Pegasystems Inc (PEGA) 2002 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Pegasystems second quarter earnings conference call. At this time all participants are on a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. If any one should require assistance during conference, please press star and then 0 on your touch-tone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Chris Sullivan. You may begin your conference.

Thank you Nicole. Good morning everyone and welcome to our second quarter 2002 conference call. Before we begin I would like to read our Safe Harbor statement. Certain statements contained in this conference call may be considered forward-looking as defined in the Private Securities Litigation Reform Act of 1995. These statements involve various risks and uncertainties, which could cause the company's actual results to differ from those expressed in such forward-looking statements. These risks and uncertainties include the impact the volatility of our quarterly operating results, difficulty and predicting the completion of the product implementations, and consequently the timing of our license revenue recognition.

Our ability to develop new products and evolve existing ones, inter-state market trends, the impact on our business of the ongoing consolidation in the financial services market, historically our core market, our ability to retract and retain key employees, reliance on certain key third-party co-relationship management of the company's growth and other risks and uncertainties. Further information regarding these and other factors, which could cause the companies actual results to differ materially from any forward-looking statements contained in this conference call, is contained in the company's quarterly report on form 10-Q for the quarter ended March 31, 2002 and other recent filings are in file with the Securities and Exchange Commission. Investors are cautioned not to place under reliance on such forward-looking statements and there are no assurances that the matters contained in such statements will be achieved. We will be filing our 10-Q for this quarter soon. The forward-looking statements, which we make on today's call, are based on our release and expectations as of July 23, 2002 only. We do not undertake any obligation to revise or update publicly any forward-looking statements expressed in today's conference call.

Moving on, let me begin by providing you with an outline of today's areas of discussion. First, I will provide a summary of our financial results for the recent quarter. Rick Jones our President and Chief Operating Officer will then discuss the company's operational accomplishments. Alan Trefler, Pegasystems founder and Chief Executive Officer will conclude with a market and product update. We will then open the floor for questions.

We are pleased to report our sixth consecutive quarter of revenue growth, profitability and positive cash flow. Pegasystems was able to rise to the economic challenges we and many others in our industry faced this quarter. We delivered sequential and year-over-year revenue growth increased our earnings and improved cash flow compared to the same period last year.

We proud of the results we have achieved this quarter and a attribute to success to our commitment to customer satisfaction, the strength of our technology, and our employee's attention to perform its management and accountability. Additionally, we remain focused on expense control and positive cash flow, while striving for continued revenue growth. Total revenues for the quarter were a record 26.7 million dollars compared with 24.2 million in the first quarter of 2002, an increase of 10 percent. This compares to 23.5 million, or a growth of 13 percent from Q2, 2001.

The year-over-year increase was driven by 10.5 million increase in software license revenue, partially offset by a 7.3 million decrease in service revenue. Software license revenue for the second quarter was 19.1 million compared to 16.3 million in Q1 2002, an increase of 17 percent. This compares to 8.7 million dollars, a growth of 121 percent from Q2 2001. The year-over-year increase was to impart to a 2.7 million dollar year-over-year increase of revenues associated with the first date of resource agreement. In addition, we saw a 4.9 million dollar increase in revenues from term license renewals, extensions, and additions.

As it has been previously noted in our NDA, we recognized the present value of multi- year term licenses by applying a discount rate that reflects the borrowing rate, applicable to our customers at the time the revenues recognized. This applicable discount rate moves directly with overall interest rate levels. Interest rates have moved steadily low throughout the past 2 years as the result of monetary actions led by the Federal Reserve Bank.

In the second quarter of 2002, the average discount rate applied by Pegasystems in reporting the present value of term licenses was 4.3 percent, which is 1.2 percentage points lower than the rate applied in the comparable period in 2001. Of the 10.5 million dollars growth in license revenue versus prior year, approximately 600,000 dollars resulted from the lower interest rates.

During Q1, 2002, the effect of the lower interest rates versus prior year was approximately 300,000 dollars. Our license revenue in Q2 includes 7.3 dollars of perpetual and subscription licenses for which cash has been received and an 11.8 million of term-license renewals, extensions, and additions. In the interest of transparency, our 10-Q for the second quarter includes more information on the composition of our revenues.

Service revenue for the second quarter was 7.6 million dollars compared to 7.9 million dollars in Q1 of 2002, a decrease of 5 percent, this compares to 14.9 million dollars in Q2, 2001, or decrease of 49 percent.

As we have said in the past, our service revenue is largely driven by implementation services, attributable to new license installations. As renewals and extensions make up a larger portion of our revenues, there are fewer implementation services required. Consulting revenue for the second quarter 2002 was 5.4 million dollars compared to 12.9 million dollars for the second quarter of 2001, a decrease of 58 percent. The decrease was partially offset by an increase in revenue for maintenance agreements.

Maintenance revenue for the second quarter of 2002 was 2.2 million dollars compared to 2 million for the second quarter 2001or an increase of 9 percent. The decrease in overall service revenue reflects the impact of

generally weak economic conditions, customer's delayed spending, and fewer new license contract. Customer reimbursements received for our out-of-pocket expenses have been reflected as services revenue in compliance with EITF 01-14.

In prior periods, the reimbursements had been reflected as reductant of cost of services. Services revenues and cost of services in the 2001 consolidated financial statements have been reclassified to be consistent with the current presentation. Revenues from customers outside the US were 20 percent of our total second quarter revenues. This is flat from Q1 and down from 26 percent for the same period last year. As was the case in the previous quarter, we were successful in leveraging relationships with existing clients to drive revenues. Additionally, 6 new customers contributed more than 2 million dollars in revenues this quarter. Our average deal size for the second quarter was approximately 950,000 dollars of license.

The average sales price for the licenses fluctuates due to the fact that we have a small number of large transactions in any given quarter. The average selling price in Q2 decreased from the 1.8 million dollar average reported for the first quarter of 2002. This decrease is primarily due to the fact that the revenue recognized from the first data resource deal was larger in Q1 than in Q2.

Revenue from FDR was expected to be flat from Q2 to Q3. The complete payment schedule for FDR was disclosed with our first quarter 10-Q. Gross profit for the second quarter was 18.4 million dollars compared to 16.3 million dollars in Q1 2002, an increase of 13 percent. This compares to 12.4 million dollars in the second quarter of 2001, an increase of 49 percent. Gross profit as a percentage of revenue for the second quarter was 69 percent, that's up from 67 percent in Q1 and up from 53 percent for the same period last year. The year-over-year and sequential increase in gross profit was due primarily to a higher proportion of license revenue relatives to service revenue.

Service gross margins for the quarter were slightly negative compared with the gross profit of 700,000 dollars approximately or 8 percent in Q1. This compares with 5 million dollars gross profit or 33 percent in Q2 of 2001. Service revenues and margins have suffered from fewer new license contracts during the past 3 quarters as well as continued weakness in software and services spending throughout the industry. Throughout the second quarter, management analyzed the services revenue prospects for the remainder of 2002.

In assessing the resouces needed to support those revenues, we have taken actions to address the service cost structure. Rick Jones will provide additional informations regarding these actions later in this call. Cost of license was 7.7 million dollars for Q2 2002; this is flat from Q1of 2002, and flat from the prior year after adjusting for a one-time charge of approximately 600,000 dollars of Q2 in 2001, for software related to our chatacter partnership. The cost of license is primarily related to purchased software and technology, which is amortized over its estimated useful life. Consistent with our accounting policies, we have not capitalized cost for internally developed software during the past few years.

Cost of services for the second quarter was 7.6 million dollars. That compares to 7.3 million dollars in Q1 of 2002, an increase of 4 percent, driven primarily by incentive compensation costs. Cost of services in Q2 2001 was 9.9 million dollars. This year-over-year increase of 23 percent was driven by reductions, sorry, this year-over-year decrease of 23 percent was driven by reductions in staff, and reductions in other compensation costs. The cost of services is recognized as expenses that are incurred. Consistent with our accounting practices, we have not deferred any material cost of services.

Operating expenses for the second quarter of 2002 was 14.7 million dollars, compared to 13.9 million dollars in Q1 2002, an increase of 6 percent. Year-over-year, our operating expenses increased 30 percent from 11.3 million dollars in Q2 of 2001. This year-over-year increase was primarily driven by increases in investments in the emerging Pega Rules business, increased in central compensation benefits, litigation fees, and sales and marketing expenses.

R&D spending for the second quarter 2002, was 5.6 million dollars, down from 5.8 million dollars sequentially, due to the reduction and use of third-party consultants. R&D spending was up 12 percent from 5 million dollars in the prior year. The increase versus prior year due to increased staff and third-party resources support investment in Pega Rules Technology, as well as other product developments and enhancements. Selling and marketing expenses for the quarter increased to 6 million dollars, that's up 4 percent from the prior quarter and 41 percent from one year ago. The year-over-year increased spending was due to higher staff and program spending in the application business, and investment in the emerging Pega Rules business. General and Administrative expenses for the second quarter 2002 was 3.1 million dollars, compared with 2.4 million dollars for the first quarter of 2002.

The increases were due to higher compensation and benefit costs and increase spending on litigation fees. Net income for the quarter was 4.6 million dollars or 13 cents per diluted share, compared with net income of 3.4 million dollars or 10 cents per share for the first quarter of 2002. This compares to a 2.7 million dollars for the same period last year. The 2 million dollars year-over-year improvement is primarily due to an 11 million dollar improvement in software license gross margins from increased revenues and this is partially offset by 5 million dollar reduction service gross margins to the lowest service revenues and increased operating expenses of 3.4 million dollars.

Accounts receivable days bill outstanding as of June 30, 2002 were 23 days. This level of DBO is unusually low reflecting reduced service billings. Historically DBO for service billings is higher than that for license billings. Deferred revenue balances increased to 9 million dollars as of June 30, 2002 compared with 8.5 million dollars as of March 31, 2002. This increase is primarily due to billings for fixed service projects, which have not yet been completed. Cash and cash equivalent as of June 30, 2002 increased to 49 million dollars, that's up 16 million dollars from December 31,2001 and double the levels from June 30,2001. Of this 16 million dollar increase, 12.8 million dollars was from operations and 3.8 million dollars is from employees stock option excercises. The 12.8 million dollar net cash provided by operations compared with 7.5 million dollars in the comparable period last year of 5.3 million dollar improvement. Of this 4.3 million dollars was due to a improved profitability and 2.4 million was due to a improved collections of accounts receivable, primarily from perpetual licenses, partially offset by net changes and accrued expenses, prepaid expenses other current assets in the third revenues.

While the possibility of seeking financing is still an option, we do not anticipate a need for additional capital fund operations in the near term. Headcount including contract is as of June 30,2002 was 519 compared to 516 at the end of the first quarter 2002. In looking towards the remainder of the year we anticipate market conditions to remain challenging, given our performance in Q2 the visibility provided by the FDR perpetual agreement and newly identified revenue opportunities related to recent customer renewals, we are reiterating the guidance provided in April for full year revenue and earnings and increasing our guidance for cash. Specifically we expect our full revenues to be 100 million dollars, plus or minus 15 percent.

As live band reflects contiued economic uncertainity in IT spending forecasts.We remained focused on keeping costs aligned with revenues and expected full year EPS will be 42 cents plus or minus ten cents. We are raising our guidance for the year and cash balances to 50 million dollars plus or minus 10 percent. This reflects the positive cash from operations from the second quarter and the larger than anticipated infusion of cash from employees stock repurchase in the second quarter. That concludes our financial summary. At this time, I would like to turn the call over to Rick Jones our President and Chief Operating Officer to provide additional insights for our results in the quarter.

Thank you Chris.

I too am pleased to be able to report our sixth consecutive quarter profitable growth. I want to thank our entire team for the hard work and the focus during the past quarter as we continued to perform in these uncertain economic times. As has been noted by many in our industry we are in the midst of a very challenging economic environment. We were able to achieve our performance due to our sustained and committed progress in achieving our operational goal. We have focused on customers as we have in the past and we've also focused on personal accountability. We were able to do with improvement in net income of approximately 70 percent compared to the second quarter of last year because of our organizational discipline.

Our financial performance is directly the result of deepened relationship with existing customers. We have broadened our reach across many of our customers through new implementations but we have also augmented these successes with new customer signings.

We had significant expansions in product extensions through out the customer base. I am particularly pleased with the continued expansion of our relationship with the Federal Reserve systems. As a result of success initially in a small majority of the Federal Reserve Bank we are continuing to grow our relationship with the Fed and now there's a platform for check adjustment. In addition we recorded more than 2 million dollars in revenue from six new customers during the quarter, so we continue to grow our customer base.

Two new license agreements deserve particular mention; the first is the Hostels Contribution Fund of Australia, which is a continuation of our success in the healthcare business. Second, is the recently announced success of Inland Revenue. These two relationships will continue to provide important service and license revenues for the second half of the year. Inland revenue success needs particular mention. As we announced in our press release, EDS, a partner of growing importance to us played a key role in both gaining interest into this account and helping us to successfully win the engagement. This deal is significant for several reasons. One it shows both progress and traction in our relationship with EDS and two it was an instance where we competed head-to-head in perhaps the most extensive selection process I have ever been a participant in, against competitors of the likes of Oracle and Siebel. We won because of our software's ability to automate work and give you more than simply present contact information. We believe the success in Inland Revenue in addition to providing significant revenues from the initial contract, will provide entry into upcoming projects with Inland Revenue. It also positions us to provide services more broadly to the public sector.A vertical market in which we had not had a relative historical preference but one in which we can leverage our historical strengths by providing similar transactions oriented capabilities to our substantial organizations.

Soon, we expect that we will be announcing an additional relationship with EDS in the British Post office, which has been renamed

. We now,

quarter that we were again active in the credit card services market. Over the past 90 days, we have identified a number of significant credit card services opportunities. In fact the number of opportunities in our pipeline has nearly doubled. We are building on our historical strengthening in the credit card market and we have launched our new template of credit card products called PegaCARD SERVICES. We expect significant positive developments in the second half of 2002.

Overall, our pipeline remains strong. In fact the pipeline have increased by nearly 20 million dollars since the end of Q1. Importantly we have not lost significant deals directly to competitive solutions or to internal IT projects rather we have continued to see a lengthening in the purchasing cycle. We are concerned by the limited number of new customer license signings in this quarter and over the last year. However, we remain optimistic that we will be able to reverse this trend during the course of the coming months. But, this reduced number of signs has decreased our service revenues and resulted in the core service margins for the quarter.

Our commitment has been to maintain expenses in line with revenue expectations. As a result due to the reliable services revenues we have reduced our staff by approximately 25 during the early parts of the third quarter. These actions looks to be completed within the next week. However our expectations for utilization rate are that they will improve in the latter part of the second half and in fact today our utilization rates are at the highest level they have been this year. We commit to maintain discipline management practices and to continue to work aggressively to communicate with merits of our products to customers in the marketplace. We are realistic about the economic challenges for the second half of the year. But we believe we will continue to execute effectively, we are all controlling our expenses. We are confident in our ability to deliver value for customers and partners, our employees and ultimately for our shareholders.

At this time, I would like to turn the call over to Alan.

Thanks Rick. I will be brief it and then will open that up for questions. In terms of the economic settings which we operated it is pretty clear that the economic recovery everyone has hope for is not yet a reality. And it appears to be a tough economic environment not just for the rest of this year but possibly in 2003. Nonetheless we've got a tough team here. They are persistent, they are credible, that's one of the things that happened from having experienced prior recessions and having been in business since 1983 and as a result I am feeling very optimistic about both Pegasystems' short-term and long-term performance.

And I'm also encouraged by some of the industry analysts forecasts. I quoted from

at the last call, at this time I would like to quote from Giga, which said recently "Despite the slowdown, CRM has not reached its saturation point presenting opportunities and potential for vendors and solutions that demonstrate value". And the work we have been doing to both deepen our product line interface with Seibel to other types of things to give us greater opportunities, I think both well for what we can do on to CRM stand. Relative to our traditional strength and business process management, the automation of complex business processes AMI also recently said "BPM business process management technology will reach 3.6 billion by 2003. "So this is a market where we have a lot of potential as we continue to deepen our product line, focus on getting some new line business, and working hard to role out new products, we will talk about.

So we have been realistic here. We are planning based on what we see in the marketplace. We see the source as long sales cycles or we see tension in the customer base or the prospect base but we still continue to see interest in our applications products and our capabilities and we are particularly, one of the thing that strikes me is how our customers and our prospects like the control that our technology gives out, how they get to be much more in control of the way they rule out and the way they give all of their operations. This is good from the point of view of how they provide service. It may actually lead in some cases to reduced service revenues for us as customers as their doubts get tight bring some of these in house but the reality is that leveraging our products is leveraging our capabilities and we think it is ultimately very good for the business.

So we see the interest and we are also seeing as we've rolled out PegaRULES, our new generation of technology. We have seen a very significant increase in request for proposals and contacts with early-adopted prospects, as I will talk about in a moment. But let us make it clear what we are doing about our core business. We are strengthening, we are building to I think a strength that we have for a long time but we deliver tangible productivity operational improvement that our software enables companies to do their jobs better and the HealthNow implementation cited in our press release talks about how in just 3 weeks of use they were able to reduce claims inventory by 40 percent. It is this sort of return that on investments that in these tough times placed to our strengths, placed to our history and it is why we are able to sit here with the results far better than, than lot of other organizations have been able to post. These examples of all help justify the expenditure required for our software and help encourage people to move forward in tougher times. To wrap the discussion of the business, let me just say I am very proud of the performance of Pegasystems' team, in environments that are tough they really hunkered down. They put a lot of energy and effort into both working on the short-term imperatives and the longer term developments and I am very pleased that they have shown the toughness, the attention to detail, and the follow through that we needed to get the financial results across the board with Chris and Rick have been able to report.

As we look forward one topic that has been near and dear to my heart over the last several years has been the evolution and now the beginnings of the Pega Rules business. The creation of what we call the Pega Rules process commander, a new generation of business process management capability and I am very pleased in the last quarter we actually signed up our first Pega Rules partners because using partners to deliver this technology is going to be very very important to the ongoing strategy and we also have begun proof of concept implementations with several companies in divergent industries and I see this product is an excellent opportunity for us to both build some new names, bring some new companies into the pool and also leverage our historic strength as we think about where the business process management market is going. I anticipate positive developments being reported in the second half of the year and we are hopeful we'll see revenue from Pega Rules process commander in the second half of the year as well. At this time I'd like to open the call up for any questions that people might have.

Thank you. Ladies and Gentlemen if you have a question at this time please press the 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue please press the pound key. Once again, if you have a question, please the 1 key. Our first question comes from Mark Murphy.

Hi guys, congratulations on a great result here. I wanted to ask you how does the EDS pipeline look outside of Inland Revenue?

This is Rick, while the BOCA the relationship with BOCA is outside of EDS or outside Inland Revenue although it remains with the British government. I'd say the other major development in the EDS relationship has been significant interest in some of the healthcare product. Our healthcare team spent a number of days in Texas last week dealing with three or four different RFPs and so I am hopeful that we will see some traction in the healthcare market.

Okay. Can you give us a look back at Q2 and may be talk to linearity in the quarter for all the deals that were signed and may be how you feel about the pipeline as you look forward into Q3, may be how the linearity sales is at the beginning of Q3?

This is Chris. The linearity continues to be a challenge for us as it is for most of our competitors and so we continue to see the purchasing behavior consistent with what we have experienced in the past and we see a large number of our license deals closing in the later part of the quarter or in cases we are recognizing revenue for previously contracted agreements in which we are awaiting the delivery of the implementation. Those things tend to be, tend to be quarter-end issues significantly. So that continues to be the case. In Q3 again overall the pipeline has improved and we are up to a feeling, we are confident that the pipeline is stronger than it was as we exited the first quarter of the year. Though the linearity still seems to be an issue for the upcoming quarters. That is something that we are dealing with at least to the balance of this year, and something that, well, we tried to address to our own internal selling efforts, it is something that is peculiar to the industry in one that we continue that to build.

But having said that, I would tell you that we are not making unreasonable concessions, we are not doing any unnatural acts, which you see sometimes happening with other companies. We are standing firm, we are holding to our principles, and unfortunately many of the buyers have been trained, to adopt a certain behavior posture which we end up having to respond to, but we are responding to it materially and good balance as we go forward.

How many of the Federal Reserve Banks are you counting as new customers in that quarter?

Three.

Okay. And Alan, can you speak to the competitive landscape and may be, and give us a inside into how that might have changed in the past three to six months, are you seeing any less of Siebel that would explain some other softness that that company is seeing, are you seeing any more less of companies like Cordiant out there?

Well you know it's Interesting. From our perspective, I think the competitive landscape has changed in a couple of ways. One, customers are little less interested in the wild promise of increased revenue, and are very much interested in pragmatic return on investment. So that's made it easier for us, I think to engage. Also, we are kind of, in the sort of, ironic position that whereas, frankly, most of the industry has kind of melted down and is now struggling to demonstrate financial credibility. We've actually reversed that. We've shown increased ability to perform even if times have gotten tougher over the last couple of years. So, I think that's really boosting our credibility as we go forward into these sorts of deals. We still see Siebel, as Rick mentioned. I think that we'll find ourselves able to compliment them in places that have already bought Siebel, and able to propose alternative shorter term, ROI oriented projects, in other sorts of places would BPM has lot of value.

Thats an important point the to the extent that we think that CRM market place is going to more into a business process management market place, as people look for ROI out of their contact center investments, we think we're pretty well positioned.

That is going to be a tough competitor than ours.

Okay. Still Rick do you think, Rick I want to ask just based upon on what you have just said there. You think you are well positioned to benefit from the removal of exclusivity that came off with the restructure of the FDR contract and, you know, shows some revenue benefit there in the second half of the year?

Yes. We are very excited by the reception in the credit card market place to our being able to be sell into that market again.

Yeah, thanks very much.

Thank you.

Thank you. Our next question comes from

.

Hi guys, nice job. Chris on the discount rate, could you go over the change over last year again and in the affect that had on reported revenue?

Sure. The discount rate change year-over-year, if you look at the second quarter versus the second quarter a year ago, the discount rate that we have applied dropped approximately 1.2 points and that's consistent with the interest rate changes overall and of that 1.2 of the impact is that it had a 600,000 dollar favorable impact to the overall license revenue that were recorded, so the license revenues grew 10.5 million dollars of which 600,000 is attributable to this discount change.

Okay. So, barely insignifant there.

Right and the first quarter of the year was about half that itself.

Okay, great and then secondly, you broke up term versus perpetual and it looks like about a 60/40 split on license revenue for this quarter, is that typical for you guys?

That I think that we are seeing, it's hard, because of the variability we have quarter-to-quarter, to say that what is typical but we do believe that we are seeing a directional movement away from the term and towards perpetual mix, greater mix of perpetuals. With that again, that will bounce around with the large values small number of deals that we have in any given quarter but our selling model right now is that for the most part, the new customers are being engaged on a perpetual license model and our existing customers tend to like and want to renew on the term but there are exceptions in both cases.

Okay and new customers of the six, I think you gave out the number, the actual amount of revenue for new customers this quarter?

Yeah, it was slightly over 2 million dollars before the revenue associated with new customers this quarter.

Okay.

That's total revenue sales and services, I mean license and services.

Okay and then finally, on the vertical expansion efforts, could you talk a little bit about how well that's going with healthcare and insurance?

Yeah, this is Alan. I am very pleased that we are continuing to get deepening traction in the healthcare and insurance markets. The new thing about HCF that we announced is that it represents our first healthcare customer in the Asian market we previously talked about BUPA earlier in the year as being our first 4 into Europe in the healthcare space and of course, we have talked for while about some of the great progress with sure customers and other types of customers we have domestically including the HealthNow example that I gave. I will tell you that the pipeline is excellent but the closings are slow. So, it's one of those situations where BPM matters, people care a lot about that. They care a lot about improving the relationships with their customers and keeping them but lets face it the economy is tough.

And Alan, have you seen any material change in the beginning of Q3 from the environment you saw in Q2?

I don't think it is materially different to tell, I think, it is neither worse nor better, it is a tough one and the good news from our prospective is that we have been able to score particulary in healthcare, the insurance that claims business, we have been able to score some documented and now public wins which give us that much more creditability when we engage with healthcare providers. So, I dont think the environment is any better, but I think we have got some better tools with which to pursue prospect.

Okay, great thanks a lot.

Thank you.

Our next question comes from Jim

.

Morning gentlemen.

Morning Jim.

Just a couple of questions, you answered most of my backlog questions, but I'm just curious about with the lingering sales, how long the 20 million or the increased backlog will take to actually turn in the revenue?

That's a tough one. If you understand the way we recognize license revenue you realize that first there's a sale and secondly we have to fully implement and have the software accepted into production. So it's kind of a two-stage process. Having said that from a services perspective typically we begin to see revenue often before we even announce that we sold a software license, as in the case of some of the new customers that we talked about generating revenue for us last quarter, where services only customers only who hopefully would result in significant license sale down the road. The sales cycle tends to be bifurcated however, we're seeing a number of instances where from first identification to the actual close of an opportunity is in the six month range and then we're seeing others where from first identification of the opportunity to closing of the deal would be within the 12 to 18 months range. It doesn't seem to be much in the 6 to 12 month level. We do not put anything into the pipeline, nor quote it as a pipeline item until a project has been identified at a particular customer. So every item in the pipeline today is an identified project, which the prospect has represented to us they have funding for. That's a long ended answer but it s a complicated question.

Yes its a little hard to ,in other words to quantify it for me really, I mean if what is it historically I mean you have any ideas of some sort as percentage of what you've noted?

I'm not sure of that, how quickly an item in the pipeline gets translated into revenue.

Right.

I think, if you work with 9 months kind of funding, that's probably blending both our opportunities with existing customers in new name opportunities.

Okay.

That's probably a reasonable blend.

And what is the new customer pipe line look like for the third quarter then? What percentage of the backlog is coming from new customers?

That is something that we haven't traditionally disclosed but we have seen an increase in the number of new customers in the pipeline and opportunities that we have identified, so we are seeing that number increase by parts of it were disclosed.

We have made a conscious decision to increase our focus on new customers through the second half of the year. Having you know, made a conscious decision I think a year and a half ago, to really deepen our base and work off that. Still see a tremendous amount of potential on that base, given the types of customers you guys consider they are. Got to, we have made the conscious decision but now the time is right for us to go and begin the cast the net wider and you are going to be seeing us do things to make that possible.

Then the next question would be about the selling and marketing expenses. That's going to be consistent now or will it continue to grow higher as you try in the comment on what you just said with the new customers?

This is Chris. We are working with and toward in evolving a timeless business models for the entire business and we have, over the last year to, been clear I think in our comments, what we think we need to improve our overall investments in sales and marketing. So you will see as the percentage of revenue that that continues to move up relative to what we told in Q2. Our investment is going to be a fueled by both investment in the emerging business technology as well as the existing application business. So we do believe that as the percentage of revenue, we should be higher than the percentage reflected in the second quarter. That said, we will, our timeless model does indicate that we would like to be in 15 to 18 percent pre-tax profit base, so we will obviously have to find assets elsewhere. But the key is, that we are working within the context of the timeless business model that we applied for the last year or two.

And we added about 8 to 10 new quarter carries at the end of the last year, early part of this year, and my expectation is you will begin to see them delivering results as we go into the second half.

Okay. And how are they, you say, compensation is the base plus commission? What is the usual compensation?

That is correct. It is base plus commission and they typically carry between the 2 and 3 million dollar quarter proportion.

And then, the other question I had is that, could you talk a little more about the third-party partners and just about what stage you are in, with some of the people and I know, if you talk a little about EDS . Can you talk about what else you have going on there?

Yeah. For the the application business. We have been working with and focused on partners like EDS but there are also others. There are major SI firms that we are working with like Accenture etc. to be able to engage in the what I would call the traditional large projects that we have done and been intimately involved in as we think about the Pega Rules process commander business we are integrating with partners with a sort of a, different model in mind with thinking that the new technology as it rolls out over the next 12 months has the opportunity to be far more installable by partners than our traditional work, frankly without our involvement. And so, it's very consistent with the feedback I've given in the past. That is you look at us with a multi year lens, you should think of us as becoming more of a traditional software oriented business, still what I think our strong services armed to be able to help out where and as needed but is a strong software business that tends to use partners who have customers do their own work as we go forward.

Okay thank you.

Thank you, our next question comes from Mark Shepherd.

Hi Fellas.Great quarter and then question on PegaRules coming up in the next 6 months in your 100 million plus or minus figure for revenues. Do you include in there anything for PegaRules or is that if anything hits going to a bonus to that number?

We have a small amount in there as we think about as to Pega rules, there are, you know, a couple of things that we keep in mind as we think about PegaRules revenue. One thing that we keep in mind is that it is a very young product and I'll tell you as I mentioned we have begun proof of concepts with real world class companies and I'm absolutely thrilled with the both the perception and the types of the things that's clear that we can do with this technology, but it is still very young and products when they are very young are still having having the training materials finished or having their documentation done. We got in a lot of progress we still have a lot of work to do, so it's difficult to caliber exactly. The other factor has to do with the recognition of revenue, we think that long term PegaRules process commander particularly as distributed by third parties, offers other ways in which revenue could be recognized because we won't be involved in some of these implementations but in the short term as you would well expect we are extremely disciplined and conservative about our revenue expectations and as a result we haven't baked the whole lot in to what we think is going to happen this year, but we got to really make sure we are on top of exactly the status of those projects and exactly were we are going. So I think its both appropriate thoughtfulness around the sales prospect and also great, great conservatism around the whole accounting and revenue recognition on that.

Excellent thank you.

Thanks.

Thank you, our next question comes from James Freidman.

Hi, regarding the 2 million contributions for new customers in the quarter. Could you remind us what the revenue contribution was for new customers in the Q1 2002 and in the Q2 2001, I wonder if you have that Chris?

I don't have that in handy. I couldn't follow up with that question, I'll ask Lee to take that and to follow up.

Okay, thanks and did you convert any existing customers to perpetual from term in the Q2?

In Q2, no.

Okay. Regarding the staff reduction on the service side, I think you said 25 people, what's the total number of service professionals?

The headcount reductions were primarily service, there were small number of reductions in other areas of the company but it was primarily services so just to clarify that, in our headcount well we don't break it out exactly our services head count is approximately 20 to 25 percent of our head count and then, as I said 25 reductions Rick mentioned the majority were services.

Okay, was that actually a Q2 event or is that a Q3 event, and I think your total head count only went down a couple.

The events that Rick referred to were actions take in Q3 and will reflect in the Q3 ending head counts.

Great. And then did you disclose the revenue contribution from any of the new customers inland UK in particular?

No we do not.

Okay.

Most of the revenue from Inland revenue will accrue in quarters after Q2 because of the way we recognize license revenue.

Was that a term perpetual?

That will be a perpetual, but only the services revenue, only some percentage of the services revenue that ultimately will be associated with that client; were performed in a Q2 and recognized in a Q2. No license revenue was recognized for that.

In the applications business, we are really quite conservative about the rate at which we recognize revenue even when the license is a perpetual license.

I heard you already recognized the revenue from HealthNow?

Well we have recognized on our service revenues but the license revenue primarily is not been recognized, remains to be recognized in the second half of this year.

Okay.And if you could just trouble you later for follow up with regard to the new customer contribution from Q1 2002 and Q2 2001?

Sure I will follow up with that.

Thank you.

Thank you. Once again if you have a question please press the 1 key on your touch-tone telephone. Our next question comes from Michael Chapman.

Good morning gentleman. A couple of short questions. With the head count reduction, what would you expect for service gross margins roughly speaking over the end of the year?

We do expect service gross margins to improve Mike, but we think over time we have, we rely on a combination of events obviously we are taking some actions to address the utilization, but we do need to see a pick up in the service revenues to get back to the level that we would like to be at. But we do expect that service revenues will improve for the second half of the year but no achieve our timeless goals of mid 30%.

All right. And secondly when you transitioned to new customers coming on to the Pega rules and process command or product line what's your general expectation for the ASP or you know, the average license revenue generated per customer?

I think we are going to see that the ASP will be somewhat lower. The traditional ASP that we talked about has been you know, half a million to two million dollars. I think we will see this from an initial order perspective being in the quarter of a million to half. That's frankly very much by intent we really do want to move this into more a very volume business taking our traditional strength and high end BPM and making them more available to broader markets that was one of the key design goals as we began this initially. Having said that our initial customers may end up being higher than that, well from a revenue timing perspective as I mentioned, we're going to be very conservative about selling expectations.

All right. And the last question, first data revenue in Q2 was as specified in the last 10-Q as laid out?

Yes. It's exactly as it was laid out in the schedule that accompanied the QA, Q1.

Great thank you.

Thank you. Our next Question comes from Robert Schwartz.

Thanks. Just sum up, the back up of, I'm positive you've covered this earlier. What are your, How many bag carrying reps do you have?

We have got 26 carrying reps today.

Okay.

And that includes about 4 in the Pega Rules Business.

Okay, and what has happened with maintenance renewals? Have you seen the drop at rate, and has there been a lot of pressure on the price that people for paying for maintenance?

In general, we are not seeing a reduction, but there are some instances in which, you see, the element of the competitive pricing pressure we are seeing but in general now we are seeing a rate supported.

Okay. And what about renewal rates. Has it gone down?

Our renewal rates in terms of the overall percentage of renewing customers who do choose to renew versus not?

Correct.

No. We are not seeing any significant decline yet. Again, as we said in the past, we have a high rate of renewal and usually a large driver for the decisions not to renew our other than competitive their consolidation or all other issues that drive it, but we are not seeing a significant change in our renewal rates

And last question, can you talk about what you are seeing in Europe competitively, and what's the buying behavior in Europe right now. We are hearing from other vendors that business sentiment has turned somewhat sour over the last couple of months.

Well. If you look at our Q2 results, we, as we suggest, only 20 percent of our revenues were international. And our biggest presence is in Europe, so, we too have seen a decline in activity in Europe. Having said that, we've, we've got some good traction as we mentioned with Inland Revenue and the British Post Office, we've also got a number of opportunities with respect to extensions at existing customers. Let's say the Economic environment in Europe is tough.

And the

announcement that we made earlier this year, I think is just a great example of how, even though the environment was tough, we were able to, we were largest provider of private health Insurance in the UK. And were able to get in there and become an important part of how they are viewing business process management going forward.

Thank you very much.

Thanks.

Thank you. Our next question comes from

Chris hi.A couple of quick questions to follow up on the two big contracts Inland Revenue and HealthNow, I think you mentioned both of those the perpetual licenses would be recognized in the second half and so far it has been mainly service revenue consulting I guess, has most of the consulting on those been already recognized?

In both cases as in our cases and services we recognize implementations that are fixed price in nature on a cost recovery basis so we are only recognizing to the degree that we incurred expense until the implementation virtually complete and the fair market value established. So we have recognized services revenues there is, in both cases it is still significant consulting and implementation services ahead of us and then when those are complete then both of the margin of the profit associable to service implementation and the license revenues will be recognized and well we are hopeful that both those will close in the second of the year but as we said before that is dependent on a number of things including the customers speed which to implement so we are hopeful that will be in the second half.

And the revenue from those two is that included in the 2 million from new customers that you mentioned earlier?

There were some service revenues associated with one of those I think but it was primarily other customers.

And none of the potential license revenue was included in that number?

Correct. It's only what was actually recognized in the quarter.

But that was, the services from Inland was a part of the 2 million you said? I am trying just to clarify.

Yes, there is a small amount in there for the 2 million.

In terms of, if I look into your quarter, this quarter, you said I think about 600,000 which really formed discount rate versus last year and then about 2 million is really from these new customers so I guess that the jump is mainly composed of renewals on your existing customer base, is that a level that you sort of to see continuing forward, the renewal rate or what's this sort of an exceptional quarter in some fashion in a more renewals than we would typically expect like say third quarter?

Well in terms of our visibility in the pipeline, these, we have visibility to these, you know, one, two, three, four quarters in advance so there is visibility but in many cases the renewals are renewals that we have built into the pipeline that are either at the time of this renewal or in advanced those renewals based on certain factors often driven by the customers preference and in those renewals there is also opportunities in terms of additional seats just in terms of implementations in other units of geographies within the company, the customer base as well as just total seat count increases, so we have both the visibility to them and we see opportunities beyond just the standard value of the scheduled renewal, those things are facted into our pipeline, so as we look forward into pipeline, we see a combination of those anywhere from 1 to 4 quarters in advance of their occurring.

Okay and almost to the end but your revenues for the first half of the year have been about 51 million according to my calculation but you kept your guidance to about a 100 million, is that just being conservative or are you, you know not really expecting a big ramp up in the next 2 quarters?

No, I think the 100 million reflects our view of the year-end outlook, given all of the uncertainties we are dealing with; the economic environment being primary among them but also again, then uncertainty that we point to in each one of our...each opportunity we talk to revenue which is light variability on a small number of transactions. So, while we look forward and expect a 100 million dollar, there is a number of things that make that variability real. So, it's up or down around that 100 million dollars.

Okay, thank you very much.

Thank you. Gentlemen, I am showing no further questions at this time. I would like to turn the program back to you.

Right this is Alan, I would like to thank everyone who has listened. I would like to thank our stockholders, our customers, and our staff, and look forward to talking to you again in 3 months. Take care everyone.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Thank you and have a great day.