Pegasystems Inc (PEGA) 2003 Q1 法說會逐字稿

Welcome to the Pegasystems First Quarter 2003 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 conference, please press "*" then "0" on your touchtone telephone.

As a reminder, this conference call is being recorded.

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

Madam, you may begin.

Thank you.

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 that 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 the license revenue recognition; our ability to develop new products and evolve existing products; interest 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 relationships; 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 most recent files 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 the statements will be achieved.

The forward-looking statements we make on today's call are based on our beliefs and expectations as of today, April 29th 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, Chief Financial Officer; and Henry Ancona, President and COO.

Henry, would you like to begin?

Thank you, Beth; and good morning, everyone.

As you've seen from our press release, we reported 25.6 million in revenue, 6.8 million in net income, and 19 cents in diluted earnings per share.

This was a great quarter for us, and I'll break down the components of our success, the drivers underlying our revenue and income performance.

First, however, I think, it's important to comment on the overall environment.

We all know this is a challenging environment.

Some are calling it the toughest quarter ever for the software industry.

You need solid fundamentals to succeed in this economy; and at Pegasystems, we have them -- we have smart technology, there is real demand, and have a focused commercialization plan.

That said we are a company that is subject to the significant fluctuation associated with having a small number of large deals.

But as to when deals close, it's really kind of an arbitrary point in time that may or may not go within a calendar quarter.

So I'm not sure we can, month-to-month or quarter-to-quarter, predict the revenue number in advance; but what we've tried to do is give annual guidance that convey the positive feeling for the year.

With that, let's talk about the quarter.

The big picture is the quarter was a resounding success.

We signed three new customers, we expanded a significant customer relationship, we saw growth in services revenues and margins, and we benefited from reduced expenses.

Our simply smart business process management with its proven ROI is enabling us not only to win new customers but also expand the solutions we provide our existing customers.

These three new customer wins, which are anticipated to result in services and license revenues in future quarters, included two new healthcare organizations and one financial services institution.

A really big win for us during the quarter was one of the larger health plans in the country.

They will be using us for the automation of claims exceptions processing.

These are claims that come into the health plan and can't be automatically processed for one reason or another.

Exceptions are, by definition, problem like missing a member ID number or the provider information is faulty.

Our system integrates with a backend, finds the missing data, verifies the information, and processes the claim right through.

No one else can do this.

Other systems can identify the source of the problem, but that's where they stop; all they can do is move data around.

We fix broken claims and increase the first batch rate.

The bottom line is that we do real work, which provide a real return on investment; and that's what it takes to sell in this environment.

We also signed a second new healthcare client, Blue Cross & Blue Shield of Rhode Island.

As noted in the past, the Blues are a close net group; and when you do good work for one or two or in our case close 20% of the Blues, news travel and we reap the benefit.

For Blue Cross & Blue Shield of Rhode Island, we are providing member services.

So, for example, if a member needs to add a newborn to their plan, our smart business process management system does the work.

The recorded is created in the Pegasystem.

It does not have to drop to paper.

Blue Cross & Blue Shield of Rhode Island told us we were their hands-bound choice given our simple-to-use, smarter systems that provide a significant return.

Our third new client signed during the quarter was a leading German bank.

They wanted to improve their business processes; and after seeing the efficiencies, they enabled the subsidiary bank to purchase our investigations software to automate their payments processing.

In turn, this allows them to best manage their operational risk with better managerial control, on-time reporting, as well as improving customer service.

During the quarter, JP Morgan Chase doubled their number of contracted Pegasystem users.

As you know, they are the resulting bank from a number of earlier mergers and acquisitions.

We were installed in predecessor banks -- in some cases, in one area in some cases, another.

Over time, the merged entities looked over the fence and saw PEGA as "the smart BPM solution."

That's why, today, we are the overall backbone for exceptions management, retail checking, and wholesale payments; and that's why, this quarter, we had the opportunity to more than double the number of users and expand their best practices.

Again, this is a case, where they know they're going to get a bang for their buck.

I'm delighted with all of these wins, and I want to congratulate everyone here at PEGA, who made these happened.

You do -- you don't get first-grade customers without first-grade products, and that's what we have with our simply smart business process management.

We released two new products since the beginning of the year and upgraded to our PegaRULES Process Commander; and a new version of our check, research and adjustments product called Smart Adjust, which is built from our fourth-generation platform.

As some of you may have heard me say, it is bug worth where compliance and brings flexibility, ease of change, and integration capabilities that our customers demand.

We remain committed to investing in the business and the research and development needed to continue to develop leading products and in the sales and marketing necessary to grow market share.

Therefore, as a percent of revenues, these expenses are likely to grow relative to first quarter spending.

Now, let's talk about operations.

We remain focused on our business processes and committed to controlling costs and driving efficiencies throughout the company.

In particular, when we take a closer look at our services, not only is revenue up this quarter due to earlier customer signings but also services utilization and productivity have shown marked improvement driving margin improvements.

We've also taken a harder look at our services pricing, and you'll see that in the margins as well.

I want to take this opportunity to thank all of our services personnel for their hard work.

I'll note that improving services margin is a commitment we made when I first joined PEGA.

So I'm pleased to be able to bring you this update, today.

Partnering remains a strategic initiative for the company, and we're actively inviting partners to participate in sales meetings and new business deals.

We're working with a range of partners including Accenture, Bearing Point, EDS, IBM Global Service; and specialized firms like, e-Loyalty announced this quarter they'd bring expertise.

We're encouraging our sales people to work with our partners and recently restructured our commission plan to ensure partners participate in service work and that we remain available when needed.

We also partner the platform, a product, and the reference able customer base that is unavailable anywhere.

And in turn, they offer us on trade to new markets and clients.

Partners are important to our future, and we're making progress in our partner program.

We continue to gain visibility among key influences in our industry.

For the second year, in a row, we were recognized as a leader in the Gartner Magic Quadrant for our Business Rules Engine.

For our clients and our prospects, the industry analyst and their recognition provide important insight into the competitive landscape and for us provide an important source of referral and leads.

We are continuing to gain recognition for our Smart Business Process Management capabilities as well.

This is very important.

Having a Business Rules Engine built into our business process management software means that our customers can not only automate decisions but also fulfill processes.

In other words, both decide and execute.

We have Simply Smart BPM, easy to use, easy to change performing real work.

I'm delighted to note that Alan Trefler was a finalist for the Manheim award, an award given for significant contribution in the field of workflow.

Speaking of visibility, we are holding our forum for clients and partners, PegaVision in Boston on May 18th through the 20th.

It's one thing to hear we talk about rules and business processes, it's another thing to hear our customers talk about being able to integrate technology with operations, support causal analysis and maximize real time service delivery.

We look forward to showing up our product and our capability and hope to see you there.

Please call Beth Lewis for additional information.

This is a good news on which to conclude and I will turn the call over to Chris for a discussion of the financials.

Thank you Henry.

Our financial performance in Q1 2003 was solid.

Total revenue in the first quarter was 25.6 million a 6% increase versus a $24.2 million in Q1 of 2002.

This growth was driven by an increase in services revenue.

The growth in services revenue was driven by an increase in consulting services primarily associated with new license implementations for which the license revenue has yet to be recognized.

We were able to maintain license revenue at approximately the same level as Q1 2002, despite the known $5.1 million decrease in revenue related to the restructure relationship with FDR.

While we did sign three new customers in Q1, the vast majority of our license revenue in the first quarter was from existing customers, which chose to renew, add on to or extend their use of our software.

Net income in Q1 2003 nearly doubled over Q1 2002 mainly due to the services gross margin improvements of 2.4 million.

This improved services margin was driven by increased consulting services and maintenance revenues coupled with consulting services expense reductions.

We generated $3.8 million in positive cash flow from operations at the end of the quarter with a strong balance sheet, including $67.7 million in cash and marketable debt securities and $81 million in combined short and long-term license installment receivables.

As a reminder, these installment receivables are indicative of future payments to be received.

Economic uncertainty remains a concern, however we did see some signs of improvement in the first quarter of 2003.

Improved new license signings and continue improvement in customer interest for our rules-based BPM software in the first quarter make us cautiously optimistic about the balance of 2003.

The successes that we've had over the past two years are the result of our commitments to customer satisfaction, the strength of our technology and our employee's attention to performance management and accountability.

The year over year increase in revenue was driven by $1.5 million or 19% growth in services revenue.

The growth in services revenue was primarily driven by an increase in revenue associated with the new service implementations for which license is yet to be recognized.

We recognized the present value of multiyear term licenses by applying a discount rate that reflects the borrowing rate applicable to our customers at the time new revenue was recognized.

This applicable discount rates moves directly with overall interest levels.

Of the $16.2 million in license revenue for the first quarter, approximately $1 million resulted from the lower interest rates.

Our recent SEC filings include more information on the composition of our revenues.

Implementation, consulting and training services revenue increased 21% to $6.9 million from $5.7 million for the first quarter of 2002.

The decrease was due primarily to implementation projects associated with the new customers installations.

Typically, we derive substantial revenue from services by widening connection with the implementation of the software license by new customers.

As was in the previous four, the previous four quarters we were successful on leveraging relationship with existing customers.

We recognized $3.4 million in revenue this quarter from eight new customers.

Our average license revenue per deal over the past years has ranged between 600,000 and $1.8 million of license revenue.

Our average deal size for the first quarter was just over $1 million of license revenue compared with just $100 million reported for the fourth quarter of 2002.

Our international revenues were 15% of total consolidated revenues for the first three months of 2003 compared to 20% for the first three months of 2002.

For the quarter, gross profit improved to 75% versus 67% in Q1 2002.

The year over year increase in gross profit was due primarily to improved service margins and reduced cost of software license.

Cost of software licenses includes the amortization of acquired technology.

This amortization was completed in the fourth quarter as a result cost of software license for Q1 2003 decreased to $100,000 from $600,000 for the first quarter of 2002.

As a percentage of software license revenue cost of software license revenue decreased to 1% versus 4% a year ago.

Cost of services for Q1 2003 decreased 12% to 6.4 million from Q1 2002, primarily due to reduced debt.

The cost of services was recognized as expenses were incurred consistent with our accounting practices.

We have not deferred any material cost of these services.

Service gross margin was $3 million or 32% for the first quarter of 2003.

This represents a significant improvement compared to the $700,000 or 8% gross margin for the first quarter of 2002.

Research and Development expenses decreased as an absolute value and as a percentage of revenue primarily due to reduced staff and staff related expenses.

Selling and marketing expenses also decreased as an absolute value as the percentage of revenue primarily due to reduction of sales commissions and incentives, partially offset by increases in marketing and sales programs and increased marketing staff related costs.

We anticipate increased spending in R&D and in selling and marketing for the balance of the year, as we continue to invest in our business.

Income from operations for the first quarter was $6.3 million, a 165% increase over Q1 '02.

This improvement was driven by the $2 million improvement in services gross margin, a $1.1 million reduction in operating expenses and $500,000 improvement in software license gross margins.

Installment receivables interest income for the first quarter of 2003, essentially the difference between the previously recognized net present value of term licenses and the total payment stream decreased to $1.2 million from 1.3 million for the first quarter of 2002.

The decrease was due to a lower average discount rate for our portfolio of terms software licenses.

The provision for income tax was $900,000 of first quarter of 2003, an increase from $200,000 for the first quarter of 2002.

Based on our current projections and our expectations that the valuation allowance related to our loss carry forward will be consumed during 2003, we expect our provision for income tax in 2004 to reflect an effective tax rate significantly higher than an early period.

Accounts receivable days billed outstanding as of March 31st 2003 was 41 days.

Although, this level of DBO remains lower than industry averages it increased during the first quarter of 2003 reflecting an increased proportion of service billings relative to license billings.

Historically, days billing outstanding for service billings is higher than that for license billings.

Deferred revenue at March 31st 2003 primarily new client license not yet recognized, unearned services or maintenance fees increased to $17 million as of March 31st 2003 from $12.1 million as of December 1st 2002 due to advanced payments of software licenses and maintenance fees and an increase in the unearned portion of services revenue due to service mile stones.

Looking ahead to the balance of 2003, we expect to achieve revenue in line with 2002 results, plus or minus 10%.

Despite the anticipated year-over-year decline in revenues from FBR, we have adjusted our full year EPS expectations upward to 45 cents, plus or minus 10 %.

And we are also expecting generate $5 million to $15 million in positive cash flow from operations in 2003.

And that concludes our financial summary.

I will turn the floor over to Alan.

Thanks, Chris.

I'm going to talk a little bit about where we are and what we are targeting for our future.

Our technology vision, present and future is very much about the bottom line.

It's about real ROI, about having systems that are simple to use, simple to change, and do real work.

Of these systems, we prefer to figure about how to solve problems, whether they push or shove data around.

What makes Pegasystems so powerful is that our product concludes a powerful ruled engine for practices and processes that mean the complex decisions can be defined and updated with ease without incorporating IT resources in all of their decisions, without down time and giving customers unprecedented control over how they want to run their businesses.

Business process management on the fly is pretty powerful stuff; and to do with the integrated backends, find the answers, and resolve problems, we drive transactions, we make things work and work better.

And you don't have to be an expert to use it.

The whole key is for the system to do the work.

And if it can't provide a guided process for the user being able to understand with the intent of the transaction is guide the user throughout.

Think about a customer contact regarding a fraudulent charge of a credit card.

On our system, we can verify his fraudulent, cancel the old card, figure out if we want to do an upsell to a new branded card to the customer, issue the new card, retain valid charges, do the right things with the bad charge, look for patents, lie off charge back, and in the midst of all of this track and report and bring visibility that puts management in control.

Or if you want to change some of the rules about write-off amounts, the way you deal with certain styles customers, these processes; we do that too with an unprecedented ease relative to specialization and putting the business uses in control.

This is what it means, we believe, to have simply smart business process management.

Now, we've been talking about this for a while; and I am glad to say that the public voices, the reorganization we all seek is growing.

Recently, Forrester Pegasystems products have got a good fit for processes that involve complicated rules that change frequently.

And Gartner recently named us as a leading one in their magic quadrant.

And the good news also is that at the beginning of the year, I've been working hard with my marketing team to go out and evangelize and in fact I'm in two major speaking engagements just next week.

So, we're working to get the message out, and we think it's a message that we are uniquely qualified to follow up on.

So what's are our goal?

Our goal is to get the word out, do a good job with our customers and partners, and to use more channels to sell more products to more users.

We see terrific potential within our existing customer base.

We want them to use more of their existing product, and we want them to expand usage into additional product lines using new technologies and new capabilities and new applications that we offer.

Our annual report is now available.

And it does a great job explaining how Rubber [ph] Bank was able to reduce the system, the number of enquiry calls by up to 80% following the implementation of our system.

Well, how we'll prefer provider of rules based BPM technology for our partner PFPC or how health now reduce claims inventory by 41% after three weeks of use.

Real customers, real ROI, that's what makes it possible to sell in difficult times.

We see a lot of potential in our existing vertical outside of our common customers.

In healthcare, last month we sponsored the Blue Cross & Blue Shield of Rhode Island annual contact center conference.

Our name is out there.

We had a record attendance and standing room only in our presentation and we show cased one of our PegaHEALTH products to a crowd that seemed very interested.

And we see enormous potential with our partners, including as Henry mention not only selling our existing offering but fine-tuning our product to reach even greater market potentials.

We are working technology partners where we've selected to develop whole new applications that they will bring to market using our process commander technology as the under pinning.

For example, there is a company called Agents Report, an insurance industry specialist, they are smart and they have good references and they selected our platform to develop insurance company specific solutions, to do things like verify risk and automatically populate the newest forums, proposals and insurance binders that go with being an insurance business.

The key is that our product, our platform enables organizations to deliver specialized solutions that are cheaper to deliver faster to change and are a terrific way to provide tangible value to customers.

And we really are excited that as we go forward we are getting champions for our cause and that we see tremendous potential for this technology and the way that that technology can be commercialized.

It is ultimately it's the commercialization, it's the bringing of customers to this neat stuff is what this business is about.

And we're really confident that the strength of our technology visions is there, and they were able even in these difficult times to attract attention.

We continue to see demand as people understand the computers today are too powerful to be used in the sort of dumb ways that we have used them in last decade, and more and more organizations, once they get the vision of smart solutions understand both the power and the return they can put in to their hands.

So I think we've got a focus on the right products.

We are working hard to develop the right partners and we are also working extremely hard to make sure we got the right marketing and sale support to be able to deliver.

So, I'd like you all to know that we're out there in the market place.

I'd like thank our number of constituencies.

I would like to thank our staff who are in terrifically tough environment, pull together as a team and has continued to work very, very intelligently.

I'll like to thank our partners, who are engaging with us to built new products and bring our technology to market in variety of channels, and I'll thank our customers for stepping up at the time when - well many of them were making hard decisions themselves and deciding that we could be actually a central vehicle by which they added value to their customs and by which they themselves could become more successful.

So, in closing I would just say to our investors that we're working hard on your behalf that we're excited about our prospects, and we're looking forward to continue to work for you.

And with that, let me turn it open to questions.

Thank you sir.

Ladies and gentlemen, if you have a question at this time, please press the "1" key on you touchtone telephone.

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

Once again, if you have a question at this time, please press the "1" key on your touchtone telephone.

Our first question comes from Richard Davis of Needham & Co, your question please.

Thank you very much.

I guess one question, it sounds like the business rule side of operation started to spool up, whether any kind of actual revenues recognized in the quarter, you know, it sounds like things are going well but we just wondered about the numbers roughly and then two, was there any at all kind of deals that were brought into this quarter that would make you guys be as conservative as you apparently are for the balance of the year because I don't know by my math you've done almost half of your earnings view in one quarter which is as always great type of front-end loaded year but maybe if you can amplify on that a little bit would be super?

Hi Davis this is Chris.

First question is related to the rules revenue and we do have services revenue from rules in the first quarter.

We have an immaterial amount of license revenue in the first quarter.

We will have a bulk of the license, as you know, if our model gets recognized when the implementations are complete.

On the other hand, we do see the underlying technology of the process commander product, now forming a basis for revenue opportunities in the vertical applications that we are addressing in financial services and healthcare.

In the terms of pure rules our revenue is, right now still limited to service revenue in first quarter right now and Henry will answer in the second quarter.

As far as our earnings guidance for the year is concerned, as we mentioned, during our prepared remarks, we expect to invest in both product and sell good marketing relative to our spending in the first quarter.

We're very pleased with the what we're seeing out there in the marketplace and we believe that now is the time to invest, to build our future and so at that explains the numbers that we are projecting for the year.

So you're -- are you going to therefore increase the amount that you're going to spend on sales and marketing and R&D relative to what people were thinking prior to this quarter being reported is that what you're saying?

No, what I'm saying is that we will increase our spending relative to the Q1 spending you saw.

Got it.

Once again, ladies and gentlemen, if you have a question at this time, please press the "1" key on your touchtone telephone.

Our next question comes from Peter Schneider of Network Capital, your question please.

Yes, I am new to the company, so I apologize for this question in advance.

But I'm curious on the revenue recognition side, how the next couple of quarters unfold when you announce your one, 3 quarters, are those services first and then licenses second?

And then, secondly, is it a flat 3.5 million a quarter from renewals with FDC for the rest of the year, and then what happens after that?

Okay.

This is Chris.

I will answer the question.

The first question is around revenue recognition.

We have -- we sell primarily software licenses and we do the implementation on new license sales.

So, typically what you'll see is that services revenues are recognized in advance over license revenues for new license sales.

And an implementation ranges typically anywhere from six to twelve months for the nine months average.

So there's that lead-time before the license is typically recognized and it's recognized again typically when the software is implemented in production.

The customer pays on a milestone basis, is that right?

Well, there -- for term licenses, there's also terms that are renewed.

So we've licenses that we sold on a term basis and periodically come up for renewal.

In those cases, that revenue was recognized upon typically upon the timing of the signing of the renewal because the software's are already in production.

So, that you will see revenue for renewals typically much more closely aligned with the date of the signing.

In terms of the payments, some customers who are on a multi-year term licenses will pay for those licenses over the life of term, sometimes quarterly, sometimes monthly, sometimes annually, but they're spread over the terms.

Perpetually and more typically the payments are ended at the time of the signing or at the time of the key milestones along the implementation of the services.

It can answer what was going on vis-à-vis FDR.

We, probably about six years ago, contracted with first date of resources, which was a large provider on the credit card business.

For them to build an application set that they would bring to market on our Rules Engine Technology at that time, and based on that they created a set of products they called evolve and for a while work contractually or exclusive channel to market in that business for which they paid us money that's we're going to agonizing detail over the last couple of case and queues and reflects the $3.5 million you talked about that actually is going to continue to be revenue through the first three quarters of this year.

What happened is last year we jointly decided that we want to change the relationship.

We wanted very much to get back in the credit card business, both because we do actually quite a bit of work with other major credit card organizations and because we've got [ph] the card business, I was wondering we could more effectively go after our sales as opposed to just being limited to being able to do business with First Data.

So we changed that nature of that relationship.

We are out actively selling into that market and are really quite exited by what we are seeing.

But frankly as of the third quarter of this year and fourth quarter of this year, we are going to have to sell systems and deliver them to be able to create revenue that otherwise we got through our channel.

That's one of the things we disclosed and one other things we're working very hard to build our pipeline and make sure we're well positioned to do as we go forward.

And specifically the FDR revenue for the balance of the year, it's approximately 3.5 million -- revenue -- 3.5 million to 3.6 million of revenue for each of the first three quarter of the year.

Right.

Great quarter, thank you.

Thank you.

Once again if you have a question at this time, please press the "1" key on your touchtone telephone.

Gentlemen, at this time I show no further questions.

Well, thank you.

As you've heard our software does real work, it provides a real return.

This was a great quarter for us, and we will continue to focus on being the leader in smart business process management on signing new customers, on delighting our current customers and on managing our business for growth.

See you at TechVision.

Thank you operator, that concludes our remarks.

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

This concluded the program.

You may now disconnect.

Good day.