, is actually in Europe. And we're seeing an increasing trend in terms of car manufacturers in Europe who are using PagerDuty, where PagerDuty is either helping them with delivering the service to their customers via the mobile app, in terms of ensuring that that's a really good experience, or in terms of how these companies are also — you know, more and more software is being used to run and manage these vehicles.

So, their ability to manage their digital operation for them is critical. So, PagerDuty actually helps them help them do that.

So, that's a sector that's showing a lot of strength in Europe, and hopefully we can replicate that in other parts of the world.

So, I think, you know, the growth in international is a real, real positive for us this quarter as well. And we still see that as a large opportunity at 25% of revenue. It's left plenty of room to grow, as we grow as a company.

We've spoken before about us having our aspirations of being a billion-dollar-revenue company, and obviously expansion internationally will be an important part of that.

 

CML: Thank you for that. Howard, I wanted to pick up on what you said about the free offering, and individual developers. Does that change A, the mix, that mix of enterprise and mid-market that is currently 80% of revenue? Does that change as you get more traction with individuals?

And, B, does it change any of the metrics such as RPO or contract length or DBNR or growth rate, even top line growth rate or margins? Does it change any of that?

 

HW: No. In fact, what's interesting about PagerDuty, we were built by developers for developers. So, our strongest contingent of followers is the developer community.

So, in fact, what we've done with free is really just make it easier for our developers, whether they are part of a company or not.

So, we actually saw this as a way of really kind-of enhancing our opportunity to create more of a community around PagerDuty.

And with our acquisition of Rundeck, late last year, Rundeck actually had started an open-source project, and has more than 60,000 developers that are part of the open-source project.

And so, this, again, is just really in line with us being able to ensure that we are looking after our community of developers. And those developers, then, may start using PagerDuty as individuals with some small project on their own.

But when they are in a company or in a company setting, they may champion PagerDuty as well. And that's really been the foundation of our viral growth, is that often we land, with, you know, one group of developers in a company, and then they start using PagerDuty, and then other people see that the team is using it, and say, Hey, what are you doing?

Why is your life looking better than mine? And they then become advocates for PagerDuty. And that advocacy is really valuable to us.

And in fact, that's often how we get into some of the other use cases.

So, a number of the examples we've seen, even, you know, one of one of our customers is [online grocer] Good Eggs.

And we started there with the developer community years ago, and it was the developers who were using PagerDuty who looked over at the operations side and said, Oh, you know what? You could actually be using PagerDuty for the operations piece too, right?

So, this is about ensuring the right delivery of food from farm to table, maintaining the cold chain, and all of those things.

And we see that developers do that, too. Like a lot of the growth, we're seeing in customer service is where developers have been advocates, saying, you know, If you just connect PagerDuty up with what you're doing with your customer service application, whether that’s Zendesk, or that's the service cloud from Salesforce, you know, it's going to make your life a whole lot better. It'll give you more context.

And that's really important for us from the perspective of, as we start bringing new products to market, we have an audience that champions what we do.

 

CML: And is it too soon to say if that is having an impact on, for example, land and expand, either qualitatively or quantitatively, to the extent you can say?

 

HW: So, we see it as having a positive impact already in terms of the conversion rates that we've seen from free to pay, has been better than we expected.

So, these are generally small numbers at this stage.

When you introduce a free offering, there's a fairly long gestation. And, previously, we had plans that you might call them the former free plans because they were, you know, you'd be paying ten dollars a month for six users.

So, you know, very low price, very inexpensive. And my view was that we realized that that was actually creating a friction, and not really adding much value to us.

So, we thought, well, take that and remove that. Don't create that friction. And it's almost as though we’ve kind-of, you know, opened up the doors.

We've had more folks come in. And so that helped us as well. It helps those folks early on in their journey. But then it also helps us to develop those customers that are, you know, going to be our target for more rapid growth, and help us drive expansion in the enterprise.

 

CML: It's not exactly the same as the ‘90s Internet, and “follow the free,” and give everything away?

 

HW: No, no. So, we're actually very measured about this.

Our free offering is a fully functioning platform. We're giving them access to the regular PagerDuty platform. But we're being measured around just how much we give away in that space, so that there is a natural progression.

As people develop and they need more functionality, they can move to our professional plan, and then they can move to our business plan. And then our digital operations plan.

So, we were very mindful when we redesigned our pricing and packaging about ensuring that we could deliver real value for each plan, but also ensure that there was a natural progression that would often align with the maturity of an organization as they were either supporting more complex digital assets or growing in their own operational maturity, or as they were trying to aspire to a higher level of service.

Each of our plans does that, they all build on each other through that cycle.

 

CML: Okay, that sounds like a good model. The 30% revenue growth that we talked about last time, you're just below 30%. And we talked last time that there is a sense between you and your CEO, and the whole team, that maybe growth above 30% is possible.

I think last time you said it's not something you want to put a timeframe on. In 90 days, have you had any kind of accentuation of your thoughts around that?

 

HW: Yeah. So, if you look at the guidance that we've given for this quarter, actually, the midpoint of our guidance for Q2 represents a 2 9% growth rate. So that certainly speaks to our increasing confidence, in getting to that that rate above 30%.

So, we've been in the 29, 28, 29 range for the last couple of quarters. And so, we see, you know, definitely seeing a good momentum, and the opportunity — that 30% is certainly more in sight now than it was a quarter ago.

 

CML: Okay. Is it something that still rests on what happens in the unlocking, in the reopening of societies, in the marketplace, in fact? Is it organic factors pertaining to your customer base, and your go to market, and things like that?

 

HW: Yes, I think it relates to, we obviously, in giving our guidance, we always try to read the macro, which is a very difficult thing to do, as you know.

So, but I think the things that we are confident in the tailwinds that drive our business are as strong as ever. And those for us are, you know, digital transformation, cloud migration, and data transformation. And those are even more relevant. So that gives us confidence.

If we have a look at what's happening in the economy around re-opening and recovery, we've seen across almost all of our verticals that there has been — either there's been increased acceleration over the last year or they’re returning to pre-COVID levels, or they're returning to growth.

With the exception of, say, travel and hospitality. They've been starting to recover, but they're still not where they were pre-COVID.

We've seen positive trends in transportation now for two quarters, right? Which had been impacted.

So, from a macro perspective, and an industry perspective, signals are looking stronger.

And our own execution has continued to improve each quarter. And so, when we see that execution tied together with the demand signal, that gives us the confidence that we will get to the 30s.

 

CML: Okay. Let’s talk just a bit about the forecast for this quarter and for the full year. Adjusted EPS, it's, I think, negative 15, 16 cents this quarter. It's below last quarter, but in line, roughly in line, for the full year. And so, is there an expense that moves up to Q2 that was kind of just shifted within the full year?

 

HW: That is correct. So, what had happened is we made the decision to move our user conference, PagerDuty summit, which would normally happen in Q3, into Q2.

So, with that, it increased expenses in Q2 significantly. That's an event that runs into millions of dollars.

And in addition, we decided to make investments in above-the-line advertising, including some TV advertisements. And with that happening, we are increasing sales and marketing expense in Q2, which is why you see the increase in EPS.

But it returns in the back half of the year.

So, our guidance for the full year remains unchanged in terms of EPS, and we're still targeting the same operating loss margin of between, negative, between 10% and 12%.

 

CML: Full year?

 

HW: Full year.

 

CML: Okay, I think you said that's why you're seeing the increase, not in EPS, but the increase in OpEx., In Q2?

 

HW: That's right, increasing OpEx, which leads to an increase in our loss. Our loss per share goes up in Q2.

 

CML: How does — is this conference virtual?

 

HW: It is, yeah, and you're welcome to attend. We're expecting about 15,000 attendees.

 

CML: It's fascinating to me that, like, a virtual event would be millions. You're not paying for a hotel, but it still costs serious money to do this?

 

HW: Well, it does. And there are a few reasons.

One is that we don't charge for the events, right? So, all the resources in terms of both the platform that we have to put in place, the marketing around the platform, all the preparation, there's also all the production quality that you would have...

In fact, it's more, because you do a fair amount of pre-recording. So, there's all that pre-recording activity.

So, the A/V costs go elsewhere. So, you don't have the hotel costs, right? And you don't have the food cost, but you also, sometimes you have external speakers that you have to pay for.

So, it’s less than doing a physical event. But it's certainly not free, not free to put it on.

 

CML: No, but the hotel booking is the hardest part in the conference business, so if you could just avoid that part. It sounds like a great business...

 

HW: Yeah. Although I must tell you, this is the second one we're doing, and I'm astonished at how much work there is in this. Because I sort of had this view it would be so much easier. But it's, you know, it creates constraints that are hard to imagine.

Because when you think about programing an event like this, you don't want to put everyone to sleep, right?

And so, you have to think about how do you make it interesting, and how do you line up speakers for a fireside chat that's virtual and keep the pace and the momentum of it going.

But we're looking forward to it. It's going to be a great event.

 

CML: What are the dates for it?

 

HW: It's the 22nd to the 24th of June. We're doing an investor day on the 24th.

 

CML: I'll be tuning in. Here is another one on the financials. What is the long-term EBITDA margin, what’s aspirational? Is this a 35% EBITDA margin company, in the long term?

 

HW: So, we haven't spoken about that specifically. We are looking at our analyst day.

You know, at our IPO, we presented a long-range model to folks in terms of what we thought we would be as we got to scale. We haven't updated that for two years now.

So, at our Analyst Day, we're planning to share a view on where we think we would be in terms of the longer-term view. And that's really saying, like when we are a billion-dollar company, what do we think the shape of the company would be, including where we would be from an operating income perspective.

 

CML: It doesn't sound like you want to preview that for us right now with a special exclusive….

 

HW: I don't want to preview that just yet because under Reg-FD, I can't share that!

 

CML: When we spoke last time about security, meaning DevSecOps, I think, the number that sticks in my mind from last quarter, the prior quarter, Howard, was 56% growth.

 

HW: Right, yes.

 

CML: So, has there been any change, amplification in the last 90 days around this sort of fortuitous blossoming of the uptake of the product in DevSecOps, or the way you go about it?

 

HW: Yeah, we still, I mean, we continue to see the same strong trends around the security use cases.

And in fact, Jen [Tejada, CEO] mentioned — I don’t know if she gave the customer's name.

Yeah, Okay, we didn't mention the name, but this is really about a DevOps team at a large online education platform.

And they are using PagerDuty to guard against more than 7,000 different phishing variants per month. And they're using PagerDuty to fully automate the blacklist updates without needing to get experts involved or have admin access, which really reduces their risk.

But that's the kind of thing that you see with people using the power of PagerDuty, both from a detection perspective but also some of the automation elements, to be able to push out activity, to be able to make preventative actions, to manage the environment.

So, that's just one example. But definitely, I would say, you know, almost every month we have a set of customers that are starting to use us with respect to the security use case.

 

CML: Right. And as we talked about last time, it's coming to you. That market's coming to you.

Is there any change in feeling that you need to be more aggressive in designing for that market or for that use function within?

 

HW: We definitely are contemplating that.

I think the approach that we've taken is that we've identified the customer service user as a group that requires some specific attention.

And that's why last year, in September, we released a specific offering that addresses the needs of the customer service use case.

We could see security building up behind that. And our view is that it will actually last. The product works with security today.

Our view is that we do need to do a similar thing around security, to understand those users and understand if we need to do something more specifically to address their requirements.

But for now, we prioritized the customer service piece.

And, you know, if I look at both the integrations that we've done with Zendesk and with Salesforce service, it does give us access to a large population of potential users over time.

I was looking at a demonstration of our Zendesk workflow just last week. And, you know, if I’m a Zendesk agent, I can actually be working within Zendesk, maybe somebody, I get an inbound ticket that says to me, a customer has an issue.

And while I'm in Zendesk, I could kind of click on a few dots, I'm actually getting the status page on PagerDuty, and I can see if that service has a problem. And then I can very rapidly, I can even go back to the customer saying, hold on, there is a problem, let me get back to you on anticipated resolution times.

Or I can say it's not a problem, maybe go and do something.

And from there I can actually then engage with the engineering team who may be working on that problem or raise an issue to them.

And I’ve let that customer know, that now I can subscribe to updates in PagerDuty automatically, so I can get on and work on something else while the engineering team fixes that.

So that's the kind of power in the workflow that we're pulling together. It's leveraging PagerDuty’s ability to orchestrate work cross-functionally in a distributed environment with the right expertise, by creating context for other parts of the business, whether you're a customer service agent, whether you’re someone in IT, so that you can do your job more effectively.

 

CML: I love it. You're not actually doing these customer support calls yourself, personally?

 

HW: Not me personally! But I'm actually really excited just to see how it works.

 

CML: I love when the CFO takes support calls. That's….

 

HW: I have, though, just to let you know, I actually ran a support organization in a previous life. A technical support organization. So, and actually, at PagerDuty, when I joined PagerDuty, in my first few weeks, I actually sat with the support team.

 

CML: Yeah, you have to shadow them….

 

HW: Yes, I could hear, like, what do customers have to say. And a lot of it's now happening, you know, they're getting texts, and emails, and all those sorts of things. It's not always the phone call, but just to see, Okay, that's our user.

 

CML: Love it. Which was the organization in the past life when you ran that?

 

HW: When I was with Oracle, I was with Oracle for a long period of time, and, I actually was responsible for the technical services team in Asia-Pacific.

 

CML: I suspect that something like what your company does is actually necessary to connect people who are helping, dealing with this screaming, sobbing customer, and the people who are just trying to stop the server from being on fire, right? The two don't always talk, right? And one is saying, get away from me, I’m busy, and the other is saying, I need an answer because the customer is freaking out.

 

HW: You know, that experience is exactly right. Because the workflow without PagerDuty, in that case, would be a case of someone said, Okay, the customer’s not happy, now I've got to go and try and find out what's going on.

So, you start a new workflow, you send an email, you can't find someone, you instant message them, you don't have visibility. They're busy now, so they don't want to tell you what's going on. And you're dealing with this customer who’s unhappy.

So, we sort of make, we push the information to you, to help you do your job. And that leads that team to solve the problem, and allows you to keep the customer informed, and then carry on working. So, I think it's, like, super powerful.

 

CML: I love it. One last question for you that's a mechanics question. The growth in enterprise accounts of over a hundred thousand a year in spending was 32%, and prior to the previous quarter was 33% growth. And full year, 2021, was 34% growth.

So, should we be concerned that there’s a deceleration in enterprise accounts of spending over $100,000, the growth of that cohort?

 

HW: No. So, we figured that there will be a little bit of fluctuation there because this is really, if you like, customers who are matriculating into that cohort who are, you know, their spend with us increases.

So, there's a little bit of movement, as they growth through that.

So, we're always looking at the different tiers, both those above 100K, those above five hundred, and those above a million.

This was, like, a great quarter in terms of looking at customers, you know, above a million. That was up 55%, growth, year over year.

So, you know, we continue trying to see, how do we move or progress customers through that. And for us, a rate above 30% of customers entering into that cohort is super healthy.

 

CML: I love it. Anything we didn't touch on in our waning seconds together?

 

HW: No, I don’t think so. It's lovely to catch up with you. Thank you for your interest in PagerDuty, and appreciate your time today.

 

CML: Thank you for taking the time, Howard. We appreciate it.

 

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