Pegasystems Inc (PEGA) 2006 Q2 法說會逐字稿

Good morning.

My name is Meredith and I'll be your conference operator.

At this time I would like to welcome everyone to the Pegasystems second-quarter financial results 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 session. (OPERATOR INSTRUCTIONS).

I would now like to turn the conference over to Beth Lewis, Director of Investor Relations.

Please go ahead, ma'am.

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 PSLRA of 1995.

The 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 volatility of our quarterly operating results, difficulty in predicting the completion of product acceptance and consequently the timing of our license revenue recognition, the level of turn software license renewals, our ability to develop new products that involve existing ones, interest rate trends, the impact on our business in 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 these forward-looking statements and there are no assurances that the matters contained in such statements will be achieved.

Forward-looking statements were made on today's calls are based on our belief and expectations as of today, August 8, 2006 only.

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

Alan Trefler, Chairman and CEO, will provide opening remarks.

Shawn Hoyt, General Counsel and Interim CFO, will review the financials, and Alan will return with additional remarks prior to opening the call for Q&A.

Alan, would you like to begin?

Thanks, Beth, and thanks to those of you who have dialed this morning.

I think in a nutshell we have continued to make significant progress.

Customer license signings are up.

Top line revenue is continuing to grow and cash CPS is stronger than ever at about $0.40 cash flow from operations for the quarter.

Our year-to-date revenue at $56.7 million is up 18% versus last year's $48 million and we're very proud of all our employees and partners who contributed to this accomplishment.

Best of all, the world's leading organizations, companies like Freddie Mac which just went live with our system, and Baxter which recently signed, are great examples of the organizations who are defining the future of the BPM and are choosing to lead the way with the Pegasystems Rules-based BPM technology.

It's a great time, and I'll turn it over to Shawn Hoyt to fill in some of color on the financials.

Thank you, Alan.

I'm going to start by reviewing the financial results for the quarter.

I will then review the stock repurchase and dividend activity and then I'll end by giving our updated guidance for the full year 2006.

Total revenue for the second quarter grew 25% to $29.6 million compared to the second quarter '05.

This was driven by services revenue growth of $6.9 million, or 44%.

Services revenue grew primarily due to the increasing number of new license implementations.

This growth was partially offset by a decrease in license revenue of $1.1 million, or 13%.

During the second quarter we signed agreements with $8.8 million in term license fees that are expected to be recognized as revenue in future periods as the payments become due.

As we've previously disclosed, going forward we expect license revenue for most new and renewing term licenses to be recognized over the term of the licenses rather than on a present value basis.

This reduces the value of revenue recognized at the beginning of the term in favor of a predictable future stream of license revenue.

The decline in our license revenue, despite the improvement in license signings, is also attributable to the fact that license signings with a single customer are occasionally bundled with service implementations or with earlier license sales.

This dynamic is reflected in the $7.6 million year-over-year increase in our deferred revenue, most of which was deferred license revenue growth.

We did have strong license signings in the second quarter both in dollar value and in the number of signings.

The dollar value of license signings in the second quarter was up significantly from both the first quarter of '06 and the second quarter of last year.

The number of license signings in the first half was double the number in the first half of last year.

These strong license signings are a clear indicator of our increasing success in selling initial quick value licenses to our target accounts and then closing follow-on sales within those target accounts.

Professional services and trading revenue for the second quarter grew to $16.8 million, or 59%.

We continue to support our customers in many new license implementations while at the same time expanding our network of partners to assist customers with their implementation needs.

Maintenance revenue was $5.9 million compared to $5.2 million during the second quarter of '05.

This 13% increase is due to a larger installed base and an increase in the proportion of perpetual licenses which provide a higher annual maintenance yield than term license.

For the second quarter of '06, gross profit was $17.3 million, an increase of $1.6 million from the second quarter of last year.

This increase was driven by $2.6 million improvement in services gross profit partially offset by a $1 million decline in license gross profit.

Professional services gross margin as a percentage of the professional services revenue continues to be pressured by our investment increasing the number of trained service employees and contractors to meet the rising demand for license implementations.

Our operating expenses increased $3.4 million or 22% to $19.2 million in the second quarter.

Most of this increase was attributable to selling and marketing expenses.

These selling and marketing expenses increased $2.3 million or 28% to $10.2 million in the second quarter primarily due to the hiring additional sales personnel.

R&D expenses increased to $0.8 million, or 17%, to $5.7 million and G&A expenses were $3.4 million for the second quarter, up $0.4 million from last year.

Other income and expenses was $2.2 million in the second quarter 2006 compared to $0.6 million in the second quarter of last year.

This change is due primarily to $1.1 million favorable impact of currency exchange rates and a $0.6 million increase in interest income, due to increase cash investment balances and improved yields.

Our income before tax was $0.2 million in the second quarter of '06, a $0.3 million decrease from last year.

Accounts receivable day's billed outstanding as of June 30, '06 was 78 days.

Although this is unchanged from March 31 of '06, it's up 23 days from June 30th last year due to slower payments by some large customers.

We are committed to reducing our DBO in future quarters.

Deferred revenues at June 30 '06 increased to $22.2 million, up from $14.6 million from a year ago.

This increase is due in large part to new license arrangements for which acceptance of the software or completion of fixed-price services had not yet occurred.

We generated $11.8 million in positive cash flow from operations during the second quarter.

For the first half this number is $14.9 million in positive cash flow.

We finished the quarter with $126.1 million of cash and short-term investments, and $46.5 million in combined short and long-term license installment receivables.

During the second quarter we took significant steps to increase the value that we're providing to our investors.

First, our Board of Directors approved $0.03 per share quarterly cash dividend.

The first payment was made on July 17.

Our strong cash position and strong positive cash flow from operations provide us the opportunity not only to invest in the Company and provide market leading technology, but also to pursue additional ways to provide shareholder value.

We do expect to continue this dividend in future quarters.

By way of reminder, our first $10 million stock buyback program expired on June 30.

During the first half of '06 we have purchased -- repurchased approximately 520,000 shares for a total of $3.7 million.

During the entire first buyback program, we repurchased approximately 1.5 million shares for a total of $9.6 million.

On May 30 our Board of Directors authorized a new $10 million stock buyback program which began on July 1 and will end on June 30 of '07.

Finally, we're updating our previous guidance for the full-year 2006.

We expect full year revenue to be between $110 and $120 million.

This increase is driven primarily by our results to date and our expectation for increased license revenue combined with continued strength in our services revenue.

The broad range of this estimate is attributable to a small number of large value license opportunities.

We are committed to becoming the world leader in BPM software and therefore we continue to invest in sales, marketing in services into the -- for the remainder of '06, to better position Pegasystems to achieve strong growth in future years.

Given its investment, we continue to expect 2006 profit before tax to be between $3 million loss and $3 million in profit.

These expected results reflect an anticipated cost of approximately $1 million associated with the expensing of stock option grants to employees under FAS 123(R).

Also as we close out our open tax studies, we may see continued wide fluctuation in our quarterly position provision for income taxes.

Given these wide fluctuations, we believe that pretax results are better measure of operating performance than earnings per share.

Full-year cash flow from operations is now expected to be in the range of $14 million to $22 million.

This concludes our financial summary, and I will now turn the call back over to Alan.

Thanks, Shawn.

We spoke last quarter about our commitment to our strategy and the evidence of its success, how we were going to work to have organizations leading organizations, achieve quick value, being able to make it so that they can get the benefits of BPM, and how our new class of BPM software that is built for change will let those organizations continue to evolve and continue to get benefit.

I compare where we are to a year ago.

We had just begun a year ago to really get our target accounts strategy bedded down, choosing to focus on organizations that were most likely to understand the importance of leadership in this important area.

We have really only begun to implement this quick value sales strategy which enables us to actually enter accounts with smaller initial pieces of business and then built for change and growth customers.

And we had also just started to really realign our sales force.

The sales force frankly as to accounts managers, account executives who in some cases had dozens of accounts.

We had just really begun the process of getting that, I think, nailed down to the right level.

We have come along way in just one year.

The 37 "caring reps" that we have are all firmly bedded down in our target accounts strategy, calling on the right accounts, making the right decisions about what pieces of business to go after.

We have got 38 signings year-to-date versus 19 in the first half of 2005, and success with existing customers and new customers has been very important, has been a key element of getting the success, of being able to drive the rules-driven BPM platform to break the cycle of long development times and those execution gaps we talk about.

You know those gaps between what businesses really want to do to achieve their goals and what their systems let them do.

We have seen that being able to use PRPC in our rules technology to control these tasks allows them to avoid sophisticated programming or ugly manual procedures.

We recently had an example of a customer who was first sold about last time this year and has done additional business with us.

They originally chose our products to try to achieve control, agility, and a competitive advantage and it is one of the larger providers of government-sponsored healthcare that acquired our BPM to drive their customer service operations, to try to get an end-to-end process-oriented approach and not just toss data up on screens but provide intelligent, guided processing to their service reps, achieving the benefits of the productivity and compliance.

This last quarter we sold the other side of the house for some of the commercial operations.

We have our healthcare payer framework which provides out of the box, intellectual property, delivers foundational elements that lets them build up at a greater rate and leverage some of our experience over the years.

And I was just back from presenting to a group of their most senior executives across the enterprise, and I will tell you when BPM takes hold in an organization, people are reevaluating how they think about how they deliver business.

We believe that our roster of existing customers represent a very fertile and in some cases very large opportunities as a these organizations grow in their understanding of BPM and understand how Pegasystems Smart BPM really provides power, opportunities for enterprise reuse, and the ability to achieve best practices in operational processes in both the back office for productivity and in the front office for growth.

I think this has caused us to achieve an 18% increase in revenue, despite a pretty tough decision to move away from present value accounting, which has sort of had the effect of moving close to $10 million in license revenue that we might have gotten from signings into situations where it is actually both off the P&L and off the balance sheet.

However, if you take a look at in the Q that we filed yesterday, you can see that there are some explicit tables that show the cash flows that we anticipate from these deals, to give you some insight into what we're doing.

We have had a number of deployment successes.

We recently announced Electric Insurance which is a call center that does cross-selling opportunities and automatic follow-up and doing things around selling and growth opportunities and, of course, we have continue to roll out with organizations like HSBC, where we have announced last year that they had picked Pega as a global BPM standard and are working with them to roll out applications across their Asia Pacific retail lending operations.

So it has been, I think, an exciting and a good quarter.

The team has been working very hard.

And one of the things that we're also very proud about is that in the final weeks of the quarter, we released a significant upgrade to our flagship PegaRULES Process Commander productline, our Version 5.1, which the analyst we have shown and the customs we have shown it to have really, I think, embraced as being the most feature-rich business useful BPM product in the marketplace.

You know we have the fortune to be able to build on more than 20 years of experience in helping real world customers and this product enables significant advances in terms of both development time and business functionality.

For example, we have updated the whole facilities that developers and business users use to control the way the processes and decisions are made, and we have added extensive features around the AJAX technology which is very hot these days in terms of sort of a state-of-the-art response of desktop and language localization for customers who want to operate with a single common rule-based but manifest that in different ways in different parts of a world.

So I think as a result of all this work we have actually had some pretty extraordinary success in the marketplace and also with the analysts.

We are really thrilled that out of over 150 firms that Gartner looked at as part of their recent BPM Magic Quadrant that we were able to achieve the leadership position and we are very excited about that and we're looking for to continue to invest, continuing to grow both our technical capabilities and our sales force to take advantage of what we think is a great opportunity set.

Part of being able to get the stuff to be delivered is being able to have an ecosystem that can support it, and we have been working extremely hard to increase our training capacity and to make sure that we have got certified partners who can actually bring the Pegasystems technology to life with our customers and with theirs.

Today we have more than 500 certified system architects, up from about 140 at the end of Q2 '05.

These are system architects that have gone through a rigorous certification program, have a real understanding about how to apply the technology, and how to create an infrastructure that will let our customers start with a quick value and then build for change and grow.

You know I think that BPM represents a very exciting and very important dynamic in the software marketplace.

It really, to our mind, represents a sea change in terms of how businesses and IT will work together to achieve the corporate goals.

We were recently at a meeting with Health and Human Services Secretary Levitt.

And it is interesting because the federal government and businesses are all wrestling with the additional responsibilities of trying to care for the folks who need it and we are, of course, doing quite a bit of work in the health field.

You know Levitt talked about how organizations were going to have to change the way that they manage their systems, how they can't have islands of people, and systems and policies and procedures and data.

And you really need to have an enterprise-wide interoperability to achieve optimum outcomes.

Levitt actually had this interesting quote that organizations can fight change and die, except change and survive, lead, change and prosper.

And you know our mission and our tagline is Build for Change.

So it is an exciting opportunity.

We are working very, very hard.

We are continuing we think to make the right investment decisions because we think that this market is an exciting one and merits that investment.

And we are committed to helping both lead the change theoretically and very pragmatically with our customers.

With that, operator, could you please open the call to any questions that there might be?

(OPERATOR INSTRUCTIONS).

Gideon Kory, Pacific Summit Security.

Good morning, everybody.

Regarding the licensing and how that changes or has changed in the last year or so, specifically regarding the term life and if you can talk more about that trend.

Sure.

We do offer both term and perpetual licenses to our customers.

I think the thing that probably has changed is that whereas historically virtually all of the term licenses were recognized on a net present value basis, which basically meant at the point of the commitment by the customer, we would typically take, let's say, five years of committed license revenue stream and a present value that, in effect, discount it, but put it immediately into the income statement and end up showing the outcome as sort of a long-term receivable that was chewed down over period of time.

We have now moved to basically saying that as a result of restructuring, a number of these pieces of business, our prevalent model for term license accounting has now become actually taking it on a month to month basis as payment becomes due.

And so that is a pretty significant change because it means that a term license from even, say, a renewing customer that under the sort of former structures would have ended up being present value under this structure actually shows up neither as revenue in the current period nor actually shows up on the balance sheet like it would have a well, which is the reason that we have put this table in so people can understand this transition.

Does that give you some insight?

And in terms of the percentage of license as a total revenue, how that changes the balance or is going to change the balance?

Well, over a five-year period, it probably won't change it that much, but in the periods where we are making this transition, in the time frames where we are no longer taking the present value, it will tend to make the services number look much bigger, because of course the license number instead of license numbers sort of accumulating as a result of MPV, the license numbers particularly during the initial transitional years are going to stretch out over a number of years.

So until we get through this transition, I think it will artificially depress the ratio of what is going on with license compared to what is going on the services that we have tried to provide information for people to be able to actually understand what we think it's really happening here.

And would you be doing some disclosures so the investors can compare apples-to-apples historically and what is happening now during the transition period?

So in the liquidity section of the Q, there is a very explicit set of tables that show the outstanding balances and frankly one of the reasons we are disclosing also the amount of signings here is so that people can look at our license number and understand that there is a bunch more that is there.

I am being flashed that it's on page 19 of the Q by one of the folks here in the room.

So I think it is actually pretty explicit and pretty clear.

Any other questions, Gideon?

Thanks.

Mark Gomes, Pipeline Data.

I was hoping you could provide me a little more color in terms of what you're seeing out of us Fuego prior to the acquisition of BEA and what you've seen from them more recently and then as a follow-up kind of where do you see this market going over the next few years and how you contrast yourself with the integration vendors that have put BPM suites into their offerings?

Sure.

Fuego is, I think, a company that has tended for my perspective to sell smaller deals and was obviously a smaller company than we were.

With the acquisition of BPM -- I mean by BEA, we have seen them a couple more times in the market, although it is generally a very, very competitive market if you take a look at the number of vendors that are out there.

I think that frankly it is viewed with some skepticism by customers as to whether companies are going to be really effective and not adjusting acquisitions.

There's a long history and long track record of some of those not being executed on as well.

And obviously there is also a long track record of the visionaries and the founders not sticking with them.

So we have seen some customers interested and we've seen some customers showing frankly some skepticism about that.

Relative to the condition of the market, I think the market is still in its formative stages.

People are trying to figure out exactly what BPM means, though there is an awful lot of interest about what it might mean.

The vendors who think of this as an integration play, I think are trying to position BPM as being something that sort of rises up from the data.

Our view is actually quite different.

Our view is that there is really a chance to kind of come down from the business objective and, as a result, I think are value proposition actually looks quite a bit different and the benefits we have were quite a bit different than the folks who want to do this as part of the integration.

There is no question in my mind there is a role for that, but the businesses that we are working at and we are working with want to move at a pace that is more close to the pace of change in their business as opposed to the pace of change in their technology stack.

So we still think we're going to be nicely differentiated here as we go forward.

Thank you very much.

Good luck going forward.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers.

Mr. Trefler, are there any closing remarks?

I would like to thank everybody for listening.

Just as a reminder we're going to be holding our music group forum called PegaWORLD here in Boston October 18-20, and we will have customers including AIG, America Home Shield, Deutsche Telekom, presenting examples of Pegasystems' SmartBPM in action.

Our folks who are interested can talk to Beth Lewis about this.

I would like to thank everyone who has been working hard at Pegasystems.

I'd like to thank our partners who have really stepped up their commitment which is very exciting.

And I would also like to thank our customers, of course, for showing continued faith in us, and I'll let you know that we'll be back next quarter.

Thanks.

Thanks, operator.

That concludes our remarks.

Thank you.

This concludes today's conference call.

You may now disconnect.