Pegasystems Inc (PEGA) 2007 Q2 法說會逐字稿

Good day, everyone. Welcome to the Pegasystems Q2 2007 earnings call. Today's call is being recorded. Today's speakers will be Alan Trefler, CEO and Chairman, and Craig Dynes, CFO. Mr. Dynes, you may begin.

Thank you. Good morning and welcome to the Pegasystems 2007 Q2 earnings conference call. Before I introduce Pegasystems' Chairman and CEO, Alan Trefler, I will start with our Safe Harbor Statement and then provide my financial commentary.

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, believe, 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 the 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 and 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 on the ongoing consolidation of financial services and health-care markets; our ability to attract and retrain key personnel; reliance on key third party relationships; management of the Company's growth and other risks and uncertainties.

Further information concerning 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 the result of new information since these statements may no longer be accurate or timely.

This is a good quarter to reflect on how much our financials have improved at the midpoint of 2007 as compared to 2006. Our year-to-date license revenue of $22.4 million is up 63%. Our services revenue of $50.7 million is up 19%. Our gross profit is up 38% and unlike 2006, we were profitable for both Q1 and Q2.

License revenue for the first half of 2007 is up 63% from last year, primarily due to $16.8 million of perpetual license revenue which is double the first half of 2006. Term license revenue has been steadily increasing and halfway through the year we are now slightly ahead of the first half of 2006. This is important since we now recognize all term license revenue on a ratable basis. So, by the end of the Q2 2007, we've surpassed term license revenue for the first half of last year and we've increased our inventory of term license arrangements to $26.3 million. The details of how this inventory of these term license arrangements will hit our P&L as revenue in future periods is provided on page 17 of the 10-Q.

While license revenue is up 63% for the first half, on an individual quarter by quarter basis, license revenue can be lumpy. This is because the quarterly mix of perpetual and term license arrangements can fluctuate and we can have license arrangements where terms of the agreement may cause us to defer license revenue from one quarter to another. As a result, while the value of license signings in Q2 was about the same as it was in Q1, our Q2 license revenue was down slightly from Q1.

Services revenue was $25.3 million in Q2, up 23% or $4.8 million from Q2 of last year. This is down by about $100,000 from Q1 as a result of arrangements where the contract terms necessitate that we defer revenue until Q3. The demand for our professional service continues to be very strong as a result of the growth in license signings last year. As an example, we put 18 new customer applications into production in Q2 and more than 25 are scheduled for Q3. Maintenance revenue grew 30% in Q2 to 7.4 million from 5.7 million in Q2 2006 as there is an expanding number of customers who renew maintenance on an annual basis.

Q2 gross profit was $21.3 million, up more than $5 million from Q2 2006. Professional services gross margin increased to 43.4% in Q2 compared to 39% in Q1. This improvement is partially due to increases in benefit and (technical difficulty) expenses associated with the new calendar year that happens every Q1 and therefore tends to lower margins in the first quarter. For the first six months, services gross margin is at 41%, which is the same as it was for the first six months of 2006.

Overall, the costs associated with the services organization decreased slightly from Q1 as a result of contracts where revenues and costs have been deferred until Q3. We anticipate strong demand for services in Q3 and Q4. As I indicated, the number of customer applications expected to go live in Q3 is even greater than in Q2. So while headcount and subcontractor costs grew only slightly in Q2, since June 30, we have already hired more than 25 new professional service employees.

Total operating expenses in Q2 were $22 million. While this is an increase of $3 million or 16% from Q2 2006, operating expenses are virtually unchanged from both Q1 '07 and Q4 '06. R&D expenses increased slightly in Q2 while both sales and marketing and G&A remained almost constant with Q1. The small quarterly increase in R&D expenses is primarily the result of increase in headcount to 116. Our local R&D employees are supplemented with a significant number of offshore contractors on which we spend approximately $1.5 million per quarter. Starting in Q3, we will be expanding our R&D activities by hiring some of our own offshore employees. This will be incremental to our current use of offshore contractors.

Our quarterly tax rate in Q2 was slightly higher than in Q1, due to some discrete tax items and foreign jurisdictions in FIN 48. However, the year-to-date rate is a good approximation as to where we should be at the end of the year.

As I said, we were profitable for both Q1 and Q2 of '07 compared to a loss for both quarters last year. Q2 net income of $647,000 was down slightly from $1 million in Q1. Accounts receivable days billed outstanding as of June 30, 2007 was 70 days compared to 69 days at March 31; 71 at December 31; and 79 at June 30, 2006. Deferred revenue increased to $21.9 million, up from $20.9 million at March 31.

We have $27 million of short and long-term installment receivables. These are installments due to us for term licenses where we have, in prior years, recognized the revenue on a net present value basis. This balance will be reduced over time as we collect the installments, since we now changed our license terms so that we recognize revenue from term licenses on a ratable basis.

In Q2 we paid our second quarterly dividend for the year which was just over $1 million. During the second quarter we repurchased 88,245 shares for $914,000. In total, we purchased 531,684 shares for a total of $4 million pursuant to our second stock repurchase program. This second stock repurchase program expired on June 30. However, on June 4, we announced that our Board of Directors approved a third $10 million stock repurchase program beginning July 1, 2007 and ending June 30, 2008. As part of this new plan we have already, since July 1, purchased 152,572 shares for $1.6 million.

Our cash flow from operations was $4.3 million for the quarter and now stands at $11.3 million for the first half of the year. We finished the quarter with $141.1 million of cash and short-term investments, up from $128 million at December 31.

So in summary, I am pleased with our financial results through Q2. Since it is our standard to give only annual and not quarterly guidance, I see no need to comment on annual guidance at this time. We have made significant progress in 2007 and we will continue to work hard through the rest of the year to maintain our leadership in the BPM space and meet our financial objectives.

I would now like to turn the call over to Pegasystem's Chairman and CEO, Allen Trefler.

Thank you. I'm going to talk about some of the key aspects that the Company has been working on, as we continue to work on growing the business, building productivity in the staff and developing a firm that can go after what we think is a very exciting opportunity in this business process management space.

I'm going to start with a product. In April, we announced a new customer service framework version, an established product called Customer Process Manager, had a new release. And it's allowed call centers and other parts of the customer experience to be materially improved. This new release allows us to peg the rules and processes of a customer of ours and marry it with the rules and process goals of one of their customers, so they can determine at the sort of instant of interaction what is the best offer to make; what is the best way to handle an issue or a problem, and how to optimize every interaction according to the intent of management.

It employs the latest in Web 2.0 Ajax and Flex technologies. If you're a Netflix user, you know what that is. That's when the little boxes pop up and sort of guide you through your process. We use this to make it so the call center reps are actually given the best advice at exactly the right moment. And right now it's generally available and being implemented by several of our customers and we're very excited about it.

At the end of the quarter, we shipped a new version of our core SmartBPM PegaRULES process commander product. Now, this really allows us to both build on what we'll talk about is, I think, a key advantage we have over our competitors. And even go further by linking in technology such as predictive analytics to make it so that companies who want to do complicated analyses about how to best so offer products, make cross-sell happen, et cetera, can decide how they want to do it using tools they already have tying into their environments.

The product was also reviewed by an independent study. It actually was demonstrated as having a five-fold improvement over trying to do comparable things in native Java. So our goal of being able to directly capture business objectives in the technology, automate the programming and automate the work is actually being, well, well-executed by our product and our technology and we're very pleased.

I'm pleased that customers are adopting this technology as well. We have significant customers going live. We actually had 18 customers put projects into production in the second quarter which ultimately is, from my perspective, the key measure of the success of a product and of its sustainability and viability and growth. Those ranged from being able to actually sign up new business and help our customers increase their topline; to being able to help them provide better client service and provide a servicing backbone; to being able to help them prevent fraud and handle exceptions and other back office type functions.

Our customers, both the customers who are putting systems into production and the customers who we signed up in this quarter, actually represent very, very broad usage of this technology, ranging from government to the credit card industry to health care to the insurance business to banking. So we're seeing a nice adoption of this technology.

We also signed up three major new organizations as customers, which is always exciting. Though consistent with our target account strategy, we're really focusing on dealing with the organizations that we think are the thought leaders that will ultimately define the future of business process management. Many of them are already our customers. And we're working to deepen and sort of hone what we call this target account strategy, looking and working to build productivity in the sales force that we've continued to increase. And making it so that as we think this market will evolve and as more people look to the thought leaders in the business, they will see that Pega is a key part of the way these organizations do their work.

While I do think that client success is the ultimate proof of whether a product is successful or not, it's also nice when the independent analyst firms decide that they think your product is special. And we have a terrific quarter -- and actually since a couple weeks after the quarter we have some additional news that I'll talk about -- in which the work that we've done for so many years has gotten quite a bit of attention.

That Customer Process Manager software framework I talked about was given very, very high marks by Forrester and actually has received a CR in Excellence award from Customer Interaction Solutions magazine, which is always terrific. [Sellit] positioned us -- which is another key analyst -- as one of the top BPM solutions for the insurance business. And it's also interesting that a number of analyst firms, both Forrester and Gardner, have recognized our strength in an area called composite applications. This frankly is kind of using the BPM technology concepts that we have to weave together the way that existing legacy systems in one of our customers work. So you can kind of organize the way that the computer systems work to be more closely aligned with the way their people think and the way their business managers want to do business.

What's interesting is that for the BPM players, we're way out front in this space. The typical folks in this area are people who write things in code, in programming languages. And one of the interesting things an analyst said was that our approach, they believe, represented the future of how composite applications were going to evolve. So it's nice from our perspective to see all the different ways that the outgrowth of our product suite are being respected and getting attention.

But I think the sweetest bit that happened in the last couple of months is that there was a new report just last week from Forrester Research -- which Forrester and Gardner are, of course, the two leading analyst firms in the IT industry -- and Forrester actually came out and positioned Pegasystems as, if you look at the picture, the leader in the business process management space. Which is quite exciting. It represents a growth and maturity of the product and I think a recognition that some of the unique things and unique approaches that we took are really merging well with the needs of the market. Forrester says, and I quote, that our product has the best platform in the BPM space and has capabilities that other BPM's do not. We were thrilled to see that but what I'm happiest about is we know that a lot of what we did to get the product to receive this sort of accolade actually is really quite distinctive in terms of architecture and we think is going to take awhile for our competitors to copy. And we are continuing to invest heavily and push hard to make sure that we're, well, staking new ground and going to see what we can do to be a key force in this market.

I was also pleased that Forrester estimated that in 2011 this would be a $6 billion market for the BPM space. So it's also nice to be in the space that at least the analysts believe has the potential for meaningful growth.

So with that, I'm going to turn the call open to any questions that folks have. Operator, are there any questions?

(OPERATOR INSTRUCTIONS) It appears we have no questions at this time.

All right, well, I guess the results will speak for themselves. Let me just say in closing that we're really continuing to invest in the business. We're working hard to take advantage of what we think is a strong opportunity to bring forth what we think BPM can do in the business. I'll also say that at the end of October we're going to be having our PegaWORLD exhibition in Orlando. Information is available on our website. And we're going to have over a dozen of our customers speaking about their successes and how they're meaningfully using BPM to change the way that they do business.

With that, Craig and I will say thank you.

Thank you very much.

Once again that does conclude today's call. We do appreciate your participation. You may disconnect at this time.