Preface

Companies often describe their software as “mission-critical,” especially when the notion of recession is in the air, and worries about potential spending cuts.

To put some meat on the bones as regards what’s mission-critical, Howard Wilson, CFO of PagerDuty (NYSE:PD), likes to point to the process by which his customers spend more and more each year, a development that has been boosting revenue growth and boosting retention rates for PagerDuty.

“What we find is that as they cross over that $100K mark [in annual spending], particularly if they’re in the upper end of mid-market or in enterprise, we see that simple team-by-team expansion changes into often customers then standardizing on PagerDuty as a platform,” said Wilson in an interview with Capital Market Labs following the company’s June 2nd first-quarter earnings report.

Wilson concurred with the notion that beyond a hundred thousand dollars in annual spend, customers undergo something of a qualitative shift: they start to standardize on the software.

At that point, said Wilson, PagerDuty’s software starts to becomes “part of the transformation that they want to see,” referring to how companies want to re-engineer the entire way in which they work.

That process of becoming more embedded with customer has led to revenue growth at PagerDuty speeding up to more than 30% in the past four quarters, and dollar-based net retention above 120% for six quarters running.

At the top end of the various “cohorts” of PagerDuty customers, those customers spending more than a hundred thousand dollars jumped by 43% last quarter, which represented a sizable leap of ten percent, quarter to quarter.

Wilson attributes such surging growth to “work that we are doing from a product perspective to make the product do more of the selling,” as he puts it.

This is not the “car that sells itself,” it’s too complicated to be that.

But the company is finding ways to surface elements of the program such that is drives upgrades — as Wilson frames it, “make more of the new product discoverable for our customers so that they can see what they need and can choose what they need.”

Because of what Wilson believes is that very well-functioning product mechanism, he expressed modest enthusiasm that PagerDuty’s sales will have some of that mission-critical quality that can mitigate any potential recession.

“The nature of what we do as critical infrastructure is in companies related to their servicing their most valuable assets, their customers,” said Wilson. “And the teams that often are delivering those services are the teams that are protected even when there are layoffs.”

PagerDuty is “not seeing any perceptible change in the demand right now,” says Wilson. “That could change — who knows— but I do think that we are in a space where what we do is important.”

 

One-on-One with the CFO of PagerDuty (PD)

Capital Market Labs: As we usually do, Howard, I throw it open to you: First of all, what’s been the most important takeaway from the results and outlook?

Howard Wilson: Yeah, so I think this is really a very solid quarter for us. Our revenue grew at 34%, and this is the fourth quarter that we had revenue growth above 30%.

So, we were really pleased to see that sustained growth above 30%. And that was a lot of quality execution as we re-accelerated growth over the last six quarters.

So, I think that was the first thing that we hit on last week.

The second piece is that we’ve spoken about how our business has this very strong land and expand model.

One of the key things for us is always to have a look at, are we continuing to expand our customers, and they’re staying with us.

So, our dollar-based net retention was 126% this quarter, which again, is a really high number by industry standards. And this is the sixth quarter that we’ve been above 120%, so that really demonstrates our retention motion is working.

So, that to me was another highlight.

And, then, I think the third thing for me is, I know that in one of our previous discussions, we’ve spoken about the introduction of our free plan and our free tier.

And when we introduced the free tier, that put pressure on our paid plan because we had people previously had landed in our most inexpensive plan, now goes into our free tier.

So, this is the third quarter that we’ve seen paid customer account growth accelerate.

So, it came from 6% in Q3 to 7% in Q4 to 8% now in Q1.

So, great to see that we’re moving back into that direction of upper-single-digits growth in terms of new customer acquisition. So, that to me was a positive.

And, then, I think from a product perspective, we continued to accelerate our pace of innovation.

And we had a really strong spring release, and what’s interesting about that, as a company, we talk about our spring release, but we actually are releasing new stuff all the time, right?

And so, because we had this mode, as we are making enhancements to our products, if they’re not going to disrupt the workflow of our customers, we release them anyway.

But when it’s a bit major, we then do it as a final, formal, quarterly release.

And our Spring release, this quarter, focused very heavily on process automation.

And so that was, again, both in terms of the On Prem solution [“On Prem 4.0” is the latest release of what the company calls “The full platform powering the PagerDuty Process Automation portfolio.”], and as a completely new version of that with enhanced security capability, that will support people with a zero-trust environment and so forth. So, that’s the process automation piece.

So, we also released a process innovation version in the cloud.

And we also introduced what is called — or, made generally available — Runbook Actions, which is an extension of the PagerDuty instance across platform that now allows companies who are using instances to acquire the add-on that gives them automation capability as part of their instance that they didn’t have before.

And, so, really a very solid release, and just continues to grow the momentum that we had from a product perspective.

So, those are a few product highlights. I mean, we released our social impact report. This is the second year that we’ve done it.

An interesting component is that we’ve also started a full ESG program, which we’ve incorporated in the social impact report, and we provide our first disclosures around how we’re doing in terms of ESG.

So, that, again, was another highlight for me. And we had some really great executive hiring. Katherine Calvert joined us as CMO, and we have a new general counsel, Shelley Webb, who joined us.

So, there was a lot happening, but those are a few things.

CML: Thank you for making it all so efficiently compact in summary.

I want to ask you about the paid customer acquisition figures going from 6% in Q3 to now 8% in the most recent quarter.

I think I get that, but, in other words, paid customer account growth is the number of total accounts that pay any amount of money — that’s what you’re talking about?

HW: Correct. Yes.

CML: It was a round number of total accounts that are paying.

HW: That is correct. If you actually have a look at the companies that are on our platform, if you take the pay customers, and you take the free companies, if you like, the businesses that are using us but not paying, that actually grew by 26%.

So, part of the thesis behind creating our free plan was to really open up the platform to smaller companies. And that has certainly worked.

It meant that when we started, a company who would’ve taken the least expensive plan, actually could do what they needed in our free plan. But that actually created a funnel for us to help develop all those companies and nurture them to becoming paid customers.

And just to see that growth in paid customers is excellent. And that goes along, we also see companies, if we look at customers who are spending more than a hundred thousand dollars with us, that actually went up by 43%.

CML: Wow.

HW: So we’ve been seeing that companies are aggressively increasing their spend with us. And we definitely are landing or expanding a lot more companies in the mid-market and enterprise, which is, by far, the majority of our business is.

But we are still providing a mechanism to expand the use.

CML: Great. I want to come back to large customer accounts in excess of a hundred thousand, but before we do, just to close out this point, when you introduced free, did you go down in paid customer account growth percentage when that happened?

HW: We did, yeah.

CML: How far did it go down to?

HW: It went down — I think six [percent growth] was our low point. We sort-of were at about 10 or 11, and that went down, and now it’s starting to climb its way back up.

CML: Great. Congratulations.

HW: Yeah. Thank you. And we are pleased to see that, because when you do these things, it’s a little bit of an experiment in terms of, like, is this going to deliver what you expect.

But we would rather have a company on our platform than not.

CML: I got you. At a certain point, the thesis has yielded great results. The ARR growth in customer accounts above a hundred thousand dollars in ACV was 43%, right?

HW: Yes.

CML: Is this from current customers scaling up or is that from new logos?

HW: Yes. So that is — annual contract value is the same as annual recurring revenue, is the way that I typically think about it.

That is largely just customers who have increased their spend with us — they’re committed to paying — to get them into that tier.

So, there’s some growth, matriculation of their cohort. We do have some customers who join us with an initial spend above $100K, but frankly that doesn’t happen a lot.

Like, most of our accounts actually started with smaller purchases or one or two tier, and then they will grow with us progressively over time.

What we find is that as they cross over that $100K mark, particularly if they’re in the upper end of mid-market or in enterprise, we see that simple team-by-team expansion changes into often customers then standardizing on PagerDuty as a platform.

And then you see large expansions, where customers might do hundreds of thousands of dollars.

Or, as we spoke about one of the examples on our earnings call, where we had a large financial services company that had started relatively small with us, continued to add — this is in 2019 — that continually added users and products until they got to a million dollars.

And in fact, this last quarter, they did another seven-figure expansion. So, that’s because you are then starting to be used more broadly across the organization, part of the standard or part of the transformation that they want to see.

CML: That’s great. On the same point, it looks like this growth from fiscal Q4 to fiscal Q1 in those $100,000-plus customers was over 10% sequential growth.

And so, I guess the question is, did something particular happen with a particular event, or with the sales motion? Because it seems like a particularly large sequential jump?

HW: Yeah, it was. And I think there was nothing particularly unusual.

It was just, I guess, sometimes just the timing of those customers.

We have such good momentum in our go-to-market motion. And I think the combination of the work that we are doing from a product perspective to make the product do more of the selling or doing more of the load — you know, we have the product-lead growth approach, where we’re trying to make more of the new product discoverable for our customers so that they can see what they need and can choose what they need, and can even trial some of these new things, in that they make it easy for the sales person to engage.

Because often the customers could be turning on a new product, seeing the value in that product, and very quickly being able to then convert to a plan.

I think it’s just part of the strong persistence in our execution that we’ve had over the last 18 months or so since that COVID quarter.

CML: So, is one quarter a trend in terms of sequential growth?

HW: Well, you know, I think — it does move around a little bit.

Like, it was 39%, I think, last quarter [in Q4], year over year, close to that cohort.

But it’s sort-of been in the upper 30s.

The COVID quarter was a bit of a special quarter. We’ll continue to help customers see value, and they will then naturally expand, and moving to those higher-value cohorts.

CML: It sounds like the most important thing, perhaps, in these couple of questions, is the qualitative shift where beyond a hundred thousand [dollars] ACV, there may be a qualitative difference where they start to standardize, and maybe not simply say catching like brush fire from team to team, but they’re actually making that thoughtful purchase?

HW: That’s right. And it is often around when — it was interesting, we were actually on a call yesterday with one of our analysts, and they were talking about an interview that they had one with one of our customers.

And they said to that customer, How do you drive DevOps transformation?

And they said, we use PagerDuty.

And they said, Well, how do you make sure that you’re meeting the needs of your business in terms of your digital acceleration? We use PagerDuty!

When they told me this, I thought, I’m sorry you haven’t got that recorded, I could really use that!

Because that’s the power of PagerDuty, the platform, because it can so easily be a vehicle to help drive cultural change in an organization in terms of delivering a better experience to a customer, which means that you want be able to respond more quickly when they are issued, or you want be able to act proactively to avoid things.

If you are trying to change the way that your development organization works, so that you can be responsive, to build applications that delight your customers, and keep your customers in the right place, and you’re adopting a DevOps or agile, combination of agile and DevOps to get there, well, PagerDuty can help you get there, right?

So, I think that is a large part: a lot of organizations find a huge benefit when they adopt that.

CML: That’s amazing. Shifting gears just a little bit, the market now I’m told, is obsessed with profitability.

HW: Yes.

CML: My understanding is, correct me if I’m wrong Howard, you’re not yet, but you may deliver a profit in fiscal Q4 this year.

So, the question becomes aside from just what has it ever had developed in Q4 longer term, should we think that at scale PagerDuty is a lot like other enterprise software companies that in terms of margin structure, for example, generally speaking, or is there something different about this company?

HW: I think, the way I look at, and at Q3, I had someone who asked me earlier today, your impression around profitability now are a plus to the marked, and I said, “No, it’s not a response to the market. We’ve been on this path for past.”

We actually said, when we IPO’d, that our plan was to consistently improve operating margin and create operating leverage as we scale so that we could be profitable.

And that’s what we’ve been doing. And so, when I look at this year, it was 600 basis points better in Q1 than we were in Q1 of last year —

CML: On non-GAAP operating profit margin?

HW: Our non-GAAP operating margin was negative three, and it was negative nine last year.

And then if I look at the guidance, we provided on Q2, we said, Look, we expect to be between negative eight and negative nine, we were negative 15 last year.

So, a really big improvement.

And we committed to being better than break-even in Q4 of this year, and profitable for the full year, next year. Right?

And that is in line with some of the information we shared with folks when we spoke about that at our analyst day, that when we were $500 million company, we’re expecting that we should be able to be in a range of possibility of at least 5%.

And if you look at the trajectory on revenue expected, and if we continue to grow the same way, then you can see where you get to find that it’s not too far off.

And so, our view is that you’re on that same goal.

Now, when I look at the longer tune as you scale, the only model or estimation that we’ve provided was very rough numbers more than a year ago, when we said, “Look, we could see ourselves at an early being at least 10%,” and I would emphasize at this because our view is that we will have our gross margin today between typically 84% and 86%, we will continue to stay within that range of 84% to 86%, which creates a really great power in a platform for being able to deliver good operating margin, right?

And so, continue to buy efficiency in sales and marketing and G&A, but we want to protect investment we’re making in R&D, to try, for as long as possible, maintain a high percentage of our [inaudible] in R&D.

So, I think that we will actually get larger, well that been out a few years.

I think that we have such a solid basis, should be stand up the company in terms of those, our growth start operating model.

CML: Is that okay to you, does that seem reminiscent power of how for example, Oracle developed over. I realize you weren’t there from very beginning.

HW: Yeah. And I think the difference with Oracle is, because they were in the perpetual license business, they ended up driving a lot of revenue out of their license and renewals, right?

And of course, perpetual license is highly profitable business on a point basis.

So, I think it’s a little bit different when you’re a SaaS company — and we don’t have a big services component to what we do.

So, it’s a slightly different mode because you have less lumpiness in your revenue, but you don’t have the windfall of that variable revenue, either.

CML: It’s always the June quarter!

HW: That’s right. So, I think that for us, it’s the case, when you in the SaaS business, it’s often about building sustainable operating [inaudible] that you can’t rely on the windfall of variable revenue to make the margins look good, right?

In a culture or anything, you have to actually build consistent practice.

And so that’s what we’ve been thinking about, how do we make our products more efficient as helping the customer understand what they can use with, right?

So that’s part of our product is growth philosophy.

We’ve looked at ourselves and marketing motion and we continue to refine it to think about, well, how do we leverage a very strong online demand motion and also a self-service motion that we make available to all customers and how do we make that more accessible to more of our customers so that they can, one, help us be efficient, but it also delivers a better experience for the customer.

And then we think about how do we make sure that we, as a company, can start operating effectively at scale, and in simple terms, so much of our labor cost today is in the US, right?

Which is the most important location for us who have all of our resources. So, we started diversifying our workforce locally.

We’re building out a team in Lisbon. We have teams in the team in Chile through a small services acquisition.

So, all of those additional resources, or pockets of resources, globally, also help us build a different cost structure deliver better service to our customers because we’re now in more regions.

So, it all starts to play out.

CML: Well, that’s fascinating. I wanted to ask you about the one more macro question.

Jennifer was asked on the call, I think, and she said there’s no impact so far from macroeconomic factors per se.

And we’ve heard this from other companies as well, for example, Elastic, it’s all the same.

And we’re seeing, in fact there seems to be a resiliency, a mission-critical aspect, I think — as you’ve explained well here — to what you’re helping companies do.

But at the same time, we are hearing about hiring freezes and even some the layoffs.

So, do any of those factors, could they start to have an impact in your market, even if you are mission critical?

HW: Sure. We look at that — as a CFO, I’m mindful of the macro, reading the economists’ reports, and those things.

I’m trying to get an understanding of what we would need to do proactively in these circumstances.

I don’t believe that any business can say that they’re immune, right? Because you can’t anticipate how a recession could unfold and which part of an economy could be impacted.

And with some of the other clients that we have, whether it was pandemic or conflict in Europe — I don’t have a crystal ball about how all those things could come together.

But what I will say is that those are the things that we can’t control.

The nature of what we do as critical infrastructure is in companies related to their servicing their most valuable assets, their customers. And the teams that often are delivering those services are the teams that are protected even when there are layoffs.

So, I think that that’s the one piece that does play in our favor, is that the people that are typically using our product are actually doing work that is critical for that organization.

Then, I think the other part of it is, for companies in the mode that you’re at right now will often think about how can they be more efficient, and how can they get greater productivity?

And some companies choose PagerDuty because in the current state of the market, they have not been able to get the resources that they would’ve needed to be able to perform this much.

So, we’ve had some companies who’ve maybe had a network operating center and they’ve actually said, you know what, if we use PagerDuty, we actually can pare that down because we intended to re-source that anyway, but now we can use PagerDuty to actually deal with a lot of this work, or this activity, in more of a virtualized environment.

Or, it could be automated work, as we often get. So, I’d rather have development engineers focusing on new innovation than spending time trying to track down an issue.

So, when they use PagerDuty, it reduces the time that they spend on those types of activities, and gives them more time for innovation.

So, we end up being able to support the efficiency and productivity of an organization, which I think will be important even in a recession. So that part, as you said, not seeing any perceptible change in the demand right now.

That could change, who knows, but I do think that we are in a space where what we do is important.

And then the other is that our team are executed well, and we’ve seen consistent execution over many courses now, both from a growing market and from a product perspective.

CML: Okay. Excellent. I guess you probably read that slide deck from Sequoia? [Venture firm Sequoia Capital in May circulated a slide deck among portfolio companies advising them to reflect on ways to tighten their belts should the need for frugality present itself.]

HW: Yes, I did. I saw that.

There have been a few going around, and I think in the private environment, if you are a company that’s pre-revenue or low-revenue, you do have to think carefully about where you’re heading, right?

Because if you’ve raised money at some extreme valuation, you’re probably going to have to grow into that valuation in the current market.

And so that means that the cash that you’ve got, you better manage it carefully, because you can’t get another round and expect you’re going to get a better evaluation.

CML: Right. And so, you start to plan, they’re telling them practically think about how you can do more with the same or actually the same with less?

HW: Yeah, yeah. And, I mean, in some respect we even do that with our own process.

We recognize we are a company that’s growing fast.

It’s very easy for you to take up resources to solve a problem, you know, that’s human that you actually can solve with better process, better system for automation, and use that resource more effectively for something else.

So, we do that internally.

We continue to do that all the time in terms of looking at how do we actually get — because that’s our goal, is to be profitable — but how do we actually get there by building efficiency into what we do.

CML: I love that. ESG: How are you trying to do this, maybe, differently from others, if at all?

And how do you prevent it from being green-washing or various kinds of, just, sort-of, lip-service, and stuff that doesn’t really lead to anything?

HW: Yeah. Yeah. So, we approached ESG from the perspective of wanting to be sure — a lot of the things that you look at ESG we were doing anyway, right?

We just didn’t have a formalized program.

And so, we thought about, as we formalized the program, we wanted to make sure that it was aligned around the stuff that was important to the company.

So, for example, we already have a very systemized approach to diversity, right? And we value that diversity, we published the data on diversity and pay equity.

We already have a very solid approach around inclusion, which is from the earliest days of the company. We have employee resource groups that represent all people across the spectrum of life, right?

And that is part of what we bring in. One of our values is being yourself. And so that feeds into social.

From a social justice perspective, as a company though small, we’ve been prepared to take a stand on important human rights issues.

To our foundation, which we established fairly early on in our, even as a private company, various tech was early, but because we felt that we had a responsibility to do more in the world and we focus a lot on time, critical health.

And we’ve made grants from the last over 600 different organizations to help them in different ways advance their way product, that align with our sense of focus.

So those are things we are already doing.

So, we’ve set an issue what we’re doing from a certain perspective.

From a value perspective, we’ve already been doing work making sure that one less compliance and security and trust, all parts of what we do.

So, it’s a little bit of formalization around those things, but also trying to see how do we continue to move and drive improvement.

On the environment side, as a tech company, we end up where we are not a resource-intensive in terms of what we do.

Obviously, we use compute, but we don’t have manufacturing plants that are generating a lot of environmental damage.

CML: And you’re not mining crypto.

HW: No, yeah. So, what we’re doing a lot of it has been around sustainable office environments, around being mindful about compute, and we actually did our first sustainability assessment, which is included in our social impact report.

And we are now looking at how to develop science-based targets for ourselves that we can then hold ourselves to. This is a working-in-progress for us.

We wanted to make sure that we are taking tests that we can actually deliver upon.

Our board’s fully engaged, nominations and governance committee is actively involved in reducing a combination of each resource and some full-time consultants to help us.

But a lot of this has been about taking what’s important for the company and then putting some structure around it, so we can communicate in a language that the rest of our customers, our suppliers, and our investors can understand.

CML: Great. I love it. Anything else you want to mention that we haven’t gone into?

HW: Yeah. I think we spent a little time on the profitability component, I think that’s important for us.

But I think the side of perhaps as a company that that’s really important is continuing to build leadership capability, not just for us, the company, but for tech in general.

So, we’re really committed to you building the next generation of leaders within tech and being committed to ensure that we are actually helping to foster a community of leaders that are multi-dimensional leaders that can take on all sorts of responsibility. That’s always focus for us as a company as well.

CML: That’s great. Wonderful, well, keep doing the good work!

HW: Yeah. And of course, it’s always great to chat with you and honestly, we had a great quarter, and it’s good to be able to share the good news with other people and share some of the things we’ve done.

CML: We’ll be here for you!

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

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