Pegasystems Inc (PEGA) 2003 Q2 法說會逐字稿

Welcome to the Pegasystems second quarter 2003 conference call.

Your host for the call is Ms. Beth Lewis, manager of Investor Relations.

Thank you, operator.

Before we begin, I'd like to read our Safe Harbor.

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 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 products, interest rate market trends, the impact on our business of ongoing consolidation in the financial services 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 filing with the SEC.

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 we make on today’s call on based on our beliefs and expectations as of today, July 29, 2003, 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.

Good morning, everyone.

As you see from our press release, we reported $25.5 million in revenue and pre-tax income of 5.9 million.

A 22% increase over the comparable quarter last year.

We had success in financial services and success with our services business.

Looking at the first half of the year, we continue to execute on our plan.

We've succeeded in signing more new customer license business than in the first half of 2002 and we have succeeded in not only increasing our services revenue but also in increasing our services margins.

All of this against the macro environment which remains very difficult.

I will tell you that we have produced good growth in our pipeline.

However, due to the economic environment, deals are moving through more slowly than I would like.

As such, execution remains critical and we remain focused on providing market leading solutions that solves customers pain points and provide real ROI.

In terms of products, you may recall last quarter we introduced our PegaCheck Smart Adjust product, our fourth generation rules base BPM solution.

This quarter, I am pleased to announced that we sold that product to a mid western bank that will be using Smart Adjust as the backbone for their retail check exception processing.

They chose Pegasystems because our rules based BPM technology can not only make decisions (it contains 17 best practice workflows around encoding errors, debits posted as credits, et cetera) but can do the work, automated case creation automated data evaluation and automated accounting and so on.

This bank’s evaluation included a walk through and a ROI study.

Our competitors simply could not compete.

They could not meet the requirements to do the work.

This quarter we announced a new product in our health care product line, PegaHealth Service Manager.

Service Manager allows service representative to handle inquiries from members and from health care providers.

Traditionally, a health care insurer would have separate contact centers to handle the different inquiries.

Our product suite allows the same customer service rep to handle both member and provider inquiries.

And once again we see that because the Pegasystems is driven by a flexible rules engine that can adapt to changing business and compliance conditions and because our system can connect directly to a healthpayer’s back end system, the Pegasystem can both decide and do receive, research, and route the case as well as responding, resolving, and reporting.

We continue to have strong traction in the health care market.

In fact, this product is being deployed at Blue Cross and Blue Shield of Rhode Island.

Looking ahead, we expect to announced two new products in our credit card product line as we build out and leverage our PegaRules and process commander solution.

These products offer a solution for automated credit card disputes based on the adaptability of a rules engine and automation of BPM.

The first product Smart Dispute guides service reps through reason codes and procedures to help deliver consistent service while providing the flexibility to change as key business drivers change.

The second product named Reason Code Advisor focuses on the card association's allowable reasons or conditions that are used to manage disputes.

We take all of the Visa regulations regarding disputes-was it a charge made three months ago or six months ago, was the price higher or lower than X- a maze of six dispute categories, 16 decision trees and over 300 questions to get to the 139 reason codes required to process a charge back.

And because this is a BPM solution, once the appropriate reason code is assigned, the system manages the appropriate process for that code.

We guide the customer service staff through intricate dispute regulations, reasons codes and procedures to ensure consistent service, a low error rate and all with or without expert training.

We remain confident that rules-based BPM is what customers need to optimize business practices and third parties are validating this as well.

Gartner cited Pegasystems for leadership in the BPM space- for our ability to execute and our technology vision.

Last quarter, we were recognized for our Business Rules Engine again for leadership in execution and for vision.

This is a real accomplishment.

Pegasystems is the only company to have been recognized as a leader in rules and as a leader in BPM.

This is critical to our customers.

It's not just that the recommendations of Gartner and the other industry analysts get translated into requirements documents and RFPs but also the fact that we are recognized in both categories, rules and BPM means that when customers are looking for a rule solution we have advanced decisioning and capability that provides maximum flexibility and agility plus you get process management to implement the decision.

For customers looking for business process management we have advanced administrative fulfillment and reporting capability plus you get a rules engine to drive your BPM.

This is not a case of 1 plus 1 equaling 2 but rather 1 plus 1 equals 3.

We also have validation from our customers.

I will read from an article regarding our customer, ANICO.

Pegasystems workflow automation solution pulls data from many sources including the caller, agent and account history and provides customer service representatives with various interconnected capabilities including contact management, claims inquiry, contract and policy maintenance and member eligibility benefits all on a single composite screen.

Since Pegasystems implementation ANICO has been consistently seeing significant drops, as much as 71% in caller abandonment rates.

As for average speed to answer, the best year saw 61% improvement while the worse year saw a 38% improvement.

The product is so highly configurable we have never been in a situation where he couldn't get the data we needed.

That's the power of rules based business process management.

We also had validation from our partners.

You've seen the names of some of the partners added during the quarter.

Satyam, KP I, Watch Hill, have joined with Pegasystems to sell and support our rules based BPM technology.

Some of the projects we are working on deployed PegaRules solution at a major manufacturer and are now establishing a rules and BPM center of excellence which will show case Pega.

Cognizant worked with us on RFPM and implementation of our card product at a brand name financial services.

With eLoyalty we are working to bring our health care capability to a broader audience and Watch Hill is helping to craft the solutions for a banking prospect with an international as well as domestic presence.

Our partner strategy remains on track.

We bring top rate technology and referenceable customers and they bring new opportunities in avenues for commercialization.

The last operational piece I want to talk about is marketing.

When I joined Pegasystems last July, we decided we needed to strengthen our marketing efforts.

You are seeing results of those efforts as we work more closely with our industry analysts who are important public voices for our target audiences.

We are working harder and smarter with our customers to share their success stories and I encourage you to take a look at our web site where we have posted an increasing number of Pegasystems media stories.

Reaching out to our target audience and through the end of the year we will be at health insurance conferences, rules conference and business process management conferences.

We are attracting more attention and reaching new constituencies.

In closing this was a strong quarter making for an excellent first half with solid execution of new customer signings and existing customer renew always and extension.

We also met our commitment to improve our services business with more revenue from new license signings and better margins based on utilization and pricing improvements.

We continue our commitment to build the processes necessary to grow with a focus on services, products, sales execution.

Next quarter, you can look for the following three metrics as a gauge of our success.

We will continue to announce new products to leverage our domain expertise and BPM platform.Two look for customer announcements as our focus on sales execution continues to drive results.

We remain committed to disciplined operations in the form of profitable operation, positive cash flow, and a healthy billion balance sheet.

With that I will turn to Chris for discussion of financial results.

Chris.

Thank you, Henry.

Our financial performance in Q2 2003 was solid with total revenue down 4% and profit before tax up 22% versus Q2 of last year.

In addition, we generated $6.8 million from cash of operations.

Total revenue in the second quarter was $25.5 million, a 4% decrease versus Q2 2002.

License revenue decreased to $15.9 million versus 19.1 million for Q2 2002 primarily due to $2.4 million in revenue related to the restructuring relationship with First Data Resources.

The $3 $3.2 million decrease in license revenue was partially offset by a $2.2 million increase in services revenue from implementation services associated with new license signings.

While we did sign three new customers in Q1 and one additional customer in Q2, the vast majority of our license revenues in Q2, 2003 was from existing customers who chose to renew, add on or extend the use of our software.

Of $15.9 million in license revenue, approximately 5% was from new customers that's of the 15.9 million of license revenue.

However, to amplify the earlier point I made on implementation services-of $25.5 million in total revenue, $4.6 million or 18% was from implementation services and licenses related to new customers.

Our year-over-year improvement in profit before tax in Q2 2003 was due in large part to service gross margin improvements of $3.1 million.

We generated $12.7 million in positive cash flow during the first half of 2003 and ended the quarter with a very strong balance sheet including $75 million in cash and investments.

In addition, we ended the second quarter with $88.9 million in combined short and long term license installment receivables.

As a reminder, these receivables are related to unbilled term licenses and are indicative of future payments.

Our average deal size over the past two years ranged between $600,000 and $1.9 million of license revenue.

The small number of license deals causes fluctuations in average deal value in the quarter.

Our average deal size in second quarter was just over $1.9 million in license revenue compared to just over $1 million average reported for the first quarter of 2003.

Due to the nature of our revenue which is comprised of a small number of large value deals, our international revenues at 15% of total revenue was down from the second quarter of last year.

International revenues have historically been in the range of 20 to 25% of total revenue and we anticipate we will remain at this level for the full year 2003.

We recognize the present value of multi-year term licenses by applying a discount rate which reflects with borrowing rate applicable to our customers at the time the revenue is recognized.

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

Of the $15.9 million in license revenues for the first quarter approximately $300,000 of that was attributable to lower interest rates versus the rate used in Q2 2002.

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

For the quarter, gross profit improved from $18.4 million in Q2, 2002 to $18.9 million in Q2 2003.

The year-over-year increase was due primarily to improved services margins as well as reduced license costs.

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

This represents a significant improvement compared to the gross margin of negative .5% for the second quarter of 2002.

This improvement was driven by a $2 million increase in service revenue combined with 14% decrease in the cost of services versus Q2 of 2002.

Cost of software license includes the amortization of acquired technology.

Amortization related to certain acquired technology was completed in the fourth quarter of 2002.

As a result, the cost of software license decreased substantially from $673,000 in the second quarter of 2002 to $88,000 for Q2, 2003.

Research and development spending as a percent of revenue remained flat with the second quarter of last year at 21%.

Selling and marketing expenses increased 7% versus Q2, 2002, and increased from 22% to 25% of revenue primarily due to increased marketing program spending in our applications business and investment in the emerging PegaRules businesses.

We anticipate increased selling and market for the balance of the year as we continue to invest in our business.

Income from operations was $4.2 million in Q2, 2003, a 13% increase over Q2, 2002,driven by a $3.1 million improvement in service gross margins, offset by $2.6 million decrease in the software license gross margin.

Installment receivable interest income for the second quarter of 2003 increased to $1.4 million from $1.3 million in the second quarter of 2002.

The increase was due to growth in our portfolio of terms software licenses and that was partially offset by lower average discount rates.

Other income and expense net for Q2 2003 increased to $300,000 of income from $300,000 of expense from the second quarter of 2002.

The increase was due to currency exchange gains in 2003 versus losses in 2002.

The provision for income tax was $2 million for the second quarter of 2003,an increase from .3 million for the second quarter of 2002.

We expect our tax rate to level off at or near the statutory rate which is approximately 39% for the second half of 2003 and beyond.

We do have some remaining valuation allowances which if reversed may cause some fluctuations in quarterly rates.

For those interested in a more detail discussion of the tax provision I refer you to 10Q filed yesterday.

We will focus on profit before tax as an indicator of our business performance going forward.

Accounts receivable days billed outstanding as of June 30, 2003 was 31 days.

Deferred revenue at June 30, 2003, primarily new client license and/or unearned service or maintenance fees increased to $7.4 million as of June 30, 2003, from $12.1 million as of December 31.

Let me clarify thatan increase to $17.4 million as of June 30 from $12.1 million as of December 31, 2002.

This was due to advance payment of software licenses and maintenance fees and an increase in the unearned portion of services revenue due to service milestones.

Looking ahead to the balance of 2003, we continue to expect revenue to be in line with 2002's $97.4 million plus or minus 10% despite the anticipated year-over-year decline in revenues that we discussed related to FDR.

We are maintaining our full year EPS expectation at 45 cents plus or minus 10%.

With the continued strong cash flow performance in second quarter, we now expect to generate between $12 to $18 million in positive cash flow from operations in 2003.

That concludes our financial summary.

I will turn the floor over to Alan.

Thank you.

I would like to start by thanking the team for the strong results, especially given the current brutally tough environment.

We are attracting attention to our growing pipeline and we’re working hard at that but buyers remain cautious and there is no such thing as low-hanging fruit.

In this environment it is especially difficult to calibrate and manage our sales and customer engagements.

Our customers prospects and partners are feeling pain, too and it ripples through the system.

We see no signs yet of that pressure abating in the coming quarters.

Nonetheless we are investing in development and marketing and taking steps that we see as leveraging our 20 years' experience to allow us to take advantage of an eventual upturn or to make the products even more successful in tough times.

Even as we build and package for a time in expanding well beyond our customer base please understand that we are validating our strategy and making sure our investments on are on target through interactions with our world-class customers and I'm letting you know that they responded to what see they saw positively.

Let me give you some feed back from our user conference held in May to show how our vision is working.

We actually call this user conference PegaVision because it highlights technology and customers and gives us a chance to show off where we're going and engage in a deep level hands on and up close and personal manner with analysts and others in a position to provide additional advice and to watch and with an unprecedented number of partners on hand to work with us and our customers to try to gauge the future.

What do these folks see?

First, standing room only for introduction to Simply Smart BPM, talking about how we can improve automation and personalization.

That was complemented by our customers speaking.

Organizations like The Federal Reserve talking about the improvements Pegasystems has brought to check processing initiatives and how they have used this to create a foundation for a national back bone for customer service, being able to tie together the 12 different Fed districts into a seamless whole gaining both productivity, efficiency and improving quality.

Bank of New York talked about managing operational risk and ensuring regulatory compliance, while at the same time saving money and improving customer service.

Exactly what organizations are looking for these days.

Health care customer Blue Cross and Blue Shield of Rhode Island and partner Watch Hill walked through the anatomy of a purchase decision and it highlighted Rhode Island's commitment to a service culture and Pegasystems clean support of technical processes, business processes and creating a simple user experience.

Solutions partner Cognizant talked about using Pegasystems for pro active customer service outreaches.

And using work flow for response fulfillment.

We also had the chance to recognize customers who have exemplified thought leadership in the way they apply technology to business process management to making businesses more effective, making customers happy and then driving home the real value that technology can provide, companies like ANICO, Blue Cross Blue Shield of Massachusetts, HealthNow, JP Morgan Chase, Barclays and partners like PFPC and Virtusa stepped forward and received awards for specific tangible results they have achieved and for their advocacy of how organizations can recast their environments to the effective use of this technology.

In sum, our user conference was a validation of our technology vision and tangible work we are doing the potential that customers have as they come out of the current tough times.

The good news here is that some of these customers are spending money with us.

They see Pegasystems as having a ROI compelling story and we help businesses as one of our customers put it, “manage complexity without visiting complexity on the user” and we are making the investments to leverage understanding of where our BPM business is going to take our customers and increasing our ROI.

ROI leads to cash, cash for our customers and you can see from our terrific results a major rise in cash for Pegasystems as we've worked forward this year and last year.

So with that, let me just tell you that despite the tough times, interactions like this provide reasons to look at the long term with optimism and I will tell you the tough times provide an excellent test of character and opportunity to invest and make sure that we can leverage the thought leadership and the advantages we have.

I would like to close my remarks by really once again thanking the team for outstanding results in tough times.

Thanking our partners, our partners are becoming increasingly important and very central vehicle by which we are looking at our market, thanking customers who continue to invest with us and working with us to broaden our footprint in many significant organizations and thank our investors for standing by us and I would like you all to know that we are working very, very hard every day on your behalf.

With that, let me open the call to questions.

Thank you.

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

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

One moment for our first question.

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

Our first comes from Richard Davis of Needham and company.

Thank you very much.

With regard to some of your systems integration partners, could you talking about Accenture and are they engaged in the business rules process or as a follow on to that would be do you have a number with regard to how much business rules generated in terms of licenses and services this quarter?

This is Chris.

I will hand the first part of the question over to Henry.

Hi.

Sure.

We're in active discussions with Accenture and working with them on the number of deals as we are with a number of the other larger systems integrators such as IBM Global Services, Bearing Point, and EDS.

So we're very pleased, in fact with our success with larger SI partners and smaller partners and specialized business rules services companies.

Second question I will hand it back to Chris.

Richard, this is Chris.

In the second quarter we recognized an immaterial amount of license revenue from PegaRules.

We are implementing new customers so there is some services revenue related to implementation that is in the Q2 results.

Again, not a significant amount yet.

We do have, though, some indications where in addition to the pure PegaRules customers we have sold and implementing that we are seeing some of our existing customers also looking for PegaRules to be underlying technology for some of the applications that we are selling them.

So we are seeing the traction although as Alan pointed out decision making around technology continues to take longer than we would have liked.

Last one would be I guess for Alan or Henry, in terms of have you seen any kind of change in the competitive environment with regard to other firms?

I mean, the firms like Epiphany and Chordiant talking about financial services.

I was wondering if you have seen any changes there.

I can answer that question.

I think the changes we've seen there I think are positive from our perspective.

The reality is I think we're getting into a lot more deals that we want to be into now and we are getting our feet under us but there were a lot of deals that we were not engaged in that we are now being invited to and I like that quite a bit.

The financial services market is still reasonably depressed, of course, I think people are looking for signs of glimmer.

We would rather actually wait for the results to become evident before we started making cheerful projections but the reality is the financial services companies are having pretty tough times.

Until they get a lot more bountiful it won't get bountiful for vendors downstream.

We are moving outside of our traditional services market.

It takes time.

Thank you very much.

Our next question comes from Steven Carter of Stonegate securities.

Congratulations on a great quarter and first half of the year.

My question is I guess with the obvious or not obvious but hopefully with, you know, the turn in the economy and the IT spending are you guys starting to see that here this quarter?

Are you guys starting to see any positive outlook from your clients?

Any good talk from them?

And my second question would be do you guys think you guys will be putting out any guidance for the following or for the upcoming year anytime soon?

I am going to actually ask Alan to answer the first question and then I will address the second one.

Okay.

I'll tell you that I don't yet see a terrific evidence of upturn in the overall IT spending environment.

And my message to the staff has been and is that we've got to make our stuff good enough so that people will just plain want it and do it and use the technology even if it is environment doesn't turn up in the future.

So we're using this as a chance to, frankly, improve our game and to set ourselves a higher standard of what we need to do in terms of engaging partners, having a broader better ecosystem to be able to use and being committed to it to try in the longer than term reduce our reliance in the IT upturn.

If that happens that will be so much the better but I think third quarter is usually a tough time for soft software companies and I don't see anything broadly that makes me feel that folks are seeing anything different we are seeing.

I think we are good in tough times.

I think the team has shown that from evidence perspective.

Chris.

We have not yet positioned guidance for 2004 and more likely we will do that at the close of the end of this year.

Thank you.

Appreciate it.

Thank you very much.

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

At this time, I show no further questions.

Thank you, operator.

Thank you for your time.

Please note that we will be at the CIBC conference in New York next week and in September we will be at the Cowen conference in Boston and back in New York for the Roth Capital conference.

We look forward to seeing you at these events.

Thank you, operator.

This concludes our remarks.

Thank you for your participation in today's conference.

This concludes the program.

You may now disconnect.

Thank you and have a great day.