Pegasystems Inc (PEGA) 2006 Q1 法說會逐字稿

Good day, everyone and welcome to Pegasystems' Q1 2007 earnings call.

This call is being recorded.

Today's speakers will be Alan Trefler, CEO and Chairman and Craig Dynes, CFO.

Mr.

Dynes will now begin the call.

Good morning and welcome to the Pegasystems 2007 Q1 earnings conference call.

Before I begin and introduce Pegasystems' President and CEO, Alan Trefler, I will start with our Safe Harbor statement and then provide a short financial summary.

Certain statements contained in this presentation may be construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

The words anticipates, projects, expects, plans, intends, believes, estimates, targets and other similar expressions identify forward-looking statements, which speak only as of the date the statement was made.

Because such statements deal with future events, they are subject to various risks and uncertainties.

Actual results for fiscal year 2007 and beyond could differ materially from the Company's current expectations.

Factors that could cause the Company's results to differ materially from those expressed in forward-looking statements include without limitation variation in demand and the difficulty in predicting the completion of product acceptance and consequently the timing of our license revenue recognition, the level of software renewals, our ability to develop new products and evolve existing ones, the impact on our business of the ongoing consolidation in the financial services and healthcare markets, our ability to attract and retain key personnel, reliance on key third-party relationships, management of the Company's growth and other risks and uncertainties.

Further information concerning the factors that could cause actual results to differ materially from those projected is contained in the Company's filings with the Securities and Exchange Commission, including its report on Form 10-K for the year ended December 31, 2006.

The Company undertakes no obligation to revise or update forward-looking statements as a result of new information since these statements may no longer be accurate or timely.

Before I start with my commentary on the quarter, I need to note that we were slightly late with filing our 10-Q due to the amount of work that was required to complete our recent restatement.

As indicated in our press announcement, we received a staff determination letter from NASDAQ Listing Qualifications department on May 16, 2007.

I am happy to report that as a result of filing our 10-Q yesterday, we have now received a letter from NASDAQ confirming that we are once again back in full compliance with the NASDAQ listing requirements.

Q1 was a great quarter and a great way to start the year.

We actually increased revenue from the Q4 to Q1 as revenue increased from almost $36 million in Q4 to just under $37.5 million in Q1.

While the increase was driven by services revenue, which increased from $22.9 million in Q4 to $25.4 million in Q1, license revenue and signings were also strong.

Both license, signings and revenue in Q1 '07 were higher than in Q1 '06, but down slightly from Q4, which is the industry seasonal norm.

Q1 '07 license revenue of $12.1 million was up substantially from $7 million in Q1 '06 and down by only about $0.5 million from $13 million in Q4 '06.

We continued to build a very strong term license business.

In fact, Q1 term license revenue of $2.7 million was higher than it was in either Q1 or Q4 of 2006.

This is impressive since we dramatically increased the inventory of term licenses that will be recognized as revenue in future periods.

As detailed on page 13 of the 10-Q, we've accumulated almost $24 million in term licenses as compared to a balance of $14 million on hand at December 31, 2006.

The 10-Q details how these licenses will be recognized as revenue in future periods as customer license fees come due.

Professional services and training revenue grew by $2.4 million from $16 million in Q4 to $18.4 million in Q1.

While about $1 million of this growth was due to the completion of a significant contract where we have been using the completed contract method of accounting, the balance of the increase was due to strong demand in support of many new license implementations even while we continued to expand the work done by our network of partners.

In fact, our partner is now leading the implementations in some of our largest accounts and we currently do not have any contracts where our services are essential and we would follow completed contract accounting.

Maintenance revenue over the year has grown to $7 million per quarter from $6 million in Q1 2006.

Q1 gross profit was $22 million, down from about $500,000 in Q4, but up almost $7 million from Q1 2006.

Professional services gross margin as a percentage of professional services revenue decreased to 39% in Q1 compared to 41% in Q4, but up from 37% in Q1 2006.

The decrease is partially due to increases in benefit and employee-related expenses associated with the new year, as well as the continued investment required to deliver the growth in professional services revenue.

To keep up with the demand for license implementations, we grew headcount from 198 at December 31 to 216 at the end of the quarter and continued with the significant use of contractors.

Total operating expenses in Q1 were $22.2 million, up only about $300,000 from Q4 2006.

While R&D expenses increased slightly, there was an offsetting decrease in selling and marketing expenses from $12.3 million in Q4 to $11.8 million in Q1.

Sales headcount increased from year-end, but sales commissions were less as salespeople were not into commission multipliers as they typically are at year-end.

G&A expenses of $4.2 million were the primary reason for the increase in operating expenses as G&A increased by $700,000 from Q4 and by $1.6 million from Q1 of '06.

The increases in G&A spending are a direct result of increased accounting and legal fees associated with our restatement and increases in headcount related to costs.

Interest income increased slightly during the quarter due to increased cash and investment balances while installment interest decreased as the value of our installment portfolio decreases over time.

Income before tax was $1.6 million in Q1 '07 compared to a loss in Q1 '06.

The $2.5 million increase in profitability was primarily the result of a $6.8 million increase in gross profit offset by an increase of $4.3 million in operating expenses.

Our Q1 tax provision was 34% of income before taxes as compared to the net benefit of last year, which was the result of certain credits and refunds in foreign jurisdictions.

During the year, we adopted the new rules governing the accounting for uncertainty in income taxes.

Known as FIN 48, the new rules change how companies account for uncertain income tax positions.

As part of this adoption, we recorded a $1.5 million reduction to retained earnings as a result of the quantification of uncertain tax positions and reclass certain tax assets and liabilities on our balance sheet.

There were no material changes to the amount of unrecognized tax benefits during the first quarter of 2007 and we expect that there will be no material changes in the next 12 months.

Accounts receivable days billed outstanding as of March 31 was down to 68 days from 70 at December 31 and 78 at March 31, '06.

Deferred revenue increased to $21 million at March 31, up from $17.1 million at December 31.

The increase was primarily the result of an increase in prepaid annual maintenance fees.

Our cash flow from operations was almost $7 million.

We finished the quarter with $132.8 million of cash and short-term investments and $30.8 million in short and long-term license installment receivables.

Our quarterly dividend was just over $1 million and we expect the dividend to continue.

On May 30, 2006, we announced that our Board of Directors approved a new 10 million stock repurchase program beginning July 1, 2006 and ending June 30, 2007.

In 2006, the Company repurchased 962,420 shares for a total of $6.8 million in open-market transactions, leaving a balance of 3.2 million for future periods, which is still available since we did not purchase any shares in Q1 as we were limited by quiet period restrictions.

I would now like to turn the call over to Pega's President and CEO, Alan Trefler.

Thank you very much, Craig.

I would like to talk a little bit about the first quarter and some of the important things that happened during it.

We were able to release the newest version of our flagship Smart BPM product, PegaRULES Process Commander.

Our version 5.2 was available in January and had more than 60 specific significant innovations in it, including support for fancy Flex-based Web 2.0 capabilities and other elements that make the product easier to use, easier to deploy and more competitive in the marketplace.

We also completed development on our new release of our customer service framework, which we call Customer Process Manager, which enables leading organizations to provide better service and drive their call centers and other front office features.

We are able to really leverage the power of our Smart BPM technology in this framework.

It enjoys the latest AJAX and Flex technologies and is currently being implemented at several customers.

The success of the products I think has a lot to do with how analysts have looked at them and how we have actually had tremendous relationships with our analyst community, listening to them carefully, trying to understand what will make us better in the market and then taking this to customers and ultimately proving this with real client success.

We have been working extensively with both Gartner and Forrester, attending conferences and spending time and we continue to be pleased that they recognize that Pegasystems is a leading product in this area of rules and process.

And we are really quite happy that our strategy of being able to automate the policies and procedures of the business proves to be a distinctive and correct way to go with this market.

The good news is that our customers are learning about the product and choosing to use it in increasing numbers.

Enablement is very key to us.

We really want our customers to be able to implement business process management themselves and continue to be able to drive the products across the organization and last year, we actually trained over 2000 customers, partners and employees to be able to drive this technology deeper and deeper.

We are continuing to invest quite a bit in building our training and enabling capacity because we believe that by enabling customers and partners to be able to do this work, it will allow us to be in a very good position as this market expands as we are very, very hopeful it will continue to expand.

We unveiled a major new training facility in Cambridge that can now handle 90 simultaneous students and we are continuing to expect meaningful increases in training at our worldwide facilities during 2007.

The quarter was good from a signing perspective as well.

We had some major new name clients in the quarter, including the financing unit of a major auto manufacturer, two significant banking customers that we have not done business with before, the UK government signing a significant additional piece of business with us and continuing to do work with service bureaus and service providers that actually see our technology as a vehicle for them to provide to their customers greater efficiency and greater effectiveness.

We also had 13 sales to existing organizations in areas such as healthcare, insurance and one of the things that is particularly strong is the whole health insurance business where in fact our customers are using this technology to meaningfully drive new products to market at faster paces, which is nice to see both because it is good business and it is also adding some pretty significant value to society here as we move forward.

So all in all, I would say this was an excellent start to the year.

However, this is a lumpy business.

It is complex and there are multiple factors that drive results, so it was good that this quarter that so many of the lumps came together.

We are excited about the potential of this business and think the space is a terrific space.

We have been working on this for a long time, but it is still an emerging space and to the extent that we can do it prudently, we think that it is important and we intend to invest to build on our leadership position.

This will enable us to really capitalize on the market and will allow us to take advantage of both the potential we think this market has to really revolutionize the way that organizations deploy technology and also frankly put us in a better position to ward off competitors in what we think will be an increasingly appealing space.

With that, let me turn this back over to Craig to talk a little bit about the prospects for the year.

Thank you, Alan.

I am pleased to provide the following financial guidance for the current year.

We are increasingly committed to building our inventory of term license arrangements.

Revenue from these term licenses will be recognized beyond 2007 as license fees become due.

Therefore, the mix of perpetual versus term license bookings can cause a significant variation in the revenue that we recognize in the year.

Accordingly, we expect that in 2007 revenue will be in the range of $140 million to $160 million.

We plan to be profitable at the low end of this range, but increases in revenue along the range may not translate into corresponding increases in profitability.

We plan to invest in sales resources where we see continued growth in market demand in order to maintain our leadership position.

Similarly, we will continue to invest in professional service organization to support new license implementations.

Our 5.2 release of PRPC received accolades from our customers and helped to drive new license signings through improvements in functionality and approachability.

We will invest in R&D to continue the success.

Lastly, we ended the quarter with $132.8 million in cash and short-term investments and we expect cash flows from operations to be approximately $20 million in 2007.

With that, I would like to turn the call back to Alan for some questions.

Operator, are there any questions queued up?

(OPERATOR INSTRUCTIONS).

Michael Kern, Canaccord Adams.

Thank you very much you guys.

The software licenses in the quarter were much stronger than I was expecting.

Can you give a little reason behind that and especially the breakout between what you're seeing with new and existing clients?

Yes, I will tell you that we are seeing good demand from both new and existing customers.

I think frankly the software results are subject to that lumpiness that I talked about.

They tend to either happen or not happen in a particular quarter and I don't think there was anything particularly different that I noticed during the quarter.

It was just more where things sell.

Craig, do you have any feedback on that?

Well, the other thing is that our term license business is starting to build up not just in terms of the inventory, but the amount of the term license revenue that does get amortized to the P&L.

In Q1, that number was larger than it was in Q4 and Q1 '06.

Okay.

And can you give a little color on the pipeline you are seeing for the next couple of quarters?

Yes, I think the customer demand continues to be quite strong for this type of technology, but it is becoming increasingly competitive.

We see lots of people sort of trying to elbow their way into this space from some of the adjacent spaces, so we are seeing the platform players and others.

So on one hand, I think the pipeline is actually very good; it has been quite strong and growing over the last six months.

But there is still quite a bit of work to be done to close any individual piece of business because of the competitiveness.

Okay.

And if I do a back of the envelope calculation on the implementation, consulting and training services, looks like the gross margin is around 20%.

Can you talk about -- do you expect that to continue to be around 20% or where do you think that can go in the future?

Well, professional service margins were I believe higher than that.

They are on sort of downward pressure as we grow the organization.

We are seeing dramatic growth in demand for new license implementations and those can only be realized by either hiring new professional services employees or using subcontractors and every time we hire a new professional service employee, there is a period of onboarding.

There is a long period of training.

There is a long period of getting them to understand our methodology and our product before we can actually put them in the field and generate revenue.

So there is always that investment period.

Similarly, we filled a gap with contractors and contractors do a great job and we have great relationship with some suppliers, but they can tend to be more expensive than your own people.

Okay.

And finally you stated in your guidance that you expect to be profitable for 2007.

Do you expect to be operationally profitable for 2007?

I think that is going to depend on where we fall in the revenue range.

I think at the lower end of the range, we would still expect to be profitable, but may not hit the operational profitability line at the higher end.

Obviously we have got more of an opportunity to do that.

What I think is interesting as I look at the profitability is over the last couple of years, the Company has moved from a firm that recognized revenue on term licenses on a present value basis to a firm where we are really now heading towards pretty exclusive ratable recognition of this, which we think is a good thing.

We think subscriptions ultimately are what our investors and everybody will prefer.

But being able to do this and pull this off and still have the business be profitable I think does also show some of the strength in the underlying business.

Okay.

Thank you very much.

I will hop back in the queue.

(OPERATOR INSTRUCTIONS).

We will go back to Mr.

Kern from Canaccord Adams.

All right.

If there is nobody else to ask questions, a couple of things.

One, I saw in the 10-Q you still have some material weaknesses.

Can you talk about those and how you are rectifying to get those cleared up?

Yes, we do have some material weaknesses.

The difficulty with material weaknesses is that they hang around for at least two quarters.

So even though we have taken action to mediate and eliminate them, the sort of rule of thumb is that they have to hang around for a couple of quarters.

One of which was a financial reporting material weakness.

In order to get all of the restatements done, we had to sort of follow a parallel process to get the documents done rather than sort of a linear process.

So we had teams preparing the documents before the financial statements were finished and were dropping numbers in and changing numbers etc.

and that's what gave rise to that weakness.

As far as revenue recognition, we have added some people.

We have improved our determination of revenue recognition.

We are changing some of our contracts, but it is a very difficult area and next to options, it is the number one sort of source of restatements.

In terms of income tax, we are having the third party come in right now -- third party professional organization who are working with us to do our provision.

So we are working on all those material weaknesses, but they don't go away overnight; they have to hang around for a little bit.

Okay.

And in the past, you have broken out the new client versus extended client relationships.

Can you give those for the quarter?

I believe we had six new name clients and 13 follow-on sales is what I am showing.

Okay.

And then the deferred revenue, I see it declined year over year.

Can you give a little color on that and do you expect that to trend as it did last year where the high point was in Q1 and then it trailed down throughout the year as you recognized the maintenance contracts?

Yes, the buildup in Q1 is pretty normal.

As you point, at the beginning of the year, we bill people for their annual maintenance and they pay it down and then we amortize that down for the year to the P&L.

So that is a natural trend.

At this point in time, I pointed out that we have no significant contracts where we are on the completed contract basis of accounting.

We finished the last one and that also has a tendency to drive down the balance of deferred revenue.

But the deferred revenue balance actually increased from Q1 over Q4.

Okay.

Two other quick housekeeping questions.

The 10% customer you had in the quarter, was that a new or existing deal?

Or new or existing client?

Actually that was due to one of the completed contracts that we finished in the quarter.

Okay.

And the average deal size?

The average deal size is a little under 500K.

All right.

Thank you very much.

That will conclude our question-and-answer session.

I would like to turn the conference back over for any additional or closing remarks.

In closing, I would just like to say that it is terrific to be current in all our filings and we look forward to continuing in this vein.

I would like to thank my finance team for incredible work that it took to actually get through a lot of what feels like -- probably feels like a decade worth of rework that needed to get done and I'm really quite pleased that they are lining up to make sure that the future continues on the right path.

I would also like to thank our investors and our customers for their patience with us as we worked through all of that, but the business continues to be strong and we are encouraged about being the leader in this space.

So thank you very much, everybody.

Thank you.

And once again, ladies and gentlemen, that will conclude today's conference.

We thank you for your participation and you may disconnect at this time.