Pegasystems Inc (PEGA) 2002 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pegasystems third quarter release conference call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question and answer session, and instructions will follow at that time.

If anyone should require assistance during the call, please press star, then zero, on your touchtone telephone.

And as a reminder, ladies and gentlemen, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Beth Lewis.

Ma'am, you may begin your call.

Before we begin, I'd 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 of the volatility of our quarterly operating results, difficulty in predicting the completion of product implementation and consequently the timing of our license revenue recognition, our ability to develop new products and evolve existing ones, interest rate market trends, the impact on our business of the ongoing consolidation in the financial services market, historically our core market, our ability to attract and retain key employees, reliance on certain key third party relationship management of the company's growth, and other risks and uncertainties.

Further information regarding these and other factors which could cause the company's actual results to differ materially from any forward-looking statements contained in this conference call is contained in the company's quarterly reported on Form 10-Q for the quarter ended September 30, 2002, and other recent filings on file with the Securities and Exchange Commission.

Investors are cautioned not to place undue reliance on such forward-looking statements, and there are no assurances that the matters contained in such statements will be achieved.

The forward-looking statements which we make on today's call are based on our beliefs and expectations as of today, October 23, 2002, only.

We do not undertake any obligation to revise or update publicly any forward-looking statements expressed in today's conference call.

With us today we have, Alan Trefler, Chairman and CEO;

Chris Sullivan, CFO; and Henry Ancona, President and COO.

Henry, would you like to begin?

Thank you

and good morning everyone.

By now, you should have had a chance to review our earnings release.

In summary, we reported 25.6 million in revenue, up from the 23.9 million in revenue we reported in the third quarter of last year.

Seven point eight million in operating cash flow and 13 cents in diluted earnings per share.

This performance is testament not only to the strength of our product, but also to our ability to execute.

So, thank you to our entire team for your continued hard work and performance.

Before going into an operational review, I'd like to talk about my reasons for joining Pegasystems.

As you know, I joined Pegasystems at the end of July.

And the reason I joined the company is because I've see in Pega a fundamental opportunity to change the way business does business.

For 20 years Pegasystems has been a company building domain expertise using rules to automate complex business prophesies, primarily for the financial services and healthcare industries.

But it turns out that the applicability of this expertise is much broader.

Every industry today is a candidate for a platform.

On this, users can change their business prophesies with only a mouse click.

Every company today is a candidate for a platform that enables real-time changes to changing market condition.

And every business today is a candidate for a platform that can quickly and easily define business practices and push these decisions through the organization.

That's why I joined Pegasystems.

I see in Pega the platform that enables businesses to change the way they do business.

So now we'll talk about the quarter, including our product and our operation.

Our performance this quarter has as its foundation a tripod, products, clients and a continued emphasis on efficient operations.

The first leg of the tripod is products.

During the quarter, for example, we released an improved version of our integrated investigation suite version 3.2.

This product enables the integration of payment, securities and treasury investigations processing onto one platform so that banks can reduce the duplication of

.

This suite also extends the Cross Legacy system and databases.

So what does this mean?

These kinds of products enable us to further penetrate our existing client base and that's exactly what we did with Rabobank.

Rabobank first deployed our integrated investigation solution in May 2001 and based on high satisfaction with the first deployment, here it is less than two years later and they're extending the deployment to branches in London, New York and Luxemburg.

Why?

One, our solution which allows network banks to track investigations independently resulted in an 80 percent drop in the number of phone calls to the Rabobank headquarters.

Two, with the extended deployment all members of the network have enhanced productivity by additional functionality over the Web, viewing full account status, transactions and outstanding investigations in real-time.

In other words, enhanced productivity across the entire Rabobank network.

The second leg of our tripod is clients.

Although the environment for new client license signings remains challenging, we signed four new booking clients during the first quarter.

During the third quarter one of which was the Bank of New York, we were delighted to sign the Bank of New York, a brand new client with deploying all solutions for funds transfer operations.

After a strenuous evaluation, we believe that it was the capability and scalability of our product that enabled us to sign this new client.

I am also very proud to tell you we signed our first Pega Rules Process Command, a client during the quarter and a pretty good find at that, Allstate.

We were selected for all the reasons we developed this new product.

Allstate wanted an open system that could store to many databases.

Second, they wanted a java based system, third, the version and capability where you can try new processes and rules and then roll back to a prior version that is desired, and fourth they wanted business users to control the rules.

In other words, you don't need an entire IT department to make rules changes.

This is proof, I think that we are on the right track with the functionality offer by our rules product.

Now about our pipeline.

We are seeing continued lengthening of the sales cycle as customers defer purchasing decisions.

We have also instituted a more disciplined pipeline evaluation methodology, which has resulted in a modest sequential decline in our pipeline, although it is up from the end of last year.

The pipeline of our new Pega Rules product, has increased significantly, although obviously from its small base.

The leg of our stool is our continued commitment to improve the productivity of our organization.

As a result of continous softness in our services margin, the challenging bookings environment and increasing operational efficiency across the company, we are taking action to reduce our workforce by approximately 50 people during the fourth quarter.

In terms of marketing, I think Pega Systems is the best kept secret in the software industry, and I hope to change that.

One of our first initiatives is to make ourselves more visible to our target market.

For example, we are participating in more conferences, and client oriented events, and already are seeing an increase in lead generation.

We have a speaker bureau program, a global trade show campaign and more, all designed to maximize our visibility.

In sum, we continue to have a enthusiasm for our new rules product that builds on our applications product expertise, and we continue to have enthusiasm for our new applications product, that allows for deeper penetration of existing clients as well as new sales to new clients.

With that, I will turn the call over to Chris for a discussion of the financial.

Thank you Henry.

We are pleased to report our seventh consecutive quarter of year over year revenue growth profitability and positive cash flow.

Pega Systems was as able to rise to the economic challenges we and many others in our industry faced this quarter.

We are proud of the results we have achieved this quarter and tribute this success to our commitment to client satisfaction, the strength of our technology and performance management and accountability.

Total revenues for the quarter were 25.6 million dollars compared with 23.9 million for a growth of 7% from Q3 2001.

This year over year increase was driven by a 6.3 million increase in software license revenue, partially offset by a 4.6 million decrease in our services revenue.

The year over year software license revenue increase was due in part to a 4.2 million dollar year over year increase of revenues associated with the First Data Resource Agreement.

In addition, we benefited from the restructuring of a reseller agreement previously accounted for on a subscription basis to a standard term license fully to recognize 2.4 million in license revenue.

As has been previously noted in our MDA, we recognize the present value of multi-year term licenses by applying a discount rate that reflects the borrowing rate applicable to our clients at the time the revenue is recognized.

This applicable discount rate moves directly with the overall interest rate levels.

Interest rates have moved steadily lower throughout the past two years as a result of monetary actions led by the Federal Reserve Bank.

In the third quarter of 2002, the average discount rate applied by Pegasystems in recording the present value of term licenses was 3.4 percent, which is 1.3 percentage points lower than the rate applied in the comparable period in 2001.

Of the $6.3 million growth in license revenue versus the prior year, approximately $225,000 resulted from the lower interest rates.

Year to date, the effect of the lower interest rate versus prior year was approximately $1.1 million.

Our license revenue in Q3 included $10.1 million in perpetual and subscription licenses, for which cash has been received, and 6.8 million of term license renewals, expansions, and additions.

Our third quarter 10-Q, which has been filed, provides a table highlighting the composition of our license revenue.

Services revenue for the third quarter was $8.7 million, compared to 13.3 million in Q3 of 2001, a decrease of 35 percent.

This compares to $7.6 million in the second quarter of 2002, or an increase of 15 percent sequentially.

As we have said in the past, our service revenue volume is largely driven by the implementation services attributable to new license installations.

Consulting revenue for the third quarter 2002 was $6.4 million, compared to $11.3 million for the third quarter of 2001.

That's a decrease of 43 percent.

This compares to $5.4 million in Q2 of 2002, or an increase of 18 percent sequentially.

Maintenance revenues for the third quarter of 2002 was $2.3 million, compared to $2 million for the third quarter a year ago, an increase of 15 percent.

This increase is attributable to higher license revenues from a year ago.

Client reimbursements received for out of pocket expenses have been reflected as services revenue in compliance with EITF01-14.

Prior to Q1, 2002, the reimbursements had been reflected as a reduction to 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 clients outside the U.S. were 25 percent of our total third quarter revenues.

This is a five point increase from Q2, and nearly double that of Q3, 2001.

We traditionally see quarterly fluctuations around our international business, but on an annual basis, revenues outside the U.S. have held steady in the low 20 percent over the past few years.

As was the case in the previous quarter, we were successful in leveraging relationships with existing clients to drive revenues.

Additionally, six new clients contributed more than 4.8 million in revenues this quarter.

Our average license deal size for the third quarter is approximately $1.482 million.

The average sales price for license fluctuates due to the fact that we have a small number of large transactions in any given quarter.

The average selling price in Q3 increased from the $950,000 average reported for the second quarter of 2002.

This increase was driven by four deals that exceeded $1 million in the third quarter.

Gross profit was up year over year due primarily to a higher proportion of license revenue relative to service revenue.

Sequentially, Q3, 2002, versus Q2, 2002, we experienced a decrease in gross profit, as service revenue comprised a large portion relative to total revenue.

A larger portion relative to total revenue.

Service gross margins of 15 percent represent a significant improvement over the previous quarters results.

This improvement was due to both increased revenues and decreased expenses.

However, the margins for Q3 are still well below our benchmark margins.

Cost of services for the third quarter were 7.4 million dollars, compared to 9.3 million in the third quarter of 2001, a decrease of 21 percent.

This year over year decrease of 20 percent was driven by reductions in staff and reductions in other consulting costs.

The cost of services in recognized as expenses are incurred.

Consistent with our accounting practices, we have not deferred any material costs to services.

Operating expenses for the third quarter of 2002 were 13.5 million, compared to $14.7 million in Q2 2002.

A decrease of eight percent.

Year over year our operating expenses increased 15 percent from 11.8 million in the third quarter of 2001.

The reduction from Q2 2002 is primarily due to reduced employee compensation related expenses.

The year over year increase was primarily driven by increased investment in the emerging Pega rules business, increase in

and compensation benefits and sales and marketing expenses.

R&D spending for the third quarter of 2002 was $5.3 million, down five percent from the $5.6 million in Q2 of 2002 due to reduced employee compensation related expenses and a reduction in use of third party consultants.

R&D spending was down one percent from $5.4 million in the prior year.

Selling and marketing expenses for the quarter increased to 6.3 million.

That's a five percent increase from the prior quarter and 59 percent growth from one year ago.

A year over year increased spending was due to a concerted investment in selling resources for both the rules and applications businesses, as well as to increased marketing programs spending.

Net income for the quarter was $4.8 million or 13 cents per diluted share, compared with net income of $3.9 million or 12 cents per diluted share for the third quarter of 2001.

The $100,000 year over year improvement is primarily due to a $6 million improvement in software license gross margins from increased revenues, which was partially offset by $2.7 million reduction in service gross margins due to the lower service revenues and increase in operating expenses, $1.8 million.

Accounts receivables day billed outstanding as of September 30, 2002 were 23 days.

This level of DBO is unusually low, reflecting reduced service billings and very strong collections.

Historically, DBO for service billings is higher than that for license billings.

Deferred revenue balances increased to $10 million as of September 30, 2002, compared with $9 million as of June 30, 2002.

This increase is primarily due to billings, 2.4 million in revenues related to the Quest resolution and fixed service projects which have not yet been completed.

Cash and cash equivalent as of September 30, 2002, increased to $52 million.

The company generated $7.8 million of cash from operations in the third quarter and $20.7 million for the first nine months of the year.

We also invested $4.8 million in debt securities to improve the yield on our cash balances.

This is presented as 4.8 million of investments held to maturity on the balance sheet.

While the possibility of seeking financing is still an option, we do not anticipate a need for additional capital to fund operations in the near term.

Head count including contractors as of September 30, was 493 compared to 519 at the end of the second quarter 2002.

In looking forward the remaining of the year, we anticipate market conditions to remain challenging.

Specifically we expect our full year revenues to be between 95 and 103 million dollars.

This range reflects the volatility and linearity of quarterly revenues.

We remain focused on keeping cross aligned with revenues, and expect that four year EPS will be between 36 and 48 cents for the full year.

Finally, we are maintaining our guidance for the year and cash balances in the 50 million dollar range and with that, I will turn the call over to Alan.

Thanks, Chris.

As I sit here in Cambridge and look out the window, it's pretty cold, gloomy and gray, and that is certainly the way the economy feels and the sentiment out there in terms of the buying public.

If it is especially in this environment, I would like to kudos to the Pega Systems team for making progress, strong progress despite this.

I think this is where more than twenty years of experience comes into play in a tough market signing companies like Bank of New York and Allstate, new applications client and the new rules client respectively.

These are exceptional victories and are consistent with the discipline and effort that comes from having been through the experiences we have been through in close to twenty years.

We continue to reach out to other premier companies.

We have our focus on blue chip industrial and blue chip financial services companies, and I will talk about it a little bit later, how Pega Rules broadens this market.

But the reality is that customers are slowing their buying decisions, it is a tough market in which to close new business.

And also you are seeing more proof of concepts and other sort of hesitant buying behavior, quite different from the era a couple of years ago.

And although I think less well is known to a lot of external audiences, some people talk about us being the best kept secret in software, we do have some niches in which we have been able to leverage oursleves despite this.

The financial services area and now the healthcare area are both places where we are getting a lot more visibility.

I recently attended the

conference in Geneva, and for those of you who aren't familiar,

it's kind of the convex of the financial world.

There were almost 6,000 participants from around the world, senior executives to technicians looking at what was new and trying to understand where the banking community was going.

We saw record attendance, not just at the conference, but a tremendous interest in what we offered, and despite the fact that financial institutions are not spending money unless they have to.

We think that we are in a very sweet spot in terms of what we can offer in terms of being in the right place at the right time.

Service has traditionally been an up and down, focus for these organizations in the last couple of years, and many of them have focused on what's called straight through processing.

Taking business prophecy's and trying to automate them.

What's happened, is this has actually exacerbated the importance of addressing the service value proposition, as value, you have more strength to processing.

Some you need to be more intelligent, more thoughtful about the way you address different types of problems, issues and exceptions.

We are now the clear leaders in this business and are ablizing to take that expertise to a lot of other areas to show that we can improve the service proposition at the same time we are saving money, tangibly saving money, with pretty quick pay back times.

In addition, regulators are pushing our organizations and increasingly directing banks to focus on operational risk, and there is no question that addressing exceptions is an important way to address operational risk and frankly it doesn't hurt that the Federal Reserve as we announced in our last call has adopted our system as a background across the whole

Federal Reserve Bank area.

Sort of a nice name to have, when you are talking to organizations about stability, and visibility and power.

And the best news, is like I said, we have a number of world-class customers who use our product, who use our product in some cases we package it and under their own brand names, give it visibility to our customers, to their customers, and that helps us across the banking industry.

When we have such a key presence, it helps us with organizations such like UBS, which it was pitching itself as the bank for banks, and is out there talking about how they offer the most exceptional service.

And frankly, in that case, it was at least even visible that this exceptional service was based on our technology.

So we're really quite happy with our ability to continue to work in this market that has a lot of potential and that the, sort of, stream of attention towards ROI and people's interest around operational risk will continue to allow us to develop business despite the very, very tough times that we, and I think everybody, sees.

Now, you need to remember that all of that was within what we call our replications, where we have our domain expertise about how to automate complex rules and business processes, how to handle the, sort of, exceptions when large wire transfers get lost or foreign exchange payments are made incorrectly.

And I think this continues to be a market that you're going to see us working, especially during the tough times.

But I think has Henry has eloquently stated, the applicability of this expertise is much broader, and as I've spoken about for over three years now, we've been working on a new generation, the PegaRULES generation of technology to allow businesses to take control of their processes across the enterprise and allow us to move into some exciting new opportunities and new markets.

With PegaRULES, we have a whole new way of doing business, and we also have an ability to execute against markets that are broader but are also driven by some of the same motivations that have made us successful in financial services organizations.

And what we can do with this product, as we web out strategically to prove is we can sell away from our install base.

We can use this as a way to both introduce ourselves to new organizations, and also introduce ourselves to partners to be able to create a different channel and a different approach to marketing.

So I'm really thrilled that after so many years of talking to you guys about this that we've actually now gotten customers to -- several customers to work on improving concepts, some customers to actually move to the signing phase, and that is I think both a terrific accomplishment, but I would also stress that we're still very early in this process.

And I cannot, I think, mute my excitement about what we can do here, but I also do want to remind folks that any time you bring in something that is as revolutionary as this is, we think there's going to be an up tick curve, especially given the sort of tough economic times.

Before we turn over the call for questions, let me make a few remarks about some of the management changes.

Our former President, Rick Jones, continues to be an active contributor in our business.

He's helping on large projects and working with some of our key customers, and has also participated in what has been a seamless transition, assisting us in the planning process, and we've

about it next year, and really working very effectively with Henry to make sure we didn't miss a beat during Henry's coming on board.

And I'll tell you that having had the chance now to work with Henry Ancona for a couple of months, I think that he is doing a terrific job.

He's showing great judgment regarding strategy.

He's showing an incredibly appropriate focus on marketing, and you're going to see us really, really dial up the visibility that we have as a company and the way we think about our markets and the way we approach our markets.

And he's also showing a terrific amount of thoughtfulness and discipline in terms of making sure that we do what we need to do for our stockholders, making sure we're thoughtful about the way we grow the business.

We're very much positioning ourselves to be a business that can grow.

Henry came here because he's got experience growing businesses, making companies successful in the software business, and I continue to be very excited that we've got a wonderful choice here who can really help us as we get through the tough times, and as we move into the better time, that no doubt, we'll be ahead at some point.

So once again, Henry, thank you very much for your dedication and the effort, and I think we're off to an excellent start in terms of this transition, here.

Before I end, let me just, I think, make one final comment.

As I step back and think strategically about where we are, you know, we've been blessed with a strong base that I think has allowed us to perform at a time when other companies have faltered.

We've got, I think, in that base the right sort of experience to not just understand their problems but understand some of what will be the next steps for the technological and business challenges that we can apply our efforts and our software to.

And I also think we've got the financial and other resources to be able to build for the future, which is a remarkable privilege giving what we see other companies going through.

You know, when you think about our experiences and when you think about other down trends we've seen, this isn't a bad time to hunker down and prepare for the up turn whenever it comes.

With 20 years under our belt, we've been through recessions before.

We've got the focus.

We've got the discipline and we continue to really, really invest strongly in making sure that our service operations, making sure that our technology and making sure that the business as a whole will be well prepared to scale when scale again is feasible.

And that's part of us being responsible to our shareholders and that's also part of us being in a position to take advantage of what we think is going to be an incredible opportunity as the economy picks up in general.

So with that, Operator, we are ready for questions.

Thank you.

Ladies and gentlemen, if you have a question at this time, please press the one key on your touchtone telephone.

If your question has been answered or wish to remove yourself from the queue, please press the pound key.

If you are using a speakerphone, please lift the handset before asking your question.

Our first question comes from

of Needham and Company.

Thanks.

Two questions, first, what level within the organization are you selling your rules product?

And then how is that different or how is that the same from your kind of historical customer target within the organization?

In other words, are you selling to different folks?

And maybe you could flesh out just a little bit how you're addressing that?

And then the second one was more of a tactical question, which is, with regard to the reseller conversion, what was the quarterly term license figure in June just so we can kind of see what the delta was versus what it would have been had they not converted?

Yes.

This is Alan.

Let me start by talking a little bit about the rules sales process.

You know, it's interesting and we're still getting our feet under us in terms of what the optimal way to sell is, but we're finding a tremendous level of interest in the IT side of the house where we have traditionally sold directly to the business user.

What has happened is particularly as the times are tight, there's a lot tension in some of these organizations about how the IT side is able to, one of our favorite themes is, able to build for change.

Able to really get the organization to be more nimble.

And the rules technology actually allows the IT side to selectively delegate business process change to the business, which plus gets the business of their back and also allows the organizations to be just way more effective as they go forward.

So, the selling that we've been doing has been much more to the strategic senior architect, CIO or one level below in these very large organizations.

With also visibility to the most senior operations manager.

So I'd say in some ways we're selling upper level from where we've often sold in the past and we're selling a mix of tangible immediate benefit and strategic benefit which actually feels really, really good.

Now we'll feel even better when we've got a couple of dozen of these under our belt, but the early signs I would say are very positive.

In terms of the reseller arrangement, the change, this was a situation where there was a customer who when they signed on five years ago, actually sold off the division we were doing business with.

And the new division when it came time, were able to resell them on the notion of going with us basically moved to one of our standard contract.

So it was much less, I would say, a direct conversion of anything than the fact that there was a new customer and they moved to standard paper.

And Chris, do you have what the actual monthly, or quarterly, amount was?

Yes, this was a deal that had components for both a reseller and a standard licenser, and the reseller agreement was handled on a subscription basis.

The quarterly amount for the quarter was fairly low, probably 100 to 200K.

But I guess the other issue I want to focus on is that this was a deal that had been contemplated.

In our estimates, it is something that was a sales opportunity for some time, and as Alan pointed out, was a successful selling effort in terms of meeting the customers' need.

Also want to point out for those of you who are preparing models that we also had the deferment of about $2.4 million associated with the settlement with Qwest.

So there's a number of things that

out, but primarily, just, Richard, in getting at I think the essence of your point, it was both contemplated in our estimates and something that in the quarter where we had other things that were moving as well.

Got it -- no, that's helpful.

OK, thanks.

Thank you.

Our next question comes from

of Fulcrum.

Hi, I was wondering, could you please comment on how many renewals you had during Q3?

Hello?

Yes, this is Chris.

We had a number of renewals in the quarter.

I'm just getting the breakdown, but we had a number of renewals for the quarter, probably 10 deals all together.

And I'd say the majority, or at least half of those, were renewals of one kind or another.

OK, and also, you did a great job on reducing your G&A expenses.

So I was wondering, was there any headcount reductions during the quarter, or do you expect to see your G&A ...

As we had said on our last call, there were some reductions which took place in the third quarter, primarily in services but there were some in G&A.

The biggest change is really related to the compensation, both in terms of variable incentive compensation adjustments, as well as headcount.

But again, part of that is quarterly fluctuations.

You should see that the number stabilizes in terms of steady state at around 2 to 2.2 million a quarter -- 1.9 is the result of primarily of incentive compensation adjustments.

Great.

Thank you.

Thank you.

Once again, ladies and gentlemen, if you have a question at this time, please press the one key on your touchtone telephone.

One moment for our next question.

Our next question comes from

of

.

Hi, good morning,

.

Two questions.

Can you elaborate on the sale of the Bank of New York, who'd you beat, who'd you compete with?

Kind of the whole scenario there.

And then second, with respect to the global straight through processing initiative, my understanding is that a lot of the mandate has been somewhat relaxed, and so the urgency by the participating members to kind of bring new technology in is somewhat sedated.

Can you just comment on that?

Kind of what you're hearing on that issue?

Thanks.

This is Henry.

Talking about the Bank of New York, I really can't talk in detail too much about the Bank of New York in particular, but let me give you an overview of the software in general.

With EFTs, combine the current currencies you can get exceptions that have to be investigated on what date and on what rate was the currency to be transferred, in whose account, and why isn't it there?

This can be a highly paper intensive and manual operations.

But with our Investigation software, part of our applications suite of products, the system can not only make the determination, but it can take the action, send, for example, an instruction letter.

This allows much greater control over risky investigations and eliminates money loss and maximizes income.

And it really goes back toward the main expertise in automating complex processes, and our strategy of targeting new customers while extending our reach with our existing customers.

Maybe I'll just comment on the straight through processing question.

The dynamics of straight through processing is that organizations due that both to try to handle the realities, there's a lot of consolidation in the financial services environment.

So businesses are getting bigger, so they need to do more straight through processing to be effective, but also organizations that are trying to save money, they find that the layers of people that typically insulate at kind of the seams of their process from being visible aren't visible because stuff's automated.

So when it falls on the floor, it falls on the floor pretty hard, there's no one to catch it.

So you can think of us as taking the mechanics of straight through processing and extending that directly to the more sophisticated, more coimplex exceptions that frankly have tremendous visibility.

You know, whether it's in the wholesale business like Henry was talking about, or in the business of a credit card dispute, people remember the bungled exception way more than they remember the 100 or 1000 transactions that went well.

So that's why organizations -- for the cost factor and operational risk factor, because exceptions often have something to do with fraud -- and -- or in some cases do.

And this also -- it frankly is just a service improvement factor that organizations want to automate.

When I was in

, one of the guys came up to the booth and said that they had an operation that was fully -- this is not a customer -- fully STP, he called it straight to paper -- is what he described.

Basically, everything that wasn't processed automatically was printed out for people to deal with.

We basically take that and using rules and business process management are able to save these organizations a tremendous amount of money in a very

ways.

Just two follow ups if I could, though.

If -- from my understanding, what I just wanted to get at was if, kind of, the implementation cycle has been somewhat relaxed, because I know they were trying to get in and I think, like, in a couple of years.

Has that -- have you seen any kind of pressure on your business in terms of that decisions aren't made as fast as you would hope in terms of buying decisions.

And then secondly, with respect to that initiative, how much are you depending on that within your financial services business in terms of as an impetus for driving revenue?

You're talking about some of the relaxation that's going on with regard to the timing of securities ..

The

initiative specifically, I think.

There -- that is not -- the slowing of that has not been particularly visible at all to our business.

And I don't think it is going to be particularly visible.

The thing that is a regulatory change, is visible, is there's a new program called

, which was just announced, in which all banks are being required to very strictly revisit over the next 18 to 24 months their operational risk.

And that actually is going to have I think a pretty positive impact, because one of the big things and one of the big issues around operational risk is trying to make sure that some of these exception processes actually get tracked, cleaned up and managed.

So we haven't seen any and I don't anticipate any negative issues from the slowing of the T plus one initiative as I think about the business.

OK.

And then as a follow up, with respect to the whole global straight through processing initiative, how much of that do you depend on that with respect to your financials?

I mean, how much of that is acting as a driver?

As I said before, I don't think that has been a material driver.

When people want global straight through processing we've got a good game, but even when they don't, I mean, long before that we became a dominant player in this industry.

And at this point, particularly with Bank of New York which was one of the few really big banks that we have not broken into at all, you know, we've got a chance to show what we can do at one more big organization.

And the next opportunity at all of these places is for us to move inter departmentally into other parts of inception processing.

So I'm not at all troubled by the slowing of the whole T plus one initiative, frankly.

I don't think that's going to be a big deal.

We don't sell to the straight through processing side.

We sell to complement straight through processing.

So I know other companies have been effected by this long

initiative.

I don't think it's a big deal for us.

OK.

Thanks a lot.

Thank you.

Our next question is a follow up from

of Fulcrum.

Yes.

Hi.

I was wondering if I could get two clarification which I may have missed during the call.

I was wondering if you could talk a little bit about your quest settlement.

Was there any contribution during Q3 and are you expecting any contribution in Q4 from that settlement?

And also then I have a follow-up question.

From the quest settlement, it's addressed in the MD&A but there was settlement.

There was no proceeds reflected in the Q3 results.

We expect the full value of the proceeds to be reflected in Q4 results.

And how much settlement?

That one was 2.4 million.

Two point four.

And also, I think you said that there's one customer that has converted to

from term licensing?

Could you give a little more color on that?

I think Alan has spoke to it a little bit, but maybe he can follow up on his comments.

Sure.

This was a customer who had sold a division.

So we ended up having to go with a new parent and a new customer and this was five years ago that we had the original relationship.

And, you know, in the sort of ordinary course we've now put them onto our ordinary agreement.

As a result we had a revenue event off of that.

I'd give you the name of the customer but some of our customers who resell promote

and some of them do it sort of on a blank label, private label sort of basis and we always try real hard to respect that.

So - the other thing I was going to tell you is that it's actually not a perpetual that they converted to.

They converted to our ordinary term license.

It was a standard term license, which as you know, is recognized on the present value basis.

So in five years we expect we'll get another revenue event from them of comparable size.

You know, assuming we're able to once again win them and keep them as customers.

Sure.

I was just wondering, is there a new customer in Q3 or I was thinking earlier in '02 you had a customer that converted.

This is not the same.

This is not the same customer as we talked about in '02.

And can we talk about the revenue contribution because of this switching, by any chance?

The revenue contribution is highlighted in the press release as well at $2.4 million was the revenue in Q3.

It is not counted as a new customer.

Great.

Thank you very much.

I appreciate that.

Thank you.

Our next question comes from

of Provident Equity.

Good morning gentlemen.

Good morning.

Could you talk a little bit about the split between the license and services revenue?

I think you had mentioned before that this -- that this was the trend that you had -- it is still pretty pronounced.

In other words, is this just because of the weakness in the new license that you're signing, new licenses, or do you expect this to -- eventually the services revenue to come back some?

Jim, this is Chris.

Yes, we expect that the long-term model holds for the applications business at 60-40, but you'll see that we did see a slight up tick in services, reflective of the fact that in Q3 and Q4, while it's still well below our plan, we have seen a slight up tick in -- I mean, in Q2 and Q3, a slight up tick in implementations and the services associated with them.

But it has not reached the steady state that we expect for the business, which we assume will be 60 percent license, 40 percent services.

And then that is mainly due to the weakness in the new ...

The number of new deals closing as a result of the IT spending clamp-down that's industry-wide.

OK, and then maybe I missed this somewhere in the press release, but have you talked about the Allstate deal, and the potential size, and how much you recognized revenue ...

We have not.

It's a very recent deal, and as Alan mentioned, with customers there's a collaborative effort in terms of the public relations associated with a deal, but we have signed a deal and have their permission to identify them in the deal and we've done so, but other details have not been disclosed at this point.

So even -- you can't even talk about how much -- has any revenue been recognized?

In Q3 in revenue, there's no license revenue associated with that deal.

There may be some modicum of services that we've done in anticipation of the license implementation, but it's modest.

So the revenue is really going to be in upcoming quarters.

OK, upcoming quarters, meaning as early as this next quarter, then?

It's really dependent upon the implementation phase.

We hope that it's sooner rather than later, but we do expect the implementations for these deals to be quicker than our traditional, but it's hard to predict on early deals.

OK, and then just one question -- you said it before, but was your -- in the Q3, what was your average selling price that you mentioned earlier?

It's $1.4 million average selling price, when you adjust for the

component, it's just slightly under 1 million, which is right in our bandwidth to 0.5 million to 1 million average.

One point million -- excluding the ...

One point four million all in and excluding

, it's slightly under 1 million.

OK, thank you very much.

That's all I have.

All right.

Thank you.

I show no further questions at this time.

Thank you very much operator.

Although the near term economy is challenging, our long-term vision remains clear.

We want to fundamentally change the way business does business.

We see Pegasystems as the company upon whose platform business users can change processes with only a few mouse clicks, upon whose platform a business can respond quickly to changing market conditions and we see Pegasystems as the platform that enables corporations to ensure consistent business practices throughout global organizations.

Again, thank you for joining us this morning, and please note that we will be at the Goldman Sachs conference on November 4th, and at the Needham conference in New York in the first week in January.

Thank you, operator, that concludes our remarks.

Ladies and gentlemen, thank you for participating in today's program.

This concludes the call.

You may now disconnect.