Pegasystems Inc (PEGA) 2005 Q3 法說會逐字稿

At this time I would like to welcome everyone to the Pegasystems' third-quarter earnings conference call.

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

After the speaker's remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS).

Ms. Lewis, you may begin your conference.

Before we begin I would like to read our Safe Harbor statement.

Certain statements contained in this conference call may be considered forward-looking as defined in the Private Securities Litigation Reform Act of 1995.

These statements involve various risks and uncertainties 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 our license revenue recognition, the timing of term software license renewals, customer acceptance of our 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 and healthcare 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, November 9th 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 and Chris Sullivan, Chief Financial Officer.

Alan will provide opening remarks.

Chris will review the financials, and Alan will return with additional remarks prior to opening the call for Q&A.

With that, Alan.

Thank you very much, Beth.

I would like to sum up the quarter as follows.

We did get evidence of improved sales execution.

The 13 new engagements, including four new name clients and nine extended sales.

The quick value strategy is working where we work with a customer to show that they can get a benefit and then look to have them buy more.

The nine included add-on sales to two customers first sold only earlier this year.

We are also seeing evidence of partner leverage, working to put the right partners in the right place and build and support relationships with our partners to help us radiate and better handle our customers.

It's really quite clear that BPM, business process management, is a winning strategy and leading corporations are understanding that they have to be able to close the gaps between what they want to do as management and what their systems and their operations infrastructure allows them to do.

Closing these execution gaps is how organizations provide better customer service, bring products to market faster and expand business.

And leading corporations are showing that Pegasystems can help them close their execution gap, making them get quick value and allowing them to build for change into the future.

As pleased as I am, we still have a lot of work to do to ensure that the business is going to move as we wish and I will talk about some of the challenges and some of the things we're seeing that are going well when I speak later in this call.

For now let me turn it over to Chris.

Thank you, Alan.

I'll begin with a quick overview of the third-quarter results and then provide a more detailed review of the year-to-date results.

New license signings were significantly stronger in the third quarter than in either of the first two quarters.

This included one large new term license signing with an existing customer who bought a new PRPC license selecting Pegasystems as its global BPM platform.

We are also encouraged by the number of new customers and existing customers who purchased PRPC licenses this quarter.

Total revenue in the third quarter was $26.8 million, up 25% compared to the third quarter of last year.

License revenue was $11.6 million comprised of $9.2 million in term license revenue and $2.5 million in perpetual license revenue.

The increase in term license revenue was related to one large new PRPC signing as noted.

Services revenue was $15.2 million, comprised of $10 million for consulting and $5.2 million of maintenance revenue.

Service revenue increased 4% compared to the prior year with maintenance up 24% from the third-quarter of 2004 and consulting down 4%.

Gross profit in Q3 was $17.5 million compared to $15 million in Q3 last year, driven by a $4.8 million increase in license gross margin offset by a decrease of $2.3 million in service gross margin.

This higher cost of services reflected investment in trained services resources to better meet anticipated demand associated with increased license signings.

Profit before tax was $3.1 million compared to a $1.1 million in Q3 2004.

Our effective tax rate for the third quarter was 56% compared to 35% in Q3 2004, as a result of an adjustment to our deferred tax liability related to term license installments.

We expect the effective rate will be closer to the statutory rate for the remainder of 2005.

And now for the year-to-date view.

License revenue for the first three quarters of 2005 was $30.5 million, up 8% compared to the first three quarters of 2004.

This $2.3 million increase includes a $3.6 million increase in term license, the results of an existing customer whose purchase included a large PRPC license.

Perpetual license revenue year-to-date dipped $1.2 million versus last year even as our rate of new customer wins has increased, due in part to our sales strategy of initially selling rapid implementation, limited scope, PegaRULES Process Commander licenses to targeted large accounts.

The successful implementation of the initial license promotes opportunities for follow-on license sales of additional uses for PRPC which is exactly what we saw this quarter.

Nine follow-on PRPC license sales.

Services revenue in the first three quarters of 2005 was $44.4 million compared to $42 million for the first three quarters of 2004.

The increase includes a $3.6 million increase in maintenance services related to new license sales partially offset by $1.3 million decrease in implementation services revenue, reflecting in part greater participation of partners in the implementation process.

It is also important to note the consulting services revenue in the first three quarters of 2004 benefited significantly from the margin associated with the completions of two unusually large fixed-price projects completed in the first three quarters of 2004.

In the first three quarters of 2005 we signed 17 new license customers, the value of total license signings in the first three quarters of 2005 was modestly higher than in the first three quarters of 2004 reflecting traction with our strategy of focusing on quick value initial sales that lead to follow-on license opportunities.

As a reminder our Q4 2004 license signings were particularly strong, so it's uncertain whether the growth in license signings experienced through the first three quarters of this year can be sustained for the full year.

In the first three quarters of 2005 international revenue represented 33% of our total revenue.

Our international revenue can fluctuate in the future because such revenue is generally dependent upon a smaller number of license transactions during any given period.

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

For the first three quarters of 2005 gross profit decreased by $1.1 million to $49.7 million compared to the first three quarters of 2004.

The decrease was due to lower consulting services gross margins only partially offset by increased maintenance gross margins.

As noted earlier, this higher cost of services reflects an investment in trained services resources to better meet anticipated demand associated with increased license signings.

R&D as a percentage of revenue is 20% through Q3 2005 versus 22% for the same period last year.

We expect to competitively invest in R&D for our spending levels -- though our spending levels will occasionally fluctuate depending on new product development schedules.

Selling and marketing expenses increased 8% to $24.7 million for the first three quarters of 2005 from $22.9 million in the first three quarters of 2004.

The increase was primarily due to increased sales commissions related to the increase in license signings and the hiring of additional sales personnel and increased marketing programs.

G&A expenses increased by $0.5 million versus the three quarters of the first three quarters of 2004, primarily due to the combined effect of the increased incentive accruals, additional staff and increased spending on audit and compliance activities associated with the requirements of Sarbanes-Oxley and related regulations.

Profit before tax was $3.8 million in the first three quarters of 2005, a $3.3 million decrease from the first three quarters of 2004, driven as noted by the decrease in service gross margin and increased operating expenses, only partially offset by license gross margin improvements.

Account receivable days billed outstanding as of September 30, 2005 were 69 days.

This is up from December 31, 2004 due to slower payments associated with outstanding amounts owed for annual license and maintenance billings.

Deferred revenues at September 30, 2005 increased to $16.2 million from $9.1 million as of December 31, 2004.

The increase is due in large part to the increase associated with new license arrangements for which acceptance of the software or achievement of service milestones had not occurred in the timing of annual maintenance fees.

We generated $18 million in positive cash flow from operations during the first three quarters of 2005.

During the first three quarters of 2005 net cash provided by operations benefited from a $7 million increase in deferred revenue and a $17.1 million reduction in short and long-term license installments, partially offset by a $9.5 million increase in trade accounts receivable.

At the end of 2004 the Pegasystems Board of Directors authorized the repurchase of up to $10 million in our outstanding common stock.

During the first three quarters of 2005 the Company has repurchased 803,312 shares for a total of $4.8 million in open market purchases under this program.

Guidance for the full year 2005 is as follows.

We now expect full year revenue to be between $97 and $105 million.

The broad range of revenue estimates is attributable to a small number of large value license opportunities in the last quarter of the year.

We expect a proportion of services revenue to continue to be above 50%.

We are committed to becoming the world leader in BPM software and as previously discussed; we continue our investment in sales, marketing and services capacity throughout 2005 and believe this investment will better position Pegasystems to achieve accelerating growth in future years.

But we also anticipate it will continue to result in lower profit before tax in 2005 as compared to 2004.

As a result, we now expect the full year of 2005 earnings per diluted share to be between $0.03 and $0.15 per share.

Full year cash flow from operations is now expected to be in the range of $18 to $22 million.

And that concludes our financial summary.

I will hand it back to Alan now.

Thank you, Chris.

Before we open up for questions I would like to talk a little bit about how I think the Company has been doing.

I think we have seen marketedly improved execution.

We continue to close more deals with the right customers and with the potential for more.

Thirty-two through the first nine months versus 22 this time last year.

Thirty-two includes 16 new and 16 expanded pieces of business, and from our perspective it is about closing the right pieces of business.

Working with leading organizations and understanding the value of aligning their systems and their business operations with the ever-changing management objectives.

As they understand how they need to do this, they tend to appreciate the importance of building for change and how Pegasystems can help them both fix small gaps in the immediate, and then work with them to put in larger and more potent infrastructures for the future.

Please note we are not entirely bypassing small organizations.

It is rather that we are targeting a focused number of accounts, and I will talk to you in a minute about how we're doing this I think in a thoughtful and ultimately more successful way.

Having engaged with an organization we think one of the most important things to do is to follow what we call a quick value strategy.

Instead of working hard to sell massive deals that could lead to a loss of shelfware, what we're looking to do is to get into an organization and work with the customer to see how they can actually apply this technology.

That is how we got into the 16 new organizations today.

And once we've proven we can provide value and for example, we've done that if you look at the Highmark release that we showed earlier where we actually brought the customer to production within five weeks of them actually signing a deal.

We show them that there is actually real value there.

That gives us the basis to sell more.

And that is why you've seen us do the follow-on pieces of business I talked about.

And then be in a situation where we are not just selling once and are done, but we're in a position having picked the right organizations to work with, to continue to develop and foster that sort of relationship.

I have been asked by a number of folks about the HSBC business that we announced and what that means.

We're very proud of the relationship with HSBC; they are known as the world's local bank.

They were the global bank of the year according to Banker Magazine this year, and they are the fifth largest company in the world according to Forbes recently.

So it is a massive organization, 260,000 employees, 110 million customers and a real privilege.

And frankly, thought leadership organization for us to deal with.

And it is wonderful we've been able to expand our relationship with them, be named as the BPM standard and we think it is actually a harbinger for both good work in the present and good work for the future.

We've also talked about other key customers.

You may have seen the release go out this morning about our relationship with CSC.

And CSC which is of course a partner organization of ours, through their partner MemberHealth, is now using Pega technology to drive very, very important Medicare and Medicaid programs around the whole Part D drug benefit.

Automating a call center and a variety of other related functions and building on other victories we've had in this area are like the previously announced ViPS subsidiary of WebMD.

So what this is about is dealing with organizations that are thought leaders; about getting a quick value selling strategy, being willing to do a smaller piece of business, working to sell a bigger piece.

And of course ultimately looking to create the sort of deep and profound relationships that we think are going to characterize the leader in the BPM space.

We are also looking to leverage partners.

I recently did a trip to India to visit the more than 100 staff who work on behalf of and with Pega at Hyderabad.

And it is actually quite exciting.

There is quite a bit of enthusiasm among the number of our partners for being able to well, apply their resources and their thought leadership to the various pieces of business.

In terms of onshore partners this quarter we closed a significant piece of business working with IBM, and we are really trying to focus on working with the right partners who want to do the right things, and buy into this notion of quick wins and ongoing customer value.

So, as we talked about last quarter, we're focusing on BPM.

We have our highly unique approach to business process management.

We are able to marry the rules of the business with their processes in ways that are both technologically unique and we frankly think support the build for change value prop extremely well.

And we're seeing an increasing range of uses; we've been selected from doing customer service to bill payment to legacy transformation.

We are doing it in the industries we said were important, in financial services.

You see us moving actually beyond banking and into other industries that are part of the greater financial services umbrella, insurance becoming an increasingly important part of what we do.

And the government and some of the healthcare work that we've been doing where we actually think there will be an increasing opportunity for us to play in this area, that is actually important to the way the economy works and frankly very important to our customers.

They both have efficiency and compliance built-in to the way that work is done.

So the quick win strategy which we put in place is working.

It doesn't mean that this causes the business to not be tough or not be lumpy.

In fact if anything it puts a special onus on us to be able to work with our customers, show the value and then be in a position to work with them to capitalize on it.

And of course there are still the periodic very large pieces of business that are just so hard to predict.

But I am very pleased that the articulated strategy, the refocusing around a smaller number of target accounts is showing itself there has been a strategy that is a good strategy, a good strategy for this time when customers are more skeptical and I think the strategy for a time in the future where people always are going to gravitate to solutions that show them value.

Vis-a-vis the sales force, we are hiring.

And in fact we're doing a good job of pulling top salespeople from competitors.

We are hearing that Pega is seen as an exciting and innovative place to work.

And we're finding it is getting easier to bring talent to the table.

I am very pleased with the caliber of employees that are coming to us and the selections we are having.

This is especially important as we move to a more geographically diverse sales force.

I think one of the issues that we had historically is we're just too inwardly focused and we're working now to find salespeople who have the right sort of relationships, who have the right sorts of skills, both technical skills to deal with the customers at a content level and relationship skills and are also closer to those customers so that we're in a position to develop much more customer intimacy.

We're in a position to be able to work more closely and understand their business.

This is about becoming more of a trusted adviser to our customers and making it so it is not just a hit-and-run opportunity sale, and making it so that this quick win strategy leads to long-term extended relationships.

So we think that SmartBPM is all about aligning businesses and systems.

This is a journey that we're making in conjunction with our customers.

We've made a lot of progress, though there still is a tremendous amount of work to do.

We've done some internal promotions, and we've set up two managing directors for North American sales so the internal organization is coming together with more structure.

And we continue to support our sales force with better work in terms of the marketing materials, the website, etc., all of which are going to be important pieces of focus as we work to build a company that can scale.

So you are going to see us looking to the marketing, looking to the selling, looking to enabling our customers to be increasingly self-sufficient, and looking to build a partner ecosystem that is able to work with customers and drive value even beyond where we ourselves can reach.

And once again, I’m pleased that we are seeing evidence that this is working.

I think as an organization we are working extremely hard; we're making the right moves.

I think our product, our people, our partners and ultimately our customers will be able to show those successes.

With that let me turn it back to the operator, and operator could you see if there are any questions?

(OPERATOR INSTRUCTIONS) Richard Davis, Needham & Co.

You may not be able to give perhaps an explicit number on this HSBC, but just in terms of helping people think about the opportunity, and HSBC as a point out is a huge company, 260,000 employees, what is the potential when you look at these big financial institutions for you guys in terms of annual licenses and services?

Or is there a way to kind of describe how big this is relative to a breadbox kind of thing?

What I will tell you that as a matter of practice, we are building the relationships with these organizations.

So we are not going in and sort of selling out everything they want.

We made it pretty clear with our customers that we intend to stick around and part of that happening is meaning that even when there is a large piece of business that crosses the transom, that doesn't obviate the potential for future business.

So we are not doing anything with these big customers to cause them to, for example, sellout.

So I think that its quite clear to me that the potential for the business with the world's largest organizations is measured, not just in millions, but perhaps even potentially tens of millions at some point in time.

We are a long, long way from being able to achieve that frankly in the typical case.

But the way we are looking at our customers is about not doing what so many software companies do which is sort of sell out the opportunity upfront and find they end up not being able to grow, drive the business.

Then more kind of a financial question.

Perpetual licenses, they move around and things like that, but you've been kind of moving in that direction is my recollection.

And it was kind of as best I can tell it looks like it was flat year-over-year.

Should we read anything into that, or is that kind of the ebb and flow and you need to kind of look at it over a couple quarter's smooth basis?

I think it will bounce around.

We said, though, that in changing the strategy, the selling strategy, we made a conscious decision in many cases to go to target accounts and be willing to sell smaller slivers upfront in order to, as Alan just said, nurture a long-term relationship.

So that is a piece of it, but our general practice of selling predominantly perpetual licenses to new customers is still the practice we employ.

But we would expect to see that grow over time.

But there will be periods of time particularly as we are in transition where it is logical to see that while the number of perpetual licenses are up, the average value of those deals and the initial sales to new customers may be smaller than it was a year or two ago.

And I guess if you're using this kind of cooperative (indiscernible) strategy with customers that would explain that service margins at least on a blended basis were down a bit sequentially.

Is that the right way to think about it?

It is nothing something that we should be worried about but that's really what it is?

That's the right way to think about it, we do want to maintain competitive gross margins in our professional services business but two things.

One is we are hiring in advance of anticipated demand there.

And even within that, we are looking for the services organization to provide the value to the customer each time.

In some cases the partner may be the solution, and in some cases it is Pega’s services and that will really rely heavily on what the customer's needs are.

Thank you very much.

Joseph Halpern, Halpern Capitol.

Nice quarter.

Most of my questions have been answered but I will just ask a quick one, on the term licenses.

I know this year was supposed to be a little bit modestly higher than last year.

Can you give us any insight into what the fourth quarter looks like and also 2006, relative to what you guys have been doing?

I think one thing we've been fairly consistent on is around our term licenses as we speak to what we have as scheduled renewals.

So in the guidance earlier in the year we referred to the fact that the scheduled renewal value this year was about the same as the scheduled renewal value last year.

But there's a lot of volatility within that number as customers make decisions to perhaps in some cases move forward to a new technology, they will add or extend on.

So when you renew a license value it isn't always renewed for the same exact value that the scheduled renewal would yield.

So it does bounce around.

In the fourth quarter again, we don't have a specific guidance for the fourth quarter but the scheduled renewals value for the year remains about what it was last year.

And we will -- it may move around based upon customers' decisions to extend or expand the value that might move it up or if a customer has a reason due to consolidation or other factors beyond our control, sometimes it causes those renewals to be a slip or be lost.

So it is hard to predict in a short window like a quarter.

And how about 2006 relative to I guess 2004 and 5?

I think we're going to just punt for now; we're going to be looking at the guidance as we close out this fourth quarter, and our traditional window for setting guidance for next year will be sometime around the release of the fourth quarter results and the K.

Okay, thanks.

Then just on perpetual licenses, what was the ASP in the quarter?

And what -- I guess just for comparison sake, what was it I guess either a blend of last year or a blend over the last few quarters?

This year it was $1.1 million for an average deal price.

And again that is purely a mathematical number – the amount of revenue divided by the number of revenue transactions -- so it does move around.

In general, though, that number has been bouncing around between 0.5 million and 1.5 million this quarter, tends to be right in the middle of that range.

And but I think if you are building models or trending the business we would expect that, again, initial sales to large customers may be smaller ASP.

But over time we expect them to see the value of the deal and buy bigger and bigger pieces of the PRPC technology for larger and more expansive purpose as we go forward.

Thank you very much.

(OPERATOR INSTRUCTIONS) Kenneth Miller, Bonanza Capital .

Congratulations on a good quarter.

I was wondering if you could give us any more color on the big deals that you're looking at as a big swing factor for Q4 in terms of what kind of companies are they, what kind of products, are they new or existing customers and things like that.

I think in all cases we are really bought into this target account strategy.

And it is the business that is on the plate is a mix of new and additional customers.

So I think we've actually done a lot of work to try to move our model to this consistent target account selling, as opposed to we used to frankly chase opportunities a lot of times I think a little too late.

And that is going to lead to targets both inside of existing customers, some of whom frankly we have underserved over the years and are now getting ourselves reintroduced to.

And the mix of new ones, but new ones that we picked to go after as opposed to -- and we don't sit around looking for leads anymore.

This is really very much about us picking the accounts and going after them.

And who are you seeing as the competitors you are up against in most of these big deals?

The competitors we're seeing actually a mix of competitors.

Recently we have beaten organizations like Chordiant, Epiphany in a variety of pieces of business.

We have beaten FileNet and ILOG and Blaze or Fair Isaac.

So we've actually been having I think a pretty good track record all in all when we commit to one of these pieces of business and we put the effort into it, we are actually finding that we are more successful just because, frankly, the focus.

Okay, and a related question.

I don't know if some of the big deals have to do with this, but what about the traction in the new frameworks for human resources, technical support and procurement you announced a little while ago?

Is it too early to tell what kind of traction those are getting or are some of these deals involved with selling these new frameworks?

It's early on those in particular, but it is really pretty clear that the framework strategy where we said we are going to take advantage of the strength of the product, which lends itself to lighter frameworks is catching on.

We've actually sold a number of our other frameworks, and we have people looking at the frameworks that you just mentioned with some seriousness.

We actually, though, see the frameworks as ways to enable the PRPC technology in an organization as opposed to going in and trying to sell the framework as an app.

The framework provides a way for these guys to get a quicker win.

In particular I would say our call center framework is to my mind doing -- I don't want to say surprisingly well because there was a lot of skepticism earlier in the year when we were thinking about what to do as to how strong a market call center would be.

But it would appear that with Oracle and Siebel PeopleSoft and a lot of the other vagaries with Epiphany having disappeared, that people still have these call center needs and they are very much more interested in being intense driven, which is what our call center technology does.

So we are thinking that that is an example of where we are seeing some of these frameworks actually really facilitate significant pieces of business.

And a quick financial question;

I might have missed this on the call but did you break out your quarterly revenue for license between perpetual and term license renewals?

Yes, it is broken out in the Q, but just so you know for a license revenue we do break it out between term and perpetual.

And we do show it year-over-year, and services we break it out between our consulting services and our maintenance.

So that is available if you want to see the breakout.

Is the Q out for this quarter already?

Yes, our practice is to provide the Q and the earnings release simultaneously.

So that should be available on Edgar at this point.

So it is.

Thanks, guys.

That's all I have.

At this time there are no further questions.

Ms. Lewis, are there any closing remarks?

Maybe just let me say to close, I think that as a business since the beginning of this year we've made some real progress.

There are challenges, of course.

There are many things that we are working on that are still in the mix, and this is still a lumpy and tough business.

But I am really quite comfortable that we are making the right moves, that the business is being thought of internally in the correct way, and we are seeing some excellent work in conjunction with our partners, with our own staff.

And frankly most important in building a base of customers that we can work with and radiate with.

So I am also pleased to tell folks that we're going to be in New York December 1, and folks who are interested in trying to connect with the Company should contact Beth Lewis for additional information.

Thanks for your interest, and operator, that concludes our remarks.

This concludes today's Pegasystems' third-quarter earnings conference call.

You may now disconnect.