Pegasystems Inc (PEGA) 2004 Q1 法說會逐字稿

Good morning.

My name is Michelle, and I will be your conference facilitator.

At this time, I would like to welcome everyone to the Pegasystems' First Quarter 2004 Earnings Conference Call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad.

If you would like to withdraw your question, press star, then the number two on your telephone keypad.

Thank you.

I would now like to turn the conference over to Ms. Beth Lewis.

Please go ahead, ma'am.

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 and the volatility of our quarterly operating results, difficulty in predicting the completion of product implementation, and consequently, the timing of our license revenue recognition, the timing of term software license renewals, customer acceptance of our new PegaRULES Process Commander technology, our ability to develop new products and evolve existing products, 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 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 filings 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 are based on our beliefs and expectations as of today, April 29, 2004 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, our President and CEO, joining us from Florida on business.

Henry, would you like to begin?

Thank you, Beth, and good morning, everyone.

I'm pleased to say that Pegasystems delivered solid performance in the first quarter.

We earned revenues of 24.7m and pre-tax profits of 2.7m.

That's 12 percent revenue growth, excluding the anticipated reduction in First Data Resources' revenue, and a 4-percent decline as reported.

Additionally, perpetual and subscription license revenue grew 2.4m, or 46 percent, versus a year ago, which is a good indicator of our success with new license sales.

As we have said before, our focus of 2004 is on sales, which is why I'm particularly happy to report that during the first quarter, we signed eight new customers.

To put this in context, during 2003, we signed anywhere from one to three new clients in a given quarter.

New clients this quarter include AIU, a division of the insurance giant AIG, Aetna, and ING Canada.

We sold product to two of our partners.

We signed a Midwest banking institution.

We signed one of the world's largest defense contractors.

And through our partner AgencyPort, we completed the sale to two new insurance companies.

In addition to signing eight new customers, we also expanded our relationship with existing client Wells Fargo, who has purchased our Smart BPM platform, PegaRULES Process Commander, for use in monitoring compliance.

Another commitment we made was to use our patented rules-based technology not just to win new accounts but also to help solve our customers' business problems.

In other words, developing new uses for our Simply Smart BPM technology beyond our traditional customer process and exceptions management applications.

So Wells Fargo weill use PegaRULES to monitor compliance.

Our partner Vitusa will use PegaRULES to build internal applications to support its global customer service.

ING Canada will be using our product as an engine for underwriting and ratings.

And to give you one last example, AIU will be using Pegasystems to manage policy issuance and claims.

More importantly, we also continue to have success with our industry-specific applications.

AETNA will be using our PegaHEALTH contact center solution to deliver superior customer service to 30 million members and 600,000 service providers.

This was a hard-fought win against some major players in the industry.

We were selected because of our scalability, flexibility, and ultimately, our ability to provide AETNA a backbone for undisputed customer service.

Our success driving new sales in the first quarter is a direct reflection of the nearly 2.5m incremental Q1 investment year on year that we've made in sales and marketing, an initiative which I outlined to you in earlier calls.

We've expanded the sales team to nearly the planned level for the year.

We still have a few more people to recruit.

The infrastructure to effectively sell the product we build is coming together nicely.

We have also equipped our sales force this year with a much broader and richer set of applications and products to respond to customer needs.

Q1 was a watershed for new product delivery by Pegasystems.

As noted in our last call, in early February, we rolled out the largest product announcement in the Company's history, including PegaRULES Process Commander Version 4, which delivered a major new upgrade to our Smart BPM platform with extensive new functionality for both business users and developers.

We also refreshed the majority of our applications suite on the PegaRULES Process Commander platform, thus providing our customers best-in-class ability to meet the demands of ever-more complex and changing business processes.

This included the announcement of two new enterprise-wide applications based on Version 4.

In March, we followed up on the February announcement by sending our BPM product suite, the PegaHEALTH Claims Repair, designed for healthcare payor organizations to manage claims processing.

For financial services institutions, we also launched PegaCARD Smart Dispute Version 4 and PegaPAYMENT Smart Adjust Version 4.

Smart Dispute is an automated card dispute and chargeback solution, while Smart Adjust is an automated payment exceptions solution for retail banks.

We gained notable momentum with PegaRULES Process Commander this quarter.

About eight new customers, the majority, purchased Process Commander.

In addition, Process Commander this quarter, accounted for a significant majority of our license revenue.

It is worth pointing out here that the time from license booking to revenue recognition for our BPM platform has proven to be shorter than the nine-month cycle that had been typical for our applications.

Again, one of our goals for the PRPC product.

Increasingly, we are finding that customers are speaking on our behalf at leading industry forums, detailing the productivity and ROI they've gained with our software.

During the quarter, Pegasystems' solutions were highlighted by Blue Cross Blue Shield of Rhode Island, by Allstate, by JP Morgan Chase, and by American National Insurance Company.

Such visibility and validation is, I believe, testimony to the inherent value of our solutions, but it is also a result of our increased investment in sales and marketing.

Our proactive outreach through integrated marketing programs is paying dividends with growing thought leadership in the BPM market.

We also said that a key objective for 2004 was to continue to build out our partner and alliance program to allow us to scale effectively and to enter new markets.

I’m pleased to say that we're moving forward effectively in this area.

Our partnership with IBM is growing.

In early March, we joined with IBM in their ISV Advantage Initiative program.

We are also partnering with IBM in their new business Performance Management Program to enable partners to deliver solutions unique to their industry.

Meanwhile, we continue to strengthen our relationships with our major partners.

During the first quarter, we trained more than 45 partners on Pegasystems' products, from such firms as EDS, Cognizant, BearingPoint, Satyam, and CSC.

I'll also note here that we have significantly ramped up our training programs, and we had 75 customers come through our programs as well.

We have demonstrated this quarter that we can develop and deliver Smart BPM applications for a broad range of requirements, existing uses for our traditional industries, and new uses, both within our traditional verticals and extending into new industries.

We will continue to deliver competitive new BPM products throughout the year that meet and exceed customer needs.

We have demonstrated that our PegaRULES Process Commander BPM platform is gaining traction in the market as witnessed by recent sales to multiple new-name accounts.

We expect this trend to continue.

Let me reiterate here, however, that our business is driven by a small number of large deals, which make us susceptible to quarterly ups and downs.

Overall, we remain positive about the business opportunities that lie ahead, and we continue to invest strategically in order to leverage these opportunities to the best possible effect.

With that, I will turn the call over to Chris Sullivan for a review of the financials.

Chris?

Thank you, Henry.

Our financial performance in the first quarter of 2004 was solid.

Total revenue was $24.7m in the first quarter for 2004, compared to $25.6m in -- or a decrease of 4 percent over the first quarter of 2003.

It should be noted, however, that total revenue grew 12 percent, excluding the $3.5m year-over-year decline anticipated in revenue associated with the restructured First Data Resources agreement.

License revenue for the first quarter of 2004 declined significantly, while services revenue grew significantly versus the first quarter of a year ago.

Profit before taxes decreased to $2.7m in the first quarter, from $7.7m in the first quarter of 2003, primarily due to a decline in revenue and increased operating expenses, most notably investments in sales and marketing.

We generated $3.3m in cash from operations during the first quarter and ended the quarter with $92.4m of cash and short-term securities investments.

License revenue decreased to 9.7m from 16.2m for the Q1 2003, primarily due to anticipated decline in term license renewals and an anticipated decline in the FDR revenue.

Perpetual and subscription licenses grew $2.4m over the same period of a year ago.

Noteworthy with respect to our license revenue is that for two licenses installations completed in the first quarter, we had a much higher ratio of service to license content than is typical.

Services revenue increased $5.6m, or 59 percent, compared to the first quarter of 2003.

This was due to completion of a number of license implementations, as well as to the high service content for the two major license implementations mentioned above.

We do not believe that this quarter's license and service revenue composition reflects a long-term shift in our revenue mix in favor of services.

Implementation, consulting, and training services increased $4.8m, or 68 percent, compared with the first quarter of 2003, while maintenance services revenue increased $800,000, or 34 percent, compared with the first quarter of 2003.

A majority of our license revenue in the first quarter of 2004 is attributable to our new PegaRULES technology.

To amplify the earlier point on implementation services, services revenue grew in part due to new license sales.

Of the $24.7m in total revenue, $9.2m, or 38 percent, was from implementation services and license revenue related to new customers, including user extensions from implementations of PegaRULES and Process Commander.

We ended the quarter with a strong balance sheet, including $92.4m in cash and investments and no debt.

In addition, we ended the first quarter with $74m in combined short- and long-term and 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 eight quarters has ranged between a half a million dollars and 1.9 million dollars of license revenue.

The small number of license deals causes this fluctuation in our average deal value from quarter to quarter.

Our average deal size for the first quarter of 2004 was just over half a million dollars of license revenue.

This is reflective of the smaller average deal size associated with the implementation of PegaRULES Process Commander.

International revenues have typically been in the range of 15 to 25 percent of total revenue but can fluctuate based on the size of any one transaction in a given quarter.

International revenues represented 35 percent of total revenue in the first quarter of 2004.

Our international revenue may fluctuate in the future because such revenue is generally dependent upon a small number of license transactions.

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

For the quarter, gross profit decreased to $17.9m from $19.1m in the first quarter of 2003.

The year-over-year decrease was due primarily to lower license revenue, partially offset by significantly improved service gross margins.

Service gross margin was $8.3m, or 56 percent, for the first quarter of 2004.

This represents a significant increase compared to the gross margin of $3m, or 32 percent, in the first quarter of 2003.

This improvement was driven by a $5.6m increase in service revenue, slightly offset by a modest increase in cost of services, and resulted from the high service content related to license implementations completed in the most recent quarter.

R&D spending as a percent of revenue increased to 22 percent in the first quarter versus 19 percent in the first quarter of last year.

The increase is primarily due to the ramp in expenses associated with the major set of product releases in the first quarter.

These new products relate to our PegaRULES technology and applications built on that technology.

I would anticipate that our R&D spending will settle back into the 19- to 21-percent range as a percentage of revenue in the future.

Selling and marketing expenses as a percent of revenue increased to 32 percent in the first quarter of 2004 versus 22 percent in Q1 2003.

The increase is primarily due to the hiring of additional sales personnel and increased sales commissions associated with higher new license bookings.

For 2004, we expect to continue this higher level of spending.

G&A expenses as a percent of revenue increased to 12 percent of revenue for Q1 2004 versus 10 percent in the first quarter of last year.

The increase was primarily due to increased spending on audit and internal audit activities and compliance activities associated with the requirements of Sarbanes-Oxley Act of 2002 and related regulations.

Our timeless model for G&A remains at approximately 10 percent of revenue.

Profit before tax was $2.7m in the first quarter of 2004, a $5m decrease from Q1 of 2003.

This decrease was driven by a $6.5m decrease in license revenue, a $3.4m increase in operating expenses, and a $5m decrease in installment receivable interest income, partially offset by $5.3m improvement in service gross profits.

The provision for income tax was $900,000 for the first quarter of 2004.

Our effective tax rate increased from 12 percent in the first quarter of last year to 35 percent in the first quarter of this year.

We expect our tax rate to level off at or near the statutory rate, somewhere between 35 and 40 percent, for future periods.

During 2004, we will focus on profit before tax as an indicator of the business performance.

Accounts receivable days billed outstanding as of March 31, 2004 was 35 days.

Deferred revenue at March 31, 2004, primarily new client license and/or unearned service or maintenance fees, decreased to $13.9m from $14.2m as of December 31, 2003, primarily due to the recognition of revenue on the completion of several large projects in the first quarter and partially offset by an increase in advanced payment of maintenance fees.

Having established a foundation for solid financial performance, we continue to expect full-year 2004 revenue of $105m plus or minus 10 percent based on our expectation of new continued -- of continued new business success, tempered by fewer scheduled term license customer renewals and the anticipated lower FDR license revenue as compared to 2003.

We remain confident about the business and are, therefore, investing in incremental sales and marketing.

This is likely to result in somewhat lower pretax profits in the first few quarters of this year, as compared to 2003.

We expect profit before tax in 2004 to be in the range of 12 to 25 million, depending primarily on revenue achieved, and positive cash flow between 10 and 18 million dollars.

As a reminder, our tax rate will be normalizing to between 35 and 40 percent.

This is contributing to an expected EPS decline on a year-over-year basis.

And that concludes our financial summary.

Now, I'll turn the floor over to Alan.

Thanks, Chris.

At the end of last quarter's call, I was talking about how we had been working to build our operations, to build our products, and now we were ready to leverage with sales.

As Henry explained, we had excellent results in that department, and I'm especially pleased with the terrific results based on the PegaRULES Process Commander technology.

It's wonderful to get customer endorsement of our technological vision and to see how the tight integration of rules and BPM allows customers to do work, not just move it around.

It lets them genuinely build for change, and it also lets them have the flexibility to start with either the PegaRULES side or the Process Commander side and then readily broaden what they're doing to be able to expand and extend the capabilities across the organizations.

We're excited to not just be enjoying this customer validation, but we're making progress in our work to continue the thought leadership relationship with critical industry influences.

For example, for the first time, Pegasystems was ranked among Forrester Research's top 10 for pure-play BPM vendors, as measured by their TechRankings, and their “Wave” reports published in the first quarter of this year.

According to Forrester, we demonstrated significant leadership in the areas of human workflow, automation, and product architecture.

Michael Moaz of Gartner in his Customer Service Contact Center MarketScope in February said that, "References praised the system's ability to allow for the modeling and execution of new business scenarios.

Business managers are able to quickly implement new business processes without resorting to complex and time-consuming coding configuration," and gave us a positive rating.

This is exactly the concept that we've been working on and are excited to see the validation, both in the customer realm and also in the analyst realm.

In a head-to-head situation in which Celent Communications did a study of top providers of BPM solutions to insurance, we were short-listed as one of the top-three providers, and they noted that we were the only vendor evaluated that met all key selling criteria for essential BPM, once again showing the power of the technology around BPM and the technology around RULES being able to be integrated and operate so seamlessly.

So we're pleased we're making progress, but it's a tough environment.

It's hard to predict exactly what's going to motivate customers, but we're seeing them responding well to our story about strong ROI.

But the reality is that customers are cautious, thoughtful, and frugal, and what we're going to do is make sure that we're not resting on our laurels.

Despite the aggressive rollout of the applications during Q1, we're going to continue to enhance and expand our product suite.

We're adding more vertical capabilities being developed on that market-leading Version 4 foundation.

Version 4 itself is undergoing constant improvement to deliver greater functionality and benefits, and we're hard at work on the development of advanced simulation, enterprise, case management, and event management solutions to address additional opportunities inside our customer base.

All along, I think the -- all in all, I think the team showed an excellent set of results, strong performance, and I'm very pleased with the work that we've done and that we can continue to put the energy into the product development and into the sales effort as we go forward.

I'd like to end by thanking our customers, our partners, and our shareholders for their support, and with that, let me turn it over to the Operator for questions.

Thank you.

At this time, I would like to remind everyone if you would like to ask a question, press star, then the number one on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Richard Davis of Needham.

Thanks.

Maybe kind of two questions.

Could you talk a little bit about -- you kind of hinted about it during the prepared part of the discussion, you know, the competitive environment, how it seems like it's playing out.

And then, you know, maybe for Alan, if you kind of step back, where does it feel like the Process Commander and the whole effort that you're going after here, where is it kind of in that [Jeffery's Moore][ph] adoption curve?

Are we still early adopters?

Are we about to cross the chasm?

You know, what does it feel like to you?

Well, as far as the competition, we're seeing -- this is Henry, by the way -- we're seeing competition across the board.

We're seeing competition from large-scale vendors, and particularly around the AETNA deal that I mentioned in my prepared remarks.

We competed with some of the large-scale CRM vendors.

On one, we're also seeing competition from smaller BPM suppliers and RULES engine suppliers and in the applications business from the applications unique to [indiscernible].

Our competition comes from many different directions.

Actually, it probably hasn't changed much.

I'm sorry?

Then it hasn't changed a lot, I guess, over the last quarter?

No, no, not at all.

The competition is strong, and we continue to price strongly against them and have shown that we can win and win effectively.

[Good.][ph]

Alan, you were going to answer the question on this phase of the PRPC market?

Yes, I think it's an interesting situation because, you know, I love the [Moore][ph] adoption curve, but the reality is, the market, as I see it -- and my interpretation is a little bit bifurcated -- we have a lot of people who have looked at the problem with historical eyes and are, I think, looking for what they believe as being sort of a next generation of workflow.

And in that situation, we're sort of in a part of the curve.

Where there are actually number of organizations that are saying, "I want to be able to sort of do the next generation of manual process improvement," and I would say that we're actually closer to the middle of the curve there because, let's face it, workflow has been around for a long time.

But the reality is that workflow, I think, never hit the full potential at all of what we're trying to do.

And relative to what I believe our true adoption curve is, I think we are actually very early.

We're approaching early adopters who really get the notion of what we call Smart BPM, that unless you have the rules and the process in a situation where they interoperate seamlessly, that you're not going to get the real benefits of orchestration in a services-oriented environment.

You're not going to really be able to make your users work smart and as productively as possible, and you're not even going to be able to get the true promise of workflow.

So we're betting, I think, that that market, that new market for Smart BPM, is one that we can dominate and is one that is ultimately going to overtake the more established market for kind of work management and workflow products, which we've worked very hard to position ourselves out of, frankly.

So I'll tell you, a lot of the deals start with people thinking they want an old-style BPM workflow system or an old-style RULES engine, and we've got to move them into this vision that, hey, put them together, you get a non-linear improvement in productivity capability.

Does that answer your question?

No, that's very helpful.

And then last question for Chris, with regard to, you know, the new customers -- AIG, AETNA, ING and stuff like that -- were those term or perpetual licenses, and how did you recognize the revenues on those?

Yes, they are -- generally, the new license sales are generally, and I believe in the instances you cite, perpetual licenses, and our revenue recognition is consistent with perpetual license as we, I think, could go into significant detail on the MD&A.

But with perpetual licenses, we recognize the revenue for vertical applications typically after they are implemented, but with PRPC, the more packaged products, we occasionally have the ability to recognize on delivery.

That really depends upon the customer purpose.

Got it.

Okay, thanks.

That's it.

Your next question comes from the line of Gideon Kory of Roth Capital Partners.

Good morning.

Good morning, Gideon.

Regarding the deals done in this quarter, how many deals in Q1 were done with partners?

This is Chris.

I'll take that.

In the first quarter, more than half of the Q1 license revenue that we booked involved partners, so we are seeing some traction there.

And we've seen that.

And the partners, just for clarity, are typically SI partners who are involved in one or more capacities, either assisting us in selling or in assisting us in the information services.

We don't have necessary classic resellers involved in our selling model.

And in this quarter, Q2, how many deals in process involve partners?

I don't have that specific number, but we do have a significant involvement in the projects underway with partners as well in the same fashion that I described, SI partners assisting us with services and/or the selling process.

Most of our customers are very large enterprises who have ongoing relationships with the folks we're engaging with now in our partner program, so there's a high involvement.

I would say, Gideon, that there's been a very significant uptick in the last 12 to 18 months.

You know, Henry put together a number of programs to really accelerate the involvement of partners, to be partner friendly, to have actual sales meetings that were organized around our relationship with partners.

And the results of that are bearing fruit, and we're going to continue to invest, we're going to continue to push it back, and be as partner-friendly an organization as we can be.

Do you expect this quarter's services to continue being dominant part of the revenue?

I generally don't speak to any specific quarter, but let me tell you that in the first quarter, there was a higher-than-usual service content in a couple of transactions.

Then as a reminder for those -- this is -- more detail again available in the MD&A, but on revenue recognition of services, we recognize the revenue on a cost basis until the project is complete.

When the project is complete, we recognize the margin associated with the services.

So in very large implementations -- and we had a couple this quarter -- you'll see a significant amount of margin associated, say, with that implementation recognized.

That carries with it a pretty nice premium in terms of the margins.

That's not something that is typical, but it can happen on occasion quarter to quarter.

I wanted then to understand if it was a rollout of the PegaRULES Commander Version 4 and was the adoption of that product, taking consideration that the expertise is still in-house, do you see your partners -- well, really a big involvement from you in implementing those projects?

And in that regard, should we see during the year, at least the next couple of quarters, still bigger service component?

Well, I think that it's -- it's a very interesting situation because from the get-go, we wanted to focus on having our PegaRULES Process Commander technology work with partners.

We actually have had the majority of those be either, in some cases, partner-led and in other cases, partner assisted.

So the involvement of partners in the PRPC technology actually has -- is a much higher number, and I think it's led the initiatives to go with partners.

So you're going to see us continuing to do that, and one of the realities of that is that over the sort of longer-term view, you should expect that our services revenue will actually go down relative to the license revenue as we work, as we've discussed in the past, to look more and more like a software company and really seek to use the partners to broaden and leverage what we do into industries and areas outside of our traditional homes in banking and then healthcare.

One of the things I’m excited about is that in conjunction with partners, we've actually been making progress to get into areas that we never would've considered getting into, frankly, 18 months ago.

The other manifestation regarding the services revenue is that, as we've discussed in the past over years, when we have a situation where we've sold the license and we do a lot of work on it and for whatever reason we end up providing more services than we had originally anticipated, that causes a morphing, a shifting, from our accounting policy perspective of money that was sold as license to end up being recorded appropriately as services revenue.

This can lead to several million dollars, particularly when projects are closing, ending up being in the services line even though when the original deal was sold, it was sold as a license.

This investment of effort, though, I think, is an appropriate thing to do in many cases because it's entirely the way that we get customers very excited about what we've delivered and have the opportunity to do a lot of follow-on sales and follow-on work in those departments.

You mentioned vertical capabilities that you're getting in.

Does it mean that you're expending beyond financials, healthcare, and insurance, or those more niche implementations within those three verticals?

This is Henry.

Our focus is, from an applications standpoint -- there have been two broad applications areas.

One is in exceptions management, and the other is in what we call customer process management.

In the exceptions management, you've seen us focus with applications, such as the disputes application, Smart Dispute or Smart Adjust, which is to manage check research and adjustments and payments adjustments of many kinds or claims exceptions in healthcare.

These are all a family of exceptions management applications.

We have built and announced in Q1 a cross-industry product called Quality and Exceptions Management, which we expect over time will be sold in cross industries.

However, the bulk of the exceptions management applications themselves are meant for financial services and healthcare.

In the customer process management area, of which the AETNA deal is a good example of that, we also in Q1 announced a horizontal cross-industry product called CPM, Customer Process Manager, and that product is available on the cross-industry basis although it will be principally positioned and customized for financial services and healthcare, including insurance.

And the last question I have was regarding insurance opportunities.

Alan, you mentioned a Celent report and you being listed there as on the short list of three companies.

How big that opportunity is for you and are you really in the early stage in that industry?

I think the opportunity in insurance is ultimately quite large.

Insurance companies are full of rules and processes, and once again, that's one of the things we do well.

We're sort of nascent, frankly, in my opinion, attacking that.

We've been able to win some great customers -- Allstate and ING Canada and a number of other firms -- but I think it's a very significant opportunity, and as we go through the year, we're going to be continuing to add depth to both our sales efforts and our marketing efforts in that area.

So we're pretty jazzed about bringing insurance into the fold.

Thank you.

[Caller instructions.]

Your next question comes from the line of Philip Rueppel of America's Growth Capital.

Yes, thanks very much.

First of all, you know, Henry, you had mentioned that you have pretty much completed hiring on the sales force side.

Can you kind of give us an idea of sort of the productivity you've seen so far and kind of if we could assume that by year-end that we'll be up to sort of 100 percent productivity on the sales force front?

Yeah, we've built a model which assumes that a sales rep by the third quarter of their employment at Pega are 100-percent effective.

That translates into our expectation by the third or maybe the fourth quarter of their employment that they will be at the standard rate of bookings per quarter.

That, however, does not necessarily translate into revenue because, obviously, depending on the product being sold, if it's revenue on delivery, then you would see it right away.

And if it's not, you would see it several months later.

But we are very much on that -- Q1 results suggest that we are at or slightly ahead of that model.

Okay, great.

Thanks.

And then on the -- you know, you mentioned, Chris, that on the renewals, much of the decline was anticipated.

Was there any unanticipated decline, any loss of customers or customers renewing at a reduced rate, or anything along those lines?

There were no customer renewals that were anticipated that were lost that I’m aware of, and in terms of the value, we don't discuss the value of any particular deals.

But for the most part, typically, we see that our renewals do renew at or above the new -- the rate that the old contract was under.

We do occasionally have exceptions in terms of with consolidation in the industry and other factors.

There may be lower seat use requirements, and so those occasionally do happen, but in the first quarter, we didn't lose any transactions that we anticipated to renew.

Yeah, but it sounds like, by and large, that the total number was anticipated?

Yeah, the renewal activity for the first quarter was pretty much what we were anticipating.

One point of clarification while I have the mic here.

In my text, I did refer to in the profit-before-tax discussion a decrease in our installment receivables, and I may have missed a decimal point.

It should've been point five million versus five million, so I just want to make sure anybody who's building their models has the right number.

Okay, thanks.

I have one other question just along the lines of the new customers.

It sounds like you had -- you know, with some, you've certainly booked a lot of revenue on the implementation side.

Is there still -- have any of them accepted their products in the current quarter, or is that something that will happen in future quarters?

Yeah, what we're seeing is that with certain products, particularly the PRPC platform product, there is the capability for customers to accept the packaged product as is.

They may have uses that they have in mind that we're not going to be involved in the implementation services.

So in those instances, revenue recognition allows for the revenue to be coincidental with the signing of the license.

That's not typical of our vertical application sales.

So, again, as the mix of PRPC platform sales increases, that will be something that will be something that should be factored into models.

An important thing also to consider in your models is as that occurs, we've talked historically about services revenue being an indicator of future license revenue.

That still remains the case in general, but, you know, the backlog necessarily shouldn't be correlated as one for one because on occasion we are able to sell a [PRPC][ph] license and we'll book in the license and the revenue at the same time.

Great.

Thanks very much.

Your next question comes from line of Joe Halpern of Halpern Capital.

Good morning.

On the eight new signed customers, just to give a little color to it, is that going to go on the revenue recognition?

Could you give a better metric?

Is it 20 percent of the revenue is recognized from these new clients through the PC, or also, through the Process Commander?

The license -- just to make sure, the license signing that we refer to in terms of eight, those are license signings.

In some cases, it's revenue.

In some cases, the revenue will be recognized later.

But the eight that we're citing we refer to license signings, new customer license signings.

In terms of the revenue recognition, again, some of that revenue was recognized in the quarter.

I think I've provided a number that might assist you in the question you're getting to.

We said about 36, 38 percent of our revenue for the quarter was associated with new customer transactions.

Okay, thanks.

And what's the potential of follow-on?

Some of these companies you mentioned -- AIG, AETNA -- are huge companies.

Did they kind of buy a small amount of seats with potential follow-on revenues, you know, after maybe a beta testing on their side, or --?

Yeah, some bought a little more and some bought a little less, but I would say in every situation, there is the opportunity for follow-on business.

So none of these consumed the customers' potential, which is consistent with our strategy there.

So there was a mix.

Some people were pretty psyched and actually bought enough for their real anticipated project, but in all sites, we see the potential for follow-on projects and follow-on business.

And was the average deal size on these new customers, was that kind of going along with the average deal size in the first quarter of around 500K or--?

Yeah, what we see is that, again, for the vertical applications, they tend to be higher than the Process Commander sales, and so, on average, a little over half a million, the Process Commander ones typically being smaller and the vertical applications typically being larger.

Okay.

And then services, kind of mentioned in the last question that it's a little of a precursor towards higher license revenues, and you also mentioned kind of that this quarter you had a higher service number just from implementations in the quarter.

Where would you put that number this quarter in terms of services being a precursor towards future license revenues?

It's hard to say exactly, but I think it's important to understand that some of those licensed bookings that we cited were revenue in the quarter and others will be revenue down the road when the service implementations are complete.

It's hard to have a specific number for this quarter's activities.

Again, that revenue also will be spread out at various time horizons as well.

Some of the licenses will be shorter than others in terms of the implementation.

Typically, though, it's nine months.

Okay.

And then last question here, just on the service margins.

It's 56 this quarter.

Where do you think that settles into?

It's been a little erratic, I guess, the last couple quarters.

Yeah, the premium in this quarter is driven by the service content of the large implementations that we completed.

So I think what you need to continue to focus on from a modeling standpoint is we expect our maintenance revenue -- service maintenance revenue to contribute 75 to 80 percent in terms of gross margin, and we expect the implementation on services to typically generate about 35 percent gross margin.

That's -- so for modeling purposes, probably still an appropriate set of assumptions.

But, again, when you get a premium or a large transaction booked in a quarter, it tends to be the margin only associated with those services, and if that's a large project, it'll skew it, as it did this quarter.

Thank you very much. [That's it.][ph]

Your next question comes from the line of Tripp Rudisill of Welch Capital

Hey, guys.

Nice quarter.

All my questions have been answered.

I got in the queue late, so good quarter, and the only thing I would maybe have you discuss is on the partners' side, if there's any -- can you mention any of the partners?

Just, you know, hearing some opportunities possibly with Cognizant.

Don't know if that's true or not, or to the extent you can speak about that, that'd be great.

This is Henry.

We're very pleased actually with the results so far with our partners.

We have ongoing projects going on with every one of the partners as I mentioned in my prepared remarks.

They're in the pipeline.

We're working closely with them.

And my hope is that that will continue to develop and expand.

Your next question comes from the line of Andy Schopick of Nutmeg Securities.

Good morning, and thank you.

I wonder if you could just characterize two things -- the overall pipeline of activity, and, secondly, just a general comment about what you are seeing happening in IT budgets in spending, recognizing, you know, that there is a cautiousness.

But if you could just characterize in some way what you are seeing taking place now in response to those questions?

As far as the pipeline, our pipeline has grown slightly relative to a quarter ago.

More importantly, I would tell you that my assessment of the velocity of the pipeline -- in other words, how quickly stuff moves through it -- is slightly improving, which means that there are more deals coming to --

Fruition?

-- yeah, to the decision point, and actually closing or not, for that matter.

But to that point, slightly more quickly.

So I look at the pipeline in two ways, from a quantity standpoint, but also a quality standpoint, where the principal quality metric is velocity, you know, how quickly stuff moving right through it.

And I think as we've seen a slight improvement in that, and that's actually a very positive question.

I think Al will pick up the second part.

Sure.

The mood in the IT department is, I think, visibly better, but still, I would describe it extremely choppy.

The IT departments have been through a pretty tough time.

They're being very rigorous; there is a bunch of people who have accustomed themselves to putting huge pricing pressure on vendors, and there's a lot of desire to do a land grab to get business.

We tend to be pretty, I think, rigorous in how we engage with our customers, so I think we're in a good position to resist it.

But I would say it's a choppy environment.

There's a lot of pressure, a lot of demands, to show me, "Before I buy," and we're engaged in a lot of efforts like that, and you know, the sort of skepticism that I think you've heard about from some of the other companies that have spoken.

So I will describe it as far better, choppy, demanding.

And, you know, as a result, I'll tell you that the staff is wildly busy.

I mean there's a huge amount of work trying to respond to the increased demands and the pressures from the IT group.

But it's far better to be engaged with them than to be in the situation where, you know, you're in pursuit and they're not as interested.

And I'll tell you, the interest's there, despite, I would say, the choppiness of the environment.

Could you discuss any specific initiatives underway to expand or grow your relationships with systems integrators or other channel partners, both domestically and internationally?

You know, are there clear target opportunities for this company to establish relationships that could help to grow its business?

This is Henry.

Sure.

We are working extremely closely with the major systems integrators.

With IBM Global Services, I mentioned a couple of programs where we have signed agreements with IBM in the first quarter.

We have work ongoing with CSC.

We have work ongoing with Accenture.

We have work ongoing with Bearing Point.

And that work with most of those integrators as the EDS is, in many cases, both in North America and in Europe, and in some cases, extending into Asia-Pacific.

So the relationships we're building are strong.

We're very, very pleased with the receptivity we've had from those integrators, and I expect that over the coming quarters, you should expect to see more deals where there is a significant systems integrator as part of the solution that we have offered to our customers.

Thank you.

At this time, there are no further questions.

Mr. Ancona, would you please give closing remarks?

Definitely.

Thank you for your time, everybody.

For those of you who have yet to register, please note that we're holding an Analysts' Day next Friday, May 7, at our headquarters here in Cambridge.

We encourage you to attend or access the webcast.

Please contact Beth Lewis for additional information.

Thanks a lot.

Thanks, Operator.

That concludes our call.

Thank you.

Ladies and gentlemen, this concludes today's conference call.

You may now disconnect.